**Exhibit 13.1**

 

**Santa Lucia Bancorp****2007 Annual Report**

 

 
| **2007** | ** ** | **Santa Lucia Bancorp**

7480  El Camino Real

Atascadero,  California 93422 |
|----------|------------|------------------------------------------------------------------------------|
|     | ** ** | ** **                                                                   |
|     | ** ** | *Stock Symbol*– SLBA.OB                                                 |
|     | ** ** | ** **                                                                   |
|     | ** ** | **Santa Lucia Bank**

7480  El Camino Real

Atascadero,  California 93422    |
|     | ** ** | ** **                                                                   |
|     | ** ** | ** **                                                                   |
|     | ** ** | **www.santaluciabank.com**                                                   |

 

 
| **Atascadero**       | ** ** | **Paso Robles**  | ** ** | **Arroyo Grande**   | ** ** | **Santa Maria**   |
|----------------------|------------|------------------|------------|---------------------|------------|-------------------|
| 7480  El Camino Real |       | 1240  Spring St. |       | 1530  E. Grand Ave. |       | 1825  S. Broadway |
| (805)  466-7087      |       | (805)  239-1140  |       | (805)  473-1988     |       | (805)  614-9100   |

 

1

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**Santa Lucia Bancorp**

 

***Message from the President***

 

DearShareholders, Customers and Friends,

 

SantaLucia Bancorp (“The Company”) is pleased to report the results from operationsfor 2007. The economy and more specifically, “The Real Estate Market”, wentthrough some difficult times in 2007, and are still in the process ofrecovering. We are pleased to report that these events, neither directly, norindirectly have had a significant affect on The Company or Santa Lucia Bank (“TheBank”), its wholly owned subsidiary.

 

Netprofits for The Company were $3,002,819 for the year 2007. This compares to2006’s net income of $3,388,271, which was an all time high for The Company.The net income for 2007 is down 11.38% from 2006.

 

 

Larry H. Putnam, President and Chief ExecutiveOfficer

 

Dueto the change in the economic conditions we operate in, our customers havereinvested funds in their businesses and have less excess funds, which have hada negative effect on the Company’s deposits. The trend of depositing excessfunds into Time Certificates of Deposit or other interest bearing accounts thatstarted in 2006 has continued into 2007. Despite this trend, the Bank has36.25% of total deposits in non-interest bearing deposits. This compares to40.50% in non-interest bearing deposits as of December 31, 2006.Non-interest bearing deposits at these levels continue to be well aboveindustry averages.

 

TheCompany was able to effectively reallocate funds from real estate lending,specifically construction lending into loans for general commercial creditpurposes. The Bank was pleased to see the significant growth in loans forgeneral commercial credit purposes, which increased 11.73% betweenDecember 31, 2006 and 2007. This is an area we have been concentrating onfor the last several years, as a significant change was anticipated in the realestate construction industry. We would expect this trend to continue.

 

Despitethe fact that we have seen some changes in our business, we have a strong coredeposit and loan base. We remain committed to providing quality customerservice on a consistent basis in the markets we serve. Building solidrelationships with our customers allows us to continue to build on our corebusiness.

 

SantaLucia Bancorp continues the practice of paying cash dividends to ourshareholders. Two cash dividends were paid in 2007 for a total of $0.45 pershare. The dividend payable to

 

2

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Santa Lucia Bancorp’s Board of Directors. Standing left to right—John C.Hansen, Executive Vice President - Chief Financial Officer, Jerry W. DeCou III,Chairman of the Board, Larry H. Putnam, President and Chief Executive Officer, DouglasC. Filipponi, Vice Chairman. Seated left to right—Paul G. Moerman, D. JackStinchfield, Jean Hawkins, Stanley R. Cherry and Khatchik H. Achadjian.

 

shareholdersas of September 30, 2007 was increased by 25% to $0.25 per share comparedto the dividend of $0.20 per share paid to shareholders of record as ofMarch 31, 2007. This is the eighteenth consecutive year that cashdividends have been paid to our shareholders.

 

OnJune 30, 2005, the Company split its stock on a 4 to 1 basis. Since thestock split, the marketability and activity has increased in the companiesstock, which was anticipated. Prior to the split, the companies stock wasselling for $81.00 per share, resulting in a post split price of $20.25 pershare compared to the current price of $25.00. Despite the recent decline inprice, the stock has increased in value $4.75 per share or 23.46% in the past2-1/2 years.

 

Welook forward to the challenges of 2008 and are very optimistic about thefuture. We have effectively weathered the economic challenges of 2007. OurBoard of Directors, Officers and Staff remain committed to building a solidbanking franchise.

 

Iwould like to thank our shareholders for your support and trust over the years.This coupled with our loyal customer base, strategic locations on the CentralCoast of California and dedicated staff will ensure that we continue to enhancethe Company’s performance and value in years to come.

 
|   |                                        |   |
|--------|----------------------------------------|--------|
|   | **Larry H. Putnam**                    |   |
|   | President  and Chief Executive Officer |   |

 

3

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**SANTALUCIA BANK**

*(a wholly owned subsidiary of Santa Lucia Bancorp)*

 

**SeniorManagement Team**

 

 

JohnC. Hansen, Larry H. Putnam, James M. Cowan

 

LARRYH. PUTNAM

ChiefExecutive Officer

 

JOHNC. HANSEN

Presidentand

ChiefOperating Officer

 

JAMESM. COWAN 

ExecutiveVice President

ChiefCredit Officer

 

***Eager to service your banking needs***

 

**Administrative Team**

 

 

MelodeeFontana, John C. Hansen, Larry H. Putnam, Julie A. Joslin, Kristie Keller,James M. Cowan, Larry Womack, Sharon Satterthwaite

 

LARRYH. PUTNAM 

ChiefExecutive Officer 

 

JOHNC. HANSEN

Presidentand Chief Operating Officer

 

JAMESM. COWAN

ExecutiveVice President 

ChiefCredit Officer

 

MELODEEFONTANA

SeniorVice President 

OperationsAdministrator

 

SHARONSATTERTHWAITE

VicePresidentController

 

LARRYWOMACK

VicePresident 

AssistantCredit Administrator

 

JULIEA. JOSLIN

VicePresident 

Cashier

 

KRISTIEKELLER

AssistantVice President 

CentralOperations

 

4

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**Atascadero Office**

 

7480El Camino Real, Atascadero, California

 

 

**Atascadero Officer Team**

 

 

Jim Kelley, Karen Sampson, Kim Donaldson, J. Darren Barnes, Teri Davis

 

TERIDAVIS

VicePresident 

LoanOfficer

 

JIMKELLEY

VicePresident 

LoanOfficer

 

KIMDONALDSON

AssistantVice President 

OperationsOfficer

 

J.DARREN BARNES

AssistantVice President 

LoanOfficer

 

KARENSAMPSON

AssistantOperations Officer

 

5

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**Paso Robles Office**

1240Spring Street, Paso Robles, California

 

 

**Paso Robles Officer Team**

 

 

RobertCovarrubias, Cheryl Mumford, Ryun McCrory

 

ROBERTCOVARRUBIAS

SeniorVice President 

Manager

 

CHERYLMUMFORD

AssistantVice President 

OperationsOfficer

 

RYUNMcCRORY

AssistantVice President 

LoanOfficer

 

6

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**Arroyo Grande Office**

1530 East Grand Avenue, Arroyo Grande,California

 

 

**Arroyo Grande Officer Team**

 

 

Richard Allen, Michael W. McKenzie, Regina M. Sheldon, Jennifer BassiGinder

 

**MICHAEL W. M****c****KENZIE**

VicePresident 

Manager

** **

**RICHARD ALLEN**

VicePresident 

LoanOfficer

** **

**JENNIFER BASSI GINDER**

AssistantVice President 

OperationsOfficer

** **

**REGINA M. SHELDON**

AssistantVice President 

LoanOfficer

 

7

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**Santa Maria Office**

1825South Broadway, Santa Maria, California

 

 

**Santa Maria Officer Team**

 

 

LeahT. West, James P. Burubeltz, Stella Martinez, Robert J. McConaghy

 

**LEAH T. WEST**

VicePresident 

Manager

 

**JAMES P. BURUBELTZ**

VicePresident 

LoanOfficer

 

**STELLA MARTINEZ**

OperationsOfficer

 

**ROBERT J. McCONAGHY**

LoanOfficer

 

8

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**SANTALUCIA BANCORP**

**FINANCIAL HIGHLIGHTS**

*As of Years Ended December 31,*

 

 

 

TheCompany has only one class of securities, common stock, which is traded on theover-the-counter market. Our stock is quoted on the OTC Bulletin Board underthe symbol SLBA.OB. The information in the following table indicates the highand low bid prices of the Company’s common stock for each quarterly periodduring the last two years based upon information provided by the Company marketmakers. These prices do not include retail mark ups, mark downs or commissions,but have been adjusted to reflect the Bank’s 4-for-1 stock split that waseffective June 2006.

 
| **Quarter Ended 2007** | ** ** | **Low** | ** ** | **High** | ** ** |
|----------------------------------|------------|---------|------------|----------|------------|
|                             |       |    |       |     |       |
| December 31                      |       | $       | 23.25      |     | $          | 26.25 |   |
| September 30                     |       | 25.00   |       | 29.00    |       |
| June 30                          |       | 26.00   |       | 28.99    |       |
| March 31                         |       | 26.00   |       | 29.00    |       |
|                                  |            |         |            |          |            |  |  |

 
| **Quarter Ended 2006** | ** ** | **Low** | ** ** | **High** | ** ** |
|----------------------------------|------------|---------|------------|----------|------------|
|                             |       |    |       |     |       |
| December 31                 |       | $       | 24.00      |     | $          | 29.00 |   |
| September 30                |       | 24.05   |       | 27.00    |       |
| June 30                     |       | 26.55   |       | 34.50    |       |
| March 31                    |       | 25.05   |       | 30.25    |       |
|                                  |            |         |            |          |            |  |  |

 

9

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**Santa Lucia Bancorp and Subsidiary**

 

**Consolidated Selected Financial Information**

 
| ** **                                           | ** ** | **Year Ended December 31,**                                      | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands, except per share data)** | ** ** |
| **Summary of Operations:**                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Interest Income                                      |       | $                                                                               | 17,719     |   | $ | 17,027 |   | $ | 13,546 |   | $ | 10,220 |   | $ | 9,157 |   |
| Interest Expense                                     |       | 4,824                                                                           |       | 3,577 |   | 1,984 |   | 1,343 |   | 1,324 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Interest Income                                  |       | 12,895                                                                          |       | 13,450 |   | 11,562 |   | 8,877 |   | 7,833 |   |
| Provision for Loan Loss                              |       | —                                                                          |       | 240 |   | 300 |   | 110 |   | 115 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Interest Income After Provision for  Loan Losses |       | 12,895                                                                          |       | 13,210 |   | 11,262 |   | 8,767 |   | 7,718 |   |
| Noninterest Income                                   |       | 1,071                                                                           |       | 1,010 |   | 1,052 |   | 1,191 |   | 1,376 |   |
| Noninterest Expense                                  |       | 9,029                                                                           |       | 8,590 |   | 7,808 |   | 7,060 |   | 6,609 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Income Before Income Taxes                           |       | 4,937                                                                           |       | 5,630 |   | 4,506 |   | 2,898 |   | 2,485 |   |
| Income Taxes                                         |       | 1,934                                                                           |       | 2,242 |   | 1,759 |   | 1,076 |   | 873 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Income                                           |       | $                                                                               | 3,003      |   | $ | 3,388 |   | $ | 2,747 |   | $ | 1,822 |   | $ | 1,612 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Cash Dividends Paid                                  |       | $                                                                               | 871        |   | $ | 768 |   | $ | 730 |   | $ | 697 |   | $ | 685 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Per Share Data:**                                  |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Income – Basic                              |       | $                                                                               | 1.55       |   | $ | 1.77 |   | $ | 1.46 |   | $ | 0.98 |   | $ | 0.89 |   |
| Net Income – Diluted                            |       | $                                                                               | 1.51       |   | $ | 1.68 |   | $ | 1.38 |   | $ | 0.94 |   | $ | 0.86 |   |
| Dividends                                            |       | $                                                                               | 0.450      |   | $ | 0.400 |   | $ | 0.388 |   | $ | 0.375 |   | $ | 0.375 |   |
| Book Value                                           |       | $                                                                               | 11.01      |   | $ | 9.93 |   | $ | 8.35 |   | $ | 7.42 |   | $ | 6.96 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Common Outstanding Shares:**                       |       | 1,924,873                                                                       |       | 1,928,097 |   | 1,899,543 |   | 1,861,764 |   | 1,844,708 |   |
| ** **                                           |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Statement of Financial Condition Summary:**        |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Total Assets                                         |       | $                                                                               | 248,640    |   | $ | 240,738 |   | $ | 231,532 |   | $ | 211,684 |   | $ | 183,827 |   |
| Total Deposits                                       |       | 212,718                                                                         |       | 212,988 |   | 206,879 |   | 194,868 |   | 168,033 |   |
| Total Net Loans                                      |       | 166,619                                                                         |       | 169,680 |   | 152,563 |   | 125,586 |   | 109,949 |   |
| Allowance for Loan Losses                            |       | 1,673                                                                           |       | 1,654 |   | 1,470 |   | 1,200 |   | 1,112 |   |
| Total Shareholders’ Equity                      |       | 21,189                                                                          |       | 19,137 |   | 15,866 |   | 13,807 |   | 12,845 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Selected Ratios:**                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Return on Average Assets                             |       | 1.22                                                                            | %          | 1.42 | % | 1.21 | % | 0.91 | % | 0.94 | % |
| Return on Average Equity                             |       | 14.87                                                                           | %          | 19.45 | % | 18.67 | % | 13.71 | % | 13.00 | % |
| Average Loans as a Percentage of Average  Deposits   |       | 76.11                                                                           | %          | 79.74 | % | 69.90 | % | 62.77 | % | 68.93 | % |
| Allowance for Loan Losses to Total Loans             |       | 0.99                                                                            | %          | 0.96 | % | 0.95 | % | 0.94 | % | 1.00 | % |
| **Company:**                                         |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Tier I Capital to Average Assets                     |       | 10.50                                                                           | %          | 10.00 | % | — |   | — |   | — |   |
| Tier I Capital to Risk-Weighted Assets               |       | 13.20                                                                           | %          | 12.70 | % | — |   | — |   | — |   |
| Total Capital to Risk-Weighted Assets                |       | 14.60                                                                           | %          | 14.40 | % | — |   | — |   | — |   |
| **Bank:**                                            |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Tier I Capital to Average Assets                     |       | 9.85                                                                            | %          | 9.11 | % | 7.16 | % | 6.53 | % | 7.00 | % |
| Tier I Capital to Risk-Weighted Assets               |       | 12.33                                                                           | %          | 11.43 | % | 9.33 | % | 8.80 | % | 9.34 | % |
| Total Capital to Risk-Weighted Assets                |       | 13.80                                                                           | %          | 13.13 | % | 11.34 | % | 10.85 | % | 11.66 | % |

 

10

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**Santa Lucia Bancorp and Subsidiary**

 

**General**

 

SantaLucia Bancorp (the “Company”) (OTC Bulletin Board SLBA.OB) is a Californiacorporation organized April 3, 2006 to act as the holding company for itswholly owned subsidiary Santa Lucia Bank (the “Bank”), collectively referred toherein as the “Company.” The Bank was organized as a national bankingassociation on December 19, 1984 and commenced operations on August 5,1985. The Bank converted from a national to a California state-chartered bankon May 30, 1997.

 

TheBank is a commercial banking business, operating from offices located at 7480El Camino Real, Atascadero, California, 1240 Spring Street, Paso Robles,California, 1530 East Grand Avenue, Arroyo Grande, California and 1825 SouthBroadway, Santa Maria, California.

 

TheBank’s operating policy since its inception has emphasized general commercialbanking. Most of the Bank’s customers are small to mid-sized businesses andindividuals. The business of the Bank emphasizes serving the needs of localbusinesses, professionals, and wage earners. The Bank provides servicesdesigned to meet the needs of the various segments of the markets it serves.These services include a full line of business loans, business leases, personalloans and deposit products.

 

**Management’s Discussion and Analysis and Results ofOperations**

 

Certainstatements contained in this report, including, without limitation, statementscontaining the words “believes”, “anticipates”, “intends”, “expects”, and wordsof similar import, constitute “forward-looking statements” within the meaningof Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934 (the “Exchange Act”). Such forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause the actual results, performance or achievements of the Companyto be materially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements. Such factors include,among others, the following: general economic and business conditions in thoseareas in which the Company operates, demographic changes, competition,fluctuations in interest rates, changes in business strategy or developmentalplans, changes in governmental regulations, credit quality, the availability ofcapital to fund the expansion of the Company’s business, and other factorsreferenced in the Company’s reports filed pursuant to the Exchange Act. Giventhese uncertainties, shareholders are cautioned not to place undue reliance onsuch forward-looking statements. The Company disclaims any obligation to updateany such factors or to publicly announce the results of any revisions to any ofthe forward-looking statements contained herein to reflect future events ordevelopments.

 

Thisdiscussion should be read in conjunction with the Company’s audited financialstatements and notes thereto which appear elsewhere in this report.

 

***Overview***

 

Thefollowing sections set forth an analysis of the significant operating changes,business trends, financial condition, earnings, capital position and liquiditythat have occurred in the three-year period ended December 31, 2007.

 

**Consolidated Results of Operations**

 

In2007 the Company recorded earnings of $3,003,000, which reflects a decrease of$385,000 or 11.4% over the previous year. In 2006, earnings were $3,388,000, anincrease of 23.3% from 2005’s earnings of $2,747,000, which reflected anincrease of 50.8% from earnings posted in 2004. Basic earnings per share in2007 were $1.55 compared with $1.77 and $1.46 for 2006 and 2005, respectively.This reflects a decrease from 2006 to 2007 of 12.4%. The earnings per share(diluted) for 2007, 2006, and 2005 were $1.51, $1.68, and $1.38, respectively,a 10.1% decrease from 2006 to 2007. The Company paid cash dividends totaling$0.45 per share during 2007 compared to $0.40 paid in 2006 and $0.388 paid in2005. Return on average shareholder’s equity was 14.9% in 2007 compared to19.5% in 2006 and 18.7% in 2005. Return on average assets was 1.22% in 2007compared to 1.42% in 2006 and 1.21% in 2005.

 

Thedecrease in the Company’s net earnings from 2006 to 2007 was due to four majorevents: a decrease in average loans of $7,105,000 or 4.2%; a 100 basis pointdecrease in the prime lending rate; an increase of $10,689,000 in averageinterest bearing deposits or 8.7%; and a 65 basis point increase in interestbearing deposit rates.

 

TheCompany believes that the local economies, in which it operates, Atascadero,Paso Robles, Arroyo Grande, and Santa Maria continue to remain relativelystable. Competition for deposits continues to be very strong both fromtraditional sources as well as alternative investments such as mutual funds,money market accounts and the stock market. The Bank’s decline in the loanportfolio has been affected by the slow down in the demand for construction lending and real estate related markets.

 

11

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***Net Interest Income***

 

Netinterest income is the Company’s largest source of operating income and isderived from interest and fees received on interest earning assets, lessinterest expense incurred on interest bearing liabilities. The most significantimpact on the Company’s net interest income between periods is derived from theinteraction of changes in the volume of and rates earned or paid on interestearning assets and interest bearing liabilities. The volume of loans,investment securities and other interest earning assets, compared to the volumeof interest bearing deposits and indebtedness, combined with the spread,produces changes in the net interest income between periods.

 

Interestincome increased $692,000 or 4.1% in 2007 from $17,027,000 in 2006 to$17,719,000 in 2007. This is compared to an increase of $3,481,000 or 25.7%from 2005 to 2006 and an increase of $3,326,000 or 32.5% from 2004 to 2005. Theslowdown in the increase in interest income is again attributable to theslowdown in real estate lending. The increase in 2007 was primarily due to theincrease in average investments of $10,451,000 or 27.1% from 2006 and anincrease in the average investment yield from 3.9% in 2006 to 5.0% in 2007.

 

Totalinterest and fees produced an 8.1% yield on average earning assets for 2007,8.1% for 2006 and 6.8% in 2005. The average loan to deposit ratio for 2007 was76.11%, which represents a decrease of 4.6% over the 79.74% average for 2006.

 

Totalinterest expense increased $1,247,000 or 34.9% from $3,577,000 in 2006 to$4,824,000 in 2007 compared to an increase of $1,593,000 or 80.3% from 2005 to2006. The increase in total interest expense in 2007 was due to a combinationof rising rates for all deposit categories coupled with an increase in interestbearing funds. In 2007, total interest bearing liabilities increased $12.1million or 9.3%. These factors increased our rate paid on interest-bearingliabilities 65 basis points from 2.76% in 2006 to 3.41% in 2007.

 

Netinterest margin decreased 46 basis points from 6.38% in 2006 to 5.92% in 2007.As noted above, this decrease was primarily due to changes in our asset mix andan increase in our cost of funds. In our asset mix, we experienced migrationfrom higher yielding loans to lower yielding investments while in our liabilitymix, we experienced migration from lower costing NOW, Money Market and Savingsaccounts to higher costing time certificates of deposits and long-term debt.

 

Weexpect this trend of reduction in our net interest margin to continue into 2008as anticipated prime rate decreases will impact our interest earning assetsfaster than we can reprice our interest-bearing deposits.

 

Thefollowing table shows the composition of average earning assets and averageinterest-bearing liabilities, average yields and rates, and the net interestmargin for the years ended December 31, 2007, 2006 and 2005. Nonaccrualloans are included in the calculation of the average balances of loans, andnonaccrued interest is excluded.

 
| ** **                                               | ** ** | **Year Ended December 31** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **Average  Balance**                      | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                               | ** ** | **(dollars  in thousands)**          | ** ** |
| Assets:                                                  |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                                    |       | $                                         | 163,741    |   | $ | 15,031 |   | 9.18 | % | $ | 169,139 |   | $ | 15,397 |   | 9.10 | % | $ | 145,195 |   | $ | 11,747 |   | 8.09 | % |
| Investment  securities                                   |       | 49,024                                    |       | 2,438 |   | 4,97 | % | 38,573 |   | 1,485 |   | 3.85 | % | 48,660 |   | 1,625 |   | 3.34 | % |
| Federal funds  sold                                      |       | 4,954                                     |       | 250 |   | 5.05 | % | 2,941 |   | 145 |   | 4.93 | % | 5,685 |   | 174 |   | 3.06 | % |
| Total average  interest-earning assets                   |       | 217,719                                   |       | 17,719 |   | 8.14 | % | 210,653 |   | 17,027 |   | 8.08 | % | 199,540 |   | 13,546 |   | 6.79 | % |
| Other assets                                             |       | 29,278                                    |       |   |   |   |   | 28,808 |   |   |   |   |   | 27,913 |   |   |   |   |   |
| Less allowance  for loan losses                          |       | (1,707                                    | )          |   |   |   |   | (1,593 | ) |   |   |   |   | (1,332 | ) |   |   |   |   |
| Total average  assets                                    |       | $                                         | 245,290    |   |   |   |   |   | $ | 237,868 |   |   |   |   |   | $ | 226,121 |   |   |   |   |   |
|                                                     |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  Shareholders’ Equity:              |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  demand - NOW                           |       | $                                         | 13,391     |   | $ | 55 |   | 0.41 | % | $ | 14,696 |   | $ | 38 |   | 0.26 | % | $ | 17,834 |   | $ | 42 |   | 0.24 | % |
| Money Market                                             |       | 24,929                                    |       | 722 |   | 2.90 | % | 24,103 |   | 503 |   | 2.09 | % | 30,186 |   | 446 |   | 1.48 | % |
| Savings                                                  |       | 27,076                                    |       | 289 |   | 1.07 | % | 28,074 |   | 222 |   | 0.79 | % | 30,560 |   | 133 |   | 0.44 | % |
| Time certificate  of deposits                            |       | 68,019                                    |       | 3,157 |   | 4.64 | % | 55,853 |   | 2,316 |   | 4.15 | % | 40,772 |   | 1,195 |   | 2.93 | % |
| Total average  interest-bearing deposits                 |       | 133,415                                   | ** ** | 4,223 |   | 3.17 | % | 122,726 |   | 3,079 |   | 2.51 | % | 119,352 |   | 1,816 |   | 1.52 | % |
| Short-term  borrowings                                   |       | 1,059                                     |       | 51 |   | 4.82 | % | 1,356 |   | 65 |   | 4.79 | % | 439 |   | 16 |   | 3.64 | % |
| Long-term  borrowings                                    |       | 7,155                                     |       | 550 |   | 7.69 | % | 5,465 |   | 433 |   | 7.92 | % | 2,000 |   | 152 |   | 7.60 | % |
| Total  interest-bearing liabilities                      |       | 141,629                                   |       | 4,824 |   | 3.41 | % | 129,547 |   | 3,577 |   | 2.76 | % | 121,791 |   | 1,984 |   | 1.63 | % |
| Demand deposits                                          |       | 81,714                                    |       |   |   |   |   | 89,383 |   |   |   |   |   | 88,366 |   |   |   |   |   |
| Other liabilities                                        |       | 1,749                                     |       |   |   |   |   | 1,515 |   |   |   |   |   | 1,253 |   |   |   |   |   |
| Sharholder’s  equity                                |       | 20,198                                    |       |   |   |   |   | 17,423 |   |   |   |   |   | 14,711 |   |   |   |   |   |
| Total average  liabilities and shareholders’ equity |       | $                                         | 245,290    |   |   |   |   |   | $ | 237,868 |   |   |   |   |   | $ | 226,121 |   |   |   |   |   |
| Net interest  income                                     |       |                                      |       | $ | 12,895 |   |   |   |   |   | $ | 13,450 |   |   |   |   |   | $ | 11,562 |   |   |   |
| Net interest  margin                                     |       |                                      |       |   |   | 5.92 | % |   |   |   |   | 6.38 | % |   |   |   |   | 5.79 | % |

 

12

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TheCompany’s net yield on interest-earning assets is affected by changes in therates earned and paid and the volume of interest-earning assets andinterest-bearing liabilities. The impact of changes in volume and rate on netinterest income are shown in the following table:

 
| ** **                                   | ** ** | **Year Ended December 31, 2007  over**                      | ** ** | **Year Ended December 31, 2006  over**                      | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Year Ended December 31, 2006**                            | ** ** | **Year Ended December 31, 2005**                            | ** ** |
| ** **                                   | ** ** | **Increase (Decrease) Due to  Change in (000’s)** | ** ** | **Increase (Decrease) Due to  Change in (000’s)** | ** ** |
| ** **                                   | ** ** | **Volume**                                                                      | ** ** | **Rate**                                                                        | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| Interest-bearing Assets:                     |       |                                                                            |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Loans                                    |       | (495                                                                            | )          | 129                                                                             |       | (366 | ) | 2,075 |   | 1,575 |   | 3,650 |   |
| Investment Securities                        |       | 459                                                                             |       | 494                                                                             |       | 953 |   | (366 | ) | 226 |   | (140 | ) |
| Federal funds sold                           |       | 102                                                                             |       | 3                                                                               |       | 105 |   | (107 | ) | 78 |   | (29 | ) |
| Interest-earning deposits                    |       | —                                                                          |       | —                                                                          |       | — |   | — |   | — |   | — |   |
| Total interest income                        |       | 66                                                                              |       | 626                                                                             |       | 692 |   | 1,602 |   | 1,879 |   | 3,481 |   |
| Interest-bearing Liabilities:                |       |                                                                            |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Interest bearing demand - NOW                |       | (3                                                                              | )          | 20                                                                              |       | 17 |   | (8 | ) | 4 |   | (4 | ) |
| Money Market                                 |       | 18                                                                              |       | 201                                                                             |       | 219 |   | (102 | ) | 159 |   | 57 |   |
| Savings                                      |       | —                                                                          |       | 67                                                                              |       | 67 |   | 1 |   | 88 |   | 89 |   |
| Time Certificates of deposit                 |       | 542                                                                             |       | 299                                                                             |       | 841 |   | 528 |   | 593 |   | 1,121 |   |
| Short-term borrowings                        |       | (14                                                                             | )          | —                                                                          |       | (14 | ) | 43 |   | 6 |   | 49 |   |
| Long-term borrowings                         |       | 16                                                                              |       | 101                                                                             |       | 117 |   | 16 |   | 265 |   | 281 |   |
| Total interest expense                       |       | 559                                                                             |       | 688                                                                             |       | 1,247 |   | 478 |   | 1,115 |   | 1,593 |   |
| Interest differential or net interest income |       | $                                                                               | (493       | )                                                                               | $          | (62 | ) | $ | (555 | ) | $ | 1,124 |   | $ | 764 |   | $ | 1,888 |   |
|                                              |            |                                                                                 |            |                                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Noninterest Income***

 

Noninterestincome totaled $1,071,000 compared to $1,010,000 for the same period in 2006.That represents an increase of $61,000 or 6.0%. The increase was primarily dueto the recovery of legal fees and costs on a previously charged off loan and anincrease in interest income derived from the investment in bank owned lifeinsurance.

 

Servicecharges on deposit accounts totaled $583,000, which represents a decrease of$33,000 or 5.4% over the same period in 2006. The decrease in service chargeswas primarily due to the decrease in non sufficient fund fees collected.

 

Othernoninterest income totaled $488,000 compared to $394,000 for the same period in2006. That represents an increase of $94,000 or 23.9%. The increase isprimarily due to the recovery of legal fees and costs on a previously chargedoff loan and an increase in interest income derived from the investment in bankowned life insurance.

 

Referto the “Statement of Earnings” for a breakdown of noninterest income.

 

***Noninterest Expense***

 

Noninterestexpense increased $439,000 or 5.1% in 2007 over 2006 to $9,029,000 as comparedto an increase of $782,000 or 10.0% in 2006 over 2005. The overall increase canbe largely attributed to the continued growth of the Company.

 

Salariesand related expenses increased $516,000 or 10.9% from 2006 to 2007 compared toan increase of $501,000 or 11.8% between 2005 and 2006. This increase isattributed to normal staff related increases, coupled with a 17.7% increase ingroup health insurance and a $54,000 shared-based payment, which is part ofSFAS 123(R), “Share-Based Payment.” SFAS 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values.

 

Occupancyexpense for the year ended December 31, 2007 totaled $628,000, which reflectsa decrease of $36,000 or 5.4% over the same period in 2006. This was primarilydue to a decrease in real estate taxes coupled with fewer maintenance andrepair costs.

 

Equipmentexpense for the year ended December 31, 2007 totaled $666,000, which reflectsa decrease of $25,000 or 3.6% over the same period in 2006. This was primarilydue to the eliminations of depreciation expense associated with fullydepreciated equipment in the Santa Maria office.

 

Professionalservices for the year ended December 31, 2007 totaled $427,000, whichreflects a decrease of $111,000 or 20.6% over the same period in 2006. This wasprimarily due to the decreases in legal and other professional services.

 

Dataprocessing expense for the year ended December 31, 2007 totaled $489,000,which reflects an increase of $21,000 or 4.5% from the same period in 2006.This was primarily due to a 5.1% increase in contracted fees coupled with thecontinued growth of the Company.

 

Officeexpenses increased $2,000 from $360,000 in 2006 to $362,000 in 2007.

 

Marketingexpense increased $15,000 or 3.7% from $408,000 in 2006 to $423,000 in 2007.

 

13

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Directorfees and expenses for the year ended December 31, 2007 totaled $329,000,which reflects an increase of $66,000 or 25.1% over the like period in 2006.The primary reason for the increase was a $56,000 stock option expenserecognized for new option grants made in late 2006.

 

Messengerand courier expenses increased $9,000 or 6.1% from $148,000 in 2006 to $157,000in 2007.

 

Otherexpense decreased $17,000 or 7.0% from $242,000 in 2006 to $225,000 in 2007.This decrease was due to $9,000 decrease in inspection fees associated withconstruction loans.

 

TheCompany’s efficiency ratio for 2007 was 64.7%. This represents an increase fromthe 2006 efficiency ratio of 60.4%, which was a decrease from the 2005 ratio of63.4%. The increase in the efficiency ratio was primarily due to the decreasein the net interest margin, and the increase in non interest expense.

 

Referto the “Statement of Earnings” for a breakdown of noninterest expense.

 

***Income Taxes***

 

Theprovision for income taxes was $1,934,000 in 2007, $2,242,000 in 2006 and$1,759,000 in 2005. The effective tax rate was 39.1% in 2007 as compared to39.9% in 2006 and 39.0% in 2005. This decrease was partially due to anincreasing percentage of tax-free investments.

 

**Financial Condition**

 

In2007, the Company’s consolidated total assets increased to $248,640,000compared to $240,738,000 in 2006 and $231,532,000 in 2005 for increases of3.3%, 4.0% and 9.4% respectively.

 

Totaldeposits decreased $270,000 to $212,718,000 compared to $212,988,000 in 2006and $206,879,000 in 2005 for a decrease of 0.1% for 2007, and increases of 3.0%and 6.2% for 2006 and 2005 respectively. Deposit competition continues to bevery strong in both the traditional bank deposits and alternative investmentsavailable in the market place.

 

Securitiesavailable for sale totaled $56,107,000 at December 31, 2007, compared to$42,778,000 at December 31, 2006 and $41,830,000 at December 31,2005. This represents an increase of 31.2% over December 31, 2006. Theincrease in securities was primarily due to the decrease in loan demand, whichis the result of the softening in the construction and real estate markets.

 

***Loan Portfolio***

 

Totalloans outstanding averaged $163,741,000 in 2007 compared to $169,139,000 in2006. This represents a decrease of $5,398,000 or 3.2% in 2007 compared to anincrease of $23,944,000 or 16.5% in 2006. Actual net loans at December 31,2007 equaled $166,619,000 for a decrease of $3,060,000 or 1.8 % over 2006.

 

Thefollowing table sets forth the amount of total loans outstanding in eachcategory for the years indicated:

 
| ** **                                    | ** ** | **Year Ended December 31** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(dollars in thousands)**      | ** ** |
| Commercial                                    |       | $                                         | 38,017     |   | $ | 36,407 |   | $ | 34,139 |   | $ | 32,797 |   | $ | 30,490 |   |
| Real Estate – construction               |       | 47,819                                    |       | 55,307 |   | 52,696 |   | 29,707 |   | 25,446 |   |
| Real Estate – other                      |       | 81,895                                    |       | 78,757 |   | 66,390 |   | 63,433 |   | 53,931 |   |
| Consumer                                      |       | 1,237                                     |       | 1,604 |   | 1,533 |   | 1,570 |   | 1,645 |   |
| Total gross loans                             |       | 168,968                                   |       | 172,075 |   | 154,758 |   | 127,507 |   | 111,512 |   |
| Less: unearned fees                           |       | (676                                      | )          | (741 | ) | (725 | ) | (721 | ) | (451 | ) |
| Less: allowance for loan losses               |       | (1,673                                    | )          | (1,654 | ) | (1,470 | ) | (1,200 | ) | (1,112 | ) |
| Total net loans                               |       | $                                         | 166,619    |   | $ | 169,680 |   | $ | 152,563 |   | $ | 125,586 |   | $ | 109,949 |   |
| Weighted average yield on loans for the  year |       | 9.2                                       | %          | 9.1 | % | 8.1 | % | 7.3 | % | 7.3 | % |

 

Thefollowing table sets forth the amount of total loans outstanding at December 31,2007 by contractual maturity date:

 
| ** **                      | ** ** | ** **                      | ** ** | **After One**    | ** ** | ** **          | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------|------------|-----------------------|------------|---------------------|------------|------------|------------|
| ** **                      | ** ** | **One Year**               | ** ** | **Year Through** | ** ** | **After**           | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **or Less**                | ** ** | **Five Years**   | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| ** **                      | ** ** | **(dollars in thousands)** | ** ** |
| Commercial                      |       | $                               | 24,140     |                  | $          | 6,865               |       | $          | 7,011      |   | $ | 38,016 |   |
| Real Estate – construction |       | 42,862                          |       | 4,505                 |       | 453                 |       | 47,820     |       |
| Real Estate – other        |       | 5,307                           |       | 7,310                 |       | 69,278              |       | 81,895     |       |
| Consumer                        |       | 607                             |       | 466                   |       | 164                 |       | 1,237      |       |
|                            |       | $                               | 72,916     |                  | $          | 19,146              |       | $          | 76,906     |   | $ | 168,968 |   |

 

14

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Asignificant portion of the loan portfolio of the Company is dependent on realestate. At December 31, 2007, real estate served as the principal sourceof collateral with respect to 78.5% of the Company’s loan portfolio. A declinein current economic conditions could have an adverse effect on the demand fornew loans even if rates continue to decline. It is also understood that theability of borrowers to repay outstanding loans, the value of real estate andother collateral securing loans and the value of real estate owned by theCompany, could affect the Company’s financial condition and results ofoperations in general and the market value of the Company’s common stock. Actsof nature, including earthquakes and floods, which may cause uninsured damageand other loss of value to real estate that secures these loans, may alsonegatively impact the Company’s financial condition.

 

Realestate construction and other real estate loans equaled $129,715,000 or 78.5%of the total loan portfolio and $134,065,000 or 77.9% of the total loanportfolio at December 31, 2007 and 2006, respectively. Other real estateloans are comprised of loans to individuals for their businesses, consumer realestate loans including home equity lines of credit and loans for farmland,including vineyards. The Company has known for some time that it has aconcentration in commercial real estate loans. As a means to more closelymonitor this concentration, the Company has instituted the use of NAICS codesto monitor industry trends within its commercial real estate portfolio. As of December 31,2007, the Company had $72,608,000 or 43.0% of its loans in commercial realestate. Of this number, $45,960,000 or 63.3% is commercial real estate forowners use. No industry type exceeds 5.0% of total loans. The remaining$26,648,000 or 36.7% is commercial real estate for non-owners use. Commercialreal estate loans for non-owners use as a percentage of total loans equates to16.0%. We watch the commercial real estate loans for non-owners use along withchanges within our owners use very closely and are familiar with theindividuals and projects and at this time we do not foresee any problems orundue risk in this segment of our portfolio. Total real estate loans decreased$4,350,000 or 3.2% in 2007 over 2006 compared to an increased of $14,705,000 or12.3% in 2006 over 2005. The decrease is spread throughout construction ofresidential units held for resale or for the borrower’s personal residence,off-site development, or land held for future development of commercial orresidential properties. The Company has seen a significant decrease in thenumber of residential construction loans, due to the softening in the realestate market. The Company has loans to customers with a long history ofsuccessful developments in our market areas, as well as a long-termrelationship with Santa Lucia Bank. The Company has experience and knowledge inconstruction lending and does not feel that there is any undue risk to theCompany. These loans are secured by real estate, and in general, do not exceed75% of the appraised value on commercial residential real estate or 80% on anindividual’s personal residence.

 

TheCompany makes commercial loans to small and mid-size businesses for variousreasons, including working capital, inventory and equipment. Commercial loansequaled $38,017,000 or 22.5% of the total loan portfolio and $36,407,000 or21.2% of the total loan portfolio at December 31, 2007 and 2006,respectively. Commercial loans increased $1,610,000 or 4.4% from 2006 to 2007compared to an increase of $2,268,000 or 6.6% in 2006 over 2005.

 

Ithas always been a part of our business banking practice to loan to smallbusinesses for their facilities as well as their other business needs.

 

Consumerand other loans equaled $1,237,000 or 0.7% of the total loan portfolio at December 31,2007 compared to $1,604,000 or 0.9% at December 31, 2006. Consumer loansdecreased $367,000 or 22.9% in 2007 over 2006 compared to an increase of$71,000 or 4.6% in 2006 over 2005.

 

TheCompany had undisbursed loans totaling $57,326,000, $56,557,000, and$53,280,000 as of December 31, 2007, December 31, 2006 and December 31,2005, respectively. Standby Letters of Credit accounted for $4,286,000,$2,603,000 and $1,546,000 of the undisbursed loans as of December 31,2007, December 31, 2006 and December 31, 2005, respectively. The Companyuses the same credit policies in making these commitments as is done for all ofits lending activities. As such, the credit risk involved in these transactionsis the same as that involved in extending loan facilities to customers.

 

Loanswith maturities greater than one year at December 31, 2007 includeapproximately $40,803,000 of fixed rate loans or 24.2% of the total loanportfolio compared to $11,060,000 or 6.4% of the total loan portfolio as of December 31,2006 and $7,642,000 or 4.9% of the total loan portfolio as of December 31,2005. The balance of the loans that have maturities of one year or less, or arevariable rate loans at December 31, 2007 totaled $128,165,000 or 31.8%compared to $161,015,000 or 93.6% as of December 31, 2006 and $147,116,000or 95.1% as of December 31, 2005. The $69.3 million in other real estateloans with five years or greater maturities are primarily owner occupiedcommercial properties. The Company has attempted to lengthen the maturities ofloans in its portfolio to add additional stability to the loan portfolio.

 

15

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***Nonperforming loans***

 

Interest income is accrued daily as earned on all loans. Loans on whichthe accrual of interest has been discontinued are designated as nonaccrualloans. The accrual of interest on loans is discontinued when principal orinterest is past due 90 days based on the contractual terms of the loan orwhen, in the opinion of management, there is reasonable doubt as tocollectibility. When loans are placed on nonaccrual status, all interestpreviously accrued but not collected is reversed against current periodinterest income. Income on nonaccrual loans is subsequently recognized only tothe extent that cash is received and the loan’s principal balance is deemedcollectible.

 

The composition of nonperforming loans as of the end of the last fivefiscal years is summarized in the following table:

 
| ** **                                                 | ** ** | **Year Ended December 31** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                  | ** ** | **2006 ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                 | ** ** | **(dollars in thousands)**                | ** ** |
| Nonaccrual loans:                                     | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Commercial                                                 |       | $                                         | 113        |   | $ | — |   | $ | — |   | $ | — |   | $ | 23 |   |
| Real estate                                                |       | 2,062                                     |       | — |   | 135 |   | 758 |   | 805 |   |
| Consumer                                                   |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total                                                      |       | 2,175                                     |       | — |   | 135 |   | 758 |   | 828 |   |
| Loans 90 days or more past due and still  accruing:        |       |                                      |       |   |   |   |   |   |   |   |   |
| Real estate                                                |       | —                                    |       | — |   | — |   | — |   | — |   |
| Consumer                                                   |       | —                                    |       | — |   | — |   | — |   | — |   |
| Commercial                                                 |       | —                                    |       | 550 |   | — |   | — |   | — |   |
| Total                                                      |       | —                                    |       | 550 |   | — |   | — |   | — |   |
| Total nonperforming loans:                                 |       | 2,175                                     |       | 550 |   | 135 |   | 758 |   | 828 |   |
| OREO                                                       |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total nonperforming assets:                                |       | $                                         | 2,175      |   | $ | 550  |   | $ | 135 |   | $ | 758 |   | $ | 828 |   |
| Nonperforming assets as a percentage of  total gross loans |       | 1.29                                      | %          | 0.32 | % | 0.09 | % | 0.59 | % | 0.74 | % |
| Nonperforming assets as a percentageof  total assets       |       | 0.87                                      | %          | 0.23 | % | 0.06 | % | 0.36 | % | 0.45 | % |
| Allowance for loan losses to nonperforming  loans          |       | 76.92                                     | %          | 300.73 | % | 1088.89 | % | 158.31 | % | 134.30 | % |

 

The Company had three nonperforming loans totaling $2,175,000 as of December 31,2007, compared to one nonperforming loan totaling $550,000 at December 31,2006 and one nonperforming loan totaling $135,000 at December 31, 2005. Ofthe Company’s nonperforming loans, two are well secured by residential realestate with minimal loss exposure. The commercial loan for $113,000 is 50%guaranteed by the U. S. Small Business Administration, and is secured bybusiness assets of the borrower in addition to the personal residence of theguarantor. The Company is in the process of assessing the value of itscollateral and any actual loss is unknown at this time. The Company hashowever, assigned loan loss reserves in an amount it feels is adequate tosatisfy any potential loss based on the collateral.

 

There were no significant loans that were current as of December 31,2007, where serious doubt existed as to the ability of the borrower to complywith the present loan repayment terms or that represent a “troubled debtrestructuring.”

 

The Company had no “Other Real Estate Owned” (OREO) property as of December 31,2007.

 

The Company experienced net charge-offs (recoveries) of ($19,000),$56,000 and $30,000 in 2007, 2006 and 2005 respectively.

 

***Quality of loans***

 

Inherent in lending is the fact that loan losses will be experiencedand that the risk of loss will vary with the type of loan extended and thecreditworthiness of the borrower. To reflect the estimated risks of loss associatedwith its loan portfolio, provisions are made to the Company’s allowance forpossible loan losses. As an integral part of this process, the allowance forpossible loan losses is subject to review and possible adjustment as a resultof regulatory examinations conducted by governmental agencies and throughmanagement’s assessment of risk. The Company’s entire allowance is a valuationallocation; that is, it has been created by direct charges against operationsthrough the provision for possible loan losses.

 

The Company evaluates the allowance for possible loan losses based uponan individual analysis of specific categories of loans, specific categories ofclassified loans and individual classified assets. The adequacy of theallowance is determinable only on an approximate basis, since estimates as tothe magnitude and timing of loan losses are not predictable because of theimpact of external events. In addition, the Company contracts with anindependent loan review firm to evaluate overall credit quality on an ongoingbasis. Management then considers the adequacy of the allowance for possibleloan losses in relation to the total loan portfolio.

 

The provision for possible loan losses charged against operatingexpense is based upon an analysis of the actual migration of loans to lossesplus an amount for other factors that, in management’s judgment, deserverecognition in estimating possible loan losses. These factors include numerousitems among which are: specific loan conditions as determined by management;the historical relationship between charge-offs and the level of the allowance;the estimated future loss

 

16

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inall significant loans; known deterioration in concentrations of credit; certainclasses of loans or pledged collateral; historical loss experience based onvolume and type of loan; the results of any independent review or evaluation ofthe loan portfolio quality conducted by or at the direction of the Company’smanagement or by bank regulatory agencies; trends in portfolio volume,maturity, and composition; off-balance sheet credit risk; volume and trends indelinquencies and nonaccruals; lending policies and procedures including thosefor charge-off, collection, and recovery; national and local economicconditions and downturns in specific local industries; and the experience,ability, and depth of the lending staff and management. The Company evaluatesthe adequacy of its allowance for possible loan losses quarterly.

 

Itwas management’s decision that no additional loan loss provision was neededduring 2007 primarily based on the foregoing analysis and due to the decline of$10.3 million in real estate and construction loans during the first ninemonths ended September 30, 2007. During the last quarter of 2007, realestate and construction loans increased approximately $6.0 million however;year to date gross loans have decreased $3.1 million or 1.8%.

 

Thefollowing table summarizes the allocation of the allowance for loan losses bytype for the years indicated and the percent loans in each category to totalloans:

 
| ** **                 | ** ** | **Year Ended December 31** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**      | ** ** |
| ** **                 | ** ** | **Amount**                                | ** ** | **Loan  Percent** | ** ** | **Amount** | ** ** | **Loan  Percent** | ** ** | **Amount** | ** ** | **Loan  Percent** | ** ** | **Amount** | ** ** | **Loan  Percent** | ** ** | **Amount** | ** ** | **Loan  Percent** | ** ** |
| Commerical                 |       | $                                         | 525        |   | 22.50 | % | $ | 495 |   | 21.16 | % | $ | 536 |   | 22.06 | % | $ | 502 |   | 25.72 | % | $ | 460 |   | 27.34 | % |
| Real Estate - construction |       | 229                                       |       | 28.30 | % | 126 |   | 32.14 | % | 118 |   | 34.05 | % | 71 |   | 23.30 | % | 55 |   | 22.82 | % |
| Real Estate - other        |       | 572                                       |       | 48.47 | % | 362 |   | 45.77 | % | 274 |   | 42.90 | % | 281 |   | 49.75 | % | 224 |   | 48.36 | % |
| Consumer                   |       | 32                                        |       | 0.73 | % | 38 |   | 0.93 | % | 36 |   | 0.99 | % | 39 |   | 1.23 | % | 155 |   | 1.48 | % |
| Unallocated                |       | 315                                       |       | n/a |   | 633 |   | n/a |   | 506 |   | n/a |   | 307 |   | n/a |   | 218 |   | n/a |   |
| Total                      |       | $                                         | 1,673      |   | 100.00 | % | $ | 1,654 |   | 100.00 | % | $ | 1,470 |   | 100.00 | % | $ | 1,200 |   | 100.00 | % | $ | 1,112 |   | 100.00 | % |

 

Managementviews the allowance for loan losses of $1,673,000 or .99% of total loans as of December 31,2007 to be adequate after considering the above factors. This allowance iscompared to $1,654,000 or .96% in 2006 and $1,470,000 or .95% in 2005. However,there can be no assurance that in any given period the Company will not sustaincharge-offs that are substantial in relation to the size of the allowance.

 

Theallocation of the allowance for possible loan losses as of the end of the lastfive fiscal years is summarized in the following table:

 
| ** **                                                                   | ** ** | **Year Ended December 31** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                   | ** ** | **(dollars in thousands)**      | ** ** |
| **Outstanding loans:**                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Average for the year (net)                                                   |       | $                                         | 163,741    |   | $ | 169,139 |   | $ | 145,195 |   | $ | 115,255 |   | $ | 109,148 |   |
| End of the year (net)                                                        |       | 166,619                                   |       | 169,680 |   | 152,563 |   | 125,586 |   | 109,949 |   |
| Allowance for loan losses:                                                   |       |                                      |       |   |   |   |   |   |   |   |   |
| Balance at beginning of year                                                 |       | $                                         | 1,654      |   | $ | 1,470 |   | $ | 1,200 |   | $ | 1,112 |   | $ | 1,026 |   |
| Actual charge-offs:                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                                   |       | 51                                        |       | 77 |   | 43 |   | 22 |   | 16 |   |
| Real estate                                                                  |       | —                                    |       | — |   | — |   | — |   | — |   |
| Consumer                                                                     |       | —                                    |       | — |   | — |   | — |   | — |   |
| All other (including overdrafts)                                             |       | 10                                        |       | 6 |   | 3 |   | 1 |   | 17 |   |
| Total charge-offs                                                            |       | 61                                        |       | 83 |   | 46 |   | 23 |   | 33 |   |
| **Less Recoveries:**                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                                   |       | 4                                         |       | 26 |   | 15 |   | — |   | 4 |   |
| Real estate                                                                  |       | 76                                        |       | — |   | — |   | — |   | — |   |
| Consumer                                                                     |       | —                                    |       | — |   | — |   | — |   | — |   |
| All other (including overdrafts)                                             |       | —                                    |       | 1 |   | 1 |   | 1 |   | — |   |
| Total recoveries                                                             |       | 80                                        |       | 27 |   | 16 |   | 1 |   | 4 |   |
| Net loan charge-offs (recoveries)                                            |       | (19                                       | )          | 56 |   | 30 |   | 22 |   | 29 |   |
| Provision for loan loss                                                      |       | —                                    |       | 240 |   | 300 |   | 110 |   | 115 |   |
| Balance at end of period                                                     |       | $                                         | 1,673      |   | $ | 1,654 |   | $ | 1,470 |   | $ | 1,200 |   | $ | 1,112 |   |
| **Ratios:**                                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Net loan charge-offs (recoveries) to average loans                           |       | -0.01                                     | %          | 0.03 | % | 0.02 | % | 0.02 | % | 0.03 | % |
| Allowance for loan losses to end of year loans                               |       | 0.99                                      | %          | 0.96 | % | 0.95 | % | 0.94 | % | 1.00 | % |
| Net loan charge-offs (recoveries) to allowance for loan losses               |       | -1.14                                     | %          | 3.39 | % | 2.04 | % | 1.83 | % | 2.61 | % |
| Net loan charge-offs (recoveries) to provision charged to operating  expense |       | 0.00                                      | %          | 23.33 | % | 10.00 | % | 20.00 | % | 25.22 | % |

 

17

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***Investment Securities***

 

Theaverage balance of Federal Funds Sold (overnight investments with other banks)was $4,954,000 in 2007, $2,941,000 in 2006, and $5,685,000 in 2005. Theseinvestments are maintained primarily for the short-term liquidity needs of theCompany. The major factors influencing the levels of required liquidity are theloan demand of the Company’s customers and fluctuations in the Company’sdeposits. The Company’s loan-to-deposit ratio averaged 76.1% in 2007, comparedto 79.7% in 2006, and 69.9% in 2005.

 

Averagetotal investment securities increased by $10,451,000 or 27.1% during 2007,compared to a decrease of $10,087,000 or 20.7% in 2006. The Company focused onmaximizing investment opportunities during 2007, due to the softening of theloan demand which decreased by $7,105,000 in average loans or 4.2%. Theaggregate market value of the investment portfolio was $334,000 over theamortized cost as of December 31, 2007. As of December 31, 2007, theCompany had the ability and intent to hold securities to maturity and saw asignificant market value increase of $796,000 over 2006. It is the Company’spolicy not to engage in securities trading transactions. There are noinvestments in the portfolio deemed to be permanently impaired. The Company hasclassified all of its investment securities as available for sale. The exposureto sub prime loans in the Mortgage-Backed securities portfolio is minimal dueto the fact these securities are guaranteed by United States GovernmentAgencies and, as such, can be viewed as having credit risk comparable to UnitedStates Treasury securities.

 
| ** **                                       | ** ** | **December 31** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **2007**             | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **Amortized  Cost**  | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Estimated  Fair Value** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Estimated  Fair Value** | ** ** |
| Securities available  for sale:        |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and  Agency securities |       | $                    | 24,097,314 |   | $ | 243,699 |   | $ | — |   | $ | 24,341,013 |   | $ | 19,094,065 |   | $ | 3,029 |   | $ | (76,599 | ) | $ | 19,020,495 |   |
| State and Political  Subdivisions                |       | $                    | 6,527,226  |   | $ | 30,399 |   | $ | (50,333 | ) | $ | 6,507,292 |   | $ | 4,805,053 |   | $ | 9,970 |   | $ | (89,397 | ) | $ | 4,725,626 |   |
| Mortgage-Backed  Securities                      |       | $                    | 25,148,131 |   | $ | 207,770 |   | $ | (97,050 | ) | $ | 25,258,851 |   | $ | 19,340,821 |   | $ | 20,303 |   | $ | (328,828 | ) | $ | 19,032,296 |   |
| Total                                            |       | $                    | 55,772,671 |   | $ | 481,868 |   | $ | (147,383 | ) | $ | 56,107,156 |   | $ | 43,239,939 |   | $ | 33,302 |   | $ | (494,824 | ) | $ | 42,778,417 |   |

 

Theamortized cost, estimated fair value, and weighted average yield for investmentsecurities available for sale based on maturity date are set forth in the tablebelow. The weighted average yield is based on the amortized cost of thesecurities using a method that approximates the level yield method:

 
| ** **                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
| ** **                                    | ** ** | **Book  Value**       | ** ** | **Market  Value** | ** ** | **Weighted  Average  Yield** | ** ** | **Book  Value** | ** ** | **Market  Value** | ** ** | **Weighted  Average  Yield** | ** ** |
| **Available-for-Sale Securities:**       |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and Agency Securities         |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                              |       | 8,002,724             |       | 8,026,354 |   | 5.27 | % | 8,998,769 |   | 8,924,794 |   | 3.59 | % |
| One to Five Years                             |       | 14,094,590            |       | 14,310,616 |   | 5.07 | % | 8,095,296 |   | 8,095,701 |   | 5.03 | % |
| Five to Ten Years                             |       | 2,000,000             |       | 2,004,043 |   | 5.00 | % | 2,000,000 |   | 2,000,000 |   | 5.10 | % |
| Over Ten Years                                |       | —                |       | — |   |   |   | — |   | — |   |   |   |
| Total U.S. Agency                             |       | 24,097,314            |       | 24,341,013 |   | 5.13 | % | 19,094,065 |   | 19,020,495 |   | 4.36 | % |
| **State and Political Subdivisions:**         |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                              |       | 1,061,296             |       | 1,070,745 |   | 6.23 | % | 708,100 |   | 702,151 |   | 4.36 | % |
| One to Five Years                             |       | 3,020,931             |       | 2,998,510 |   | 4.99 | % | 3,859,382 |   | 3,790,725 |   | 5.20 | % |
| Five to Ten Years                             |       | 2,444,999             |       | 2,438,037 |   | 6.26 | % | 237,571 |   | 232,750 |   | 5.74 | % |
| Over Ten Years                                |       | —                |       | — |   |   |   | — |   | — |   |   |   |
| Total State & Political Subdivisions |       | 6,527,226             |       | 6,507,292 |   | 5.67 | % | 4,805,053 |   | 4,725,626 |   | 5.10 | % |
| **Mortgage Backed Securities:**               |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                              |       | 3,430,820             |       | 3,441,374 |   | 4.70 | % | 3,650,978 |   | 3,590,877 |   | 4.26 | % |
| One to Five Years                             |       | 14,849,863            |       | 14,894,034 |   | 4.66 | % | 11,261,147 |   | 11,033,390 |   | 4.20 | % |
| Five to Ten Years                             |       | 3,869,173             |       | 3,907,814 |   | 5.05 | % | 2,711,676 |   | 2,695,483 |   | 4.63 | % |
| Over Ten Years                                |       | 2,998,275             |       | 3,015,629 |   | 4.90 | % | 1,717,020 |   | 1,712,546 |   | 4.71 | % |
| Total Mortgage Backed Securities              |       | 25,148,131            |       | 25,258,851 |   | 4.75 | % | 19,340,821 |   | 19,032,296 |   | 4.32 | % |
| Total Available-for-Sale Securities           |       | $                     | 55,772,671 |   | $ | 56,107,156 |   | 5.02 | % | $ | 43,239,939 |   | $ | 42,778,417 |   | 4.42 | % |
|                                               |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

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***Deposits***

 

Totalaverage deposits increased $3,020,000 or 1.4% during 2007, compared to anincrease of $4,391,000 or 2.1% in 2006 and an increase of $24,109,000 or 13.1%in 2005. Average noninterest-bearing deposits decreased $7,669,000 or 8.6% in2007, compared to an increase of $1,017,000 or 1.2% in 2006 and an increase of$10,896,000 or 14.1% in 2005. Average interest-bearing deposits increased$10,689,000 or 8.7% in 2007 compared to an increase of $3,374,000 or 2.8% in2006 and an increase of $13,213,000, or 12.5% in 2005.

 

Thechart below indicates a shift in lower interest-bearing deposits (NOW, MoneyMarket and Savings) to higher interest rate Time Certificates of Deposit. Thisappears to be a trend that is common throughout the local banking industry andis expected to continue in 2008. This was management’s strategy to retain andattract deposits to offset loss of funds to non-bank competition.

 

Thefollowing table summarizes the distribution of average deposits and the averagerates paid for the period indicated:

 
| ** **                          | ** ** | **December 31**       | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **Average  Balance**       | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Average  Rate** | ** ** |
| ** **                          | ** ** | **(dollars in thousands)** | ** ** |
| Noninterest-bearing demand deposits |       | $                          | 81,714     |   |   |   | $ | 89,383 |   |   |   | $ | 88,366 |   |   |   |
| Money Market Accounts               |       | 24,929                     |       | 2.90 | % | 24,103 |   | 2.09 | % | 30,186 |   | 1.48 | % |
| NOW accounts                        |       | 13,391                     |       | 0.41 | % | 14,696 |   | 0.26 | % | 17,834 |   | 0.24 | % |
| Savings deposits                    |       | 27,076                     |       | 1.07 | % | 28,074 |   | 0.79 | % | 30,560 |   | 0.44 | % |
| Time deposits of $100,000 or more   |       | 39,242                     |       | 4.67 | % | 29,800 |   | 4.21 | % | 19,859 |   | 2.93 | % |
| Other time deposits                 |       | 28,777                     |       | 4.60 | % | 26,053 |   | 4.08 | % | 20,913 |   | 2.94 | % |
| Total deposits                      |       | $                          | 215,129    |   | 1.96 | % | $ | 212,109 |   | 1.45 | % | $ | 207,718 |   | 0.87 | % |

 

Theremaining maturities of the Company’s certificates of deposit in the amount of$100,000 or more as of December 31, 2007 are indicated in the table below.Interest expense on these certificates of deposit totaled $1,834,000 in 2007:

 
| **Deposits Maturing in**    | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| Three months or less                  |       | $                               | 15,967,166 |   |
| Over three months through six months  |       | 10,750,684                      |       |
| Over six months through twelve months |       | 8,958,008                       |       |
| Over twelve months                    |       | 3,153,935                       |       |
| Total                                 |       | $                               | 38,829,793 |   |

 

***Capital***

 

TheBank is required to maintain a minimum leverage-capital ratio of Tier I (asdefined) to total assets based on the Bank’s ratings under the regulatoryrating system. At the end of 2007, all Bank capital ratios were above allcurrent Federal capital guidelines for a “well capitalized” bank. As of December 31,2007 the regulatory total capital to risk-weighted assets ratio was 13.8%compared to 13.1% as of December 31, 2006 and 11.3% as of December 31,2005. The regulatory Tier I capital to risk-weighted assets ratio was 12.3% on December 31,2007 compared to 11.4% on December 31, 2006 and 9.3% as of December 31,2005. The regulatory Tier I capital to average assets ratio was 9.9% as of December 31,2007 compared to 9.1% as of December 31, 2006 and 7.2% as of December 31,2005.

 

TheBank’s Tier I Capital ratio increased 74 basis points and the Bank’s TotalCapital to Risk Weighted Assets ratio increased 67 basis points, due to thestrong earnings of $3.2 million for 2007.

 

***Short-term Borrowings***

 

TheBank has two borrowing arrangements with the Federal Home Loan Bank of SanFrancisco. The first allows the Bank to borrow up to approximately $41 millionagainst which the Bank has pledged approximately $100 million of its realestate secured loans. The second arrangement allows the Bank to borrow up toapproximately $12 million against which the Bank has pledged approximately $12million of its investment securities.

 

Asof December 31, 2007 the Bank has borrowed $5,900,000 under thesearrangements. This amount is due on January 2, 2008 and includes interestat 3.25%. During 2007 the bank had average borrowings outstanding of $1,100,000at an effective rate of 4.55%.

 

19

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***Long-term Borrowings***

 

SantaLucia Bancorp issued $5,155,000 in junior subordinated debt securities (the “debtsecurities”) to the Santa Lucia Bancorp (CA) Capital Trust, a statutory trustcreated under the laws of the State of Delaware. These debt securities aresubordinated to effectively all borrowings of the Company and are due andpayable on July 7, 2036. These debt securities may be redeemed for 105% ofthe principal balance through July 7, 2011 and then at par thereafter.Interest is payable quarterly beginning July 7, 2006 at 1.48% over thequarterly adjustable 3-month LIBOR. Of this $5.2 million, the Companycontributed $3.0 million to the Bank and retained $2.0 million at the Companylevel. The securities do not entitle the holders to voting rights in theCompany but will contain certain restrictive covenants, including restrictionson the payment of dividends to the holders of the Company’s common stock in theevent that interest payments on the trust preferred securities are postponed.The capital received from the trust preferred issuance is designated as Tier 1capital for regulatory purposes.

 

Duringthe third quarter of 2003, the Bank undertook and completed a private placementof subordinated debentures (“notes”) to augment its Tier 2 capital. The totalprincipal amount of the notes issued was $2,000,000. The notes were soldpursuant to an applicable exemption from registration under the Securities Actof 1933 to certain accredited investors, including some of the Company’sdirectors and executive officers. The notes include quarterly payment ofinterest at prime plus 1.5% and quarterly principal installments ofapproximately $166,666 commencing on September 30, 2008 until paid in fullon June 30, 2011.

 

***Interest Rate Sensitivity and Liquidity***

 

TheCompany closely follows the maturities and repricing opportunities of bothassets and liabilities to reduce gaps in interest spreads. An analysis isperformed quarterly to determine the various interest sensitivity gaps thatexist. In general, the Company is asset sensitive, meaning that when interestrates change, assets (loans) will reprice faster than short-term liabilities(deposits). Therefore, higher interest rates improve short-term profits andlower rates decrease short-term profits. Currently, management’s analysisindicates that the Company’s asset sensitive position would not materiallyaffect income for interest rate changes of one percent or less in one year.

 

Thefollowing table presents the Bank’s Rate Sensitivity Gap Report as of December 31,2007.

 
| ** **                             | ** ** | **0-3 months**                  | ** ** | **3-12 months** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Beyond** | ** ** | **Non-Rate  Sensitive** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|------------|------------|-------------------------|------------|-----------|------------|
| ** **                             | ** ** | **(dollars in thousands)** | ** ** | ** **           |
| **Interest sensitive assets:**         |       |                                 |       |                 |       |               |       |               |       |       |       |                    |       |      |       |
| Investment securities                  |       | $                                    | 5,183      |                 | $          | 3,857              |       | $                  | 17,594     |       | $          | 21,189                  |       | $         | 9,405      |   | $ | — |   | $ | 57,228 |   |
| Loan receivables                       |       | 90,316                               |       | 27,823               |       | 32,983             |       | 14,578             |       | 3,268      |       | —                  |       | 168,968   |       |
| Federal funds sold                     |       | —                               |       | —               |       | —             |       | —             |       | —     |       | —                  |       | —    |       |
| Non-earning assets                     |       | —                               |       | —               |       | —             |       | —             |       | —     |       | 21,847                  |       | 21,847    |       |
| **Total assets**                       |       | $                                    | 95,499     |                 | $          | 31,680             |       | $                  | 50,577     |       | $          | 35,767                  |       | $         | 12,673     |   | $ | 21,847 |   | $ | 248,043 |   |
| **Interest sensitive liabilities:**    |       |                                 |       |                 |       |               |       |               |       |       |       |                    |       |      |       |
| Demand deposits                        |       | $                                    | —     |                 | $          | —             |       | $                  | —     |       | $          | —                  |       | $         | —     |   | $ | 76,829 |   | $ | 76,829 |   |
| NOW accounts                           |       | 349                                  |       | 1,048                |       | 2,796              |       | 2,795              |       | 5,008      |       | —                  |       | 11,996    |       |
| Money Market Accounts                  |       | 2,522                                |       | 7,565                |       | 16,811             |       | —             |       | —     |       | —                  |       | 26,898    |       |
| Savings deposits                       |       | 930                                  |       | 2,789                |       | 7,436              |       | 7,436              |       | 7,746      |       | —                  |       | 26,337    |       |
| Time deposits                          |       | 26,851                               |       | 37,950               |       | 6,189              |       | 705                |       | 149        |       | —                  |       | 71,844    |       |
| Total saving and time deposits         |       | $                                    | 30,652     |                 | $          | 49,352             |       | $                  | 33,232     |       | $          | 10,936                  |       | $         | 12,903     |   | $ | 76,829 |   | $ | 213,904 |   |
| Short-term borrowing                   |       | 5,900                                |       | —               |       | —             |       | —             |       | —     |       | —                  |       | 5,900     |       |
| Long-term borrowing                    |       | 2,000                                |       | —               |       | —             |       | —             |       | —     |       | —                  |       | 2,000     |       |
| Non-funding liabilities and capital    |       | —                               |       | —               |       | —             |       | —             |       | —     |       | 26,239                  |       | 26,239    |       |
| Total liabilities and capital          |       | $                                    | 38,552     |                 | $          | 49,352             |       | $                  | 33,232     |       | $          | 10,936                  |       | $         | 12,903     |   | $ | 103,068 |   | $ | 248,043 |   |
| Interest rate sensitivity gap          |       | $                                    | 56,947     |                 | $          | (17,672            | )          | $                  | 17,345     |       | $          | 24,831                  |       | $         | (230       | ) |   |   |   |   |
| **Risk Indicators from GAP Analysis:** |       |                                 |       |                 |       |               |       |               |       |       |       |                    |       |      |       |
| Cumulative GAP                         |       | $                                    | 56,947     |                 | $          | 39,275             |       | $                  | 56,620     |       | $          | 81,451                  |       | $         | 81,221     |   |   |   |   |   |
| Cumulative GAP (% of total assets)     |       | 22.96                                | %          | 15.83                | %          | 22.83              | %          | 32.84              | %          | 32.74      | %          |                    |       |      |       |

 

20

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Theasset liability reports indicate that the Bank has an actual dollar riskexposure of $574,000 if interest rates fall 100 basis points. This represents a-4.5% risk to interest income.

 
| ** **          | ** ** | **Interest Income and Expense Under Rate Shock** | ** ** |
|---------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **          | ** ** | **-200bp**                                                                     | ** ** | **-100bp** | ** ** | **0bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** |
| Net Interest Income |       |                                                                           |       |   |   |   |   |   |   |   |   |
| Earnings at Risk    |       | $                                                                              | (1,088     | ) | $ | (574 | ) | $ | 0 |   | $ | 471 |   | $ | 931 |   |
| Percent of Risk     |       | -8.5                                                                           | %          | -4.5 | % | 0.00 | % | 3.7 | % | 7.3 | % |
| Equity Ratio        |       | 14.3                                                                           | %          | 15.1 | % | 16.0 | % | 16.7 | % | 17.3 | % |
|                     |            |                                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

TheCompany closely monitors its liquidity so that the cash requirements for loansand deposit withdrawals are met in an orderly manner. Management monitorsliquidity in relation to trends of loans and deposits for short term andlong-term requirements. Liquidity sources are cash, deposits with other banks,overnight Federal Fund investments, investment securities and the ability tosell loans. As of December 31, 2007, the Bank’s liquidity ratio was 25.0%compared to 24.5% at December 31, 2006 and 27.7% at December 31,2005. The 25.0% liquidity ratio at December 31, 2007 is well within theCompany’s policy limit.

 

**Critical Accounting Policies**

 

Thisdiscussion should be read in conjunction with the consolidated financialstatements of the Company, including the notes thereto.

 

Ouraccounting policies are integral to understanding the results reported. Ourmost complex accounting policies require management’s judgment to ascertain thevaluation of assets, liabilities, commitments and contingencies. We haveestablished detailed policies and control procedures that are intended toensure valuation methods are well controlled and applied consistently fromperiod to period. In addition, the policies and procedures are intended toensure that the process for changing methodologies occurs in an appropriatemanner. The following is a brief description of our current accounting policiesinvolving significant management valuation judgments.

 

***Use of Estimates in the Preparation ofFinancial Statements***

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of certain assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of certain revenues andexpenses during the reporting period. Actual results could differ from thoseestimates.

 

***Allowance for Loan Losses***

 

Theallowance for loan losses represents management’s best estimate of lossesinherent in the existing loan portfolio. The allowance for loan losses isincreased by the provision for loan losses charged to expense and reduced byloans charged off, net of recoveries. The provision for loan losses isdetermined based on management’s assessment of several factors: reviews andevaluation of specific loans, changes in the nature and volume of the loanportfolio, current economic conditions and the related impact on specificborrowers and industry groups, historical loan loss experiences, the level ofclassified and nonperforming loans and the results of regulatory examinations.

 

Loansare considered impaired if, based on current information and events, it isprobable that we will be unable to collect the scheduled payments of principalor interest when due according to the contractual terms of the loan agreement.The measurement of impaired loans is generally based on the present value ofexpected future cash flows discounted at the historical effective interest ratestipulated in the loan agreement, except that all collateral-dependent loansare measured for impairment based on the fair value of the collateral. Inmeasuring the fair value of the collateral, management uses assumptions andmethodologies consistent with those that would be utilized by unrelated thirdparties.

 

Changesin the financial condition of individual borrowers, in economic conditions, inhistorical loss experience and in the condition of the various markets in whichcollateral may be sold may all affect the required level of the allowance forloan losses and the associated provision for loan losses.

 

***Available-for-Sale Securities***

 

Thefair value of most securities classified as available-for-sale are based onquoted market prices. If quoted market prices are not available, fair valuesare extrapolated from the quoted prices of similar instruments.

 

21

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***Deferred Tax Assets***

 

Weuse an estimate of future earnings to support our position that the benefit ofour deferred tax assets will be realized. If future income should provenon-existent or less than the amount of the deferred tax assets within the taxyears to which they may be applied, the asset may not be realized and our netincome will be reduced.

 

***Deferred Compensation Liabilities***

 

Managementestimates the life expectancy of the participants and the accrual methods usedto accrue compensation expense. If individuals outlive their assumedexpectancies the amounts accrued for the payment of their benefits will beinadequate and additional changes to income will be required.

 

**Availability of Form 10-KSB**

 

If any shareholder would like a copy of the Company’sAnnual Report on Form 10-KSB for the fiscal year ending December 31,2007, they can be obtained without charge by sending a written request to JohnC. Hansen, Executive Vice President and Chief Financial Officer, P. O. Box6047, Atascadero, California 93423.

 

22

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** **

 

**Report of Independent Registered Public AccountingFirm**

 

TheBoard of Directors and Shareholders

SantaLucia Bancorp and Subsidiary

 

Wehave audited the consolidated balance sheets of Santa Lucia Bancorp andSubsidiary (the Company) as of December 31, 2007 and 2006, and the relatedconsolidated statements of earnings, cash flows and shareholders’ equity forthe three years ended December 31, 2007. These financial statements arethe responsibility of the Company’s management. Our responsibility is to expressan opinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Santa Lucia Bancorp and Subsidiaryas of December 31, 2007 and 2006, and the results of its operations andcash flows for the three years ended December 31, 2007, in conformity withaccounting principles generally accepted in the United States of America.

 

 

LagunaHills, California

January 16,2008

 

25231 Paseo De Alicia, Suite 100   Laguna Hills, CA 92653   Tel:949.768.0833   Fax: 949.768.8408   www.vtdcpa.com

 

**FRESNO  ****·  LAGUNAHILLS  ****·  PALOALTO  ****·  PLEASANTON  ****·****  RANCHO CUCAMONGA**

 

23

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**Santa Lucia Bancorp and SubsidiaryConsolidated Balance Sheets**

 

*December 31, 2007 and 2006*

 
| ** **                                                      | ** ** | **2007**    | ** **  | **2006**    | ** ** |
|-----------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                      | ** ** | ** **  | ** **  | ** **  | ** ** |
| Cash and due from banks                                         |       | $           | 7,399,412   |        | $          | 10,139,526 |   |
| Federal funds sold                                              |       | —      |        | —      |       |
| TOTAL CASH  AND CASH EQUIVALENTS                                |       | 7,399,412   |        | 10,139,526  |       |
| Securities available for sale                                   |       | 56,107,156  |        | 42,778,417  |       |
| Loans, net                                                      |       | 166,619,494 |        | 169,680,473 |       |
| Premises and equipment, net                                     |       | 8,868,507   |        | 9,258,207   |       |
| Deferred income tax assets                                      |       | 814,000     |        | 941,000     |       |
| Cash surrender value of life insurance                          |       | 5,005,357   |        | 3,336,076   |       |
| Federal Reserve Bank and Federal Home Loan  Bank stock, at cost |       | 1,453,850   |        | 1,397,700   |       |
| Accrued interest and other assets                               |       | 2,371,999   |        | 3,206,685   |       |
| TOTAL ASSETS                                                    |       | $           | 248,639,775 |        | $          | 240,738,084 |   |

 
| ** **                                                                                                                                                                          | ** ** | **2007**    | ** **  | **2006**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **LIABILITIES &  SHAREHOLDERS’ EQUITY**                                                                                                                               |       |        |        |        |       |
| Deposits                                                                                                                                                                            |       |        |        |        |       |
| Noninterest-bearing demand                                                                                                                                                          |       | $           | 77,100,561  |        | $          | 86,252,426 |   |
| Interest-bearing demand and NOW accounts                                                                                                                                            |       | 11,996,402  |        | 12,968,951  |       |
| Money market                                                                                                                                                                        |       | 25,440,394  |        | 20,465,756  |       |
| Savings                                                                                                                                                                             |       | 26,336,827  |        | 27,383,605  |       |
| Time certificates of deposit of $100,000 or  more                                                                                                                                   |       | 38,829,793  |        | 37,226,189  |       |
| Other time certificates                                                                                                                                                             |       | 33,014,401  |        | 28,691,525  |       |
|                                                                                                                                                                                |       |        |        |        |       |
| TOTAL DEPOSITS                                                                                                                                                                      |       | 212,718,378 |        | 212,988,452 |       |
|                                                                                                                                                                                |       |        |        |        |       |
| Short-term borrowings                                                                                                                                                               |       | 5,900,000   |        | —      |       |
| Long-term borrowings                                                                                                                                                                |       | 7,155,000   |        | 7,155,000   |       |
| Accrued interest and other liabilities                                                                                                                                              |       | 1,677,551   |        | 1,457,716   |       |
|                                                                                                                                                                                |       |        |        |        |       |
| TOTAL LIABILITIES                                                                                                                                                                   |       | 227,450,929 |        | 221,601,168 |       |
|                                                                                                                                                                                |       |        |        |        |       |
| *Commitments and contingencies**(Note M)*                                                                                                                                           | * *   | *—*    | * *    | *_*         | * *   |
| Shareholders’ equity                                                                                                                                                           |       |        |        |        |       |
| Common stock – no par value; 20,000,000  shares authorized; issued and outstanding: 1,924,873 shares at  December 31, 2007 and 1,928,097 shares at December 31, 2006 |       | 9,851,392   |        | 9,566,563   |       |
| Additional paid-in capital                                                                                                                                                          |       | 358,203     |        | 216,558     |       |
| Retained earnings                                                                                                                                                                   |       | 10,782,741  |        | 9,624,939   |       |
| Accumulated other comprehensive income-net  unrealized losses on available-for-sale securities, net of taxes of $137,975  in 2007 and $190,378 in 2006                              |       | 196,510     |        | (271,144    | )          |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                                                     |       | 21,188,846  |        | 19,136,916  |       |
| TOTAL LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                    |       | $           | 248,639,775 |        | $          | 240,738,084 |   |

* *

*The accompanying notes are an integral part of thesefinancial statements.*

 

24

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**Santa Lucia Bancorp and Subsidiary**

**Consolidated Statements of Earnings**

** **

*Years Ended December 31, 2007, 2006 and 2005*

 
| ** **                                           | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Interest income                                 |       |       |       |       |       |       |       |
| Interest and fees on loans                           |       | $          | 15,030,928 |       | $          | 15,397,450 |       | $ | 11,747,437 |   |
| Federal funds sold                                   |       | 249,434    |       | 145,314    |       | 173,515    |       |
| Investment securities – taxable                 |       | 2,232,966  |       | 1,352,675  |       | 1,476,915  |       |
| Investment securities – nontaxable              |       | 205,285    |       | 131,233    |       | 148,368    |       |
|                                                 |       | 17,718,613 |       | 17,026,672 |       | 13,546,235 |       |
| Interest expense                                     |       |       |       |       |       |       |       |
| Time certificates of deposit of $100,000 or  more    |       | 1,833,831  |       | 1,254,951  |       | 581,566    |       |
| Other deposits                                       |       | 2,389,580  |       | 1,824,577  |       | 1,234,377  |       |
| Long-term debt and other borrowings                  |       | 600,727    |       | 497,610    |       | 167,979    |       |
|                                                 |       | 4,824,138  |       | 3,577,138  |       | 1,983,922  |       |
| Net interest income                                  |       | 12,894,475 |       | 13,449,534 |       | 11,562,313 |       |
| Provision for loan losses                            |       | —     |       | 240,000    |       | 300,000    |       |
| Net interest income after provision for  loan losses |       | 12,894,475 |       | 13,209,534 |       | 11,262,313 |       |
|                                                 |       |       |       |       |       |       |       |
| Noninterest income                                   |       |       |       |       |       |       |       |
| Service charges and fees                             |       | 583,445    |       | 615,917    |       | 602,809    |       |
| Dividends on cash surrender value of life  insurance |       | 222,071    |       | 138,181    |       | 132,319    |       |
| Mortgage fees                                        |       | —     |       | 48,487     |       | 94,972     |       |
| Gain (loss) on sale of investment  securities        |       | —     |       | —     |       | (5,877     | )          |
| Other income                                         |       | 265,798    |       | 207,676    |       | 227,727    |       |
|                                                 |       | 1,071,314  |       | 1,010,261  |       | 1,051,950  |       |
| Noninterest expense                                  |       |       |       |       |       |       |       |
| Salaries and employee benefits                       |       | 5,259,456  |       | 4,743,094  |       | 4,241,897  |       |
| Occupancy                                            |       | 627,685    |       | 664,482    |       | 565,467    |       |
| Equipment                                            |       | 666,003    |       | 691,028    |       | 583,772    |       |
| Professional services                                |       | 426,667    |       | 538,282    |       | 465,661    |       |
| Data processing                                      |       | 488,636    |       | 468,211    |       | 439,591    |       |
| Office expenses                                      |       | 362,057    |       | 359,588    |       | 374,478    |       |
| Marketing                                            |       | 422,914    |       | 407,638    |       | 397,907    |       |
| Regulatory assessments                               |       | 64,436     |       | 63,851     |       | 65,793     |       |
| Directors’ fees and expenses                    |       | 328,801    |       | 263,444    |       | 261,338    |       |
| Messenger and courier expenses                       |       | 156,870    |       | 148,335    |       | 143,834    |       |
| Other                                                |       | 225,445    |       | 241,571    |       | 268,705    |       |
|                                                 |       | 9,028,970  |       | 8,589,524  |       | 7,808,443  |       |
| Earnings before income taxes                         |       | 4,936,819  |       | 5,630,271  |       | 4,505,820  |       |
|                                                 |       |       |       |       |       |       |       |
| Income taxes                                         |       | 1,934,000  |       | 2,242,000  |       | 1,759,000  |       |
| Net earnings                                         |       | $          | 3,002,819  |       | $          | 3,388,271  |       | $ | 2,746,820 |   |
|                                                 |       |       |       |       |       |       |       |
| Per share data:                                      |       |       |       |       |       |       |       |
| Net earnings – basic                            |       | $          | 1.55       |       | $          | 1.77       |       | $ | 1.46 |   |
| Net earnings – diluted                          |       | $          | 1.51       |       | $          | 1.68       |       | $ | 1.38 |   |

 

*The accompanying notes are an integral part of thesefinancial statements.*

 

25

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**Santa Lucia Bancorp and SubsidiaryConsolidated Statements of Cash Flows**

 

*YearsEnded December 31, 2007, 2006 and 2005*

 
| ** **                                                                           | ** ** | **2007**    | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Cash flows from operating activities:                                                |       |        |       |        |       |        |       |
| Net earnings                                                                         |       | $           | 3,002,819  |        | $          | 3,388,271   |       | $ | 2,746,820 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities: |       |        |       |        |       |        |       |
| Depreciation and amortization                                                        |       | 652,290     |       | 669,159     |       | 556,907     |       |
| Provision for loan losses                                                            |       | —      |       | 240,000     |       | 300,000     |       |
| Amortization of investment securities                                                |       | —      |       | 5,450       |       | 32,240      |       |
| Loss (gain) on sale of investment  securities                                        |       | —      |       | —      |       | 5,877       |       |
| Deferred income taxes                                                                |       | (201,000    | )          | (147,000    | )          | (25,000     | )          |
| Dividends in cash value of life insurance                                            |       | (222,071    | )          | (138,181    | )          | (132,319    | )          |
| Other items, net                                                                     |       | 1,101,676   |       | (1,131,715  | )          | (432,992    | )          |
| Net cash provided by operating activities                                            |       | 4,333,714   |       | 2,885,984   |       | 3,051,533   |       |
|                                                                                 |       |        |       |        |       |        |       |
| Cash flows from investing activities:                                                |       |        |       |        |       |        |       |
| Proceeds from maturities of investment  securities                                   |       | 14,202,010  |       | 18,962,594  |       | 11,007,571  |       |
| Proceeds from sale of investment securities                                          |       | —      |       | —      |       | 6,016,550   |       |
| Purchases of investment securities                                                   |       | (26,658,965 | )          | (19,391,969 | )          | (2,001,378  | )          |
| Purchase of Federal Reserve Bank and  Federal Home Loan Bank stock                   |       | —      |       | (155,550    | )          | (194,450    | )          |
| Net change in loans                                                                  |       | 3,060,979   |       | (17,357,365 | )          | (27,277,292 | )          |
| Purchases of bank premises and equipment                                             |       | (262,590    | )          | (466,782    | )          | (347,532    | )          |
| Proceeds from sale of bank premises and  equipment                                   |       |        |       | —      |       | —      |       |
| Proceeds from (purchase of) life insurance                                           |       | (1,485,000  | )          | —      |       | 132,255     |       |
| Proceeds from sale of other real estate  owned                                       |       | —      |       | —      |       | —      |       |
| Net cash used in investing activities                                                |       | (11,143,566 | )          | (18,409,072 | )          | (12,664,276 | )          |
|                                                                                 |       |        |       |        |       |        |       |
| Cash flows from financing activities:                                                |       |        |       |        |       |        |       |
| Net change in deposits                                                               |       | (270,074    | )          | 6,109,373   |       | 12,011,229  |       |
| Proceeds and tax benefit from exercise of  stock options                             |       | 164,275     |       | 372,781     |       | 416,562     |       |
| Stock repurchases                                                                    |       | (853,351    | )          | —      |       | —      |       |
| Net (repayments) proceeds from borrowings                                            |       | 5,900,000   |       | (345,000    | )          | 5,500,000   |       |
| Cash dividends paid                                                                  |       | (871,112    | )          | (767,587    | )          | (729,550    | )          |
| Net cash provided by financing activities                                            |       | 4,069,738   |       | 5,369,567   |       | 17,198,241  |       |
| Net increase (decrease) in cash and cash  equivalents                                |       | (2,740,114  | )          | (10,153,521 | )          | 7,585,498   |       |
|                                                                                 |       |        |       |        |       |        |       |
| Cash and cash equivalents at beginning of  year                                      |       | 10,139,526  |       | 20,293,047  |       | 12,707,549  |       |
| Cash and cash equivalents at end of year                                             |       | $           | 7,399,412  |        | $          | 10,139,526  |       | $ | 20,293,047 |   |
|                                                                                 |       |        |       |        |       |        |       |   |   |   |
| Supplemental disclosure of cash flow  information:                                   |       |        |       |        |       |        |       |
| Interest paid                                                                        |       | $           | 4,824,138  |        | $          | 3,415,383   |       | $ | 1,957,610 |   |
| Income taxes paid                                                                    |       | $           | 1,865,000  |        | $          | 2,415,000   |       | $ | 1,720,000 |   |
| Cashless exercise of stock options                                                   |       | $           | 120,554    |        | $          | 48,034      |       | $ | 32,515 |   |

 

*The accompanying notes are an integral part of these financialstatements.*

 

26

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**Santa Lucia Bancorp and SubsidiaryConsolidated Statement of Shareholders’ Equity**

 

*Years Ended December 31, 2007, 2006 and 2005*

 
| ** **                                                                                      | ** ** | ** **                | ** ** | **Common Stock**   | ** ** | **Additional** | ** ** | ** **           | ** ** | **Accumulated  Other** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|----------------|------------|----------------------|------------|------------------------|------------|
| ** **                                                                                      | ** ** | **Comprehensive  Income** | ** ** | **Shares  Outstanding** | ** ** | **Amount**     | ** ** | **Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Comprehensive  Income** | ** ** |
| **Balance at January 1, 2005**                                                             |       |                      |       | $                       | 1,861,764  |           | $          | 8,849,671            |       | $                      | —     |   | $ | 5,067,534 |   | $ | (110,291 | ) |
| ** **                                                                                      |       |                      |       |                    |       |           |       |                 |       |                   |       |   |   |   |   |   |   |   |
| Cash dividends – $0.3875 per share                                                         |       |                      |       |                    |       |           |       |                 |       | (729,550               | )          |   |   |
| Exercise of stock options, including the  realization of tax benefits of $226,000               |       |                      |       | 37,779                  |       | 449,077        |       |                 |       | (32,515                | )          |   |   |
| **Comprehensive Income:**                                                                       | ** ** | ** **                |       |                    |       |           |       |                 |       |                   |       |   |   |
| Net earnings for the year                                                                       |       | $                         | 2,746,820  |                    |       |           |       |                 |       |                   | 2,746,820  |   |   |   |
| Change in unrealized loss on  available-for-sale securities, net of taxes of $265,409           |       | (378,040                  | )          |                    |       |           |       |                 |       |                   |       | (378,040 | ) |
| Less reclassification adjustments for gains  included in the net income, net of taxes or $2,410 |       | 3,467                     |       |                    |       |           |       |                 |       |                   |       | 3,467 |   |
| **Total Comprehensive Income**                                                                  |       | $                         | 2,372,247  |                    |       |           |       |                 |       |                   |       |   |   |   |
| ** **                                                                                      |       |                      |       |                    |       |           |       |                 |       |                   |       |   |   |   |
| **Balance at December 31, 2005**                                                           |       |                      |       | 1,899,543               |       | 9,298,748      |       | —               |       | 7,052,289              |       | (484,864 | ) |
| ** **                                                                                      |       |                      |       |                    |       |           |       |                 |       |                   |       |   |   |
| Cash dividends – $0.40 per share                                                           |       |                      |       |                    |       |           |       |                 |       | (767,587               | )          |   |   |
| Exercise of stock options, including the  realization of tax benefits of $153,000               |       |                      |       | 28,554                  |       | 267,815        |       | 153,000              |       | (48,034                | )          |   |   |
| Stock Option Compensation Expense                                                               |       |                      |       |                    |       |           |       | 63,558               |       |                   |       |   |   |
| **Comprehensive Income:**                                                                       | ** ** | ** **                |       |                    |       |           |       |                 |       |                   |       |   |   |
| Net earnings for the year                                                                       |       | $                         | 3,388,271  |                    |       |           |       |                 |       |                   | 3,388,271  |   |   |   |
| Change in unrealized loss on  available-for-sale securities, net of taxes or $150,059           |       | 213,720                   |       |                    |       |           |       |                 |       |                   |       | 213,720 |   |
| **Total Comprehensive Income**                                                                  |       | $                         | 3,601,991  |                    |       |           |       |                 |       |                   |       |   |   |   |
| ** **                                                                                      |       |                      |       |                    |       |           |       |                 |       |                   |       |   |   |   |
| **Balance at December 31, 2006**                                                           |       |                      |       | 1,928,097               |       | $              | 9,566,563  |                 | 216,558    |                   | 9,624,939  |   | (271,144 | ) |
| ** **                                                                                      |       |                      |       |                    |       |           |       |                 |       |                   |       |   |   |   |
| Cash dividends – $0.45 per share                                                           |       |                      |       |                    |       |           |       |                 |       | (871,112               | )          |   |   |
| Exercise of stock options, including the  realization of tax benefits of $19,000                |       |                      |       | 29,247                  |       | 284,829        |       | 19,000               |       | (120,554               | )          |   |   |
| Repurchase and retirement of stock                                                              |       |                      |       | (32,471                 | )          |           |       |                 |       | (853,351               | )          |   |   |
| Stock Option Compensation Expense                                                               |       |                      |       |                    |       |           |       | 122,645              |       |                   |       |   |   |
| **Comprehensive Income:**                                                                       | ** ** | ** **                |       |                    |       |           |       |                 |       |                   |       |   |   |
| Net earnings for the year                                                                       |       | $                         | 3,002,819  |                    |       |           |       |                 |       |                   | 3,002,819  |   |   |   |
| Change in unrealized loss on available-for-sale  securities, net of taxes of $328,353           |       | 467,654                   |       |                    |       |           |       |                 |       |                   |       | 467,654 |   |
| **Total Comprehensive Income**                                                                  |       | $                         | 3,470,473  |                    |       |           |       |                 |       |                   |       |   |   |   |
| ** **                                                                                      |       |                      |       |                    |       |           |       |                 |       |                   |       |   |   |   |
| **Balance at December 31, 2007**                                                           |       |                      |       | 1,924,873               |       | $              | 9,851,392  |                 | $          | 358,203                |       | $ | 10,782,741 |   | $ | 196,510 |   |

 

*The accompanying notes are an integral partof these financial statements.*

 

27

----

 

**Santa Lucia Bancorp and Subsidiary**

 

**NOTES TO FINANCIAL STATEMENTS**

 

*December 31, 2007, 2006 and 2005*

 

**NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES –**The consolidated financial statements includethe accounts of Santa Lucia Bancorp and its wholly owned subsidiary Santa LuciaBank (the “Bank”), collectively referred to herein as the “Company.” Allsignificant intercompany transactions have been eliminated.

 

Theaccounting and reporting policies of the Company are in accordance withaccounting principles generally accepted in the Unites States of America andprevailing practices within the banking industry. A summary of the significantaccounting policies consistently applied in preparation of the accompanyingfinancial statements follows:

 

**Nature of Operations –**The Company has been organized as a singleoperating segment and maintains four branches in the San Luis Obispo andnorthern Santa Barbara Counties. The Company’s primary source of revenue isinterest income from loans to customers. The Company’s customers arepredominantly small and middle-market businesses and individuals.

 

**Use of Estimates in the Preparation of Financial Statements –**The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andat the date of the financial statements and the reported amounts of certainrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

**Presentation of Cash Flows –**For the purposes of reporting cash flows, cashand cash equivalents includes cash, noninterest-earning deposits and federalfunds sold. Generally, federal funds are sold for one day periods.

 

**Cash and Due From Banks –**Banking regulations require that all banksmaintain a percentage of their deposits as reserves in cash or on deposit withthe Federal Reserve Bank. The Bank was in compliance with the reserverequirements as of December 31, 2007 and 2006.

 

TheCompany periodically maintains amounts due from banks that exceed federallyinsured limits. The Company has not experienced any losses in such accounts.

 

**Investment Securities –**Bonds, notes, and debentures for which theCompany has the positive intent and ability to hold to maturity are reported atcost, adjusted for premiums and discounts that are recognized in interestincome using the interest method over the period to maturity.

 

Investmentsnot classified as trading securities nor as held-to-maturity securities areclassified as available-for-sale securities and recorded at fair value.Unrealized gains or losses on available-for-sale securities are excluded fromnet income and reported as an amount net of taxes as a separate component ofother comprehensive income included in shareholders’ equity. Premiums ordiscounts on held-to-maturity and available-for-sale securities are amortizedor accreted into income using the interest method. Realized gains or losses onsales of held-tomaturity or available-for-sale securities are recorded usingthe specific identification method.

 

Declinesin the fair value of individual held-to-maturity and availablefor-salesecurities below their cost that are other-than-temporary result in write-downsof the individual securities to their fair value. The related write-downs areincluded in earnings as realized losses. In estimating other-than-temporaryimpairment losses, management considers the length of time and the extent towhich the fair value has been less than cost, the financial condition andnear-term prospects of the issuer, and the intent and ability of the Company toretain its investment in the issuer for a period of time sufficient to allowfor any anticipated recovery in fair value.

 

**Provision and Allowance for Loan Losses –**The determination of the balance in theallowance for loan losses is based on an analysis of the loan portfolio andreflects an amount which, in management’s judgment, is adequate to provide forpotential credit losses after giving consideration to the character of the loanportfolio, current economic conditions, past credit loss experience and suchother factors as deserve current recognition in estimating credit losses. Theprovision for loan losses is charged to expenses.

 

TheCompany considers a loan to be impaired when it is probable that the Companywill be unable to collect all amounts due (principal and interest) according tothe contractual terms of the loan agreement. Measurement of impairment is basedon the expected future cash flows of an impaired loan, which are to bediscounted at the loan’s effective interest rate, or measured by reference toan observable market value, if one exists, or the fair value of the collateralfor a collateral-dependent loan. The Company selects the measurement method ona loan-by-loan basis except that collateral-dependent loans for whichforeclosure is probable are measured at the fair value of the collateral. TheCompany recognizes interest income on impaired loans based on its existingmethods of recognizing interest income on nonaccrual loans.

 

**Interest and Fees on Loans –**Interest income is accrued daily as earned onall loans. Loans on which the accrual of interest has been discontinued aredesignated as nonaccrual loans. The accrual of interest on loans isdiscontinued when principal or interest is past due 90 days based oncontractual terms of the loan or when, in the opinion of management, there isreasonable doubt as to collectibility. When loans are placed on nonaccrualstatus, all interest previously accrued but not collected is reversed againstcurrent period interest income. Income on nonaccrual loans is subsequentlyrecognized only to the extent that cash is received and the loan’s principalbalance is deemed collectible. Interest accruals are resumed on such loans onlywhen they are brought current with respect to interest and principal and when,in the judgment of management, the loans are estimated to be fully collectibleas to all principal and interest. Loan origination fees and certain directorigination costs are capitalized and recognized as an adjustment of the yieldof the related loan.

 

**Premises and Equipment –**Land is carried at cost. Premises andequipment are carried at cost less accumulated depreciation and amortization.Depreciation is computed using the straight-line method over the estimateduseful lives, which ranges from three to ten years for furniture and fixturesand forty years for buildings. Expenditures for betterments or major repairsare capitalized and those for ordinary repairs and maintenance are charged tooperations as incurred.

** **

**Other Real Estate Owned –**Other real estate owned represents real estateacquired through foreclosure and is carried at the lower of the recorded investmentin the property or its fair value. Prior to foreclosure, the value of theunderlying loan is written down to the fair market value of the real estate tobe acquired by a charge to the allowance for credit losses, if necessary. Anysubsequent write-downs are charged against operating expenses. Operatingexpenses of such properties, net of related income, are included in otherexpenses.

 

28

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**Income Taxes –**Deferred income taxes are computed using the asset and liability method,which recognizes a liability or asset representing the tax effects, based oncurrent tax law, of future deductible or taxable amounts attributable to eventsthat have been recognized in the financial statements. A valuation allowance isestablished to reduce the deferred tax asset to the level at which it is “morelikely than not” that the tax asset or benefits will be realized. Realizationof tax benefits of deductible temporary differences and operating losscarryforwards depends on having sufficient taxable income of an appropriatecharacter within the carryforward periods.

 

TheCompany has adopted Financial Accounting Standards Interpretation No. 48 (“Fin48”), Accounting for Uncertainty in Income Taxes. Fin 48 clarifies theaccounting for uncertainty in tax positions taken or expected to be taken on atax return and provides that the tax effects from an uncertain tax position canbe recognized in the financial statements only if, based on its merits, theposition is more likely than not to be sustained on audit by the taxingauthorities. Management believes that all tax positions taken to date arehighly certain and, accordingly, no accounting adjustment has been made to thefinancial statements. Interest and penalties related to uncertain tax positionsare recorded as part of income tax expense.

 

**Advertising Costs –**The Company expenses the costs of advertising in the period incurred.

 

**Comprehensive Income –**Beginning in 1998, the Company adoptedStatement of Financial Accounting Standard (“SFAS”) No. 130, *“Reporting ComprehensiveIncome*” (SFAS No. 130),which requires the disclosure of comprehensive income and its components.Changes in unrealized gain or loss on available-for-sale securities net ofincome taxes is the only component of accumulated other comprehensive incomefor the Company.

 

**Financial Instruments –**In the ordinary course of business, theCompany has entered into off-balance sheet financial instruments consisting ofcommitments to extend credit, commercial letters of credit, and standby lettersof credit as described in Note M. Such financial instruments are recorded inthe financial statements when they are funded or related fees are incurred orreceived.

 

**Earnings Per Shares (EPS) –**Basic EPS excludes dilution and is computed bydividing income available to common stockholders by the weighted-average numberof common shares outstanding for the period. Diluted EPS reflects the potentialdilution that could occur if securities or other contracts to issue common stockwere exercised or converted into common stock or resulted in the issuance ofcommon stock that then shared in the earnings of the entity.

 

**Stock-Based Compensation –**The Company has adopted SFAS No. 123(R) “Shared-BasedPayment.” This Statement generally requires entities to recognize the cost ofemployee services received in exchange for awards of stock options, or otherequity instruments, based on the grant-date fair value of those awards. Thiscost is recognized over the period which an employee is required to provideservices in exchange for the award, generally the vesting period.

 

**Change in Accounting Principle –**The Company adopted SFAS No. 123(R) on January 1, 2006 using the “modified prospective method.” Underthis method compensation expense is recognized using the fair-value method forall new stock option awards as well as any existing awards that are modified,repurchased or cancelled after January 1, 2006 and prior periods are notrestated. In addition, the unvested portion of previously awarded optionsoutstanding as of January 1, 2006 will also be recognized as expense overthe requisite service period based on the fair value of those options aspreviously calculated at the grant date under the pro-forma disclosures of SFASNo. 123. The fair value of each grant is estimated using the Black-Scholesoption pricing model. During 2007 and 2006 the Company recognized pre-taxstock-based compensation expense of $122,645 and $63,558, respectively, as aresult of adopting SFAS No. 123 (R).

 

Priorto the adoption of SFAS No. 123 (R), the Company accounted for stock-basedawards using the intrinsic value method prescribed in Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,”and related interpretations. Accordingly, compensation cost for stock optionswas measured as the excess, if any, of the quoted market price of the Company’sstock at the date of the grant over the amount an employee must pay to acquirethe stock. All of the Company’s stock option grants included exercise pricesequal to the Company’s current market price per share; accordingly, nocompensation expense was reported using the intrinsic value method of APBOpinion No. 25.

 

Hadcompensation cost for the Company’s stock option plans been determined based onthe fair value at the grant dates for awards under those plans consistent withthe method of SFAS No. 123, the Company’s net income and income per sharefor 2005 would have changed to the pro forma amounts indicated below:

 
| ** **                                                                                      | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|------------|
| Net income:                                                                                     |       |     |       |
| As reported                                                                                     |       | $        | 2,746,820  |   |
| Stock-Based Compensation using the Intrinsic  Value Method                                      |       | —   |       |
| Stock-Based Compensation that would have been  reported using the Fair Value Method of SFAS 123 |       | (43,436  | )          |
| Pro Forma                                                                                       |       | $        | 2,703,384  |   |
| Per share:                                                                                      |       |     |       |
| Net Income - Basic                                                                              |       |     |       |
| As Reported                                                                                     |       | $        | 1.46       |   |
| Pro Forma                                                                                       |       | $        | 1.44       |   |
| Net Income - Diluted                                                                            |       |     |       |
| As Reported                                                                                     |       | $        | 1.38       |   |
| Pro Forma                                                                                       |       | $        | 1.36       |   |

 

**Disclosure about Fair Value of Financial Instruments –**SFAS No. 107 specifies the disclosure ofthe estimated fair value of financial instruments. The Company’s estimated fairvalue amounts have been determined by the Company using available marketinformation and appropriate valuation methodologies.

 

However,considerable judgment is required to develop the estimates of fair value.Accordingly, the estimates are not necessarily indicative of the amounts theCompany could have realized in a current market exchange. The use of differentmarket assumptions and/or estimation methodologies may have a material effecton the estimated fair value amounts.

 

Althoughmanagement is not aware of any factors that would significantly affect theestimated fair value amounts, such amounts have not been comprehensivelyrevalued for purposes of these financial statements since the balance sheetdate and, therefore, current estimates of fair value may differ significantlyfrom the amounts presented in the accompanying notes.

 

**New Accounting Pronouncements –**In September 2006, the FASB issued SFASNo. 157, “Fair Value Measurements”, effective for the CompanyJanuary 1, 2008. This Statement defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements. This Statement defines fair value, establishes a fair valuehierarchy that distinguishes between valuations obtained from sourcesindependent of the entity and those from the entity’s own observable inputsthat are not corroborated by observable market data. SFAS No. 157 expandsdisclosures about the use of fair value to measure assets and liabilities ininterim and annual periods subsequent to initial recognition. The disclosuresfocus on the inputs used to measure fair value, and for recurring fair valuemeasurements using significant unobservable inputs, the effect of the measurementson earnings or changes inn net assets for the period. The Company is currentlyassessing the impact of this pronouncement on its financial statements.

 

29

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InFebruary 2007, the FASB issued SFAS No. 159, The Fair Value Optionfor Financial Assets and Financial Liabilities - Including an Amendment of FASBStatement No. 115. SFAS 159 permits an entity to choose to measure manyfinancial instruments and certain other items at fair value. Most of the provisionsof SFAS 159 are elective; however, the amendments to SFAS 115, Accounting forCertain Investments in Debt and Equity Securities, applies to all entities withavailable-for-sale or trading securities. For financial instruments elected tobe accounted for at fair value, an entity will report the unrealized gains andlosses in earnings. SFAS 159 is effective as the beginning of an entity’s firstfiscal year that begins after November 15, 2007. The Company is currentlyassessing the impact of this pronouncement on its financial statements.

 

InSeptember 2006, the FASB ratified the FASB’s Emerging Issues Task Force(or EITF) consensus on EITF Issue No. 06-4, “Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-Dollar LifeInsurance Arrangements” and in March 2007 the FASB ratified EITF IssueNo. 06-10, “Accounting for Collateral Assignment Split-Dollar LifeInsurance Arrangements” The EITF’s consensus on both of these issues focuses onthe accounting for arrangements in which a company has agreed to share aportion of the value of the insurance policy with the employee. Thesearrangements are referred to as “split-dollar” arrangements. Entities withsplit-dollar life insurance policies will have to accrue, for years beginningafter December 15, 2007, liabilities and associated expense for thoseinsurance benefits under the same rules that apply when such benefits areprovided by means other than life insurance. The provisions of the consensuswould be applied through a cumulative effect adjustment to retained earningswith the option of retrospective application. The Company has estimated thecharged to retained earnings effective January 1, 2008 to be approximately$196,000 net of taxes.

 

**Reclassification –**Certain reclassifications have been made in the 2006 and 2005 financialstatements to conform to the presentation used in 2007. These reclassificationshad no impact on the Company’s previously reported financial statements.

 

**NOTE B – INVESTMENT SECURITIES****–**The amortized cost, carrying value andestimated fair values of investment securities available for sale as ofDecember 31, are as follows:

 
| ** **                            | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Amortized  cost**             | ** ** | **Unrealized  gains** | ** ** | **Unrealized  (losses)** | ** ** | **Estimated  fair value** | ** ** |
| U.S. Government and Agency Securities |       | $                               | 24,097,314 |   | $ | 243,699 |   | $ | — |   | $ | 24,341,013 |   |
| States and Political Subdivisions     |       | 6,527,226                       |       | 30,399 |   | (50,333 | ) | 6,507,292 |   |
| Mortgage-Backed Securities            |       | 25,148,131                      |       | 207,770 |   | (97,050 | ) | 25,258,851 |   |
|                                  |       | $                               | 55,772,671 |   | $ | 481,868 |   | $ | (147,383 | ) | $ | 56,107,156 |   |

 
| ** **                            | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                            | ** ** | **cost**                        | ** ** | **gains** | ** ** | **(losses)** | ** ** | **fair value** | ** ** |
| U.S. Government and Agency Securities |       | $                               | 19,094,065 |   | $ | 3,029 |   | $ | (76,599 | ) | $ | 19,020,495 |   |
| States and Political Subdivisions     |       | 4,805,053                       |       | 9,970 |   | (89,397 | ) | 4,725,626 |   |
| Mortgage-Backed Securities            |       | 19,340,821                      |       | 20,303 |   | (328,828 | ) | 19,032,296 |   |
|                                  |       | $                               | 43,239,939 |   | $ | 33,302 |   | $ | (494,824 | ) | $ | 42,778,417 |   |

 

Thecarrying value of investment securities pledged to secure public funds,borrowings and for other purposes as required or permitted by law amounts toapproximately $14,025,000 and $14,316,000 at December 31, 2007 and 2006,respectively. During 2007 and 2006 the Bank had no proceeds from the sale ofavailable for sale securities. During 2005 the Bank had proceeds from the saleof available for sale securities of $6,016,550, gross gains of $1,298 and grosslosses of $7,175.

 

Theamortized cost and estimated fair value of debt securities at December 31,2007, by contractual maturity, are shown below. Mortgage-backed securities areclassified in accordance with their estimated lives. Expected maturities maydiffer from contractual maturities because borrowers may have the right toprepay obligations.

 
| ** **                             | ** ** | **Amortized  cost** | ** ** | **Estimated  fair value** | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------------------------|------------|
| Securities available-for-sale:    |       |                |       |                           |       |
| Due in one year or less                |       | $                   | 12,494,840 |                           | $          | 12,538,473 |   |
| Due after one year through five years  |       | 31,965,384          |       | 32,203,159                     |       |
| Due after five years through ten years |       | 8,314,172           |       | 8,349,895                      |       |
| Due after ten years                    |       | 2,998,275           |       | 3,015,629                      |       |
|                                   |       | $                   | 55,772,671 |                           | $          | 56,107,156 |   |

 

Thegross unrealized loss and related estimated fair value of investment securitiesthat have been in a continuous loss position for less than twelve months andover twelve months at December 31, are as follows:

 
| ** **                                    | ** ** | **Less than**     | ** ** | **Over**                   | ** ** | ** **             | ** ** | ** **                 | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **Twelve Months** | ** ** | **Twelve Months**     | ** ** | **Total**              | ** ** |
| ** **                                    | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair  value** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair  value** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair  value** | ** ** |
| December 31, 2007:                       |       |                   |       |                       |       |                   |       |                       |       |   |   |   |   |
| U.S. Government & Agency  Securities |       | $                      | —     |                       | $          | —                 |       | $                          | —     |   | $ | — |   | $ | — |   | $ | — |   |
| States and Political Subdivisions             |       | (22,168                | )          | 968,403                    |       | (28,165                | )          | 2,224,642                  |       | (50,333 | ) | 3,193,045 |   |
| Mortgage-Backed Securities                    |       | (4,626                 | )          | 2,971,470                  |       | (92,424                | )          | 7,118,850                  |       | (97,050 | ) | 10,090,320 |   |
|                                          |       | $                      | (26,794    | )                          | $          | 3,939,873              |       | $                          | (120,589   | ) | $ | 9,343,492 |   | $ | (147,383 | ) | $ | 13,283,365 |   |

 
| ** **                                    | ** ** | **Less than**     | ** ** | **Over**                   | ** ** | ** **             | ** ** | ** **                 | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **Twelve Months** | ** ** | **Twelve Months**     | ** ** | **Total**              | ** ** |
| ** **                                    | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair  value** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair  value** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair  value** | ** ** |
| December 31, 2006:                       |       |                   |       |                       |       |                   |       |                       |       |   |   |   |   |
| U.S. Government & Agency  Securities |       | $                      | (2,954     | )                          | $          | 4,000,971              |       | $                          | (73,645    | ) | $ | 6,924,317 |   | $ | (76,599 | ) | $ | 10,925,288 |   |
| States and Political Subdivisions             |       | (493                   | )          | 352,419                    |       | (88,905                | )          | 3,587,649                  |       | (89,398 | ) | 3,940,068 |   |
| Mortgage-Backed Securities                    |       | —                 |       | —                     |       | (328,827               | )          | 12,473,837                 |       | (328,827 | ) | 12,473,837 |   |
|                                          |       | $                      | (3,447     | )                          | $          | 4,353,390              |       | $                          | (491,377   | ) | $ | 22,985,803 |   | $ | (494,824 | ) | $ | 27,339,193 |   |

 

Asof December 31, 2007, the Company has 21 investment securities whereestimated fair market value had decreased 1.13% from amortized cost. Managementevaluates investment securities for other-than-temporary impairment taking intoconsideration the extent and length of time the fair value has been less thancost, the financial condition of the issuer and whether the Bank has the intentand ability to retain the investment for a period of time sufficient to allowfor any anticipated recovery in fair value. As of December 31, 2007, nodeclines are deemed to be other than temporary.

 

**NOTE C – LOANS –** The Bank’s loan portfolio consists primarily of loans to borrowerswithin San Luis Obispo and northern Santa Barbara Counties, California.Although the Bank seeks to avoid concentrations of loans to a single industryor based upon a single class of collateral, real estate and real estateassociated businesses are among the principal industries in the Bank’s marketareas. As a result, the Bank’s loan and collateral portfolios are, to somedegree, concentrated in those industries.

 

30

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Thecomposition of the loan portfolio at December 31, is as follows:

 
| ** **                      | ** ** | **2007**    | ** **  | **2006**    | ** ** |
|---------------------------------|------------|-------------|-------------|-------------|------------|
| Real estate – construction |       | $           | 47,819,615  |        | $          | 55,307,210 |   |
| Real estate – other        |       | 81,895,109  |        | 78,757,513  |       |
| Commercial                      |       | 38,016,713  |        | 36,406,663  |       |
| Consumer                        |       | 1,237,325   |        | 1,603,836   |       |
|                            |       | 168,968,762 |        | 172,075,222 |       |
| Deferred loan fees              |       | (675,858    | )           | (741,054    | )          |
| Allowance for loan losses       |       | (1,673,410  | )           | (1,653,695  | )          |
|                            |       | $           | 166,619,494 |        | $          | 169,680,473 |   |

 

Theallowance for loan losses is increased by the provision to income and decreasedby net charge-offs. Management’s periodic evaluation of the adequacy of theallowance is based on the Company’s past loan experience, known and inherentrisks in the portfolio, adverse situations that may affect the borrower’sability to repay, the estimated value of any underlying collateral, and currenteconomic conditions.

 

Transactionsin the allowance for credit losses are summarized as follows:

 
| ** **                                       | ** ** | **2007** | ** ** | **2006** | ** ** | **2005**  | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Balance at beginning of year |       | $        | 1,653,695  |     | $          | 1,470,261 |       | $ | 1,200,036 |   |
| Provision charged to expense                     |       | —   |       | 240,000  |       | 300,000   |       |
| Loans charged off                                |       | (60,779  | )          | (84,002  | )          | (46,355   | )          |
| Recoveries on loans previously charged off       |       | 80,494   |       | 27,436   |       | 16,580    |       |
| Balance at end of year                           |       | $        | 1,673,410  |     | $          | 1,653,695 |       | $ | 1,470,261 |   |

 

Thefollowing is a summary of the investment in impaired loans, the relatedallowance for loan losses, income recognized and information pertaining tononaccrual and past due loans as of December 31:

 
| ** **                                                   | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Recorded investment in impaired loans                        |       | $        | 2,175,694  |     | $          | —   |       | $ | 134,872 |   |
| Related allowance for loan losses                            |       | $        | 144,000    |     | $          | —   |       | $ | — |   |
| Average recorded investment in impaired  loans               |       | $        | 591,000    |     | $          | 250,000  |       | $ | 459,000 |   |
| Interest income recognized for cash payments                 |       | $        | —     |     | $          | 3,045    |       | $ | 28,581 |   |
| Total nonaccrual loans                                       |       | $        | 2,175,694  |     | $          | —   |       | $ | 134,872 |   |
| Total loans past-due ninety days or more  and still accruing |       | $        | —     |     | $          | 550,000  |       | $ | — |   |

 

**NOTE D – RELATED PARTY TRANSACTIONS****–**In the ordinary course of business, the Bankhas granted loans to certain executive officers, directors and the businesseswith which they are associated. All such loans and commitments to lend weremade under terms which are consistent with the Bank’s normal lending policies.

 

Thefollowing is an analysis of the activity of all such loans:

 
| ** **                          | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|
| Beginning balance                   |       | $          | 3,734,153  | )          | $          | 2,976,502 | ) |
| Credits granted, including renewals |       | 5,515,322  | )          | 2,797,483  | )          |
| Repayments                          |       | (4,484,643 | )          | (2,039,832 | )          |
|                                |       | $          | 4,764,832  | )          | $          | 3,734,153 | ) |

 

Undisbursedloans amount to approximately $894,712 and $2,337,163 at December 31, 2007and 2006, respectively.

 

Depositsfrom related parties held by the Bank at December 31, 2007 and 2006amounted to $2,367,291 and $3,323,903, respectively.

 

**NOTE E – PREMISES AND EQUIPMENT –**The composition of premises and equipment atDecember 31 is as follows:

 
| ** **                        | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
| Premises                          |       | $          | 7,497,978  |       | $          | 7,411,967 |   |
| Furniture, fixtures and equipment |       | 3,990,273  |       | 4,149,808  |       |
|                              |       | 11,488,251 |       | 11,561,775 |       |
| Less accumulated depreciation     |       | 4,650,509  |       | 4,334,333  |       |
|                              |       | 6,837,742  |       | 7,227,442  |       |
| Land                              |       | 2,030,765  |       | 2,030,765  |       |
|                              |       | $          | 8,868,507  |       | $          | 9,258,207 |   |

 

**NOTE F – DEPOSITS****–**AtDecember 31, 2007, the scheduled maturities of time deposits are asfollows:

 
| Due in one year           |   | $         | 64,801,857 |   |
|---------------------------|--------|-----------|------------|--------|
| Due in one to three years |   | 6,188,863 |       |
| Due after three years     |   | 853,474   |       |
|                      |   | $         | 71,844,194 |   |

 

**NOTE G – SHORT-TERM BORROWINGS****–**The Bank has two borrowing arrangements withthe Federal Home Loan Bank of San Francisco. The first allows the Bank toborrow up to approximately $41 million against which the Bank has pledgedapproximately $100 million of its real estate secured loans. The secondarrangement allows the Bank to borrow up to approximately $12 million againstwhich the Bank has pledged approximately $12 million of its investmentsecurities.

 

Asof December 31, 2007 the Bank has borrowed $5,900,000 under thesearrangements. This amount is due on January 2, 2008 and includes interestat 3.25%. During 2007 the bank had average borrowings outstanding of $1,100,000at an effective rate of 4.55%.

 

TheBank may also borrow up to $5,900,000 overnight on an unsecured basis from twocorrespondent banks.

 

**NOTE H – LONG-TERM BORROWINGS****–**During the third quarter of 2003, the Bankissued Subordinated Debentures to nineteen investors including executiveofficers and members of the Bank’s Board of Directors, in the total sum of$2,000,000 (“Debentures”). The total amount issued to executive officers anddirectors was $1,100,000. The Debentures include quarterly payment of interestat prime plus 1.5% and quarterly principal installments of $166,666 commencingon September 30, 2008 until paid in full on June 30, 2011. TheDebentures, which are subordinated to the right of payment to depositors andother creditors, partially qualify as Tier 2 Capital.

 

OnApril 28, 2006, the Company issued $5,155,000 in junior subordinated debtsecurities (the “debt securities”) to the Santa Lucia Bancorp (CA) CapitalTrust, a statutory trust created under the laws of the State of Delaware. Thesedebt securities are subordinated to effectively all borrowings of the Companyand are due and payable on July 7, 2036. These debt securities may beredeemed for 105% of the principal balance through July 7, 2011 and thenat par thereafter. Interest is payable quarterly beginning July 7, 2006 at1.48% over the quarterly adjustable 3-month LIBOR.

 

TheCompany also purchased a 3% minority interest in Santa Lucia Bancorp (CA)Capital Trust. The balance of the equity of Santa Lucia Bancorp (CA) CapitalTrust is comprised of mandatorily redeemable preferred securities.

 

**NOTE I – INCOME TAXES****–**The asset and liability method is used inaccounting for income taxes. Under this method, deferred tax assets andliabilities are determined based on differences between financial reporting andtax bases of assets and liabilities and are measured using the enacted taxrates and laws that will be in effect when the differences are expected toreverse.

 

31

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Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of the Company’sdeferred tax liabilities and assets as of December 31 are as follows:

 
| ** **                                        | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|---------------------------------------------------|------------|-----------|------------|-----------|------------|
| Deferred liabilities:                             |       |      |       |      |       |
| Tax over book depreciation                        |       | $         | 425,000    |      | $          | 493,000 |   |
| Market value adjustment on investment  securities |       | 138,000   |       | —    |       |
| Other                                             |       | 111,000   |       | 107,000   |       |
| Total deferred tax liabilities                    |       | 674,000   |       | 600,000   |       |
| Deferred tax assets:                              |       |      |       |      |       |
| Allowance for loan losses                         |       | 673,000   |       | 673,000   |       |
| Deferred compensation plans                       |       | 498,000   |       | 390,000   |       |
| Market value adjustment on investment  securities |       | —    |       | 190,000   |       |
| State taxes                                       |       | 191,000   |       | 224,000   |       |
| Net loss carryforward                             |       | 41,000    |       | 55,000    |       |
| Other                                             |       | 85,000    |       | 9,000     |       |
| Total deferred tax assets                         |       | 1,488,000 |       | 1,541,000 |       |
| Net deferred tax assets                           |       | $         | 814,000    |      | $          | 941,000 |   |

 

Theprovision for income taxes consists of the following:

 
| ** **                | ** ** | **2007** | ** ** | **2006** | ** ** | **2005**  | ** ** |
|---------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Currently payable         |       | $        | 2,135,000  | )        | $          | 2,389,000 |       | $ | 1,784,000 |   |
| Deferred taxes (benefits) |       | (201,000 | )          | (147,000 | )          | (25,000   | )          |
|                      |       | $        | 1,934,000  |     | $          | 2,242,000 |       | $ | 1,759,000 |   |

 

The principal sources ofdeferred income taxes and the tax effect of eachare as follows:

 
| ** **                 | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax over book depreciation |       | $        | (68,000    | )        | $          | 6,000    | )          | $ | 173,000 |   |
| Provision for loan losses  |       | —   |       | (75,000  | )          | (118,000 | )          |
| State taxes                |       | 33,000   |       | (75,000  | )          | (46,000  | )          |
| Net loss carryforward      |       | 14,000   |       | 14,000   |       | 14,000   |       |
| Deferredcompensationplans  |       | (108,000 | )          | (42,000  | )          | (41,000  | )          |
| Other                      |       | (72,000  | )          | (25,000  | )          | (7,000   | )          |
| Net deferred taxes         |       | $        | (201,000   | )        | $          | (147,000 | )          | $ | (25,000 | ) |

 

Asof December 31, 2007, the Bank had federal net operating losscarryforwards available to reduce future taxable income of approximately $163,000.These net operating loss carryforwards expire in 2010. The 1995 merger withCentral Coast National Bank resulted in an ownership change as defined in theInternal Revenue Code Section 382. Accordingly, the utilization of the netoperating loss will be subject to the limitations prescribed inSection 382.

 

Asa result of the following items, the total tax expense was different from theamount computed by applying the statutory income tax rate to earnings beforeincome taxes:

 
| ** **                       | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal “expected” tax |       | $        | 1,679,000  |     | 34.0       | %        | $          | 1,914,000 |   | 34.0 | % | $ | 1,532,000 |   | 34.0 | % |
| State franchise tax, net         |       | 347,000  |       | 7.0      |       | 396,000  |       | 7.0 |   | 318,000 |   | 7.0 |   |
| Tax exempt income                |       | (122,000 | )          | (2.5     | )          | (80,000  | )          | (1.3 | ) | (82,000 | ) | (1.8 | ) |
| Other                            |       | 30,000   |       | 0.6      |       | 12,000   |       | 0.2 |   | (9,000 | ) | (0.2 | ) |
| Total expense                    |       | $        | 1,934,000  |     | 39.1       | %        | $          | 2,242,000 |   | 39.9 | % | $ | 1,759,000 |   | 39.0 | % |

 

TheCompany is subject to Federal income tax and California franchise tax. Federalincome tax returns for the years ended December 31, 2006, 2005 and 2004are open to audit by the Federal authorities and California returns for theyears ended December 31, 2006, 2005, 2004 and 2003 are open to audit bystate authorities.

 

**NOTE J – EMPLOYEE PROFIT SHARING AND DEFERRED COMPENSATION****–**The Bank sponsors a 401 (k) plan for thebenefit of its employees. In 1994 the Bank also approved the creation of anEmployee Stock Ownership Plan for the benefit of its employees. Contributionsto these plans are determined by the Board of Directors. For income tax purposes,the annual contribution is limited to 15% of the compensation of eligibleemployees. The Bank contributed $203,000 in 2007, $210,000 in 2006, and$240,000 in 2005, to the Employee Stock Ownership Plan. The Bank contributed$57,000 to the 401 (k) plan in 2007 and $50,000 in 2006. There were nocontributions to the 401 (k) plan in 2005.

 

TheBank has entered into deferred compensation agreements with key officers andboard members. Under these agreements, the Bank is obligated to provide, uponretirement, a lifetime benefit for the officers and directors. The annualbenefits ranging from $25,000 to $75,000 for key officers and $4,000 to $6,000for directors. The estimated present value of future benefits to be paid isbeing accrued over the period from the effective date of the agreements untilthe expected retirement dates of the participants. The expense incurred andamount accrued for this plan for the years ended December 31, 2007, 2006,and 2005 totaled $292,385, $131,454, and $120,715, respectively. The Bank is abeneficiary of life insurance policies that have been purchased as a method offinancing the benefits under the agreements.

 

**NOTE K – STOCK OPTIONS****–**The Company sponsors one compensatoryincentive and non-qualified stock option plan which provides certain keyemployees and the Board of Directors with the option to purchase shares ofcommon stock, and one Equity Based Compensation Plan which provides certain keyemployees and the Board of Directors with the award of any Option, StockAppreciation Right, Restricted Stock Award, Restricted Share Unit, PerformanceShare Award, Dividend Equivalent, or any combination thereof. In 1999, the Bankadopted a stock option plan (the 2000 plan) under which up to 360,000 shares ofthe Bank’s common stock may be issued to directors, officers, and keyemployees. In 2006, the Company adopted the 2006 Equity Based Compensation Plan(the Plan), which the maximum number of shares of common stock that may beawarded under this Plan shall not exceed 200,000 shares, including 38,200shares rolled over from the Company’s 2000 Stock Option Plan. Option prices maynot be less than 100% of the fair market value of the stock at the date ofgrant. Options became exercisable at the rate of 20% per year beginning atvarious dates and expire not more than ten years from the date of grant. TheCompany recognized stock-based compensation costs of $122,645 and $63,558 andrelated tax benefits of $18,450 and $7,193 for 2007 and 2006, respectively.

 

Thefair value of each option granted was estimated on the date of grant using theBlack-Scholes options pricing model with the following assumptions:

 
| ** **                             | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Risk-free rates                        |       | 4.65      | %          | 4.77      | %          | 3.75      | %          |
| Expected volatility                    |       | 20.00     | %          | 20.00     | %          | 17.00     | %          |
| Expected dividened yield               |       | 1.40      | %          | 1.40      | %          | 2.10      | %          |
| Expected term                          |       | 6.0 years |       | 6.0 years |       | 6.5 years |       |
| Weighted-average grant date fair value |       | $         | 6.72       |      | $          | 6.43      |       | $ | 4.47 |   |
|                                        |            |           |            |           |            |           |            |  |  |  |

 

32

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Asummary of the status of the Company’s fixed stock option plan as ofDecember 31, 2007 and changes during the year then ended is presentedbelow:

 
| ** **                               | ** ** | **December 31, 2007** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **Shares**                      | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| Outstanding at the beginning of the year |       | 243,176                         |       | $ | 15.55 |   |   |   |   |   |
| Granted                                  |       | 34,000                          |       | 26.15 |   |   |   |   |   |
| Exercised                                |       | (36,916                         | )          | 10.23 |   |   |   |   |   |
| Foreited or expired                      |       | (16,500                         | )          | 23.04 |   |   |   |   |   |
| Outstanding at the end of the year       |       | 223,760                         |       | 17.48 |   | 6.5 years |   | $ | 1,730,000 |   |
| Options Exercisable                      |       | 126,260                         |       | $ | 13.04 |   | 4.9 years |   | $ | 1,518,000 |   |

 

Thetotal intrinsic value of options exercised during the years endedDecember 31, 2007, 2006, and 2005 were approximately $638,000, $539,000, and$760,000 respectively. As of December 31, 2007 there was $503,000 of totalunrecognized compensation cost related to the outstanding stock options thatwill be recognized over a weighted average period of 2.4 years.

 

**NOTE L – EARNINGS PER SHARE (EPS)****–**The following is a reconciliation of netincome and shares outstanding to the income and number of shares used tocompute EPS:

 
| ** **                                    | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **Income  (Numerator)**         | ** ** | **Shares  (Denominator)** | ** ** |
| Net income                                    |       | $                               | 3,002,819  |   |   |   |
| Average shares outstanding                    |       |                            |       | 1,933,231 |   |
| Used in  Basic EPS                            |       | 3,002,819                       |       | 1,933,231 |   |
| Dilutive effect of outstanding stock  options |       |                            |       | 59,823 |   |
| Used in  Diluted EPS                          |       | $                               | 3,002,819  |   | 1,993,054 |   |

 
| ** **                                    | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **Income  (Numerator)**         | ** ** | **Shares  (Denominator)** | ** ** |
| Net income                               |       | $                               | 3,388,271  |   |   |   |
| Average shares outstanding                    |       |                            |       | 1,916,253 |   |
| Used in  Basic EPS                            |       | 3,388,271                       |       | 1,916,253 |   |
| Dilutive effect of outstanding stock  options |       |                            |       | 98,413 |   |
| Used in  Diluted EPS                          |       | $                               | 3,388,271  |   | 2,014,666 |   |

 
| ** **                                    | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **Income  (Numerator)**         | ** ** | **Shares  (Denominator)** | ** ** |
| Net income                               |       | $                               | 2,746,820  |   |   |   |
| Average shares outstanding                    |       |                            |       | 1,878,949 |   |
| Used in  Basic EPS                            |       | 2,746,820                       |       | 1,878,949 |   |
| Dilutive effect of outstanding stock  options |       |                            |       | 105,289 |   |
| Used in  Diluted EPS                          |       | $                               | 2,746,820  |   | 1,984,238 |   |

 

**NOTE M – COMMITMENTS AND CONTINGENCIES****–**The Company’s exposure to credit loss in theevent of nonperformance by the other party to the financial instrument forcommitments to extend credit and standby letters of credit is represented bythe contractual amount of those commitments. Commitments to extend credit (suchas the unfunded portion on lines of credit and commitments to fund new loans)as of December 31, 2007 and 2006 amounts to approximately $57,326,000 and$56,557,000, respectively, of which approximately $4,286,000 and $2,603,000 arerelated standby letters of credit, respectively. The Company uses the samecredit policies in these commitments as is done for all of its lendingactivities. As such, the credit risk involved in these transactions isessentially the same as that involved in extending loan facilities tocustomers.

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Since many of thecommitments are expected to expire without being drawn upon, the total amountsdo not necessarily represent future cash requirements. The Company evaluateseach client’s credit worthiness on a case-by-case basis. The amount ofcollateral obtained if deemed necessary by the Company is based on management’scredit evaluation of the customer. The majority of the Company’s commitments toextend credit and standby letters of credit are secured by real estate.

 

Inthe normal course of business, the Company is involved in various litigation.In the opinion of management, and based on the advise of the Company’s legalcounsel, the disposition of all pending litigation will not have a materialeffect on the Company’s financial position.

 

**NOTE N – FAIR VALUES OF FINANCIAL INSTRUMENTS****–**The fair value of a financial instrument isthe amount at which the asset or obligation could be exchanged in a currenttransaction between willing parties, other than in a forced or liquidationsale. Fair value estimates are made at a specific point in time based onrelevant market information and information about the financial instrument.These estimates do not reflect any premium or discount that could result fromoffering for sale at one time the entire holdings of a particular financialinstrument. Because no market value exists for a significant portion of thefinancial instruments, fair value estimates are based on judgments regardingfuture expected loss experience, current economic conditions, riskcharacteristics of various financial instruments, and other factors. Theseestimates are subjective in nature, involve uncertainties and matters ofjudgment, and therefore cannot be determined with precision. Changes inassumptions could significantly affect the estimates.

 

Fairvalue estimates are based on financial instruments both on and off the balancesheet without attempting to estimate the value of anticipated future businessand the value of assets and liabilities that are not considered financialinstruments. Additionally, tax consequences related to the realization of theunrealized gains and losses can have a potential effect on fair value estimatesand have not been considered in many of the estimates.

 

Thefollowing methods and assumptions were used to estimate the fair value ofsignificant financial instruments:

 

**Financial Assets –**The carrying amounts of cash, short term investments, due from customerson acceptances, and bank acceptances outstanding are considered to approximatefair value. Short term investments include federal funds sold, securitiespurchased under agreements to resell, and interest bearing deposits with banks.The fair values of investment securities, including available for sale, aregenerally based on quoted market prices. The fair value of loans are estimatedusing a combination of techniques, including discounting estimated future cashflows and quoted market prices of similar instruments where available.

 

**Financial Liabilities –**The carrying amounts of deposit liabilitiespayable on demand, commercial paper, and other borrowed funds are considered toapproximate fair value. For fixed maturity deposits, fair value is estimated bydiscounting estimated future cash flows using currently offered rates fordeposits of similar remaining maturities. The fair value of long term debt is basedon rates currently available for debt with similar terms and remainingmaturities.

 

**Off-Balance Sheet Financial Instruments –**The fair value of commitments to extend creditand standby letters of credit is estimated using the fees currently charged toenter into similar agreements. The fair values of these financial instrumentsare not deemed to be material.

 

33

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Theestimated fair value of financial instruments at December 31, 2007 and2006 are summarized as follows:

 
| ** **                             | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Carrying  Value**             | ** ** | **Market  Value**               | ** ** | **Carrying  Value** | ** ** | **Market  Value** | ** ** |
| Financial Assets:                      |       |                            |       |                            |       |   |   |   |   |
| Cash and cash equivalents              |       | $                               | 7,399,412  |                            | $          | 7,399,412 |   | $ | 10,139,526 |   | $ | 10,139,526 |   |
| Investment securities                  |       | 56,107,156                      |       | 56,107,156                      |       | 42,778,417 |   | 42,778,417 |   |
| Loans receivable, net                  |       | 166,619,494                     |       | 167,422,617                     |       | 169,680,473 |   | 170,091,100 |   |
| Cash surrender value of life insurance |       | 5,005,376                       |       | 5,005,376                       |       | 3,336,076 |   | 3,336,076 |   |
| Federal Reserve Bank FHLB Stock        |       | 1,453,850                       |       | 1,453,850                       |       | 1,397,700 |   | 1,397,700 |   |
| Accrued interest receivable            |       | 1,465,402                       |       | 1,465,402                       |       | 1,559,551 |   | 1,559,551 |   |
| Financial Liabilities:                 |       |                            |       |                            |       |   |   |   |   |
| Time deposits                          |       | $                               | 71,844,194 |                            | $          | 72,612,333 |   | $ | 65,917,714 |   | $ | 65,838,613 |   |
| Other deposits                         |       | 140,874,184                     |       | 141,374,184                     |       | 147,070,738 |   | 147,070,738 |   |
| Other borrowings                       |       | 5,900,000                       |       | 5,900,000                       |       | — |   | — |   |
| Long-term debt                         |       | 7,155,000                       |       | 7,155,000                       |       | 7,155,000 |   | 7,155,000 |   |
| Accrued interest and other liabilities |       | 1,677,551                       |       | 1,677,551                       |       | 1,457,716 |   | 1,457,716 |   |

 

**NOTE O – REGULATORY MATTERS –** The Company and the Bank are subject tovarious regulatory capital requirements administered by the federal bankingagencies. Failure to meet minimum capital requirements can initiate certainmandatory, and possibly additional discretionary, actions by regulators that,if undertaken, could have a direct material effect on the Bank’s financialstatements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Bank must meet specific capital guidelines thatinvolve quantitative measures of the Bank’s assets, liabilities, and certainoffbalance-sheet items as calculated under regulatory accounting practices. TheBank’s capital amounts and classifications are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require the Bankto maintain minimum amounts and ratios (set forth in the table below) of totaland Tier 1 capital (as defined in the regulations) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to average assets (as defined).Management believes, as of December 31, 2007, that the Bank meets allcapital adequacy requirements to which it is subject.

 

Asof December 31, 2007, the most recent notification from the FederalReserve Bank (FRB) categorized the Bank as well capitalized under theregulatory framework for prompt corrective action (there are no conditions orevents since that notification that management believes have changed the Bank’scategory). To be categorized as well capitalized, the Bank must maintainminimum ratios as set forth in the table below. The following table also setsforth the Company’s and Bank’s actual capital amounts and ratios (dollaramounts in thousands):

 
| ** **                                 | ** ** | **Actual**                | ** ** | **For capital  adequacy purposes** | ** ** | **To be well  capitalized under  prompt corrective  action provisions** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Amount****(thousands)** | ** ** | **Ratio**                                    | ** ** | **Amount****(thousands)**                                                                        | ** ** | **Ratio** | ** ** | **Amount****(thousands)** | ** ** | **Ratio** | ** ** |
| **As of  December 31, 2007:**         |       |                      |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| **Company**                                |       |                      |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total Capital(to Risk-Weighted Assets)     |       | $                         | 29,075     |                                         | 14.6       | %                                                                                                | $          | 15,912 |   | 8.0 | % | $ | 19,890 |   | 10.0 | % |
| Tier 1 Capital   (to Risk-Weighted Assets) |       | $                         | 26,147     |                                         | 13.2       | %                                                                                                | $          | 7,956 |   | 4.0 | % | $ | 11,934 |   | 6.0 | % |
| Tier 1 Capital   (to Average Assets)       |       | $                         | 26,147     |                                         | 10.5       | %                                                                                                | $          | 9,794 |   | 4.0 | % | $ | 12,243 |   | 5.0 | % |
| **Bank**                                   |       |                      |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total Capital   (to Risk-Weighted Assets)  |       | $                         | 27,410     |                                         | 13.8       | %                                                                                                | $          | 15,888 |   | 8.0 | % | $ | 19,860 |   | 10.0 | % |
| Tier 1 Capital   (to Risk-Weighted Assets) |       | $                         | 24,482     |                                         | 12.3       | %                                                                                                | $          | 7,944 |   | 4.0 | % | $ | 11,916 |   | 6.0 | % |
| Tier 1 Capital   (to Average Assets)       |       | $                         | 24,482     |                                         | 9.9        | %                                                                                                | $          | 9,941 |   | 4.0 | % | $ | 12,427 |   | 5.0 | % |
| **As of December 31, 2006:**          |       |                      |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| **Company**                                |       |                      |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total Capital   (to Risk-Weighted Assets)  |       | $                         | 27,872     |                                         | 14.4       | %                                                                                                | $          | 14,026 |   | 8.0 | % | $ | 17,533 |   | 10.0 | % |
| Tier 1 Capital   (to Risk-Weighted Assets) |       | $                         | 24,563     |                                         | 12.7       | %                                                                                                | $          | 7,013 |   | 4.0 | % | $ | 10,520 |   | 6.0 | % |
| Tier 1 Capital   (to Average Assets)       |       | $                         | 24,563     |                                         | 10.0       | %                                                                                                | $          | 9,794 |   | 4.0 | % | $ | 12,243 |   | 5.0 | % |
| **Bank**                                   |       |                      |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total Capital   (to Risk-Weighted Assets)  |       | $                         | 25,575     |                                         | 13.1       | %                                                                                                | $          | 15,588 |   | 8.0 | % | $ | 19,485 |   | 10.0 | % |
| Tier 1 Capital   (to Risk-Weighted Assets) |       | $                         | 22,266     |                                         | 11.4       | %                                                                                                | $          | 7,794 |   | 4.0 | % | $ | 11,691 |   | 6.0 | % |
| Tier 1 Capital   (to Average Assets)       |       | $                         | 22,266     |                                         | 9.1        | %                                                                                                | $          | 9,777 |   | 4.0 | % | $ | 12,221 |   | 5.0 | % |

 

TheCalifornia Financial Code provides that a bank may not make a cash distributionto its shareholders in excess of the lesser of the Bank’s undivided profits orthe Bank’s net income for its last three fiscal years less the amount of anydistribution made by the Bank to shareholders during the same period.

 

Withcertain exceptions the Company may not pay a dividend to its shareholdersunless its retained earnings equal at least the amount of the proposeddividend.

 

**NOTE P – HOLDING COMPANY –** On April 3, 2006 Santa Lucia Bancorpacquired all the outstanding shares of Santa Lucia Bank by issuing 1,909,837shares of common stock in exchange for the surrender of all outstanding sharesof the Bank’s common stock. There was no cash involved in this transaction. Theacquisition was accounted for like a pooling of interest and the consolidatedfinancial statements contained herein have been restated to give full effect tothis transaction.

 

SantaLucia Bancorp has no significant business activities other than its investmentin Santa Lucia Bank and its investment and related borrowings from Santa Lucia(CA) Capital Trust as discussed in Note H. Accordingly, no separate financialinformation on the Company is provided.

 

34

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35

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**SANTA LUCIA BANCORP**

 
| **SANTA  LUCIA BANCORP BOARD OF DIRECTORS** |   |          |
|---------------------------------------------|--------|---------------|
| **JERRY W. DECOU III**                      |   | CHAIRMAN      |
| **DOUGLAS C. FILIPPONI**                    |   | VICE CHAIRMAN |
| **KHATCHIK H. ACHADJIAN**                   |   |          |
| **STANLEY R. CHERRY**                       |   |          |
| **JOHN C. HANSEN**                          |   |          |
| **JEAN HAWKINS**                            |   |          |
| **PAUL G. MOERMAN**                         |   |          |
| **LARRY H. PUTNAM**                         |   |          |
| **D. JACK STINCHFIELD**                     |   |          |

 
| **SANTA  LUCIA BANCORP EXECUTIVE OFFICERS** |   |                                              |
|---------------------------------------------|--------|---------------------------------------------------|
| **LARRY H. PUTNAM**                         |   | PRESIDENT AND CHIEF EXECUTIVE OFFICER             |
| **JOHN C. HANSEN**                          |   | EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL OFFICER |

 
| **SANTA  LUCIA BANK BOARD OF DIRECTORS** |   |          |
|------------------------------------------|--------|---------------|
| **JERRY W. DECOU III**                   |   | CHAIRMAN      |
| **DOUGLAS C. FILIPPONI**                 |   | VICE CHAIRMAN |
| **KHATCHIK H. ACHADJIAN**                |   |          |
| **STANLEY R. CHERRY**                    |   |          |
| **JOHN C. HANSEN**                       |   |          |
| **JEAN HAWKINS**                         |   |          |
| **PAUL G. MOERMAN**                      |   |          |
| **LARRY H. PUTNAM**                      |   |          |
| **D. JACK STINCHFIELD**                  |   |          |

 

**SANTA LUCIA BANK**

 
| **EXECUTIVE OFFICERS** |   |                                           |   |
|------------------------|--------|------------------------------------------------|--------|
| **LARRY H. PUTNAM**    |   | Chief Executive Officer                        |
| **JOHN C. HANSEN**     |   | President and Chief Operating Officer          |
| **JAMES M. COWAN**     |   | Executive Vice President, Chief Credit Officer |

 
| **SENIOR  VICE PRESIDENTS** |   |                                            |
|-----------------------------|--------|-------------------------------------------------|
| **MELODEE FONTANA**         |   | Senior Vice President, Operations Administrator |
| **ROBERT COVARRUBIAS**      |   | Senior Vice President, Manager                  |

 
| **VICE  PRESIDENTS**     |   |                         |
|--------------------------|--------|------------------------------|
| **TERI DAVIS**           |   | Vice President, Loan Officer |
| **SHARON SATTERTHWAITE** |   | Vice President, Controller   |
| **LEAH T. WEST**         |   | Vice President, Manager      |
| **JIM KELLEY**           |   | Vice President, Loan Officer |
| **MICHAEL W. McKENZIE**  |   | Vice President, Manager      |
| **LARRY WOMACK**         |   | Vice President, Loan Officer |
| **JAMES P. BURUBELTZ**   |   | Vice President, Loan Officer |
| **RICHARD ALLEN**        |   | Vice President, Loan Officer |
| **JULIE A. JOSLIN**      |   | Vice President, Cashier      |

 
| **ASSISTANT  VICE PRESIDENTS** |   |                                         |
|--------------------------------|--------|----------------------------------------------|
| **JENNIFER BASSI GINDER**      |   | Assistant Vice President, Operations Officer |
| **KRISTIE KELLER**             |   | Assistant Vice President, Central Operations |
| **KIM DONALDSON**              |   | Assistant Vice President, Operations Officer |
| **CHERYL MUMFORD**             |   | Assistant Vice President, Operations Officer |
| **RYUN McCRORY**               |   | Assistant Vice President, Loan Officer       |
| **J. DARREN BARNES**           |   | Assistant Vice President, Loan Officer       |
| **REGINA M. SHELDON**          |   | Assistant Vice President, Loan Officer       |

 
| **OFFICERS**         |   |                         |
|----------------------|--------|------------------------------|
| **KAREN SAMPSON**    |   | Assistant Operations Officer |
| **STELLA MARTINEZ**  |   | Operations Officer           |
| **ROBERT McCONAGHY** |   | Loan Officer                 |

 
| **ATASCADERO**        | ** ** | **PASO ROBLES**        | ** ** | **ARROYO GRANDE**        | ** ** | **SANTA MARIA**        |
|-----------------------|------------|------------------------|------------|--------------------------|------------|------------------------|
| 7480  EL CAMINO REAL  |       | 1240  SPRING STREET    |       | 1530  E. GRAND AVENUE    |       | 1825  S. BROADWAY      |
| ATASCADERO,  CA 93422 |       | PASO  ROBLES, CA 93446 |       | ARROYO  GRANDE, CA 93420 |       | SANTA  MARIA, CA 93454 |
| 805-466-7087          |       | 805-239-1140           |       | 805-473-1988             |       | 805-614-9100           |

 

**MARKETMAKERS**

 
| **GEORGE CROSBY, MAGUIRE INVESTMENTS – SANTA MARIA, CA**                               |   | 805/922-6901 or 800/244-4183 |
|---------------------------------------------------------------------------------------------|--------|------------------------------|
| **LISA GALLO, WEDBUSH MORGAN SECURITIES – LAKE OSWEGO, OR**                            |   | 503/675-3100 or 866/491-7828 |
| **MICHAEL S. HEDREI, HOWE BARNES HOEFER & ARNETT,  INC. – SAN FRANCISCO, CA** |   | 415/538-5749 or 800/774-8723 |
| **RANDY KRUMLAND, EDWARD JONES – ATASCADERO, CA**                                      |   | 805/466-0244 or 800/467-0244 |
| **JIM MOFFATT, MORGAN STANLEY – PASO ROBLES, CA**                                      |   | 805/239-0920 or 800/733-0920 |
| **TREVOR MORRIS, UBS FINANCIAL SERVICES, INC. – LOS ANGELES,  CA**                     |   | 213/972-1511 or 800/443-5203 |
| **JOEY J. WARMENHOVEN, McADAMS WRIGHT RAGEN – PORTLAND, OR**                           |   | 503/922-4888 or 866/662-0351 |

 

 

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