**Santa Lucia Bancorp 2009 Annual Report**

 

 
| **2009** | ** ** | **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 Street |       | 1530 E. Grand Avenue |       | 1825 South Broadway |
| (805) 466-7087      |       | (805) 239-1140     |       | (805) 473-1988       |       | (805) 614-9100      |

 

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**Santa Lucia Bancorp**

 

***Message from the President***

 

Dear Shareholders, Customersand Friends,

 

Inmy letter to the shareholders last year I stated that we were looking forwardto the challenges of 2009. At that time I had no idea how challenging 2009would actually be. In looking back at one of the most severe economic downturnsin my 47 year banking career, the Company found itself in the unfamiliarterritory of reporting an annual net loss for the first time in 22 years. Thefact that all of the independent banks in our market area likely experiencednet losses for the year provides little comfort as this is not the kind ofperformance a bank with our history, experience and strength findssatisfactory. In this coming year, we are dedicated to increasing the financialstrength of our Company while continuing to provide the safest and highestquality products and services to our customers.

 

TheCompany’s profitability declined from a net profit of $1,138,904 at December 31,2008 to a net loss of $1,825,475 for the same period in 2009. Several factorscontributed to this decline in profitability including an increase innon-performing loans, net loan losses, and substantially increased allocationsto the allowance for loan losses.  Inaddition, there was a significant increase to the quarterly FDIC assessments,coupled with a large special assessment that was imposed on all financialinstitutions by the FDIC to increase its reserves. Our problem credits remaincentered in our real estate portfolio where we were required to write down thecollateral value of several loans due to the decline in the real estate market.Many of these write-downs arose and were addressed in the fourth quarter of2009.  Further, our loan portfoliocontinued to grow during 2009 which also contributed to the need to increasethe overall level of the allowance for loan losses. The allowance stood at $3.4million or 1.67% of gross loans at year end 2009 compared to $2.3 million or1.22% of gross loans at year end 2008.

 

 

John C. Hansen, President andChief Executive Officer

 

Ourhistory has always been to have conservative banking practices, particularly inour lending, and last year was no exception. However, the severity and depth ofthe current recessionary climate tested our experience and has required us toredouble our efforts. As we move into the new year, we have made significantprogress toward improving our problem loans and strengthening our overallcredit administration. To address all of our needs we have reorganized ourcredit administration, tightened our procedures and strengthened creditadministration with the addition of a Senior Vice President with 15 years ofcredit experience who is familiar with the lending philosophy of Santa LuciaBank.

 

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Santa Lucia Bancorp’s Boardof Directors. Standing left to right—John C. Hansen, President and ChiefExecutive Officer, Jerry W. DeCou III, Chairman of the Board, Larry H. Putnam,Douglas C. Filipponi, Vice Chairman of the Board.

Seated left to right—Paul G.Moerman, D. Jack Stinchfield, Jean Hawkins, Stanley R. Cherry and Khatchik H.Achadjian.

 

Therewas some good news in 2009. We are pleased to report that the Companyexperienced substantial increases in both loans and deposits during the year. Totalloans, net of unearned income increased 6.64% during the year to $201,484,990at year end December 31, 2009 and total deposits increased 12.44% to$238,722,524 at year end December 31, 2009. This coupled with our strongcapital position puts us in a good position to move forward in 2010.

 

Whilewe are not sure that our local economy has completely turned the corner, we arecautiously optimistic as we move into the year. We are committed to continue topursue our prudent, conservative banking practices upon which this Company wasfounded and which have held us in good stead over the past 24 years. On behalfof the entire Board of Directors, we extend our thanks to our shareholders foryour continued support, to our customers for your business, and to ouremployees for their continued dedication to providing superior customerservice.

 

**John C.Hansen**

President and Chief Executive Officer

 

 

Executive Management - JohnMcNinch, John C. Hansen, James M. Cowan

 

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**S****ANTA****L****UCIA****B****ANK**

*(a wholly owned subsidiary of SantaLucia Bancorp)*

 

**ExecutiveManagement**

 

 

James M. Cowan, John C.Hansen, John McNinch

 

**JOHN C.HANSEN**

President and Chief

Executive Officer

 

**JAMES M.COWAN**

Executive Vice President

Chief Administrative Officer

Chief Credit Officer

 

**JOHN McNINCH**

Executive Vice President

Credit Administrator

* *

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

 

**Accounting**

 

 

Julie A. Joslin, SharonSatterthwaite

 

**SHARONSATTERTHWAITE**

Vice President

Controller

 

**JULIE A.JOSLIN**

Vice President

Cashier

 

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**CreditAdministration**

 

 

Standing left to right -Claudya Oglesby, John McNinch, James M. Cowan

Seated left to right - LarryWomack, Lila Bogardus

 

**JAMES M.COWAN**

Executive Vice President

Chief Administrative Officer

Chief Credit Officer

 

**JOHN McNINCH**

Executive Vice President

Credit Administrator

 

**CLAUDYAOGLESBY**

Senior Vice President

Credit Administration

 

**LARRY WOMACK**

Vice President

Assistant CreditAdministrator

 

**LILABOGARDUS**

Note Department Manager

 

**Operations**

 

 

Melodee Fontana, GeorgeGarcia, Kristie Keller

 

**MELODEEFONTANA**

Senior Vice President

Operations Administrator

 

**KRISTIEKELLER**

Vice President

Central Operations

 

**GEORGEGARCIA**

IT Manager

 

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**AtascaderoOffice**

7480 El Camino Real,Atascadero, California

 

 

**AtascaderoOfficer Team**

 

 

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

 

**TERI DAVIS**

Senior Vice President

Manager

 

**KIMDONALDSON**

Vice President

Operations Officer

 

**JIM KELLEY**

Vice President

Loan Officer

 

**J. DARRENBARNES**

Assistant Vice President

Loan Officer

 

**KARENSAMPSON**

Assistant Operations Officer

 

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**Paso RoblesOffice**

1240 Spring Street, PasoRobles, California

 

 

**Paso RoblesOfficer Team**

 

 

Robert Covarrubias, CherylMumford, Ryun McCrory, Joshua R. Bivin

 

**ROBERTCOVARRUBIAS**

Senior Vice President

Manager

 

**RYUN McCRORY**

Vice President

Loan Officer

 

**JOSHUA R.BIVIN**

Vice President

Loan Officer

 

**CHERYLMUMFORD**

Assistant Vice President

Operations Officer

 

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**ArroyoGrande Office**

1530 East Grand Avenue,Arroyo Grande, California

 

 

**ArroyoGrande Officer Team**

 

 

Richard Allen, Michael W.McKenzie, Regina M. Sheldon, Jennifer Bassi Ginder

 

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

Vice President

Manager

 

**RICHARDALLEN**

Vice President

Loan Officer

 

**JENNIFERBASSI GINDER**

Vice President

Operations Officer

 

**REGINA M.SHELDON**

Assistant Vice President

Loan Officer

 

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**Santa MariaOffice**

1825South Broadway, Santa Maria, California

 

 

**Santa MariaOfficer Team**

 

 

Leah T. West, James P.Burubeltz, Stella Martinez, Robert J. McConaghy

 

**LEAH T. WEST**

Vice President

Manager

 

**JAMES P.BURUBELTZ**

Vice President

Loan Officer

 

**STELLAMARTINEZ**

Operations Officer

 

**ROBERT J.McCONAGHY**

Loan Officer

 

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**Santa Lucia Bancorp and Subsidiary**

 

**Consolidated Selected Financial Information**

 
| ** **                                           | ** ** | **Year Ended December 31,**                  | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | **2009**                                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands, except per share data)** | ** ** |
| **Summary  of Operations:**                          |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest Income                                      |       | $                                                 | 13,851     |   | $ | 15,276 |   | $ | 17,719 |   | $ | 17,027 |   | $ | 13,546 |   |
| Interest Expense                                     |       | 3,021                                             |       | 3,877 |   | 4,824 |   | 3,577 |   | 1,984 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Net Interest  Income                                 |       | 10,830                                            |       | 11,399 |   | 12,895 |   | 13,450 |   | 11,562 |   |
| Provision for  Loan Losses                           |       | 5,460                                             |       | 975 |   | — |   | 240 |   | 300 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Net Interest  Income After Provision for Loan Losses |       | 5,370                                             |       | 10,424 |   | 12,895 |   | 13,210 |   | 11,262 |   |
| Noninterest  Income                                  |       | 1,236                                             |       | 1,111 |   | 1,071 |   | 1,010 |   | 1,052 |   |
| Noninterest  Expense                                 |       | 9,865                                             |       | 9,763 |   | 9,029 |   | 8,590 |   | 7,808 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Income Before  Income Taxes                          |       | (3,259                                            | )          | 1,772 |   | 4,937 |   | 5,630 |   | 4,506 |   |
| Income Taxes                                         |       | (1,434                                            | )          | 633 |   | 1,934 |   | 2,242 |   | 1,759 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Net Income  (Loss)                                   |       | $                                                 | (1,825     | ) | $ | 1,139 |   | $ | 3,003 |   | $ | 3,388 |   | $ | 2,747 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Cash Dividends  Paid                                 |       | $                                                 | 483        |   | $ | 963 |   | $ | 871 |   | $ | 768 |   | $ | 730 |   |
| ** **                                           |       |                                              |       |   |   |   |   |   |   |   |   |
| **Per  Share Data:**                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Net Income –  Basic                             |       | $                                                 | (1.05      | ) | $ | 0.59 |   | $ | 1.55 |   | $ | 1.77 |   | $ | 1.46 |   |
| Net Income –  Diluted                           |       | $                                                 | (1.05      | ) | $ | 0.58 |   | $ | 1.51 |   | $ | 1.68 |   | $ | 1.38 |   |
| Dividends                                            |       | $                                                 | 0.25       |   | $ | 0.50 |   | $ | 0.45 |   | $ | 0.40 |   | $ | 0.388 |   |
| Book Value                                           |       | $                                                 | 9.58       |   | $ | 11.21 |   | $ | 11.01 |   | $ | 9.93 |   | $ | 8.35 |   |
| ** **                                           |       |                                              |       |   |   |   |   |   |   |   |   |
| **Common  Outstanding Shares:**                      |       | 1,961,334                                         |       | 1,923,053 |   | 1,924,873 |   | 1,928,097 |   | 1,899,543 |   |
| ** **                                           |       |                                              |       |   |   |   |   |   |   |   |   |
| **Statement  of Financial Condition Summary:**       |       |                                              |       |   |   |   |   |   |   |   |   |
| Total Assets                                         |       | $                                                 | 269,923    |   | $ | 251,880 |   | $ | 248,640 |   | $ | 240,738 |   | $ | 231,532 |   |
| Total Deposits                                       |       | 238,723                                           |       | 212,317 |   | 212,718 |   | 212,988 |   | 206,879 |   |
| Total Net Loans                                      |       | 198,099                                           |       | 186,632 |   | 166,619 |   | 169,680 |   | 152,563 |   |
| Allowance for  Loan Losses                           |       | 3,386                                             |       | 2,310 |   | 1,673 |   | 1,654 |   | 1,470 |   |
| Total  Shareholders’ Equity                     |       | 23,030                                            |       | 25,551 |   | 21,189 |   | 19,137 |   | 15,866 |   |
| ** **                                           |       |                                              |       |   |   |   |   |   |   |   |   |
| **Selected  Ratios:**                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Return on  Average Assets                            |       | -0.69                                             | %          | 0.46 | % | 1.22 | % | 1.42 | % | 1.21 | % |
| Return on  Average Equity                            |       | -7.18                                             | %          | 5.19 | % | 14.87 | % | 19.45 | % | 18.67 | % |
| Average Loans as  a Percentage of Average Deposits   |       | 87.82                                             | %          | 83.84 | % | 76.11 | % | 79.74 | % | 69.90 | % |
| Allowance for  Loan Losses to Total Loans            |       | 1.67                                              | %          | 1.22 | % | 0.99 | % | 0.96 | % | 0.95 | % |
| **Company:**                                         |       |                                              |       |   |   |   |   |   |   |   |   |
| Tier I Capital  to Average Assets                    |       | 10.28                                             | %          | 11.89 | % | 10.50 | % | 10.00 | % | — |   |
| Tier I Capital  to Risk-Weighted Assets              |       | 12.54                                             | %          | 14.41 | % | 13.20 | % | 12.70 | % | — |   |
| Total Capital to  Risk-Weighted Assets               |       | 13.87                                             | %          | 15.92 | % | 14.60 | % | 14.40 | % | — |   |
| **Bank:**                                            |       |                                              |       |   |   |   |   |   |   |   |   |
| Tier I Capital  to Average Assets                    |       | 9.71                                              | %          | 11.44 | % | 9.85 | % | 9.11 | % | 7.16 | % |
| Tier I Capital  to Risk-Weighted Assets              |       | 11.85                                             | %          | 13.65 | % | 12.33 | % | 11.43 | % | 9.33 | % |
| Total Capital to  Risk-Weighted Assets               |       | 13.18                                             | %          | 15.17 | % | 13.80 | % | 13.13 | % | 11.34 | % |

 

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**Santa Lucia Bancorp and Subsidiary**

 

**General**

 

Santa Lucia Bancorp (the “Company”) (OTC BulletinBoard SLBA.OB) is a California corporation organized April 3, 2006 to actas the holding company for its wholly owned subsidiary Santa Lucia Bank (the “Bank”),collectively referred to herein as the “Company.” The Bank was organized as anational banking association on December 19, 1984 and commenced operationson August 5, 1985. The Bank converted from a national to a Californiastate-chartered bank on May 30, 1997.

 

The Bank is a commercial banking business, operatingfrom offices located at 7480 El Camino Real, Atascadero, California, 1240Spring Street, Paso Robles, California, 1530 East Grand Avenue, Arroyo Grande,California and 1825 South Broadway, Santa Maria, California.

 

The Bank’s operating policy since its inception hasemphasized general commercial banking. Most of the Bank’s customers are smallto mid-sized businesses and individuals. The business of the Bank emphasizesserving the needs of local businesses, professionals, and wage earners. TheBank provides services designed to meet the needs of the various segments ofthe markets it serves. These services include a full line of business loans,business leases, personal loans and deposit products.

 

**Management’sDiscussion and Analysis and Results of Operations**

 

Certain statements contained in this report,including, without limitation, statements containing the words “believes”, “anticipates”,“intends”, “expects”, and words of similar import, constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934 (the “ExchangeAct”). Such forward-looking statements involve known and unknown risks,uncertainties and other factors that may cause the actual results, performanceor achievements of the Company to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements. Such factors include, among others, the following:general economic and business conditions in those areas in which the Companyoperates, the ongoing financial crisis and recession in the United States,California and foreign financial markets, and bank regulatory and governmentresponse thereto, the increase in nonperforming loans and the decrease in realestate values collateralizing many of the Bank’s loans,  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.  TheCompany disclaims any obligation to update any such factors or to publiclyannounce the results of any revisions to any of the forward-looking statementscontained herein to reflect future events or developments.

 

This discussion should be read in conjunction with theCompany’s audited financial statements and notes thereto which appear elsewherein this report.

 

***Overview***

 

The following sections set forth an analysis of thesignificant operating changes, business trends, financial condition, earnings,capital position and liquidity that have occurred in the three-year periodended December 31, 2009.

 

**ConsolidatedResults of Operations**

 

Highlights for the year ending December 31, 2009were as follows:

 

·                  Net Loss for the twelve month period ending December 31,2009 was $1,825,000 which reflects a decrease of $2,964,000 or 260.3% in netincome when compared to a profit of $1,139,000 for the same period in 2008. Theprimary reason for this decrease was the addition of $5,460,000 to theallowance for loan losses.

 

·                  Earnings (loss) per common share (on a fully dilutedbasis) equaled ($1.05) for 2009. This compares to $0.58 in 2008 and $1.51 in2007.

 

·                  Total assets, loans and deposits all increased in 2009over 2008 by 7.2%, 6.1% and 12.4% respectively. Non interest bearing depositswere 29.3% of total deposits compared to 35.4% at year end 2008.

 

·                  Return on Average Assets equaled (0.69%) for 2009compared to 0.46% in 2008 and 1.22% in 2007.

 

·                  Return on Average Equity equaled (7.18%) in 2009compared to 5.19% in 2008 and 14.87% in 2007.

 

·                  A cash dividend of $0.25 per share was paid toshareholders in 2009 which represents a decrease of 50.0% compared to totalcash dividends of $0.50 per share paid to shareholders in 2008. In 2007, totalcash dividends of $0.45   per share werepaid to shareholders. In addition, the Company also declared a 2% stockdividend to all shareholders of record as of September 30, 2009 reflectingthe Board’s decision to issue stock dividends rather than cash dividends duringthese difficult economic conditions in order to maintain its high capitallevels.

 

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·                  Total shareholders equity decreased to $23,030,000 asof December 31, 2009 compared to $25,551,000 as of December 31, 2008,representing a 9.9% decrease. Total shareholders equity stood at $21,189,000 asof December 31, 2007. The Company’s capital ratios at December 31,2009 which were all well above regulatory requirements for “well capitalized”institutions were: Tier 1 Capital to Average Assets 10.28%; Tier 1 Capital toRisk-Weighted Assets 12.54%; and Total Capital to Risk-Weighted Assets 13.87%.

 

·                  Nonperforming assets increased to $6,835,000 as of December 31,2009 compared to $1,614,000 for the same period in 2008. Nonperforming loanstotaled 3.38% of total gross loans as of December 31, 2009, compared to0.85% and 1.29% as of the same period in 2008 and 2007. The allowance for loanlosses to total loans increased to $3,386,000 or 1.67% as of December 31,2009 compared to $2,310,000 or 1.22% in 2008 and $1,673,000 or 0.99% in 2007.

 

In 2009 the Company recorded a net loss of $1,825,000,which reflects a decrease of $2,964,000 or 260.3% in net income over theprevious year. In 2008, earnings were $1,139,000, a decrease of 62.1% from 2007’searnings of $3,003,000. Earnings per common shares are calculated by using theCompany’s net earnings (loss) of $1,825,000 less preferred stock dividends of$200,000 less accreted discount on preferred stock of $40,199 for net earning(loss) available to common shareholders of $2,065,674. Basic net earnings(loss) per common share in 2009 were ($1.05) compared with $0.59 and $1.55 for2008 and 2007, respectively. This reflects a decrease from 2008 to 2009 of278.0% and 61.9% from 2008 to 2007. Fully diluted earnings (loss) per commonshare for 2009, 2008, and 2007 were ($1.05), $0.58, and $1.51, respectively, a281.0% decrease from 2008 to 2009 and 61.6% from 2008 to 2007. This is thefirst year end net loss that the Company has experienced in the last twenty twoyears.

 

Contributing largely to the decline in profitabilitywas the $5,460,000 provision to the allowance for loan losses in 2009. Thisprovision was made to cover net loan losses of $1,567,000, write-downs of thecollateral value of several nonperforming loans of $2,817,000 required due tothe decline in real estate values in the local market, the increase innonperforming loans and the increase in new loans. Also contributing to the netloss for the year ended 2009 was the decrease in the net interest margin from5.05% in December of 2008 to 4.49% for the same period in 2009, as well asa significant increase to the quarterly FDIC assessment coupled with a one timespecial assessment imposed on all financial institutions by the FDIC toincrease reserves.

 

The Company paid cash dividends on its common sharestotaling $0.25 per share and a 2% stock dividend during 2009 compared to $0.50cash dividend paid in 2008 and $0.45 cash dividend paid in 2007. Return onaverage shareholder’s equity was (7.2%) in 2009 compared to 5.2% in 2008 and14.9% in 2007. Return on average assets was (0.69%) in 2009 compared to 0.46%in 2008 and 1.22% in 2007.

 

The Company believes that the local economies in whichit operates, Atascadero, Paso Robles, Arroyo Grande, and Santa Maria continueto decline as the loss of jobs increase, businesses cash flows continue todecline as a result of reduced consumer spending and the real estate marketcontinued to suffer. During 2009 the company saw its first signs ofdeterioration in the real estate loan portfolio. Management continued toevaluate the loan portfolio as market values continued to decline. Based onmanagements’ evaluations the Company placed eight loans totaling $6,407,000 onnonaccrual, reversed accrued interest of approximately $179,000 and charged-off$4,384,000. The Company had one “other real estate owned” OREO property at December 31,2009 of $428,000 and booked a second OREO property of $427,000 in January 2010.Management believes that it identified and wrote down loan balances on allnonperforming loans to reflect current market values on the problem loans inthe loan portfolio existing at this time. As of December 31, 2009managements’ analysis of the allowance for loan losses was considered adequate.However, there is no guarantee that 2010 will not require further adjustments.Management will monitor and reassess the loan portfolio throughout the year.

 

The University of California Santa Barbara EconomicForecast Project reports that the local real estate markets will continue todecline through the first quarter of 2010 and at best California may show signsof slow growth averaging 1.0% to 2.0% in 2010 and 2011. New constructionprojects, even retail sites, are being developed in the San Luis Obispo Countyand expansion plans for the county’s prisons will certainly create jobs,especially in the construction field where they are critically needed. Weaknessin the commercial real estate sector is still intensifying. The decline in thelabor market has produced a rapid decline in demand for office and industrialspace and many retail store closings. However, both San Luis Obispo and SantaBarbara Counties have unemployment rates below the State and National averages.

 

***Net Interest Income***

 

Net interest income for the year ended December 31,2009 decreased $569,000 or 5.0% to $10,830,000 compared to $11,399,000 and$12,895,000 for the years ended December 31, 2008 and December 31,2007, respectively. Total interest income decreased $1,425,000 in 2009 whileinterest expense decreased $856,000 during the same period in 2009. Thedecrease in interest income was primarily due to a 103 basis point decrease inthe yield on average earning assets from 6.77 % in 2008 to 5.74% in 2009,resulting from the increased amount of loans placed on nonaccrual and the lowerrates received on the overall portfolio caused by a decline in the prime lendingrate during the fourth quarter of 2008 of 1.75%.

 

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The net interest margin decreased 56 basis points from5.05% in 2008 to 4.49% in 2009. The primary reason for this decrease was thedecline in the yield on average earning assets coupled with interest reversalsof $179,000 for loans that were placed on nonaccrual. Of the loans placed onnonaccrual, 5 loans were written down $2,818,000 due to the deterioration inreal estate collateral values, 23 loans totaling $1,567,000 were charged offand one property for $428,000 was transferred to OREO. Further, lower interestrates on new investments that were purchased to replace previous investmentsthat were either sold, matured or called decreased the average investment yield83 basis points from 4.86% at December 31, 2008 to 4.03% for the sameperiod in 2009.

 

Net interest income is the Company’s largest source ofoperating income and is derived from interest and fees received on interestearning assets, less interest expense incurred on interest bearing liabilities.The most significant impact on the Company’s net interest income betweenperiods is derived from the interaction of changes in the volume of and ratesearned or paid on interest earning assets and interest bearing liabilities.

 

Interest income decreased $1,425,000 or 9.3% from$15,276,000 in 2008 to $13,851,000 in 2009. This is compared to a decrease of$2,443,000 or 13.8% from 2007 to 2008 and an increase of $692,000 or 4.1% from2006 to 2007. The decrease in interest income was primarily due to a 103 basispoint decrease in the yield on average earning assets from 6.77% in 2008 to5.74% in 2009, resulting from the reversal of approximately $181,000 ininterest from loans placed on nonaccrual along with lower rates received on theoverall portfolio caused by a decline in the prime lending rate during thefourth quarter of 2008 of 1.75%.

 

Total interest and fees produced a 5.7% yield onaverage earning assets for 2009, 6.8% for 2008 and 8.1% in 2007. The averageloan to deposit ratio for 2009 was 87.8%, which represents an increase of 4.7%over the 83.8% average for 2008 which was an increase of 10.2% over the 76.1%average for 2007.

 

Total interest expense decreased $856,000 or 22.1%from $3,877,000 in 2008 to $3,021,000 in 2009 compared to a decrease of$947,000 or 19.6% from 2007 to 2008. The decrease in total interest expense in2009 was due to decreasing interest rates for all deposit categories despite anoverall increase in deposits for the year of 12.4%. The rate paid oninterest-bearing liabilities decreased 76 basis points from 2.58% in 2008 to1.82% in 2009.

 

The following table shows the composition of averageearning assets and average interest-bearing liabilities, average yields andrates, and the net interest margin for the years ended December 31, 2009,2008 and 2007. Nonaccrual loans are included in the calculation of the averagebalances of loans, and nonaccrued interest is excluded.

 
| ** **                                      | ** ** | **Year  Ended December 31** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                      | ** ** | **Average********Balance**       | ** ** | **Interest** | ** ** | **Yield/********Rate** | ** ** | **Average********Balance** | ** ** | **Interest** | ** ** | **Yield/********Rate** | ** ** | **Average********Balance** | ** ** | **Interest** | ** ** | **Yield/********Rate** | ** ** |
| ** **                                      | ** ** | **(dollars in thousands)**       | ** ** |
| **Assets:**                                     |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                           |       | $                                | 199,228    |   | $ | 12,355 |   | 6.20 | % | $ | 177,988 |   | $ | 12,994 |   | 7.30 | % | $ | 163,741 |   | $ | 15,031 |   | 9.18 | % |
| Investment  securities                          |       | 37,019                           |       | 1,491 |   | 4.03 | % | 46,440 |   | 2,258 |   | 4.86 | % | 49,024 |   | 2,438 |   | 4,97 | % |
| Federal funds  sold                             |       | 5,082                            |       | 5 |   | 0.10 | % | 1,309 |   | 24 |   | 1.83 | % | 4,954 |   | 250 |   | 5.05 | % |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total average  interest-earning assets          |       | 241,329                          |       | 13,851 |   | 5.74 | % | 225,737 |   | 15,276 |   | 6.77 | % | 217,719 |   | 17,719 |   | 8.14 | % |
| Other assets                                    |       | 25,402                           |       |   |   |   |   | 26,120 |   |   |   |   |   | 29,278 |   |   |   |   |   |
| Less allowance  for loan losses                 |       | (2,407                           | )          |   |   |   |   | (1,739 | ) |   |   |   |   | (1,707 | ) |   |   |   |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total average  assets                           |       | $                                | 264,324    |   |   |   |   |   | $ | 250,118 |   |   |   |   |   | $ | 245,290 |   |   |   |   |   |
| ** **                                      |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity:** |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  demand - NOW                  |       | $                                | 13,628     |   | $ | 49 |   | 0.36 | % | $ | 12,636 |   | $ | 41 |   | 0.32 | % | $ | 13,391 |   | $ | 55 |   | 0.41 | % |
| Money Market                                    |       | 32,196                           |       | 589 |   | 1.83 | % | 26,070 |   | 541 |   | 2.08 | % | 24,929 |   | 722 |   | 2.90 | % |
| Savings                                         |       | 27,387                           |       | 68 |   | 0.25 | % | 26,166 |   | 88 |   | 0.34 | % | 27,076 |   | 289 |   | 1.07 | % |
| Time certificate  of deposits                   |       | 82,723                           |       | 2,046 |   | 2.47 | % | 71,671 |   | 2,605 |   | 3.63 | % | 68,019 |   | 3,157 |   | 4.64 | % |
| Total average  interest-bearing deposits        |       | 155,934                          | ** ** | 2,752 |   | 1.76 | % | 136,543 |   | 3,275 |   | 2.40 | % | 133,415 |   | 4,223 |   | 3.17 | % |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                          |       | 3,177                            |       | 79 |   | 2.49 | % | 6,612 |   | 191 |   | 2.89 | % | 1,059 |   | 51 |   | 4.82 | % |
| Long-term  borrowings                           |       | 6,555                            |       | 190 |   | 2.90 | % | 7,106 |   | 411 |   | 5.78 | % | 7,155 |   | 550 |   | 7.69 | % |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities             |       | 165,666                          |       | 3,021 |   | 1.82 | % | 150,261 |   | 3,877 |   | 2.58 | % | 141,629 |   | 4,824 |   | 3.41 | % |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                 |       | 70,935                           |       |   |   |   |   | 75,752 |   |   |   |   |   | 81,714 |   |   |   |   |   |
| Other liabilities                               |       | 2,281                            |       |   |   |   |   | 2,170 |   |   |   |   |   | 1,749 |   |   |   |   |   |
| Sharholder’s  equity                       |       | 25,442                           |       |   |   |   |   | 21,935 |   |   |   |   |   | 20,198 |   |   |   |   |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total average  liabilities and                  |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| shareholders’  equity                      |       | $                                | 264,324    |   |   |   |   |   | $ | 250,118 |   |   |   |   |   | $ | 245,290 |   |   |   |   |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income                            |       |                             |       | $ | 10,830 |   |   |   |   |   | $ | 11,399 |   |   |   |   |   | $ | 12,895 |   |   |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin                            |       |                             |       |   |   | 4.49 | % |   |   |   |   | 5.05 | % |   |   |   |   | 5.92 | % |

 

13

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The Company’s net yield on interest-earning assets isaffected by changes in the rates earned and paid and the volume ofinterest-earning assets and interest-bearing liabilities. The impact of changesin volume and rate on net interest income are shown in the following table:

 
| ** **                                  | ** ** | **Year  Ended December 31, 2009********over********Year Ended December 31, 2008** | ** ** | **Year  Ended December 31, 2008********over********Year Ended December 31, 2007** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **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                                   |       | 1,421                                                                                       |       | (2,060                                                                                      | )          | (639 | ) | 1,228 |   | (3,265 | ) | (2,037 | ) |
| Investment Securities                       |       | (415                                                                                        | )          | (352                                                                                        | )          | (767 | ) | (127 | ) | (53 | ) | (180 | ) |
| Federal funds sold                          |       | 20                                                                                          |       | (39                                                                                         | )          | (19 | ) | (121 | ) | (105 | ) | (226 | ) |
| Interest-earning deposits                   |       | —                                                                                      |       | —                                                                                      |       | — |   | — |   | — |   | — |   |
| Total interest income                       |       | 1,026                                                                                       |       | (2,451                                                                                      | )          | (1,425 | ) | 980 |   | (3,423 | ) | (2,443 | ) |
| **Interest-bearing Liabilities:**           |       |                                                                                        |       |                                                                                        |       |   |   |   |   |   |   |   |   |
| Interest bearing demand - NOW               |       | 3                                                                                           |       | 5                                                                                           |       | 8 |   | (3 | ) | (11 | ) | (14 | ) |
| Money Market                                |       | 117                                                                                         |       | (69                                                                                         | )          | 48 |   | 32 |   | (213 | ) | (181 | ) |
| Savings                                     |       | 8                                                                                           |       | (28                                                                                         | )          | (20 | ) | (1 | ) | (200 | ) | (201 | ) |
| Time Certificates of deposit                |       | 360                                                                                         |       | (919                                                                                        | )          | (559 | ) | 163 |   | (715 | ) | (552 | ) |
| Short-term borrowings                       |       | (88                                                                                         | )          | (24                                                                                         | )          | (112 | ) | 167 |   | (27 | ) | 140 |   |
| Long-term borrowings                        |       | 16                                                                                          |       | (237                                                                                        | )          | (221 | ) | 16 |   | (155 | ) | (139 | ) |
| Total interest expense                      |       | 416                                                                                         |       | (1,272                                                                                      | )          | (856 | ) | 374 |   | (1,321 | ) | (947 | ) |
| Interest differential or net interestincome |       | $                                                                                           | 610        |                                                                                        | $          | (1,179 | ) | $ | (569 | ) | $ | 606 |   | $ | (2,102 | ) | $ | (1,496 | ) |
|                                             |            |                                                                                             |            |                                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Noninterest Income***

 

Noninterest income totaled $1,235,000 compared to$1,111,000 for the same period in 2008. That represents an increase of $124,000or 11.2%. The increase was primarily due to the sale of $5,176,000 in mortgagebacked securities which created a net gain of $225,000 compared to $108,000 forthe same period in 2008. In addition, dividends on cash surrender value lifeinsurance increased $10,000 and other income increased $35,000. 

 

Service charges on deposit accounts totaled $517,000,which represents a decrease of $37,000 or 6.6% compared to a decrease of$29,000 or 5.0% over the same period in 2008. The decrease in services chargeswas primarily due to the decrease in non sufficient fund fees collected.

 

Refer to the “Statement of Earnings” for a breakdownof noninterest income.

 

***Noninterest Expense***

 

Noninterest expense increased $102,000 or 1.0% in 2009over 2008 from $9,763,000 to $9,865,000 as compared to an increase of $734,000or 8.1% in 2008 over 2007. The overall increase can be largely attributed tothe FDIC special assessment levied on all banks coupled with the increase inthe quarterly assessment fees and the participation in the TGLP TransactionAccount Guarantee Program.

 

Regulatory assessment fees for the year ended December 31,2009 were $511,000, which reflects an increase of $343,000 or 204.2% comparedto $168,000 for an increase of $104,000 or 162.5% over the same period in 2008.This was primarily due to the $120,000 special FDIC assessment levied on thebank during the first six months of 2009; the special assessment was leviedagainst all financial institutions to replenish the FDIC’s deposit insurancefund. The FDIC also increased the deposit insurance premium during the lastthree quarters of 2009 and the additional expense of $9,000 for theparticipation in the TGLP Transaction Account Guarantee Program.

 

Salaries and related expenses decreased $291,000 or5.2% from $5,650,000 in 2008 to $5,359,000 in 2009 compared to an increase of$391,000 or 7.4% between 2007 and 2008. The decrease is attributed to theretirement of Larry H. Putnam, the freezing of officer salaries and thereduction in salary continuation plan expense due to the retirement of Mr. Putnam.

 

Occupancy expense for the year ended December 31,2009 totaled $663,000, which reflects an increase of $10,000 or 1.6% comparedto an increase of $25,000 or 3.9% over the same period in 2008. This wasprimarily due to the depreciation of building repairs.

 

Equipment expense for the year ended December 31,2009 totaled $633,000, which reflects a decrease of $37,000 or 5.5% compared toan increase of $4,000 or 0.6% over the same period in 2008.

 

Professional services for the year ended December 31,2009 totaled $638,000, which reflects an increase of $37,000 or 6.2% comparedto an increase of $174,000 or 40.9% over the same period in 2008. This wasprimarily due to the increases in legal fees related to the collection ofnonaccrual loans.

 

Data processing expense for the year ended December 31,2009 totaled $520,000, which reflects an increase of $16,000 or 3.1% comparedto an increase of $16,000 or 3.3% from the same period in 2008. This wasprimarily due to the continued growth of the Company.

 

14

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Office expenses for the year ended December 31,2009 totaled $413,000, which reflects an increase of $21,000 or 5.3% comparedto an increase of $30,000 or 8.2% for the same period in 2008.

 

Messenger and courier expenses decreased $28,000 or22.5% from $123,000 in 2008 to $95,000 in 2009. This decrease was due to theBank switching to electronic cash letters.

 

Other expense increased $31,000 or 12.6% from $249,000in 2008 to $280,000 in 2009. This increase was due to additional loan relatedexpenses associated with the collection of nonaccrual loans coupled with OtherReal Estate Owned expenses.

 

The Company’s efficiency ratio for 2009 was 81.8%.This represents a worsening from the 2008 efficiency ratio of 78.0%, which wasa worsening from the 2007 ratio of 64.7%. The decrease in the efficiency ratiowas primarily due to the decrease in net interest income coupled with theincrease in non interest expense.

 

Refer to the “Statement of Earnings” for a breakdownof noninterest expense.

 

***Income Taxes***

 

The provision for income tax was ($1,434,000) in 2009,$633,000 in 2008 and $1,934,000 in 2007. The effective tax rate was (44.0%) in2009 as compared to 35.7% in 2008 and 39.1% in 2007.

 

**FinancialCondition**

 

In 2009, the Company’s consolidated total assetsincreased to $269,923,000 compared to $251,880,000 in 2008 and $248,640,000 in2007 for increases of 7.2%, 1.3% and 3.3% respectively.

 

Total deposits increased $26,406,000 to $238,723,000compared to $212,317,000 in 2008 and $212,718,000 in 2007 for an increase of12.4% for 2009, compared to a decrease of 0.2% and 0.1% for 2008 and 2007respectively. Despite deposit competition continuing to be very strong in boththe traditional bank deposits and alternative investments available in themarket place the Company’s total deposits increased significantly during thepast year. The increase in deposits is largely due to the increased confidencein community banks and the increase in the FDIC insurance limits to $250,000 onTime Certificates of Deposit. The recent trend of customers depositing excessfunds into Time Certificates of Deposit or other interest bearing accountscontinued throughout 2009. Average time certificates of deposits increased$11,052,000, average money market accounts increased $6,126,000 and averagesavings increased $1,221,000 in 2009 compared to 2008. Despite this trend, theCompany had 29.3% of total deposits in non-interest bearing deposits as of December 31,2009 compared to 35.4% as of December 31, 2008. Non-interest bearingdeposits at these levels continue to be above industry averages.

 

Securities available for sale totaled $40,990,000 at December 31,2009, compared to $38,470,000 at December 31, 2008 and $56,107,000 at December 31,2007. This represents an increase of $2,520,000 or 6.5% over December 31,2008.

 

***Loan Portfolio***

 

Total loans outstanding averaged $199,228,000 in 2009compared to $177,988,000 in 2008. This represents an increase of $21,240,000 or11.9% in 2009 compared to an increase of $14,247,000 or 8.7% in 2008. Actualnet loans at December 31, 2009 equaled $198,099,000 for an increase of$11,467,000 or 6.1% over 2008 

 

The following table sets forth the amount of totalloans outstanding in each category for the years indicated:

 
| ** **                                   | ** ** | **Year  Ended December 31** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(dollars in thousands)**       | ** ** |
| Commercial                                   |       | $                                | 41,744     |   | $ | 41,478 |   | $ | 38,017 |   | $ | 36,407 |   | $ | 34,139 |   |
| Real Estate – construction              |       | 47,458                           |       | 52,389 |   | 47,819 |   | 55,307 |   | 52,696 |   |
| Real Estate – other                     |       | 111,183                          |       | 94,372 |   | 81,895 |   | 78,757 |   | 66,390 |   |
| Consumer                                     |       | 1,783                            |       | 1,415 |   | 1,237 |   | 1,604 |   | 1,533 |   |
| Total gross loans                            |       | 202,168                          |       | 189,654 |   | 168,968 |   | 172,075 |   | 154,758 |   |
| Less: unearned fees                          |       | (683                             | )          | (712 | ) | (676 | ) | (741 | ) | (725 | ) |
| Less: allowance for loan losses              |       | (3,386                           | )          | (2,310 | ) | (1,673 | ) | (1,654 | ) | (1,470 | ) |
|                                         |       |                             |       |   |   |   |   |   |   |   |   |
| Total net loans                              |       | $                                | 198,099    |   | $ | 186,632 |   | $ | 166,619 |   | $ | 169,680 |   | $ | 152,563 |   |
|                                         |       |                             |       |   |   |   |   |   |   |   |   |
| Weighted average yield on loans for the year |       | 6.2                              | %          | 7.3 | % | 9.2 | % | 9.1 | % | 8.1 | % |

 

15

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The following table sets forth the amount of totalgross loans outstanding at December 31, 2009 by contractual maturity date:

 
| ** **                      | ** ** | ** **                 | ** ** | **After  One**    | ** ** | ** **      | ** ** | ** ** | ** ** |
|---------------------------------|------------|----------------------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                      | ** ** | **One  Year**              | ** ** | **Year  Through** | ** ** | **After**       | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **or  Less**               | ** ** | **Five  Years**   | ** ** | **Five  Years** | ** ** | **Total**  | ** ** |
| ** **                      | ** ** | **(dollars in thousands)** | ** ** |
| Commercial                      |       | $                          | 20,906     |              | $          | 11,578          |       | $          | 9,260      |   | $ | 41,744 |   |
| Real Estate – construction |       | 32,840                     |       | 10,492            |       | 4,126           |       | 47,458     |       |
| Real Estate – other        |       | 1,663                      |       | 12,467            |       | 97,053          |       | 111,183    |       |
| Consumer                        |       | 947                        |       | 385               |       | 451             |       | 1,783      |       |
|                            |       | $                          | 56,356     |              | $          | 34,922          |       | $          | 110,890    |   | $ | 202,168 |   |

 

A significant portion of the loan portfolio of theCompany is collateralized by real estate. At December 31, 2009, realestate served as the principal source of collateral with respect to 78.5% ofthe Company’s loan portfolio. A decline in current economic conditions has hadan adverse effect on the demand for new loans even as rates continue todecline. It is also understood that the ability of borrowers to repayoutstanding loans, the value of real estate and other collateral securing loansand the value of real estate owned by the Company, could affect the Company’sfinancial condition and results of operations in general and the market valueof the Company’s common stock. Acts of nature, including earthquakes andfloods, which may cause uninsured damage and other loss of value to real estatethat secures these loans, may also negatively impact the Company’s financialcondition.

 

Real estate construction and other real estate loansequaled $158,641,000 or 78.5% of the total loan portfolio and $146,761,000 or77.4% of the total loan portfolio at December 31, 2009 and 2008,respectively. Other real estate loans are comprised of loans to individuals fortheir businesses, consumer real estate loans including home equity lines ofcredit and loans for farmland. The company has known for some time that it hasa concentration in commercial real estate loans. As a means to more closelymonitor this concentration, the Company has instituted the use of NAICS codes,individual commercial real estate stress tests and an overall portfolio stresstest to monitor industry trends within its commercial real estate portfolio. Asof December 31, 2009, the Company had $90,610,000 or 45.0% of its loans incommercial real estate. Of this number, $53,404,000 or 58.9% is commercial realestate for owners use. No industry type exceeds 10.0% of total loans. Theremaining $37,206,000 or 41.0% is commercial real estate for non-owners use.Commercial real estate loans for non-owners use as a percentage of total loansequates to 18.5%. We watch the commercial real estate loans for non-owners usealong with changes within our owners use very closely and are familiar with theindividuals and projects. Total real estate loans increased $11,879,958 or 8.1%in 2009 over 2008 compared to an increase of $17,047,000 or 13.1% in 2008 over2007. The increase is spread throughout construction of residential units heldfor sale, construction of commercial properties and commercial incomeproperties. The Company has seen a significant decrease in the number ofresidential construction loans, due to the softening in the real estate market.The Company has construction 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 exceed70% of the appraised value on commercial residential real estate or 75% on anindividual’s personal residence.

 

The Company makes commercial loans to small andmid-size businesses for various reasons, including working capital, inventoryand equipment. Commercial loans equaled $41,744,000 or 20.6% of the total loanportfolio and $41,478,000 or 21.9% of the total loan portfolio at December 31,2009 and 2008, respectively. Commercial loans increased $266,000 or 0.6% from2009 to 2008 compared to an increase of $3,461,000 or 9.1% in 2008 over 2007.

 

Consumer and other loans equaled $1,783,000 or 0.9% ofthe total loan portfolio at December 31, 2009 compared to $1,415,000 or0.7% at December 31, 2008. Consumer loans increased $368,000 or 26.0% in2009 over 2008 compared to a decrease of $178,000 or 14.4% in 2008 over 2007.

 

The Company had undisbursed loans totaling$43,105,000, $57,168,000, and $57,326,000 as of December 31, 2009, December 31,2008 and December 31, 2007, respectively. Standby Letters of Creditaccounted for $1,298,000, $3,106,000 and $4,286,000 of the undisbursed loans asof December 31, 2009, December 31, 2008 and December 31, 2007,respectively. The Company uses the same credit policies in making thesecommitments as is done for all of its lending activities. As such, the creditrisk involved in these transactions is the same as that involved in extendingloan facilities to customers.

 

Loans with maturities greater than one year at December 31,2009 totaled $145,812,000 and include approximately $4,754,000 of fixed rateloans or 2.3% of the total loan portfolio compared to $11,291,000 or 6.0% ofthe total loan portfolio as of December 31, 2008 and $7,704,000 or 4.6% ofthe total loan portfolio as of December 31, 2007. The balance of the loansthat have maturities of one year or less, or are variable rate loans at December 31,2009 totaled $197,414,000 or 97.7% compared to $178,363,000 or 94.0% as of December 31,2008 and $161,265,000 or 95.4% as of December 31, 2007. The $97,053,000 inother real estate loans with five years or greater maturities are primarily owneroccupied commercial properties.

 

Overall management of the Bank’s loan portfolio isconsidered good; however, loans have been adversely affected by the decline inthe economy and its impact on our borrowers, especially in the real estatesector. Throughout 2009 the Bank tightened its overall underwriting standardsand strengthened credit administration with the addition of a Senior VicePresident who is familiar with the lending philosophy of Santa Lucia Bank.

 

16

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***Troubled DebtRestructurings***

 

The Bank has eight loans to three borrowers totaling$3,768,000, which were considered Troubled Debt Restructurings (TDR’s) as of December 31,2009.

 

The loan categories andInterest Income received during 2009 are as follows:

 
| ** **                          | ** ** | **Principal  Balance** | ** ** | **Interest  Paid** | ** ** | **Interest  Earned** | ** ** |
|-------------------------------------|------------|------------------------|------------|--------------------|------------|----------------------|------------|
| Residential Real  Estate            |       | $                      | 1,105,000  |               | $          | 50,281               |       | $ | 44,706 |   |
| Commercial  Property for Owners Use |       | 1,468,000              |       | 100,635            |       | 93,934               |       |
| Offsite  Developement               |       | 565,000                |       | 34,283             |       | 32,381               |       |
| Land                                |       | 630,000                |       | 36,191             |       | 34,965               |       |
|                                     |            |                        |            |                    |            |                      |            |  |  |  |

 

As of December 31, 2009 all loans considered TDR’swere on accrual status. The Bank generally returns loans to accrual statusafter six monthly payments are made on a timely basis.

 

Concessions granted by the Bank were reductions ininterest rate. Thus far, the concessions granted have allowed the borrowers toretain their properties and/or to continue to operate their business.

 

The Residential Real Estate loans considered TDR’swere measured for impairment utilizing the expected future cash flows. Thismethod was chosen as each property has a rental contract in place. Theborrowers anticipate either selling the properties when the real estate marketrebounds or they will obtain long term financing and retain the properties asrentals.

 

The remaining loans were analyzed utilizing the fairvalue of the collateral. The borrowers have the properties listed for sale andthe Bank expects to receive repayment of the principal balances of the loansfrom sale proceeds. The determined impairments of these loans were reserved forin the allowance for loan losses, however no direct charge was made as theborrowers have additional repayment sources available should the sale of thecollateral be insufficient.

 

***Nonperforming loans***

 

Interest income is accrued daily as earned on allloans. 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 on thecontractual 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.

 

The composition ofnonperforming loans as of the end of the last five fiscal years is summarizedin the following table:

 
| ** **                                                 | ** ** | **Year Ended December 31** | ** ** |
|------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                 | ** ** | **2009**                        | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **(dollars  in thousands)**     | ** ** |
| **Nonaccrual  loans:**                                     |       |                            |       |   |   |   |   |   |   |   |   |
| Commercial                                                 |       | $                               | 221        |   | $ | 714 |   | $ | 113 |   | $ | — |   | $ | — |   |
| Real estate                                                |       | 6,186                           |       | 900 |   | 2,062 |   | — |   | 135 |   |
| Consumer                                                   |       | —                          |       | — |   | — |   | — |   | — |   |
| Total                                                      |       | 6,407                           |       | 1,614 |   | 2,175 |   | — |   | 135 |   |
| **Loans  90 days or more past due and still accruing:**    |       |                            |       |   |   |   |   |   |   |   |   |
| Real estate                                                |       | —                          |       | — |   | — |   | — |   | — |   |
| Consumer                                                   |       | —                          |       | — |   | — |   | — |   | — |   |
| Commercial                                                 |       | —                          |       | — |   | — |   | 550 |   | — |   |
| Total                                                      |       | —                          |       | — |   | — |   | 550 |   | — |   |
| Total  nonperforming loans:                                |       | 6,407                           |       | 1,614 |   | 2,175 |   | 550 |   | 135 |   |
| OREO                                                       |       | 428                             |       | — |   | — |   | — |   | — |   |
| Total  nonperforming assets:                               |       | $                               | 6,835      |   | $ | 1,614 |   | $ | 2,175 |   | $ | 550 |   | $ | 135 |   |
| Nonperforming  assets as a percentage of total gross loans |       | 3.38                            | %          | 0.85 | % | 1.29 | % | 0.32 | % | 0.09 | % |
| Nonperforming  assets as a percentage of total assets      |       | 2.53                            | %          | 0.64 | % | 0.87 | % | 0.23 | % | 0.06 | % |
| Allowance for  loan losses to nonperforming loans          |       | 52.85                           | %          | 143.12 | % | 76.92 | % | 300.73 | % | 1088.89 | % |

 

The Company had eight nonperforming loans totaling$6,407,000 as of December 31, 2009, compared to three nonperforming loantotaling $1,614,000 at December 31, 2008 and one nonperforming loantotaling $2,175,000 at December 31, 2007. The increase in nonperformingloans as of December 31, 2009 was a result of the current economicdownturn and a reduction in real estate collateral values. For loans that wereconsidered to be impaired, the Bank determined the fair value of the realestate collateral and charged-off the portions of such loans considereduncollectible based on these analyses.

 

17

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There are three nonperforming loans in the Commercialand Industrial category totaling $221,000 which are largely secured by realestate.

 

Nonperforming real estate secured loans consists offive loans totaling $6,186,000, which were written down in the aggregate totalof $2,818,000 prior to year end. Two of these loans are on homes built forspeculative purposes. The first home has been sold and escrow is expected toclose in the first quarter of 2010. The Bank took the second home into “OtherReal Estate Owned” OREO in January 2010. There is one loan for anindividual’s personal residence within this category. The Bank is working withlegal counsel and has begun the foreclosure process. The Bank placed an offsitedevelopment loan for a mixed use project on nonaccrual as of December 31, 2009.The development has not progressed and the Bank is exploring options (includinglegal) at this time. The last loan in this category is an offsite developmentloan that the Bank has a participation interest in totaling $1,576,000 afterwrite-down. The property is located outside the Bank’s service area. One of theguarantors and the owner of additional collateral that was pledged in supportof this loan have filed bankruptcy. The Bank is working with the originatingbank and legal counsel to vigorously pursue the collection of this loan fromboth the borrower and guarantors.

 

The Company had one “Other Real Estate Owned” OREOproperty as of December 31, 2009 totaling $428,000 and added anotherproperty in the amount of $427,000 for an aggregate total of $855,000 as of January 31,2010. The first property is actively being marketed for sale at this time withminimal loss anticipated. The second piece of property is currently in escrowand the Company anticipates closure in March 2010 with a minimal loss.

 

***Allowance for LoanLosses***

 

Inherent in lending is the fact that loan losses willbe experienced and that the risk of loss will vary with the type of loanextended and the creditworthiness of the borrower. To reflect the estimatedrisks of loss associated with its loan portfolio, provisions are made to theCompany’s allowance for loan losses. As an integral part of this process, theallowance for loan losses is subject to review and possible adjustment as aresult of regulatory examinations conducted by governmental agencies andthrough management’s assessment of risk. The Company’s entire allowance is avaluation allocation; that is, it has been created by direct charges againstoperations through the allowance for loan losses.

 

The Company evaluates the allowance for loan lossesbased upon an individual analysis of specific categories of loans, specificcategories of classified loans and individual classified assets. The adequacyof the allowance is determinable only on an approximate basis, since estimatesas to the magnitude and timing of loan losses are not predictable because ofthe impact of external events. In addition, the Company contracts with anindependent loan review firm to evaluate new loans on a monthly basis and anoverall credit quality examination on an annual basis. Management thenconsiders the adequacy of the allowance quarterly for possible loan losses inrelation to the total loan portfolio.

 

The allowance for loan losses charged againstoperating expense is based upon an analysis of the actual migration of loans tolosses plus 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 in all significant loans; known deterioration inconcentrations of credit; certain classes of loans or pledged collateral;historical loss experience based on volume and type of loan; the results of anyindependent review or evaluation of the loan portfolio quality conducted by orat the direction of the Company’s management or by bank regulatory agencies;trends in portfolio volume, maturity, and composition; 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 loan losses at least quarterly.

 

The following table summarizes the allocation of theallowance for loan losses by type for the years indicated and the percent ofloans in each category to total loans (dollar amounts in thousands):

 
| ** **                 | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                  | ** ** | **(dollars in thousands)**  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | ** **                  | ** ** | **Loan**                    | ** ** | ** **                  | ** ** | **Loan**                    | ** ** | ** **                  | ** ** | **Loan** | ** ** | ** ** | ** ** | **Loan** | ** ** | ** ** | ** ** | **Loan** | ** ** |
| ** **                 | ** ** | **Amount**                  | ** ** | **Percent**                 | ** ** | **Amount**                  | ** ** | **Percent**                 | ** ** | **Amount**                  | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Commerical                 |       | $                           | 1,145      |                        | 20.65      | %                           | $          | 696                         |       | 21.87                       | %          | $ | 525 |   | 22.50 | % | $ | 495 |   | 21.16 | % | $ | 536 |   | 22.06 | % |
| Real Estate - construction |       | 784                         |       | 23.47                       | %          | 483                         |       | 27.62                       | %          | 229                         |       | 28.30 | % | 126 |   | 32.14 | % | 118 |   | 34.05 | % |
| Real Estate -  other       |       | 1,412                       |       | 55.00                       | %          | 1,073                       |       | 49.76                       | %          | 572                         |       | 48.47 | % | 362 |   | 45.77 | % | 274 |   | 42.90 | % |
| Consumer                   |       | 39                          |       | 0.88                        | %          | 39                          |       | 0.75                        | %          | 32                          |       | 0.73 | % | 38 |   | 0.93 | % | 36 |   | 0.99 | % |
| Unallocated                |       | 6                           |       | n/a                         |       | 19                          |       | n/a                         |       | 315                         |       | n/a |   | 633 |   | n/a |   | 506 |   | n/a |   |
| Total                      |       | $                           | 3,386      |                        | 100.00     | %                           | $          | 2,310                       |       | 100.00                      | %          | $ | 1,673 |   | 100.00 | % | $ | 1,654 |   | 100.00 | % | $ | 1,470 |   | 100.00 | % |

 

The Company experienced net charge-offs (recoveries)of $4,384,000, $338,000 and ($19,000) in 2009, 2008 and 2007 respectively.

 

18

----

 

The Company increased the allowance for loan losses$5,460,000 during the twelve month period ending December 31, 2009compared to $975,000 for the same period in 2008. The primary reasons for theincrease was the amount of net loan charge-offs, the increase in non-performingloans, the write-downs of several loans to the fair value due to the downturnin the real estate market and the $12,515,000 or 6.6% growth in gross loans.

 

Management views the allowance for loan losses of$3,386,000 or 1.67% of total loans as of December 31, 2009 to be adequateafter considering the above factors. This allowance is compared to $2,310,000or 1.22% in 2008 and $1,673,000 or .99% in 2007. However, there can be noassurance that in any given period the Company will not sustain charge-offsthat are substantial in relation to the size of the allowance.

 

The activity in the allowance for loan losses as ofthe end of the last five fiscal years is summarized in the following table:

 
| ** **                                                                   | ** ** | **Year  Ended December 31** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **(dollars in thousands)**       | ** ** |
| **Outstanding loans:**                                                       |       |                             |       |   |   |   |   |   |   |   |   |
| Average for the year (net)                                                   |       | $                                | 199,228    |   | $ | 177,988 |   | $ | 163,741 |   | $ | 169,139 |   | $ | 145,195 |   |
| End of the year (net)                                                        |       | 198,099                          |       | 186,632 |   | 166,619 |   | 169,680 |   | 152,563 |   |
| Allowance for loan losses:                                                   |       |                             |       |   |   |   |   |   |   |   |   |
| Balance at beginning of year                                                 |       | $                                | 2,310      |   | $ | 1,673 |   | $ | 1,654 |   | $ | 1,470 |   | $ | 1,200 |   |
| Actual charge-offs:                                                          |       |                             |       |   |   |   |   |   |   |   |   |
| Commercial                                                                   |       | 1,080                            |       | 308 |   | 51 |   | 77 |   | 43 |   |
| Real estate                                                                  |       | 3,262                            |       | — |   | — |   | — |   | — |   |
| Consumer                                                                     |       | 38                               |       | 31 |   | — |   | — |   | — |   |
| All other (including overdrafts)                                             |       | 6                                |       | 13 |   | 10 |   | 6 |   | 3 |   |
| Total charge-offs                                                            |       | 4,386                            |       | 352 |   | 61 |   | 83 |   | 46 |   |
| **Less Recoveries:**                                                         |       |                             |       |   |   |   |   |   |   |   |   |
| Commercial                                                                   |       | 1                                |       | 12 |   | 4 |   | 26 |   | 15 |   |
| Real estate                                                                  |       | —                           |       | — |   | 76 |   | — |   | — |   |
| Consumer                                                                     |       | —                           |       | — |   | — |   | — |   | — |   |
| All other (including overdrafts)                                             |       | 1                                |       | 2 |   | — |   | 1 |   | 1 |   |
| Total recoveries                                                             |       | 2                                |       | 14 |   | 80 |   | 27 |   | 16 |   |
| Net loan charge-offs (recoveries)                                            |       | 4,384                            |       | 338 |   | (19 | ) | 56 |   | 30 |   |
| Provision for loan loss                                                      |       | 5,460                            |       | 975 |   | — |   | 240 |   | 300 |   |
| Balance at end of period                                                     |       | $                                | 3,386      |   | $ | 2,310 |   | $ | 1,673 |   | $ | 1,654 |   | $ | 1,470 |   |
| **Ratios:**                                                                  |       |                             |       |   |   |   |   |   |   |   |   |
| Net loan charge-offs (recoveries) to average loans                           |       | 2.20                             | %          | 0.19 | % | -0.01 | % | 0.03 | % | 0.02 | % |
| Allowance for loan losses to end of year loans                               |       | 1.67                             | %          | 1.22 | % | 0.99 | % | 0.96 | % | 0.95 | % |
| Net loan charge-offs (recoveries) to allowance for loan losses               |       | 129.47                           | %          | 14.63 | % | -1.14 | % | 3.39 | % | 2.04 | % |
| Net loan charge-offs (recoveries) to provision charged to operating  expense |       | 80.29                            | %          | 34.67 | % | 0.00 | % | 23.33 | % | 10.00 | % |

 

***Interest Reserves***

 

The Bank providesinterest reserves on construction loan projects, if requested by the borrowerand if the request meets the underwriting criteria of the Bank. The borrowermust demonstrate the ability to cash flow the interest carry on the projectonce the interest reserve is exhausted and the project, including interestreserves, must meet the loan to value parameters set forth by the Bank’s LoanPolicy. If construction is not complete at the initial maturity date and anextension of time is requested, additional interest reserves are not provided.The Bank advances funds on construction loans via the 5 or 10-draw system,percentage of completion or by vouchers. The 5 or 10-draw system forconstruction loans is utilized occasionally by contractors for payment. TheBank divides the construction project into segments with funds being advancedto the contractor after each segment is completed and inspected by the BankInspector. Inspections are made to ensure work has been completed prior tofunding for both the draw system and percentage of completion. Loans that arefunded via the voucher system are inspected to ensure work is completed on amonthly basis.

 

The Bank has one loan in the amount of $670,000 thatwas extended in early 2009 with additional interest reserves. A new appraisalwas obtained prior to extension and the loan to value is very low, affordingthe borrowers to request cash out to service the debt. The borrowers have beeninformed that any further extension requests will not include additionalinterest reserves.

 

The Bank also has one loan with interest reserves thatis nonperforming in the amount of $427,000. The loan is for a speculativeconstruction project. This property was taken into OREO in January 2010and listed for sale. The Bank recently received and accepted an offer on thehome with escrow expected to close in early March 2010.

 

***InvestmentSecurities***

 

The average balance of Federal Funds Sold (overnightinvestments with other banks) was $5,082,000 in 2009, $1,309,000 in 2008, and$4,954,000 in 2007. These investments are maintained primarily for theshort-term liquidity needs of the Company. The major factors influencing thelevels of required liquidity are the loan demand of the Company’s customers andfluctuations in the Company’s deposits.

 

19

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Average total investment securities decreased by$9,421,000 or 20.3% during 2009, compared to a decrease of $2,584,000 or 5.3%in 2008. The decrease in securities was primarily due to the maturities, calledsecurities and the principal pay downs of mortgage backed securities coupledwith the sale of $5,176,000 in mortgage backed securities. The aggregate marketvalue of the investment portfolio was $560,000 over the amortized cost as of December 31,2009. It is the Company’s policy not to engage in securities tradingtransactions. There are no investments in the portfolio deemed to bepermanently impaired. The Company has classified all of its investmentsecurities as available for sale. The exposure to sub prime loans in themortgage-backed securities portfolio is minimal due to the fact these securitiesare guaranteed by United States Government Agencies and, as such, can be viewedas having credit risk comparable to United States Treasury securities.

 
| ** **                             | ** ** | **Year Ended December 31** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                             | ** ** | **Amortized**                             | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Cost**                                  | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Fair Value** | ** ** | **Cost** | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Fair Value** | ** ** |
| **Securities  available for sale:**    |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Government  and Agency Securities |       | $                                         | 21,824,979 |   | $ | 217,016 |   | $ | (8,531 | ) | $ | 22,033,464 |   | $ | 16,093,125 |   | $ | 565,115 |   | $ | — |   | $ | 16,658,240 |   |
| State and  Political Subdivisions      |       | 3,714,014                                 |       | 95,484 |   | (5,416 | ) | 3,804,082 |   | 5,742,575 |   | 49,245 |   | (51,056 | ) | 5,740,764 |   |
| Mortgage-Backed  Securities            |       | 14,890,559                                |       | 294,505 |   | (32,711 | ) | 15,152,353 |   | 15,787,914 |   | 345,063 |   | (61,505 | ) | 16,071,472 |   |
| Total                                  |       | $                                         | 40,429,552 |   | $ | 607,005 |   | $ | (46,658 | ) | $ | 40,989,899 |   | $ | 37,623,614 |   | $ | 959,423 |   | $ | (112,561 | ) | $ | 38,470,476 |   |

 

The amortized cost, estimated fair value, and weightedaverage yield for investment securities available for sale based on maturitydate are set forth in the table below. The weighted average yield is based onthe amortized cost of the securities using a method that approximates the levelyield method:

 
| ** **                                    | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                                    | ** ** | ** **                                 | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                    | ** ** | **Book**                                   | ** ** | **Market** | ** ** | **Average** | ** ** | **Book** | ** ** | **Market** | ** ** | **Average** | ** ** |
| ** **                                    | ** ** | **Value**                                  | ** ** | **Value** | ** ** | **Yield** | ** ** | **Value** | ** ** | **Value** | ** ** | **Yield** | ** ** |
| **Available-for-Sale Securities:**            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and Agency Securities         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                              |       | $                                          | 3,996,116  |   | $ | 4,080,570 |   | 3.14 | % | $ | 4,103,572 |   | $ | 4,216,776 |   | 5.11 | % |
| One to Five Years                             |       | 17,828,863                                 |       | 17,952,894 |   | 2.61 | % | 11,989,553 |   | 12,441,464 |   | 5.05 | % |
| Five to Ten Years                             |       | —                                     |       | — |   |   |   | — |   | — |   |   |   |
| Over Ten Years                                |       | —                                     |       | — |   |   |   | — |   | — |   |   |   |
| Total U.S. Agency                             |       | 21,824,979                                 |       | 22,033,464 |   | 2.71 | % | 16,093,125 |   | 16,658,240 |   | 5.06 | % |
| ** **                                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **State and Political Subdivisions:**         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                              |       | 762,383                                    |       | 769,203 |   | 5.26 | % | 2,017,532 |   | 2,028,376 |   | 4.57 | % |
| One to Five Years                             |       | 1,207,750                                  |       | 1,238,794 |   | 5.96 | % | 1,482,818 |   | 1,493,854 |   | 6.02 | % |
| Five to Ten Years                             |       | 1,743,881                                  |       | 1,796,085 |   | 5.91 | % | 2,242,225 |   | 2,218,534 |   | 6.17 | % |
| Over Ten Years                                |       | —                                     |       | — |   |   |   | — |   | — |   |   |   |
| Total State & Political Subdivisions |       | 3,714,014                                  |       | 3,804,082 |   | 5.79 | % | 5,742,575 |   | 5,740,764 |   | 5.57 | % |
| ** **                                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Mortgage Backed Securities:**               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                              |       | 2,091,548                                  |       | 2,162,657 |   | 3.99 | % | 3,797,529 |   | 3,830,610 |   | 4.35 | % |
| One to Five Years                             |       | 4,562,519                                  |       | 4,705,152 |   | 4.12 | % | 6,763,493 |   | 6,876,346 |   | 4.65 | % |
| Five to Ten Years                             |       | 3,079,177                                  |       | 3,126,799 |   | 3.89 | % | 2,069,490 |   | 2,135,980 |   | 5.05 | % |
| Over Ten Years                                |       | 5,157,315                                  |       | 5,157,745 |   | 3.24 | % | 3,157,402 |   | 3,228,536 |   | 5.08 | % |
| Total Mortgage Backed Securities              |       | 14,890,559                                 |       | 15,152,353 |   | 4.72 | % | 15,787,914 |   | 16,071,472 |   | 4.72 | % |
| Total Available-for-Sale Securities           |       | $                                          | 40,429,552 |   | $ | 40,989,899 |   | 3.37 | % | $ | 37,623,614 |   | $ | 38,470,476 |   | 5.00 | % |

 

***Deposits***

 

Total average deposits increased $14,574,000 or 6.9%during 2009, compared to a decrease of $2,834,000 or 1.3% in 2008 and anincrease of $3,202,000 or 1.4% in 2007. Average noninterest-bearing depositsdecreased $4,817,000 or 6.4% in 2009, compared to a decrease of $5,962,000 or7.3% in 2008 and a decrease of $7,669,000 or 8.6% in 2007. Averageinterest-bearing deposits increased $19,391,000 or 14.2% in 2009 compared to anincrease of $3,128,000 or 2.3% in 2008 and an increase of $10,689,000 or 8.7%in 2007.

 

20

----

 

The following chart below indicates a shift innoninterest bearing demand deposits and an increase in interest-bearingdeposits (NOW, Money Market and Savings) to higher interest rate TimeCertificates of Deposit. This appears to be a trend that is common throughoutthe local banking industry during 2009 and is expected to continue in 2010. Itwas management’s strategy to retain and attract deposits to offset loss offunds to non-bank competition:

 
| ** **                          | ** ** | **Year  Ended December 31** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **Average**                      | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** |
| ** **                          | ** ** | **Balance**                      | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Rate** | ** ** |
| ** **                          | ** ** | **(dollars in thousands)**       | ** ** |
| Noninterest-bearing demand deposits |       | $                                | 70,935     |   | 0.00 | % | $ | 75,752 |   | 0.00 | % | $ | 81,714 |   | 0.00 | % |
| Money Market Accounts               |       | 32,196                           |       | 1.83 | % | 26,070 |   | 2.08 | % | 24,929 |   | 2.90 | % |
| NOW accounts                        |       | 13,628                           |       | 0.36 | % | 12,636 |   | 0.32 | % | 13,391 |   | 0.41 | % |
| Savings deposits                    |       | 27,387                           |       | 0.25 | % | 26,166 |   | 0.34 | % | 27,076 |   | 1.07 | % |
| Time deposits of $100,000 or more   |       | 46,533                           |       | 2.45 | % | 39,021 |   | 3.62 | % | 39,242 |   | 4.67 | % |
| Other time deposits                 |       | 36,190                           |       | 2.51 | % | 32,650 |   | 3.66 | % | 28,777 |   | 4.60 | % |
| Total deposits                      |       | $                                | 226,869    |   | 1.21 | % | $ | 212,295 |   | 1.54 | % | $ | 215,129 |   | 1.96 | % |

 

The remaining maturities of the Company’s certificatesof deposit in the amount of $100,000 or more as of December 31, 2009 areindicated in the table below. Interest expense on these certificates of deposittotaled $1,139,000 in 2009:

 
| **Deposits Maturing in**              | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|
| Three months or less                  |       | $                           | 32,341,136 |   |
| Over three months through six months  |       | 19,126,904                  |       |
| Over six months through twelve months |       | 25,280,711                  |       |
| Over twelve months                    |       | 13,034,130                  |       |
| Total                                 |       | $                           | 89,782,881 |   |

 

***Capital***

 

The Bank is required to maintain a minimumleverage-capital ratio of Tier I (as defined) to total assets based on the Bank’sratings under the regulatory rating system. At the end of 2009, all Bankcapital ratios were above all current Federal capital guidelines for a “wellcapitalized” bank. The Bank and Company ratios are indicated in the tablebelow:

 
| ** **                               | ** ** | **Actual**              | ** ** | ** ** | ** ** | **For  capital  adequacy purposes** | ** ** | ** ** | ** ** | **To  be well  captitalized under  prompt corrective  action provisions** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|-------------------------|------------|------------|------------|-------------------------------------|------------|------------|------------|---------------------------------------------------------------------------|------------|------------|------------|
| ** **                               | ** ** | **Amount**              | ** ** | ** ** | ** ** | **Amount**                          | ** ** | ** ** | ** ** | **Amount**                                                                | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **(****thousands****)** | ** ** | **Ratio**  | ** ** | **(****thousands****)**             | ** ** | **Ratio**  | ** ** | **(****thousands****)**                                                   | ** ** | **Ratio**  | ** ** |
| **As of December 31, 2009**         |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| Company                                  |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| Total Capital (to Risk-Weighted Assets)  |       | $                       | 30,808     |       | 13.9       | %                                   | $          | 17,773     |       | 8.0                                                                       | %          | $          | 22,216     |   | 10.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $                       | 27,856     |       | 12.5       | %                                   | $          | 8,886      |       | 4.0                                                                       | %          | $          | 13,330     |   | 6.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $                       | 27,856     |       | 10.3       | %                                   | $          | 10,834     |       | 4.0                                                                       | %          | $          | 13,543     |   | 5.0 | % |
| Bank                                     |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| Total Capital (to Risk-Weighted Assets)  |       | $                       | 29,223     |       | 13.2       | %                                   | $          | 17,740     |       | 8.0                                                                       | %          | $          | 22,175     |   | 10.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $                       | 26,276     |       | 11.9       | %                                   | $          | 8,870      |       | 4.0                                                                       | %          | $          | 13,305     |   | 6.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $                       | 26,276     |       | 9.7        | %                                   | $          | 10,821     |       | 4.0                                                                       | %          | $          | 13,526     |   | 5.0 | % |
| ** **                               |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| **As of December 31, 2008**         |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| Company                                  |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| Total Capital (to Risk-Weighted Assets)  |       | $                       | 33,373     |       | 15.9       | %                                   | $          | 16,770     |       | 8.0                                                                       | %          | $          | 20,963     |   | 10. | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $                       | 30,208     |       | 14.4       | %                                   | $          | 8,385      |       | 4.0                                                                       | %          | $          | 12,578     |   | 6.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $                       | 30,208     |       | 11.9       | %                                   | $          | 10,074     |       | 4.0                                                                       | %          | $          | 12,592     |   | 5.0 | % |
| Bank                                     |       |                    |       |       |       |                                |       |       |       |                                                                      |       |       |       |
| Total Capital (to Risk-Weighted Assets)  |       | $                       | 31,748     |       | 15.2       | %                                   | $          | 16,746     |       | 8.0                                                                       | %          | $          | 20,933     |   | 10.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $                       | 28,583     |       | 13.7       | %                                   | $          | 8,373      |       | 4.0                                                                       | %          | $          | 12,560     |   | 6.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $                       | 28,583     |       | 11.4       | %                                   | $          | 9,995      |       | 4.0                                                                       | %          | $          | 12,494     |   | 5.0 | % |

 

In 2008, as part of the United States Treasury’sCapital Purchase Program, the Company entered into a Letter Agreement on December19, 2008 with the United States Department of Treasury, where the Companyissued and sold 4,000 shares of the Company’s Preferred Stock and a warrant topurchase 38,107 shares of the Company’s Common Stock (adjusted for the 2% stockdividend issued in 2009) for an aggregate purchase price of $4,000,000 in cash.The Preferred Stock qualifies as Tier 1 capital and pays cumulative dividendsat a rate of 5% per annum for the first five years and 9% per annum thereafter.It is the Company’s intention to repay the capital within five years ofissuance. The warrant has a 10-year term and is immediately exercisable uponits issuance, with an exercise price equal to $15.745 per share of the CommonStock (adjusted for 2% stock dividend).

 

21

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***Short-termBorrowings***

 

As of December 31, 2009 the Bank had no shortterm borrowings.

 

***Long-termBorrowings***

 

Santa Lucia Bancorp issued $5,155,000 in juniorsubordinated debt securities (the “debt securities”) to the Santa Lucia Bancorp(CA) Capital Trust, a statutory trust created under the laws of the State ofDelaware. These debt securities are subordinated to effectively all borrowingsof the Company and are due and payable on July 7, 2036. These debtsecurities may be redeemed for 105% of the principal balance through July 7,2011 and then at par thereafter. Interest is payable quarterly beginning July 7,2006 at 1.48% over the quarterly adjustable 3-month LIBOR. Of this $5.2million, the Company contributed $3.0 million to the Bank and retained $2.0million at the Company level. The securities do not entitle the holders tovoting rights in the Company but will contain certain restrictive covenants,including restrictions on the payment of dividends to the holders of the Company’scommon stock in the event that interest payments on the trust preferredsecurities are postponed. The capital received from the trust preferredissuance is designated as Tier 1 capital for regulatory purposes.

 

During the third quarter of 2003, the Bank undertookand completed a private placement of subordinated debentures (“notes”) toaugment its Tier 2 capital. The total principal amount of the notes issued was$2,000,000. The notes were sold pursuant to an applicable exemption fromregistration under the Securities Act of 1933 to certain accredited investors,including some of the Company’s directors and executive officers. The notesinclude quarterly payment of interest at prime plus 1.5% and quarterlyprincipal installments of approximately $166,666 commencing on September 30,2008 until paid in full on June 30, 2011. As of December 31, 2009 theoutstanding balance of subordinated debt was $999,932.

 

***Interest RateSensitivity and Liquidity***

 

The Company closely follows the maturities andrepricing opportunities of both assets and liabilities to reduce gaps ininterest spreads. An analysis is performed quarterly to determine the variousinterest sensitivity gaps that exist. In general, the Company is assetsensitive, meaning that when interest rates change, assets (loans) will repricefaster than short-term liabilities (deposits). Therefore, higher interest ratesimprove short-term profits and lower rates decrease short-term profits.Currently, management’s analysis indicates that the Company’s asset sensitiveposition would not materially affect income for interest rate changes of onepercent or less in one year.

 

The following table presents the Bank’s RateSensitivity Gap Report as of December 31, 2009.

 
| ** **                             | ** ** | **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                  |       | $                          | 2,896      |             | $          | 6,630          |       | $              | 18,005     |       | $          | 7,041                   |       | $         | 7,501      |   | $ | — |   | $ | 42,073 |   |
| Loan receivables                       |       | 90,659                     |       | 23,147           |       | 65,678         |       | 21,584         |       | 1,100      |       | —                  |       | 202,168   |       |
| Federal funds sold                     |       | 2,500                      |       | —           |       | —         |       | —         |       | —     |       | —                  |       | 2,500     |       |
| Non-earning assets                     |       | —                     |       | —           |       | —         |       | —         |       | —     |       | 20,097                  |       | 20,097    |       |
| **Total assets**                       |       | $                          | 96,055     |             | $          | 29,777         |       | $              | 83,683     |       | $          | 28,625                  |       | $         | 8,601      |   | $ | 20,097 |   | $ | 266,838 |   |
| ** **                             |       |                       |       |             |       |           |       |           |       |       |       |                    |       |      |       |
| **Interest sensitive liabilities:**    |       |                       |       |             |       |           |       |           |       |       |       |                    |       |      |       |
| Demand deposits                        |       | $                          | —     |             | $          | —         |       | $              | —     |       | $          | —                  |       | $         | —     |   | $ | 69,111 |   | $ | 69,111 |   |
| NOW accounts                           |       | 414                        |       | 1,242            |       | 3,312          |       | 3,312          |       | 5,934      |       | —                  |       | 14,214    |       |
| Money Market Accounts                  |       | 3,624                      |       | 10,871           |       | 24,158         |       | —         |       | —     |       | —                  |       | 38,653    |       |
| Savings deposits                       |       | 970                        |       | 2,910            |       | 7,758          |       | 7,759          |       | 8,082      |       | —                  |       | 27,479    |       |
| Time deposits                          |       | 32,341                     |       | 44,408           |       | 11,694         |       | 1,182          |       | 158        |       | —                  |       | 89,783    |       |
| Total saving and time deposits         |       | $                          | 37,349     |             | $          | 59,431         |       | $              | 46,922     |       | $          | 12,253                  |       | $         | 14,174     |   | $ | 69,111 |   | $ | 239,240 |   |
| Short-term borrowing                   |       | —                     |       | —           |       | —         |       | —         |       | —     |       | —                  |       | —    |       |
| Long-term borrowing                    |       | 1,000                      |       | —           |       | —         |       | —         |       | —     |       | —                  |       | 1,000     |       |
| Non-funding liabilities and capital    |       | —                     |       | —           |       | —         |       | —         |       | —     |       | 26,598                  |       | 26,598    |       |
| Total liabilities and capital          |       | $                          | 38,349     |             | $          | 59,431         |       | $              | 46,922     |       | $          | 12,253                  |       | $         | 14,174     |   | $ | 95,709 |   | $ | 266,838 |   |
| **Interest rate sensitivity gap**      |       | $                          | 57,706     |             | $          | (29,654        | )          | $              | 36,761     |       | $          | 16,372                  |       | $         | (5,573     | ) |   |   |   |   |
| ** **                             |       |                       |       |             |       |           |       |           |       |       |       |                    |       |      |       |
| **Risk Indicators from GAP Analysis:** |       |                       |       |             |       |           |       |           |       |       |       |                    |       |      |       |
| Cumulative GAP                         |       | $                          | 57,706     |             | $          | 28,052         |       | $              | 64,813     |       | $          | 81,185                  |       | $         | 75,612     |   |   |   |   |   |
| Cumulative GAP (% of total assets)     |       | 21.63                      | %          | 10.51            | %          | 24.29          | %          | 30.42          | %          | 28.34      | %          |                    |       |      |       |

 

22

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***Liquidity***

 

The Company closely monitors its liquidity so that thecash requirements for loans and deposit withdrawals are met in an orderlymanner. Management monitors liquidity in relation to trends of loans anddeposits for short term and long-term requirements. Liquidity sources are cash,deposits with other banks, overnight Federal Fund investments, investmentsecurities and the ability to sell loans. As of December 31, 2009, theBank’s liquidity ratio was 20.9% compared to 20.2% at December 31, 2008and 25.0% at December 31, 2007. The 20.9% liquidity ratio at December 31,2009 is within the Company’s policy limit. The Company’s loan-to-deposit ratioaveraged 87.8% in 2009, compared to 83.8% in 2008, and 76.1% in 2007.

 

**CriticalAccounting Policies**

 

This discussion should be read in conjunction with theconsolidated financial statements of the Company, including the notes thereto.

 

Our accounting policies are integral to understandingthe results reported. Our most complex accounting policies require management’sjudgment to ascertain the valuation of assets, liabilities, commitments andcontingencies. We have established detailed policies and control proceduresthat are intended to ensure valuation methods are well controlled and appliedconsistently from period to period. In addition, the policies and proceduresare intended to ensure that the process for changing methodologies occurs in anappropriate manner. The following is a brief description of our currentaccounting policies involving significant management valuation judgments.

 

***Use of Estimates inthe Preparation of Financial Statements***

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of certain assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of certain revenues and expenses during the reporting period. Actualresults could differ from those estimates.

 

***Allowance for LoanLosses***

 

The allowance for loan losses represents management’sbest estimate of losses inherent in the existing loan portfolio. The allowancefor loan losses is increased by the provision for loan losses charged toexpense and reduced by loans charged off, net of recoveries. The provision forloan losses is determined based on management’s assessment of several factors:reviews and evaluation of specific loans, changes in the nature and volume ofthe loan portfolio, current economic conditions and the related impact onspecific borrowers and industry groups, historical loan loss experiences, thelevel of classified and nonperforming loans and the results of regulatoryexaminations.

 

Loans are considered impaired if, based oncurrent information and events, it is probable that we will be unable tocollect the scheduled payments of principal or interest when due according tothe contractual terms of the loan agreement. The measurement of impaired loansis generally based on the present value of expected future cash flowsdiscounted at the historical effective interest rate stipulated in the loanagreement, except that all collateral-dependent loans are measured forimpairment based on the fair value of the collateral. In measuring the fairvalue of the collateral, management uses assumptions and methodologiesconsistent with those that would be utilized by unrelated third parties.

 

Changes in the financial condition of individualborrowers, in economic conditions, in historical loss experience and in thecondition of the various markets in which collateral may be sold may all affectthe required level of the allowance for loan losses and the associated provisionfor loan losses.

 

***Available-for-SaleSecurities***

 

The fair value of most securities classified asavailable-for-sale are based on quoted market prices. If quoted market pricesare not available, fair values are extrapolated from the quoted prices of similarinstruments.

 

23

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***Deferred Tax Assets***

 

We use an estimate of future earnings to support ourposition that the benefit of our deferred tax assets will be realized. Iffuture income should prove non-existent or less than the amount of the deferredtax assets within the tax years to which they may be applied, the asset may notbe realized and our net income will be reduced.

 

***DeferredCompensation Liabilities***

 

Management estimates the life expectancy of the participantsand the accrual methods used to accrue compensation expense. If individualsoutlive their assumed expectancies the amounts accrued for the payment of theirbenefits will be inadequate and additional changes to income will be required.

 

**Availabilityof Form 10-KSB**

 

**If any shareholder would like a copyof the Company’s Annual Report on Form 10-K for the fiscal year ending December 31,2009, they can be obtained without charge by sending a written request to JamesM. Cowan, Executive Vice President and Chief Financial Officer, P. O. Box 6047,Atascadero, California 93423.**

 

 

 

24

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|  |  |
|--|--|

 

**Report of Independent Registered Public AccountingFirm**

 

The Board of Directors andShareholders

Santa Lucia Bancorp andSubsidiary

 

Wehave audited the consolidated balance sheets of Santa Lucia Bancorp andSubsidiary (the Company) as of December 31, 2009 and 2008, and the relatedconsolidated statements of earnings, cash flows and shareholders’ equity forthe three years ended December 31, 2009. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion 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, 2009 and 2008, and the results of its operations and cashflows for the three years ended December 31, 2009, in conformity withaccounting principles generally accepted in the United States of America.

 

Laguna Hills, California

March 12, 2010

 

 

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

 

**FRESNO ****·****  LAGUNA HILLS ****·****  PALO ALTO ****·****  PLEASANTON ****·****  RANCHO CUCAMONGA**

 

25

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**Santa Lucia Bancorp and Subsidiary**

** **

**Consolidated Balance Sheets**

* *

*December 31, 2009 and 2008*

 

**ASSETS**

 
| ** **                                                      | ** ** | **2009**    | ** **  | **2008**    | ** ** |
|-----------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| Cash and due  from banks                                        |       | $           | 6,588,396   |        | $          | 8,220,406 |   |
| Federal funds  sold                                             |       | 2,500,000   |        | —      |       |
| TOTAL CASH AND CASH EQUIVALENTS                                 |       | 9,088,396   |        | 8,220,406   |       |
| Securities  available for sale                                  |       | 40,989,899  |        | 38,470,476  |       |
| Loans, net                                                      |       | 198,098,998 |        | 186,631,960 |       |
| Premises and  equipment, net                                    |       | 8,223,225   |        | 8,624,148   |       |
| Deferred income  tax assets                                     |       | 1,429,000   |        | 974,000     |       |
| Cash surrender  value of life insurance                         |       | 5,390,410   |        | 5,194,688   |       |
| Federal Reserve  Bank andFederal  Home Loan Bank stock, at cost |       | 1,643,400   |        | 1,516,850   |       |
| Other Real  Estate Owned                                        |       | 428,000     |        | —      |       |
| Accrued interest  and other assets                              |       | 4,631,529   |        | 2,246,995   |       |
| TOTAL ASSETS                                                    |       | $           | 269,922,857 |        | $          | 251,879,523 |   |

 

**LIABILITIES &SHAREHOLDERS’ EQUITY**

 
| ** **                                                                                                                                                              | ** ** | **2009**    | ** **  | **2008**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| Deposits                                                                                                                                                                |       |        |        |        |       |
| Noninterest-bearing  demand                                                                                                                                             |       | $           | 69,850,394  |        | $          | 75,155,323 |   |
| Interest-bearing  demand and NOW accounts                                                                                                                               |       | 14,214,894  |        | 12,888,894  |       |
| Money market                                                                                                                                                            |       | 37,396,049  |        | 26,214,153  |       |
| Savings                                                                                                                                                                 |       | 27,478,300  |        | 26,754,057  |       |
| Time  certificates of deposit of $100,000 or more                                                                                                                       |       | 52,145,948  |        | 37,893,469  |       |
| Other time  certificates                                                                                                                                                |       | 37,636,939  |        | 33,410,702  |       |
| TOTAL DEPOSITS                                                                                                                                                          |       | 238,722,524 |        | 212,316,598 |       |
| Short-term  borrowings                                                                                                                                                  | * *   | *—*    |        | 5,000,000   |       |
| Long-term  borrowings                                                                                                                                                   |       | 6,154,932   |        | 6,821,644   |       |
| Accrued interest  and other liabilities                                                                                                                                 |       | 2,015,491   |        | 2,190,584   |       |
| TOTAL LIABILITIES                                                                                                                                                       |       | 246,892,947 |        | 226,328,826 |       |
| Commitments and  contingencies *(Note M)*                                                                                                                               | * *   | *—*    | * *    | *—*    | * *   |
| Shareholders’  equity                                                                                                                                              |       |        |        |        |       |
| Preferred Stock  - Series A                                                                                                                                             |       | 3,839,202   |        | 3,799,003   |       |
| Common stock –  no par value; 20,000,000 shares authorized;issued and outstanding: 1,961,334  shares at December 31, 2009and 1,923,053 shares at December 31, 2008 |       | 9,894,507   |        | 9,894,507   |       |
| Additional  paid-in capital                                                                                                                                             |       | 813,765     |        | 676,734     |       |
| Retained  earnings                                                                                                                                                      |       | 8,153,232   |        | 10,682,922  |       |
| Accumulated  other comprehensive income-net unrealizedlosses on available-for-sale  securities, net of taxesof $231,143 in 2009 and $349,330 in 2008                    |       | 329,204     |        | 497,531     |       |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                                         |       | 23,029,910  |        | 25,550,697  |       |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                         |       | $           | 269,922,857 |        | $          | 251,879,523 |   |

 

*Theaccompanying notes are an integral part of these financial statements.*

 

26

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**Santa LuciaBancorp and Subsidiary**

 

**ConsolidatedStatements of Earnings**

* *

*YearsEnded December 31, 2009, 2008 and 2007*

 
| ** **                                          | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Interest income                                     |       |       |       |       |       |       |       |
| Interest and  fees on loans                         |       | $          | 12,355,119 |       | $          | 12,994,444 |       | $ | 15,030,928 |   |
| Federal funds  sold                                 |       | 5,148      |       | 24,487     |       | 249,434    |       |
| Investment  securities – taxable               |       | 1,319,123  |       | 2,051,637  |       | 2,232,966  |       |
| Investment  securities – nontaxable            |       | 171,721    |       | 205,934    |       | 205,285    |       |
|                                                |       | 13,851,111 |       | 15,276,502 |       | 17,718,613 |       |
| Interest expense                                    |       |       |       |       |       |       |       |
| Time  certificates of deposit of $100,000 or more   |       | 1,138,962  |       | 1,411,081  |       | 1,833,831  |       |
| Other deposits                                      |       | 1,613,306  |       | 1,863,907  |       | 2,389,580  |       |
| Long-term debt  and other borrowings                |       | 268,761    |       | 602,120    |       | 600,727    |       |
|                                                |       | 3,021,029  |       | 3,877,108  |       | 4,824,138  |       |
| Net interest  income                                |       | 10,830,082 |       | 11,399,394 |       | 12,894,475 |       |
|                                                |       |       |       |       |       |       |       |
| Provision for  loan losses                          |       | 5,460,000  |       | 975,000    |       | —     |       |
| Net interest  income afterprovision for loan losses |       | 5,370,082  |       | 10,424,394 |       | 12,894,475 |       |
|                                                |       |       |       |       |       |       |       |
| Noninterest  income                                 |       |       |       |       |       |       |       |
| Service charges  and fees                           |       | 517,209    |       | 554,018    |       | 583,445    |       |
| Dividends on  cash surrender value oflife insurance |       | 239,898    |       | 230,010    |       | 222,071    |       |
| Gain on sale of  investment securities              |       | 224,875    |       | 108,163    |       | —     |       |
| Other income                                        |       | 253,354    |       | 218,574    |       | 265,798    |       |
|                                                |       | 1,235,336  |       | 1,110,765  |       | 1,071,314  |       |
| Noninterest  expense                                |       |       |       |       |       |       |       |
| Salaries and  employee benefits                     |       | 5,358,634  |       | 5,650,160  |       | 5,259,456  |       |
| Occupancy                                           |       | 662,587    |       | 652,335    |       | 627,685    |       |
| Equipment                                           |       | 632,954    |       | 669,527    |       | 666,003    |       |
| Professional  services                              |       | 638,264    |       | 600,977    |       | 426,667    |       |
| Data processing                                     |       | 520,208    |       | 504,688    |       | 488,636    |       |
| Office expenses                                     |       | 412,597    |       | 391,655    |       | 362,057    |       |
| Marketing                                           |       | 402,129    |       | 427,635    |       | 422,914    |       |
| Regulatory  assessments                             |       | 511,281    |       | 168,090    |       | 64,436     |       |
| Directors’ fees  and expenses                  |       | 351,296    |       | 326,792    |       | 328,801    |       |
| Messenger and  courier expenses                     |       | 95,152     |       | 122,833    |       | 156,870    |       |
| Other                                               |       | 279,791    |       | 248,563    |       | 225,445    |       |
|                                                |       | 9,864,893  |       | 9,763,255  |       | 9,028,970  |       |
| Earnings  (losses) before income taxes              |       | (3,259,475 | )          | 1,771,904  |       | 4,936,819  |       |
| Income taxes                                        |       | (1,434,000 | )          | 633,000    |       | 1,934,000  |       |
| Net earnings  (loss)                                |       | $          | (1,825,475 | )          | $          | 1,138,904  |       | $ | 3,002,819 |   |
|                                                |       |       |       |       |       |       |       |
| Per share data:                                     |       |       |       |       |       |       |       |
| Net earnings  (loss) per common share - basic       |       | $          | (1.05      | )          | $          | 0.59       |       | $ | 1.55 |   |
|                                                |       |       |       |       |       |       |       |
| Net earnings  (loss) per common - diluted           |       | $          | (1.05      | )          | $          | 0.58       |       | $ | 1.51 |   |

 

*Theaccompanying notes are an integral part of these financial statements.*

 

27

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**Santa LuciaBancorp and Subsidiary**

** **

**ConsolidatedStatements of Cash Flows**

* *

*YearsEnded December 31, 2009, 2008 and 2007*

 
| ** **                                                                                           | ** ** | **2009**    | ** ** | **2008**    | ** ** | **2007**    | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Cash flows from  operating activities:                                                               |       |        |       |        |       |        |       |
| Net earnings  (losses)                                                                               |       | $           | (1,825,475 | )           | $          | 1,138,904   |       | $ | 3,002,819 |   |
| Adjustments to  reconcile net earnings (losses) tonet cash provided (used) by operating  activities: |       |        |       |        |       |        |       |
| Depreciation and  amortization                                                                       |       | 598,783     |       | 643,241     |       | 652,290     |       |
| Provision for  loan losses                                                                           |       | 5,460,000   |       | 975,000     |       | —      |       |
| Loss (gain) on sale  of investment securities                                                        |       | (224,875    | )          | (108,163    | )          | —      |       |
| Deferred income  taxes                                                                               |       | (337,000    | )          | (371,000    | )          | (201,000    | )          |
| Dividends on  cash value of life insurance                                                           |       | (239,898    | )          | (230,010    | )          | (222,071    | )          |
| Other items, net                                                                                     |       | (2,414,012  | )          | 789,187     |       | 1,101,676   |       |
| Net cash provided  by operating activities                                                           |       | 1,017,523   |       | 2,837,159   |       | 4,333,714   |       |
|                                                                                                 |       |        |       |        |       |        |       |
| Cash flows from  investing activities:                                                               |       |        |       |        |       |        |       |
| Proceeds from  maturities of investment securities                                                   |       | 16,677,933  |       | 12,616,836  |       | 14,202,010  |       |
| Proceeds from  sale of investment securities                                                         |       | 5,176,324   |       | 5,513,276   |       | —      |       |
| Purchases of  investment securities                                                                  |       | (24,426,873 | )          | —      |       | (26,658,965 | )          |
| Purchase of  Federal Reserve Bankand Federal Home Loan Bank stock                                    |       | (126,550    | )          | —      |       | —      |       |
| Net change in  loans                                                                                 |       | (17,818,538 | )          | (20,987,466 | )          | 3,060,979   |       |
| Purchases of  bank premises and equipment                                                            |       | (197,860    | )          | (398,882    | )          | (262,590    | )          |
| Proceeds on sale  of OREO                                                                            |       | 490,074     |       | —      |       | (1,485,000  | )          |
| Net cash used in  investing activities                                                               |       | (20,225,490 | )          | (3,256,236  | )          | (11,143,566 | )          |
|                                                                                                 |       |        |       |        |       |        |       |
| Cash flows from  financing activities:                                                               |       |        |       |        |       |        |       |
| Net change in  deposits                                                                              |       | 26,406,685  |       | (401,780    | )          | (270,074    | )          |
| Proceeds and tax  benefit from exerciseof stock options                                              |       | —      |       | 34,390      |       | 164,275     |       |
| Proceeds from  Issuance of Preferred Stock, Net                                                      |       | —      |       | 3,950,000   |       | —      |       |
| Stock  repurchases                                                                                   |       | —      |       | (146,649    | )          | (853,351    | )          |
| Net (repayments)  proceeds from borrowings                                                           |       | (5,666,712  | )          | (1,233,356  | )          | 5,900,000   |       |
| Dividends paid  on Preferred Stock                                                                   |       | (181,111    | )          | —      |       | —      |       |
| Cash dividends  paid Common Stock                                                                    |       | (482,905    | )          | (962,534    | )          | (871,112    | )          |
| Net cash  provided (used) by financing activities                                                    |       | 20,075,957  |       | 1,240,071   |       | 4,069,738   |       |
| Increase  (decrease) in cash andcash equivalents                                                     |       | 867,990     |       | 820,994     |       | (2,740,114  | )          |
|                                                                                                 |       |        |       |        |       |        |       |
| Cash and cash  equivalents at beginning of year                                                      |       | 8,220,406   |       | 7,399,412   |       | 10,139,526  |       |
|                                                                                                 |       |        |       |        |       |        |       |
| Cash and cash  equivalents at end of year                                                            |       | $           | 9,088,396  |        | $          | 8,220,406   |       | $ | 7,399,412 |   |
|                                                                                                 |       |        |       |        |       |        |       |
| Supplemental  disclosure of cash flow information:                                                   |       |        |       |        |       |        |       |
| Interest paid                                                                                        |       | $           | 3,170,170  |        | $          | 3,925,557   |       | $ | 4,824,138 |   |
|                                                                                                 |       |        |       |        |       |        |       |
| Income taxes  paid                                                                                   |       | $           | 265,000    |        | $          | 1,130,000   |       | $ | 1,865,000 |   |
|                                                                                                 |       |        |       |        |       |        |       |
| Cashless  exercise of stock options                                                                  |       | $           | —     |        | $          | 27,725      |       | $ | 120,554 |   |
|                                                                                                 |       |        |       |        |       |        |       |
| Transfer of  Loans to Other Real Estate Owned                                                        |       | $           | 891,500    |        | $          | —      |       | $ | — |   |

 

*Theaccompanying notes are an integral part of these financial statements.*

 

28

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**Santa Lucia Bancorp and Subsidiary**

** **

**ConsolidatedStatement of Shareholders’ Equity**

* *

*Years Ended December 31, 2009, 2008 and 2007*

 
| ** **                                                                                                 | ** ** | ** **                      | ** ** | ** **                 | ** ** | **Common  Stock**             | ** ** | **Additional** | ** ** | ** **                 | ** ** | **Accumulated  Other** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-------------------------------|------------|----------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                                                 | ** ** | **Comprehensive********Income** | ** ** | **Preferred********Stock** | ** ** | **Shares********Outstanding** | ** ** | **Amount**     | ** ** | **Paid-in********Capital** | ** ** | **Retained  Earnings** | ** ** | **Comprehensive********Income** | ** ** |
| **Balance  at January 1, 2007**                                                                            |       |                            |       |                       |       | 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 |   |
| Cash dividends —  $0.50 per share                                                                     |       |                            |       |                       |       |                          |       |           |       |                       |       | (962,534               | )          |   |   |
| Exercise of stock  options, including the realization of tax benefits of $19,000                           |       |                            |       |                       |       | 4,360                         |       | 43,115         |       | 19,000                     |       | (27,725                | )          |   |   |
| Repurchase and  retirement of stock                                                                        |       |                            |       |                       |       | (6,180                        | )          |           |       |                       |       | (146,649               | )          |   |   |
| Cumulative —  effect adjustment of change in accounting for split-dollar life insurance  arrangements |       |                            |       |                       |       |                          |       |           |       |                       |       | (101,815               | )          |   |   |
| Preferred Stock —  Series A                                                                           |       |                            |       | $                          | 3,799,003  |                          |       |           |       |                       | 150,997    |                   |       |   |   |   |
| Stock Option  Compensation Expense                                                                         |       |                            |       |                       |       |                          |       |           |       | 148,534                    |       |                   |       |   |   |
| **Comprehensive  Income:**                                                                                 |       |                            |       |                       |       |                          |       |           |       |                       |       |                   |       |   |   |
| Net earnings for  the year                                                                                 |       | $                               | 1,138,904  |                       |       |                          |       |           |       |                       |       |                   | 1,138,904  |   |   |   |
| Change in  unrealized gain on available-for-sale securities, net of taxes of $255,702                      |       | 364,837                         |       |                       |       |                          |       |           |       |                       |       |                   |       | 364,837 |   |
| Less  reclassification adjustment for gains included in net income, deferred of tax  of $44,347            |       | (63,816                         | )          |                       |       |                          |       |           |       |                       |       |                   |       | (63,816 | ) |
| **Total  Comprehensive Income**                                                                            |       | $                               | 1,439,925  |                       |       |                          |       |           |       |                       |       |                   |       |   |   |   |
| **Balance  at December 31, 2008**                                                                          |       |                            |       | 3,799,003                  |       | 1,923,053                     |       | 9,894,507      |       | 676,734                    |       | 10,682,922             |       | 497,531 |   |
| Dividends  Preferred Stock                                                                                 |       |                            |       |                       |       |                          |       |           |       |                       |       | (181,111               | )          |   |   |
| Cash dividends —  $0.25 per share                                                                     |       |                            |       |                       |       |                          |       |           |       |                       |       | (480,763               | )          |   |   |
| Stock dividend —  2%                                                                                  |       |                            |       |                       |       | 38,281                        |       |           |       |                       |       |                   |       |   |   |
| Cash in lieu for  fractional shares                                                                        |       |                            |       |                       |       |                          |       |           |       |                       |       | (2,142                 | )          |   |   |
| Accretion on  Preferred Stock                                                                              |       |                            |       | 40,199                     |       |                          |       |           |       |                       |       | (40,199                | )          |   |   |
| Stock Option  Compensation Expense                                                                         |       |                            |       |                       |       |                          |       |           |       | 136,272                    |       |                   |       |   |   |
| **Comprehensive  Income:**                                                                                 |       |                            |       |                       |       |                          |       |           |       |                       |       |                   |       |   |   |
| Net earnings  (losses) for the year                                                                        |       | $                               | (1,825,475 | )                          |       |                          |       |           |       |                       |       |                   | (1,825,475 | ) |   |   |
| Change in  unrealized gain on available-for-sale securities, net of taxes of $210,949                      |       | (300,441                        | )          |                       |       |                          |       |           |       |                       |       |                   |       | (300,441 | ) |
| Less  reclassification adjustment for gains included in net income, deferred of tax  of ($92,761)          |       | 132,114                         |       |                       |       |                          |       |           |       |                       |       |                   |       | 132,114 |   |
| Refund TARP  expenses                                                                                      |       |                            |       |                       |       |                          |       |           |       | 759                        |       |                   |       |   |   |
| **Total  Comprehensive Income**                                                                            |       | $                               | (1,993,802 | )                          |       |                          |       |           |       |                       |       |                   |       |   |   |   |
| **Balance  at December 31, 2009**                                                                          |       |                            |       | $                          | 3,839,202  |                          | 1,961,334  |           | $          | 9,894,507                  |       | $                      | 813,765    |   | $ | 8,153,232 |   | $ | 329,204 |   |

 

*Theaccompanying notes are an integral part of these financial statements.*

 

29

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**Santa Lucia Bancorp and Subsidiary**

**NOTES TO FINANCIAL STATEMENTS**

*December 31, 2009, 2008 and 2007*

 

**NOTE A —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES —**The consolidated financialstatements include the accounts of Santa Lucia Bancorp and its wholly ownedsubsidiary Santa Lucia Bank (the “Bank”), collectively referred to herein asthe “Company.” All significant intercompany transactions have been eliminated.

 

The accounting and reportingpolicies of the Company are in accordance with accounting principles generallyaccepted in the Unites States of America and prevailing practices within thebanking industry.  A summary of thesignificant accounting policies consistently applied in preparation of theaccompanying financial statements follows:

 

**Nature ofOperations —**The Company has been organized as a single operatingsegment and maintains four branches in the San Luis Obispo and northern SantaBarbara Counties. The Company’s primary source of revenue is interest incomefrom loans to customers. The Company’s customers are predominantly small andmiddle-market businesses and individuals.

 

Santa Lucia Bancorp has nosignificant business activities other than its investment in Santa Lucia Bankand its investment and related borrowings from Santa Lucia Bancorp Trusts asdiscussed in Note H. Accordingly, no separate financial information on theCompany is provided.

 

**SubsequentEvents —**As required by ASC Topic 855, Subsequent Events, theCompany has evaluated subsequent events through March 12, 2010, which isthe date of the filing of its consolidated financial statements with the SEC.

 

**Use ofEstimates in the Preparation of Financial Statements —**The preparationof financial 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.

 

**Cash andCash Equivalents —**For the purposes of reporting cash flows, cash andcash equivalents includes cash, noninterest-earning deposits and federal fundssold. Generally, federal funds are sold for one day periods.

 

**Cash and DueFrom Banks —**Banking regulations require that all banks maintain apercentage of their deposits as reserves in cash or on deposit with the FederalReserve Bank. The Bank was in compliance with the reserve requirements as of December 31,2009 and 2008.

 

The Company periodicallymaintains amounts due from banks that exceed federally insured limits. TheCompany has not experienced any losses in such accounts.

 

**InvestmentSecurities —**Bonds, notes, and debentures for which the Companyhas the positive intent and ability to hold to maturity are reported at cost,adjusted for premiums and discounts that are recognized in interest incomeusing the interest method over the period to maturity.

 

Investments not classified astrading securities nor as held-to-maturity securities are classified asavailable-for-sale securities and recorded at fair value. Unrealized gains orlosses on available-for-sale securities are excluded from net income andreported as an amount net of taxes as a separate component of othercomprehensive income included in shareholders’ equity. Premiums or discounts onheld-to-maturity and available-for-sale securities are amortized or accretedinto income using the interest method. Realized gains or losses on sales ofheld-to-maturity or available-for-sale securities are recorded using thespecific identification method.

 

Management evaluatessecurities for other-than-impaired (OTTI) at least on a quarterly basis andmore frequently when economic or market conditions warrant.

 

**Loans —**Loans receivablethat management has the intent and ability to hold for the foreseeable futureor until maturity or payoff are reported at their outstanding unpaid principalbalances reduced by any charge-offs or specific valuation accounts and net ofany deferred fees or costs on originated loans, or unamortized premiums ordiscounts on purchased loans.

 

The determination of thebalance in the allowance for loan losses is based on an analysis of the loanportfolio and reflects an amount which, in management’s judgment, is adequateto provide for potential credit losses after giving consideration to thecharacter of the loan portfolio, current economic conditions, past credit lossexperience and such other factors as deserve current recognition in estimatingcredit losses. The provision for loan losses is charged to expenses.

 

The Company considers a loanto be impaired when it is probable that the Company will be unable to collectall amounts due (principal and interest) according to the contractual terms ofthe loan agreement. Measurement of impairment is based on the expected futurecash flows of an impaired loan, which are to be discounted at the loan’seffective interest rate, or measured by reference to an observable marketvalue, if one exists, or the fair value of the collateral for acollateral-dependent loan. The Company selects the measurement method on aloan-by-loan basis except that collateral-dependent loans for which foreclosureis probable are measured at the fair value of the collateral. The Companyrecognizes interest income on impaired loans based on its existing methods ofrecognizing interest income on nonaccrual loans.

 

**Interest andFees on Loans —**Interest income is accrued daily as earned on allloans. 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 collectability. 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. Amortization of deferred loan fees is discontinued when aloan is placed on nonaccrual status.

 

**Premises andEquipment —**Land is carried at cost. Premises and equipment arecarried at cost less accumulated depreciation and amortization. Depreciation iscomputed using the straight-line method over the estimated useful lives, whichranges from three to ten years for furniture and fixtures and forty years forbuildings. Expenditures for betterments or major repairs are capitalized andthose for ordinary repairs and maintenance are charged to operations as incurred.

 

**CompanyOwned Life Insurance —**Company owned life insurance is recorded atthe amount that can be realized under insurance contracts at the date of thestatement of financial condition, which is the cash surrender value adjustedfor other charges or the amounts due that are probable at settlement.

 

**Other RealEstate Owned —**Other real estate owned represents real estateacquired through foreclosure and is carried at the lower of the recordedinvestment in the property or its fair value. Prior to

 

30

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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.

 

**Federal HomeLoan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock —**The Bank is amember of the FHLB and the FRB system. Members are required to own a certainamount of stock based on the level of borrowings and other factors and mayinvest in additional amounts. FHLB and FRB stock are carried at cost,classified as restricted securities, and periodically evaluated for impairmentbased on the ultimate recovery of par value. Both cash and stock dividends arereported as income.

 

**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.

 

The Company has adoptedguidance issued by the Financial Accounting Standards Board that 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. Interest and penalties related to uncertain tax positions are recordedas part of income tax expense.

 

**AdvertisingCosts —**The Company expenses the costs of advertising in theperiod incurred.

 

**ComprehensiveIncome —**Changes in unrealized gain or loss onavailable-for-sale securities net of income taxes is the only component ofaccumulated other comprehensive income for the Company.

 

**FinancialInstruments —**In the ordinary course of business, the Company hasentered into off-balance sheet financial instruments consisting of commitmentsto extend credit, commercial letters of credit, and standby letters of creditas described in Note N. Such financial instruments are recorded in thefinancial statements when they are funded or related fees are incurred orreceived.

 

**Earnings PerCommon Share (EPS) —**Basic earnings per common share (“EPS”) arebased on the weighted average number of common shares outstanding before anydilution from common stock equivalents. Diluted earnings per common sharereflect the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stockor resulted in the issuance of common stock that then shared in the earnings ofthe entity. All outstanding stock options were not considered in computingdiluted earnings per share for 2009 because they were antidilutive.

 

**Stock-BasedCompensation —**The Company has two stock option plans, which arefully described in Note K in the Bank’s Annual Report on Form 10-K. TheCompany recognizes the cost of employee services received in exchange forawards of stock options or other equity instruments, based on the grant-datefair value of those awards. The cost is recognized over the period which anemployee is required to provide services in exchange for the award, generallythe vesting period.

 

**Fair ValueMeasurement —**Fair values is the exchange price that would bereceived for an asset or paid to transfer a liability (an exit price) in theprincipal or most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date. Currentaccounting guidance establishes a fair value hierarchy, which requires anentity to maximize the use of observable inputs and minimize the use ofunobservable inputs when measuring fair value. The guidance describes threelevels of inputs that may be used to measure fair value.

 

Level1: Quoted prices (unadjusted) for identical assets or liabilities in activemarkets that the entity has the ability to access as of the measurement date.

 

Level2: Significant other observable inputs other than Level 1 prices such as quotedprices for similar assets or liabilities; quoted prices in markets that are notactive; or other inputs that are observable or can be corroborated byobservable market data.

 

Level3: Significant unobservable inputs that reflect a Bank’s own assumptions aboutthe assumptions that market participants would use in pricing an asset orliability.

 

See note P for moreinformation and disclosures relating to the Bank’s fair value measurement.

 

**Reclassifications—**Certain reclassifications have been made in the 2008 and 2007 financialstatements to conform to the presentation used in 2009. These reclassificationshad no impact on the Company’s previously reported financial statements.

 

**Adoption ofNew Accounting Standards**

 

**SubsequentEvents —**In May 2009, the FASB issued guidance whichrequires the effects of events that occur subsequent to the balance-sheet datebe evaluated through the date the financial statements are either issued oravailable to be issued. Entities are to disclose the date through whichsubsequent events have been evaluated and whether that date is the date thefinancial statements were issued or the date the financial statements wereavailable to be issued. Entities are required to reflect in their financialstatements the effects of the subsequent events that provide additionalevidence about conditions at the balance-sheet date (recognized subsequentevents). Entities are also prohibited from reflecting in their financialstatements the effect of subsequent events that provide evidence aboutconditions that arose after the balance-sheet date (nonrecognized subsequentevents), but requires information about those events to be discussed if thefinancial statements would otherwise be misleading. This guidance was effectivefor annual financial periods ended after June 15, 2009 with prospectiveapplication. The Company adopted the guidance for the year ended December 31,2009 by including the required disclosures in Note A to the financial statements.

 

**AccountingStandards Codification and Hierarchy of Generally Accepted AccountingPrinciples —**In June 2009, accounting standards were revisedto establish the Accounting Standards Codification (the “Codification”) as thesource of authoritative accounting principles recognized by the FASB to beapplied by nongovernmental entities in the preparation of financial statementsin conformity with Generally Accepted Accounting Principles (“GAAP”). TheCodification does not change current GAAP, but is intended to simplify useraccess to all authoritative literature related to a particular topic in oneplace. The Codification is effective for annual periods ended after September 15,2009, and as of the effective date, all existing accounting standard documentswere superseded. Adoption of the Codification in 2009 did not have a materialimpact on the Company’s financial statements.

 

**Fair ValueMeasurements —**In April 2009, accounting standards were amendedto provide additional guidance for determining the fair value of a financialasset or financial liability when the volume and level of activity for suchasset or liability decreased significantly and also to provide guidance fordetermining whether a transaction is orderly. The amendments were effective forannual reporting periods ended after June 15, 2009. Adoption of theamendments in 2009 did not have a material impact on the Company’s financialstatements.

 

In February 2008, theFASB issued instructions that delayed the effective date of fair value measurementfor all non-financial assets and non-

 

*Continued on next page           *

 

31

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financial liabilities, exceptthose that are recognized or disclosed at fair value on a recurring basis (atleast annually) for fiscal years beginning after November 15, 2008.Adoption of the fair value measurement rules in 2009 for non-financialassets and non-financial liabilities subject to the delay did not have amaterial impact on the Company’s financial statements.

 

**Other-Than-TemporaryImpairment —**In April 2009, accounting standards were amendedto provide expanded guidance concerning the recognition and measurement ofother-than-temporary impairments of debt securities classified as available forsale or held to maturity. The amendments require an entity to recognize thecredit component of an other-than-temporary impairment of a debt security inearnings and the noncredit component in other comprehensive income when theentity does not intend to sell the security prior to recovery. Expandeddisclosures are also required concerning such impairments. The amendments wereeffective for annual reporting periods ended after June 15, 2009. Adoptionof the amendments in 2009 did not have a material impact on the Company’s financialstatements.

 

**Newly IssuedNot Yet Effective Accounting Standards —**In June 2009, accountingstandards were amended to clarify when a transferor has surrendered controlover transferred financial assets and thus is entitled to account for the transferas a sale. The amendments established specific conditions for accounting forthe transfer of a financial asset, or a portion of a financial asset, as asale. The amendments could impact when a loan participation or SBA loan salemay be accounted for as a sale and the related transferred asset derecognizedby the company. The guidance is effective for transfers occurring on or after January 1,2010. The Bank has not yet completed its evaluation of these amendments, butdoes not expect that they will have a material impact on its balance sheet orstatement of operations.

 

**NOTE B —INVESTMENT SECURITIES —**The amortized cost, carrying value andestimated fair values of investment securities available for sale as of December 31,2009 and December 31, 2008 are as follows:

 
| ** **                           | ** ** | **December 31,  2009** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **Amortized**               | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                           | ** ** | **cost**                    | ** ** | **gains** | ** ** | **(losses)** | ** ** | **fair  value** | ** ** |
| U.S. Government andAgency Securities |       | $                           | 21,824,979 |   | $ | 217,016 |   | $ | (8,531 | ) | $ | 22,033,464 |   |
| States and PoliticalSubdivisions     |       | 3,714,014                   |       | 95,484 |   | (5,416 | ) | 3,804,082 |   |
| Mortgage-Backed Securities           |       | 14,890,559                  |       | 294,505 |   | (32,711 | ) | 15,152,353 |   |
|                                 |       | $                           | 40,429,552 |   | $ | 607,005 |   | $ | (46,658 | ) | $ | 40,989,899 |   |
|                                 | ** ** | ** **                  |       |   |   |   |   |   |   |
|                                 | ** ** | **December 31,  2008** |       |
|                                 | ** ** | **Amortized**               | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
|                                 | ** ** | **cost**                    | ** ** | **gains** | ** ** | **(losses)** | ** ** | **fair  value** | ** ** |
| U.S. Government andAgency Securities |       | $                           | 16,093,125 |   | $ | 565,115 |   | $ | — |   | $ | 16,658,240 |   |
| States and PoliticalSubdivisions     |       | 5,742,575                   |       | 49,245 |   | (51,056 | ) | 5,740,764 |   |
| Mortgage-Backed Securities           |       | 15,787,914                  |       | 345,063 |   | (61,505 | ) | 16,071,472 |   |
|                                 |       | $                           | 37,623,614 |   | $ | 959,423 |   | $ | (112,561 | ) | $ | 38,470,476 |   |

 

The carrying value ofinvestment securities pledged to secure public funds, borrowings and for otherpurposes as required or permitted by law amounts to approximately $12,556,000and $13,493,000 at December 31, 2009 and 2008, respectively. During 2009the Bank had proceeds from the sale of $5,176,324 in Mortgage Backed Securitiesand gross gains of $224,875 during 2009 compared to $108,163 for the periodending 2008.

 

The amortized cost andestimated fair value of debt securities at December 31, 2009, bycontractual maturity, are shown below. Mortgage-backed securities areclassified in accordance with their estimated lives.  Expected maturities may differ from contractualmaturities because borrowers may have the right to prepay obligations.

 
| ** **                             | ** ** | **Amortized** | ** ** | **Estimated**   | ** ** |
|----------------------------------------|------------|---------------|------------|-----------------|------------|
| ** **                             | ** ** | **cost**      | ** ** | **fair  value** | ** ** |
| Securities available-for-sale:         |       |          |       |            |       |
| Due in one year or less                |       | $             | 6,850,047  |            | $          | 7,012,430 |   |
| Due after one year through five years  |       | 23,599,132    |       | 23,896,840      |       |
| Due after five years through ten years |       | 4,823,058     |       | 4,922,884       |       |
| Due after ten years                    |       | 5,157,315     |       | 5,157,745       |       |
|                                   |       | $             | 40,429,552 |            | $          | 40,989,899 |   |

 

The gross unrealized loss andrelated estimated fair value of investment securities that have been in acontinuous loss position for less than twelve months and over twelve months at December 31,are as follows:

 
| ** **                                    | ** ** | **Less  than**     | ** ** | **Over**           | ** ** | ** **     | ** ** | ** **    | ** ** |
|-----------------------------------------------|------------|--------------------|------------|--------------------|------------|----------------|------------|---------------|------------|
| ** **                                    | ** ** | **Twelve  Months** | ** ** | **Twelve  Months** | ** ** | **Total**      | ** ** |
| ** **                                    | ** ** | ** **         | ** ** | **Estimated**      | ** ** | ** **     | ** ** | **Estimated** | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                    | ** ** | **Unrealized**     | ** ** | **fair**           | ** ** | **Unrealized** | ** ** | **fair**      | ** ** | **Unrealized** | ** ** | **fair** | ** ** |
| ** **                                    | ** ** | **losses**         | ** ** | **value**          | ** ** | **losses**     | ** ** | **value**     | ** ** | **losses** | ** ** | **value** | ** ** |
| December 31,  2009:                      |       |               |       |               |       |           |       |          |       |   |   |   |   |
| U.S.  Government & Agency Securities |       | $                  | (8,531     | )                  | $          | 3,995,450      |       | $             | —     |   | $ | — |   | $ | (8,531 | ) | $ | 3,995,450 |   |
| States  and Political Subdivisions            |       | —             |       | —             |       | (5,416         | )          | 290,678       |       | (5,416 | ) | 290,678 |   |
| Mortgage-Backed  Securities                   |       | (31,845            | )          | 3,038,225          |       | (866           | )          | 198,720       |       | (32,711 | ) | 3,236,945 |   |
|                                          |       |               |       |               |       |           |       |          |       |   |   |   |   |
|                                          |       | $                  | (40,376    | )                  | $          | 7,033,675      |       | $             | (6,282     | ) | $ | 489,398 |   | $ | (46,658 | ) | $ | 7,523,073 |   |

 
| ** **                                    | ** ** | **Less  than**     | ** **   | **Over**           | ** ** | ** **     | ** ** | ** **    | ** **   |
|-----------------------------------------------|------------|--------------------|--------------|--------------------|------------|----------------|------------|---------------|--------------|
| ** **                                    | ** ** | **Twelve  Months** | ** **   | **Twelve  Months** | ** ** | **Total**      | ** ** |
| ** **                                    | ** ** | ** **         | ** **   | **Estimated**      | ** ** | ** **     | ** ** | **Estimated** | ** **   | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                    | ** ** | **Unrealized**     | ** **   | **fair**           | ** ** | **Unrealized** | ** ** | **fair**      | ** **   | **Unrealized** | ** ** | **fair** | ** ** |
| ** **                                    | ** ** | **losses**         | ** **   | **value**          | ** ** | **losses**     | ** ** | **value**     | ** **   | **losses** | ** ** | **value** | ** ** |
| December 31,  2008:                      |       |               |         |               |       |           |       |          |         |   |   |   |   |
| U.S.  Government & Agency Securities |       | $                  |  — |               | $          |  —   |       | $             |  — |   | $ |  — |   | $ |  — |   | $ |  — |   |
| States  and Political Subdivisions            |       |  —       |         |  —       |       | (51,056        | )          | 1,176,019     |         | (51,056 | ) | 1,176,019 |   |
| Mortgage-Backed  Securities                   |       |  —       |         |  —       |       | (61,505        | )          | 2,414,802     |         | (61,505 | ) | 2,414,802 |   |
|                                          |       |               |         |               |       |           |       |          |         |   |   |   |   |
|                                          |       | $                  |  — |               | $          |  —   |       | $             | (112,561     | ) | $ | 3,590,821 |   | $ | (112,561 | ) | $ | 3,590,821 |   |

 

As of December 31, 2009,the Company has six investment securities where estimated fair market value haddecreased 0.61% from amortized cost. Unrealized losses on the six securitieshave not been recognized into income because the issuer bonds are of highcredit quality (rated AAA), management does not intend to sell and it is notlikely that management would be required to sell the securities prior to theiranticipated recovery, and the decline in fair value is largely due to changesin interest rates. The fair value is expected to recover as the bonds approachmaturity.

 

**NOTE C —LOANS —**The Bank’s loan portfolio consists primarily of loansto borrowers within San Luis Obispo and northern Santa Barbara Counties,California. Although the Bank seeks to avoid concentrations of loans to asingle industry or based upon a single class of collateral, real estate andreal estate associated businesses are among the principal industries in theBank’s market areas. As a result, the Bank’s loan and collateral portfoliosare, to some degree, concentrated in those industries.

 

As of December 31, 2009the Bank could pledge $131 million of loans to secure the borrowingarrangements discussed in Note G.

 

The composition of the loanportfolio at December 31, is as follows:

 
| ** **                      | ** ** | **2009**    | ** **  | **2008**    | ** ** |
|---------------------------------|------------|-------------|-------------|-------------|------------|
| Real Estate — construction |       | $           | 47,457,781  |        | $          | 52,388,923 |   |
| Real Estate — other        |       | 111,183,199 |        | 94,372,099  |       |
| Commercial                      |       | 41,743,898  |        | 41,477,697  |       |
| Consumer                        |       | 1,783,495   |        | 1,414,867   |       |
|                            |       | 202,168,373 |        | 189,653,586 |       |
| Deferred loan fees              |       | (683,384    | )           | (711,852    | )          |
| Allowance for loan losses       |       | (3,385,991  | )           | (2,309,774  | )          |
|                            |       | $           | 198,098,998 |        | $          | 186,631,960 |   |

 

32

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The allowance for loan lossesis increased by the provision to income and decreased by net charge-offs.Management’s periodic evaluation of the adequacy of the allowance is based onthe Company’s past loan experience, known and inherent risks in the portfolio,adverse situations that may affect the borrower’s ability to repay, theestimated value of any underlying collateral, and current economic conditions.

 

Transactionsin the allowance for loan losses are summarized as follows:

 
| ** **                                | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007**  | ** ** |
|-------------------------------------------|------------|------------|------------|----------|------------|-----------|------------|
| Balance at beginning of year              |       | $          | 2,309,774  |     | $          | 1,673,410 |       | $ | 1,653,695 |   |
| Provision charged to expense              |       | 5,460,000  |       | 975,000  |       | —    |       |
| Loans charged off                         |       | (4,385,741 | )          | (351,983 | )          | (60,779   | )          |
| Recoveries on loanspreviously charged off |       | 1,958      |       | 13,347   |       | 80,494    |       |
| Balance at end of year                    |       | $          | 3,385,991  |     | $          | 2,309,774 |       | $ | 1,673,410 |   |

 

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, 2009:

 
| ** **                                                  | ** ** | **2009** | ** ** | **2008** | ** ** | **2007**  | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Recorded investment inimpaired loans                        |       | $        | 10,175,114 |     | $          | 1,613,647 |       | $ | 2,175,694 |   |
|                                                        |       |     |       |     |       |      |       |
| Related allowance forloan losses                            |       | $        | 472,170    |     | $          | 394,000   |       | $ | 144,000 |   |
|                                                        |       |     |       |     |       |      |       |
| Average recorded investment inimpaired loans                |       | $        | 4,831,826  |     | $          | 1,528,000 |       | $ | 591,000 |   |
|                                                        |       |     |       |     |       |      |       |
| Interest income recognizedfor cash  payments                |       | $        | 205,986    |     | $          | —    |       | $ | — |   |
|                                                        |       |     |       |     |       |      |       |
| Total nonaccrual loans                                      |       | $        | 6,407,114  |     | $          | 1,613,647 |       | $ | 2,175,694 |   |
|                                                        |       |     |       |     |       |      |       |
| Total loans past-due ninety daysor more and  still accruing |       | $        | —     |     | $          | —    |       | $ | — |   |

 

**NOTE D —RELATED PARTY TRANSACTIONS —**In the ordinary course ofbusiness, the Bank has granted loans to certain executive officers, directorsand the businesses with which they are associated. All such loans andcommitments to lend were made under terms which are consistent with the Bank’snormal lending policies.

 

The following is an analysisof the activity of all such loans:

 
| ** **                          | ** ** | **2009**   | ** ** | **2008**  | ** ** |
|-------------------------------------|------------|------------|------------|-----------|------------|
| Beginning balance                   |       | $          | 5,197,043  |      | $          | 4,951,537 |   |
| Credits granted, including renewals |       | 1,179,500  |       | 1,176,000 |       |
| Repayments                          |       | (1,296,340 | )          | (930,494  | )          |
|                                |       | $          | 5,080,203  |      | $          | 5,197,043 |   |

 

Undisbursed loans amount toapproximately $699,537 and $764,183 at December 31, 2009 and 2008,respectively.

 

Deposits from related partiesheld by the Bank at December 31, 2009 and 2008 amounted to $841,828 and$3,656,080 respectively.

 

**NOTE E —PREMISES AND EQUIPMENT —**The composition of premises and equipment at December 31is as follows:

 
| ** **                        | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
| Premises                          |       | $          | 7,750,465  |       | $          | 7,753,334 |   |
| Furniture, fixtures and equipment |       | 4,298,039  |       | 4,115,960  |       |
|                              |       | 12,048,504 |       | 11,869,294 |       |
| Less accumulated depreciation     |       | 5,856,044  |       | 5,275,911  |       |
|                              |       | 6,192,460  |       | 6,593,383  |       |
| Land                              |       | 2,030,765  |       | 2,030,765  |       |
|                              |       | $          | 8,223,225  |       | $          | 8,624,148 |   |

 

**NOTE F —DEPOSITS —**At December 31, 2009, the scheduled maturitiesof time deposits are as follows:

 
| Due in one year             |   | $          | 76,748,757 |   |
|-----------------------------|--------|------------|------------|--------|
| Due from one to three years |   | 10,548,778 |       |
| Due after three years       |   | 2,485,352  |       |
|                        |   | $          | 89,782,887 |   |

 

**NOTE G —SHORT-TERM BORROWINGS —**The Bank has two borrowing arrangements withthe Federal Home Loan Bank of San Francisco. The first would allow the Bank toborrow up to approximately $48 million against which the Bank could pledgeapproximately $131 million of its real estate secured loans. The secondarrangement allows the Bank to borrow up to approximately $11 million againstwhich the Bank has pledged approximately $11 million of its investmentsecurities.

 

As of December 31, 2009the Bank had no borrowings.

 

The Bank may also borrow upto $6,000,000 overnight on an unsecured basis from two correspondent 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. As of December 31,2009 the Debentures totaled $999,932 and an average rate of 4.75% . TheDebentures, which are subordinated to the right of payment to depositors andother creditors, partially qualify as Tier 2 Capital.

 

On April 28, 2006, theCompany 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 are subordinated toeffectively all borrowings of the Company and are due and payable on July 7,2036. These debt securities may be redeemed for 105% of the principal balancethrough July 7, 2011 and then at par thereafter. Interest is payablequarterly beginning July 7, 2006 at 1.48% over the quarterly adjustable3-month LIBOR.

 

The Company also purchased a3% minority interest in Santa Lucia Bancorp (CA) Capital Trust. The balance ofthe equity of Santa Lucia Bancorp (CA) Capital Trust is comprised ofmandatorily redeemable preferred securities.

 

**NOTE I —INCOME TAXES —**The asset and liability method is used in accountingfor income taxes. Under this method, deferred tax assets and liabilities aredetermined based on differences between financial reporting and tax bases ofassets and liabilities and are measured using the enacted tax rates and lawsthat will be in effect when the differences are expected to reverse.

 

*Continued on next page           *

 

33

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Deferred income taxes reflectthe net tax effects of temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes and the amounts usedfor income tax purposes. Significant components of the Company’s deferred taxliabilities and assets as of December 31 are as follows:

 
| ** **                                       | ** ** | **2009**  | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|--------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Deferred liabilities:                            |       |      |       |      |       |      |       |
| Tax over book depreciation                       |       | 300,000   |       | 369,000   |       | 425,000   |       |
| Market value adjustment oninvestment  securities |       | 231,000   |       | 349,000   |       | 138,000   |       |
| Other                                            |       | 129,000   |       | 130,000   |       | 111,000   |       |
|                                             |       |      |       |      |       |      |       |   |   |   |
| Total deferred tax liabilities                   |       | $         | 660,000    |      | $          | 848,000   |       | $ | 674,000 |   |
|                                             |       |      |       |      |       |      |       |   |   |   |
| Deferred tax assets:                             |       |      |       |      |       |      |       |
| Allowance for loan losses                        |       | 1,009,000 |       | 909,000   |       | 673,000   |       |
| Deferred compensation plans                      |       | 699,000   |       | 671,000   |       | 498,000   |       |
| State taxes                                      |       | 1,000     |       | 95,000    |       | 191,000   |       |
| Net loss carryforward                            |       | 232,000   |       | 28,000    |       | 41,000    |       |
| Other                                            |       | 148,000   |       | 119,000   |       | 85,000    |       |
|                                             |       |      |       |      |       |      |       |
| Total deferred tax assets                        |       | 2,089,000 |       | 1,822,000 |       | 1,488,000 |       |
|                                             |       |      |       |      |       |      |       |   |   |   |
| Net deferred tax assets                          |       | $         | 1,429,000  |      | $          | 974,000   |       | $ | 814,000 |   |

 

The provision for incometaxes consists of the following:

 
| ** **                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007**  | ** ** |
|---------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Currently payable         |       | $        | (1,097,000 | )        | $          | 1,004,000 |       | $ | 2,135,000 |   |
| Deferred taxes (benefits) |       | (337,000 | )          | (371,000 | )          | (201,000  | )          |
|                      |       | $        | (1,434,000 | )        | $          | 633,000   |       | $ | 1,934,000 |   |

 

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

 
| ** **                  | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax over book depreciation  |       | $        | (69,000    | )        | $          | (56,000  | )          | $ | (68,000 | ) |
| Provision for loan losses   |       | (100,000 | )          | (236,000 | )          | —   |       |
| State taxes                 |       | 94,000   |       | 96,000   |       | 33,000   |       |
| Net loss carryforward       |       | (204,000 | )          | 13,000   |       | 14,000   |       |
| Deferred compensation plans |       | (28,000  | )          | (173,000 | )          | (108,000 | )          |
| Other                       |       | (30,000  | )          | (15,000  | )          | (72,000  | )          |
|                        |       |     |       |     |       |     |       |   |   |   |
| Net deferred taxes          |       | $        | (337,000   | )        | $          | (371,000 | )          | $ | (201,000 | ) |

 

As of December 31, 2009,the Bank had federal net operating loss carry forwards available to reducefuture taxable income of approximately $40,617. The net operating loss carryforwards expire in 2010. The 1995 merger with Central Coast National Bankresulted in an ownership change as defined in the Internal Revenue Code Section 382.Accordingly, the utilization of the net operating loss will be subject to thelimitations prescribed in Section 382.

 

The Bank has net operatingloss carryforwards of approximately $2,854,815 for state income tax purposesthat will expire in 2029 if not previously utilized.

 

As a result of the followingitems, the total tax expense was different from the amount computed by applyingthe statutory income tax rate to earnings before income taxes:

 
|                             |   | **2009** |       | **2008** |   | **2007** |   |
|----------------------------------|--------|----------|------------|----------|--------|----------|--------|
| Federal “expected” tax |   | $        | (1,108,000 | )        | (34.0  | )%       | $      | 602,000 |   | 34.0 | % | $ | 1,679,000 |   | 34.0 | % |
| State franchise tax, net         |   | (240,000 | )          | (7.4     | )      | 122,000  |   | 6.9 |   | 347,000 |   | 7.0 |   |
| Tax exempt income                |   | (119,000 | )          | (3.7     | )      | (128,000 | )      | (7.2 | ) | (122,000 | ) | (2.5 | ) |
| Other                            |   | 33,000   |       | 1.1      |   | 37,000   |   | 2.1 |   | 30,000 |   | 0.6 |   |
| Total expense                    |   | $        | (1,434,000 | )        | (44.0  | )%       | $      | 633,000 |   | 35.7 | % | $ | 1,934,000 |   | 39.1 | % |

 

The Company is subject toFederal income tax and California franchise tax. Federal income tax returns forthe years ended December 31, 2008, 2007 and 2006 are open to audit by theFederal authorities and California returns for the years ended December 31,2008, 2007, 2006 and 2005 are open to audit by state authorities.

 

**NOTE J —EMPLOYEE PROFIT SHARING AND DEFERRED COMPENSATION —**The Banksponsors a 401 (k) plan for the benefit of its employees. In 1994 the Bankalso approved the creation of an Employee Stock Ownership Plan for the benefitof its employees. Contributions to these plans are determined by the Board ofDirectors. The Bank contributed $154,000 in 2009, $202,000 in 2008, and$203,000 in 2007, to the Employee Stock Ownership Plan. The Bank contributed$56,000 to the 401 (k) plan in 2009, $58,000 to the 401 (k) plan in2008 and $57,000 in 2007.

 

The Bank has entered intodeferred compensation agreements with key officers and board members. Underthese agreements, the Bank is obligated to provide, upon retirement, a lifetimebenefit for the officers and directors. The annual benefits ranging from$25,000 to $75,000 for key officers and $4,000 to $6,000 for directors. Theestimated present value of future benefits to be paid is being accrued over theperiod from the effective date of the agreements until the expected retirementdates of the participants. The expense incurred and amount accrued for thisplan for the years ended December 31, 2009, 2008, and 2007 totaled$137,185, $275,140, and $292,385, respectively. The Bank is a beneficiary of life insurance policies that have beenpurchased as a method of financing the benefits under the agreements.

 

**NOTE K —STOCK OPTIONS —**The Company sponsors one compensatory incentive andnon-qualified stock option plan which provides certain key employees and theBoard of Directors with the option to purchase shares of common stock, and oneEquity Based Compensation Plan which provides certain key employees and theBoard of Directors with the award of any Option, Stock Appreciation Right,Restricted Stock Award, Restricted Share Unit, Performance Share Award,Dividend Equivalent, or any combination thereof. In 1999, the Bank adopted astock option plan (the 2000 plan) under which up to 367,200 shares of the Bank’scommon stock may be issued to directors, officers, and key employees.  In 2006, the Company adopted the 2006 EquityBased Compensation Plan (the Plan), which the maximum number of shares ofcommon stock that may be awarded under this Plan shall not exceed 204,000shares, including 38,964 shares rolled over from the Company’s 2000 StockOption Plan which expires on August 15, 2015. Option prices may not beless than 100% of the fair market value of the stock at the date of grant.Options became exercisable at the rate of 20% per year beginning at variousdates and expire not more than ten years from the date of grant. The Companyrecognized stock-based compensation costs of $136,272, $148,534 and $122,645and related tax benefits of $26,400, $41,700 and $18,450 for 2009, 2008 and2007, respectively.

 

The fair value of each optiongranted was estimated on the date of grant using the Black-Scholes optionspricing model with the following assumptions:

 
| ** **                             | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|----------------------------------------|------------|-----------|------------|-----------|------------|
| Risk-free rates                        |       | 3.18      | %          | 4.65      | %          |
| Expected volatility                    |       | 20.00     | %          | 20.00     | %          |
| Expected dividend yield                |       | 1.40      | %          | 1.40      | %          |
| Expected term                          |       | 6.0 years |       | 6.0 years |       |
| Weighted-average grant date fair value |       | $4.98     |       | $6.59     |       |

 

There were no options grantedin 2009.

 

34

----

 

A summary of the status ofthe Company’s fixed stock option plan as of December 31, 2009 and changesduring the year then ended is presented below:

 
| ** **                              | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | ** **                  | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | ** **                  | ** ** | **Average** | ** ** | **Average** | ** ** | **Aggregate** | ** ** |
| ** **                              | ** ** | ** **                  | ** ** | **Exercise** | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** |
| ** **                              | ** ** | **Shares**                  | ** ** | **Price** | ** ** | **Contractual  Term** | ** ** | **Value** | ** ** |
| Outstanding at thebeginning of the year |       | 233,131                     |       | $ | 19.05 |   |   |   |   |   |
| Granted                                 |       | —                      |       | — |   |   |   |   |   |
| Exercised                               |       | —                      |       | — |   |   |   |   |   |
| Foreited or expired                     |       | —                      |       | — |   |   |   |   |   |
| Outstanding at theend of the year       |       | 233,131                     |       | 19.05 |   | 5.5 years |   | $ | None |   |
| Options Exercisable                     |       | 208,316                     |       | $ | 15.25 |   | 4.2 years |   | $ | None |   |

 

The total intrinsic value ofoptions exercised during the years ended December 31, 2009, 2008, and 2007were approximately $0, $92,810, and $638,000 respectively. As of December 31,2009 there was $271,000 of total unrecognized compensation cost related to theoutstanding stock options that will be recognized over a weighted averageperiod of 1.7 years.

 

**NOTE L —DIVIDENDS —**The Company paid cash dividends of $0.25 per share toall shareholders of record as of March 31, 2009 and declared a 2% stockdividend to all shareholders of record as of September 30, 2009. All ofthe per share data in the financial statements have been retroactively adjustedto reflect the 2% stock dividend.

 

**NOTE M —EARNINGS PER SHARE (EPS) —**The following is areconciliation of net earnings (loss) and shares outstanding to the income andnumber of shares used to compute EPS:

 
| ** **                                  | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **Income**                  | ** ** | **Shares** | ** ** |
| ** **                                  | ** ** | **(Numerator)**             | ** ** | **(Denominator)** | ** ** |
| Net income (loss)                           |       | $                           | (1,825,475 | ) |   |   |
| Less dividends earned onPreferred  Stock    |       | $                           | (200,000   | ) |   |   |
| Accreted discount onPreferred Stock         |       | $                           | (40,199    | ) |   |   |
| Average shares outstanding                  |       |                        |       | 1,961,483 |   |
| **Used in  Basic EPS**                      |       | (2,065,674                  | )          | 1,961,483 |   |
| Dilutive effect of outstandingstock options |       |                        |       |   |   |
| **Used in  Diluted EPS**                    |       | $                           | (2,065,674 | ) | 1,961,483 |   |

 
|                                        | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|
|                                        | ** ** | **Income**                  | ** ** | **Shares** | ** ** |
|                                        | ** ** | **(Numerator)**             | ** ** | **(Denominator)** | ** ** |
| Net income                                  |       | $                           | 1,138,904  |   |   |   |
| Average shares outstanding                  |       |                        |       | 1,924,023 |   |
| **Used in  Basic EPS**                      |       | 1,138,904                   |       | 1,924,023 |   |
| Dilutive effect of outstandingstock options |       |                        |       | 48,465 |   |
| **Used in  Diluted EPS**                    |       | $                           | 1,138,904  |   | 1,972,488 |   |

 
|                                        | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|
|                                        | ** ** | **Income**                  | ** ** | **Shares** | ** ** |
|                                        | ** ** | **(Numerator)**             | ** ** | **(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 outstandingstock options |       |                        |       | 59,823 |   |
| **Used in  Diluted EPS**                    |       | $                           | 3,002,819  |   | 1,993,054 |   |

 

**NOTE N —COMMITMENTS AND CONTINGENCIES —**The Company’s exposure tocredit loss in the event of nonperformance by the other party to the financialinstrument for commitments to extend credit and standby letters of credit isrepresented by the contractual amount of those commitments.  Commitments to extend credit (such as theunfunded portion on lines of credit and commitments to fund new loans) as of December 31,2009 and 2008 amounts to approximately $43,105,000 and $57,168,000,respectively, of which approximately $1,298,000 and $3,106,000 are related standbyletters of credit, respectively. The Company uses the same credit policies inthese commitments as is done for all of its lending activities. As such, thecredit risk involved in these transactions is essentially the same as thatinvolved in extending loan facilities to customers.

 

Commitments to extend creditare agreements to lend to a customer as long as there is no violation of anycondition established in the contract. Since many of the commitments areexpected to expire without being drawn upon, the total amounts do notnecessarily represent future cash requirements. The Company evaluates eachclient’s credit worthiness on a case-by-case basis. The amount of collateralobtained if deemed necessary by the Company is based on management’s credit evaluationof the customer. The majority of the Company’s commitments to extend credit andstandby letters of credit are secured by real estate.

 

In the normal course ofbusiness, the Company is involved in various litigation. In the opinion ofmanagement, and based on the advise of the Company’s legal counsel, thedisposition of all pending litigation will not have a material effect on theCompany’s financial position.

 

**NOTE O —PREFFERED STOCK AND RELATED WARRANT —**December 19, 2008, theCompany entered into a Purchase Agreement with the United States Department ofthe Treasury (the “Treasury”), pursuant to which the Company agreed to issueand sell 4,000 shares of the Company’s Preferred Stock as Fixed Rate CumulativePerpetual Preferred Stock, Series A (the “Preferred Stock) and a Warrantto purchase 37,360 shares of the Company’s Common Stock for an aggregatepurchase price of $4,000,000 in cash. In connection with this transaction theCompany incurred $50,000 in costs.

 

The Preferred Stock qualifiesas Tier 1 capital and will pay cumulative dividends quarterly at a rate of 5%per annum for the first five years and 9% per annum thereafter. The PreferredStock may be redeemed by the Company after three years. Prior to the end of thethree years, the Preferred Stock may be redeemed only with proceeds from thesale of qualifying equity securities of the Company.

 

The Warrant has a 10-yearterm and is immediately exercisable upon its issuance, with an exercise price,subject to anti-dilution adjustments, equal to $16.06 per share. On September 21,2009 the Board of Directors declared a 2% stock dividend which automaticallyincreased the number of common shares subject to the warrant to 38,107 andreduced the exercise price of the warrant to $15.745.

 

If the Company receivesaggregate gross cash proceeds of not less than $4,000,000 from a QualifiedEquity Offering on or prior to December 31, 2009, the number of shares ofCommon Stock issuable pursuant to Treasury’s exercise of the Warrant will bereduced by one half of the original number of shares, taking into account alladjustments, underlying the Warrant. Pursuant to the Purchase Agreement, theTreasury has agreed not to exercise voting power with respect to any shares ofCommon Stock issued upon exercise of the Warrant. 

 

Neither the Preferred Stocknor the Warrant will be subject to any contractual restrictions on transfer,except that Treasury may only transfer or exercise an aggregate of one-half ofthe Warrant Shares prior to the earlier of the redemption of 100% of the sharesof Preferred Stock and December 31, 2009.

 

*Continuedon next page           *

 

35

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In the Purchase Agreement,the Company agreed that, until such time as Treasury ceases to own any debt orequity securities of the Company acquired pursuant to the Purchase Agreement,the Company will take all necessary action to ensure that its benefit planswith respect to its senior executive officers comply with Section 111(b) ofthe Emergency Economic Stabilization Act of 2008 (the “EESA”) as implemented byany guidance or regulation under the EESA that has been issued and is in effectas of the date of the issuance of the Preferred Stock and the Warrant, and hasagreed to not adopt any benefit plans with respect to, or which covers, itssenior executive officers that do not comply with the EESA, and the applicableexecutives have consented to the foregoing.

 

The net proceeds from theissuance of the Preferred Stock and Warrant of $3,950,000 were allocated betweenthe Preferred Stock and the Warrant based on their estimated relative fairvalues. The resulting discount of $200,997 on the Preferred Stock will beaccreted against retained earnings over the estimated five-year life of thePreferred Stock reducing the reported income available for common shareholders.

 

**NOTE P —FAIR VALUE MEASUREMENT —**The following is a description of valuationmethodologies used for assets and liabilities recorded at fair value:

 

**Securities:**The fair valuesof securities available for sale are determined by obtaining quoted prices onnationally recognized securities exchanges (Level 1).

 

**Collateral-DependentImpaired Loans:**The Bank does not record loans at fair value on arecurring basis. However, from time to time, fair value adjustments arerecorded on these loans to reflect (1) partial write-downs, throughcharge-offs or specific reserve allowances, that are based on the currentappraised or market-quoted value of the underlying collateral or (2) thefull charge-off of the loan carrying value. In some cases, the properties forwhich market quotes or appraised values have been obtained are located in areaswhere comparable sales data is limited, outdated, or unavailable. Fair valueestimates for collateral-dependent impaired loans are obtained from real estatebrokers or other third-party consultants (Level 3).

 

**Other RealEstate Owned:**Nonrecurring adjustments to certain commercial andresidential real estate properties classified as other real estate owned (OREO)are measured at the lower of carrying amount of fair value, less costs to sell.Fair values are generally based on third party appraisals of the property,resulting in a Level 3 classification. In cases where the carrying amountexceeds the fair value, less costs to sell, an impairment loss is recognized.

 

The following table providesthe hierarchy and fair value for each major category of assets and liabilitiesmeasured at fair value at December 31, 2009 and 2008:

 
| ** **                                                         | ** ** | **Fair  Value Measurements as of December 31, 2009 using** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Level  1**                                                    | ** ** | **Level  2** | ** ** | **Level  3** | ** ** | **Level  4** | ** ** |
| Assets and liabilitiesmeasured at  fair valueon a recurring basis  |       |                                                            |       |   |   |   |   |   |   |
| Assets:                                                            |       |                                                            |       |   |   |   |   |   |   |
| Securities Available forSale                                       |       | $                                                               | 40,989,899 |   | $ | — |   | $ | — |   | $ | 40,989,899 |   |
| Assets measured atfair value on a non-recurringbasis               |       |                                                            |       |   |   |   |   |   |   |
| Collateral-DependentImpaired Loans, Netof Specific  Reserves  |       | $                                                               | —     |   | $ | — |   | $ | 6,407,114 |   | $ | 6,407,114 |   |
| Other Real EstateOwned                                             |       | $                                                               | —     |   | $ | — |   | $ | 428,000 |   | $ | 428,000 |   |

 
| ** **                                                        | ** ** | **Fair  Value Measurements as of December 31, 2008 using** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **Level  1**                                                    | ** ** | **Level  2** | ** ** | **Level  3** | ** ** | **Level  4** | ** ** |
| Assets and liabilitiesmeasured at  fair valueon a recurring basis |       |                                                            |       |   |   |   |   |   |   |
| Assets:                                                           |       |                                                            |       |   |   |   |   |   |   |
| Securities Available forSale                                      |       | $                                                               | 38,470,476 |   | $ | — |   | $ | — |   | $ | 38,470,476 |   |
| Assets measured atfair value on a non-recurringbasis              |       |                                                            |       |   |   |   |   |   |   |
| Collateral-DependentImpaired Loans, Netof Specific  Reserves      |       | $                                                               | —     |   | $ | — |   | $ | 1,219,647 |   | $ | 1,219,647 |   |

 

Collateral-dependent impairedloans had a net carrying value of $6,407,114, which is made up of the loanbalance, net of specific reserves of $0 at December 31, 2009 compared to$1,219,647 at December 31, 2008.

 

Other real estate owned had anet carrying amount of $428,000, which is made up of the outstanding balance of$428,000, net of a valuation allowance of $0 at December 31, 2009.

 

**NOTE Q —FAIR VALUE OF FINANCIAL INSTRUMENTS —**The fair value of a financialinstrument is the amount at which the asset or obligation could be exchanged ina current transaction between willing parties, other than in a forced orliquidation sale. Fair value estimates are made at a specific point in timebased on relevant market information and information about the financialinstrument. These estimates do not reflect any premium or discount that couldresult from offering for sale at one time the entire holdings of a particularfinancial instrument. Because no market value exists for a significant portionof the financial instruments, fair value estimates are based on judgmentsregarding future expected loss experience, current economic conditions, riskcharacteristics of various financial instruments, and other factors.  These estimates are subjective in nature,involve uncertainties and matters of judgment, and therefore cannot bedetermined with precision. Changes in assumptions could significantly affectthe estimates.

 

Fair value estimates arebased on financial instruments both on and off the balance sheet withoutattempting to estimate the value of anticipated future business and the valueof assets and liabilities that are not considered financial instruments.Additionally, tax consequences related to the realization of the unrealizedgains and losses can have a potential effect on fair value estimates and havenot been considered in many of the estimates.

 

The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

 

**FinancialAssets —**The carrying amounts of cash, short term investments,due from customers on acceptances and bank acceptances outstanding areconsidered to approximate fair value. Short term investments include federalfunds sold, securities purchased under agreements to resell, and interestbearing deposits with banks. The fair values of investment securities,including available for sale, are discussed in Note P. The fair value of loansare estimated using a combination of techniques, including discountingestimated future cash flows and quoted market prices of similar instrumentswhere available.

 

36

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**FinancialLiabilities —**The carrying amounts of deposit liabilities payableon 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 isbased on rates currently available for debt with similar terms and remainingmaturities.

 

**Off-BalanceSheet Financial Instruments —**The fair value of commitmentsto extend credit and standby letters of credit is estimated using the feescurrently charged to enter into similar agreements. The fair values of thesefinancial instruments are not deemed to be material.

 

The estimated fair value offinancial instruments at December 31, 2009 and 2008 are summarized asfollows:

 
| ** **                                    | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **Carrying**          | ** ** | **Market**            | ** ** | **Carrying** | ** ** | **Market** | ** ** |
| ** **                                    | ** ** | **Value**             | ** ** | **Value**             | ** ** | **Value** | ** ** | **Value** | ** ** |
| Financial  Assets:                            |       |                  |       |                  |       |   |   |   |   |
| Cash  and cash equivalents                    |       | $                     | 6,588,396  |                  | $          | 6,588,396 |   | $ | 8,220,406 |   | $ | 8,220,406 |   |
| Investment  securities                        |       | 40,989,899            |       | 40,989,899            |       | 38,470,476 |   | 38,470,476 |   |
| Loans  receivable, net                        |       | 198,098,998           |       | 195,723,998           |       | 186,631,960 |   | 185,936,829 |   |
| Cash  surrender value of life insurance       |       | 5,390,410             |       | 5,390,410             |       | 5,194,688 |   | 5,194,688 |   |
| Federal  Reserve Bank and FHLB Stock          |       | 1,643,400             |       | 1,643,400             |       | 1,516,850 |   | 1,516,850 |   |
| Accrued  interest receivable and other assets |       | 6,060,529             |       | 6,060,529             |       | 2,246,995 |   | 2,246,995 |   |
| Financial  Liabilities:                       |       |                  |       |                  |       |   |   |   |   |
| Time  deposits                                |       | $                     | 89,782,887 |                  | $          | 90,088,000 |   | $ | 71,304,171 |   | $ | 71,175,000 |   |
| Other  deposits                               |       | 148,939,637           |       | 145,844,637           |       | 141,012,427 |   | 140,601,598 |   |
| Other  borrowings                             |       | —                |       | —                |       | 5,000,000 |   | 5,000,000 |   |
| Long-term  debt                               |       | 6,154,932             |       | 6,154,932             |       | 6,821,644 |   | 6,821,644 |   |
| Accrued  interest and other liabilities       |       | 2,015,491             |       | 2,015,491             |       | 2,190,584 |   | 2,190,584 |   |

 

**NOTE R —REGULATORY MATTERS —**The Company and the Bank are subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory and possibly additionaldiscretionary, actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements. Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The Bank’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the table below) of total andTier 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, 2009, that the Bank meets all capitaladequacy requirements to which it is subject.

 

As of December 31, 2009,the most recent notification from the Federal Reserve Bank (FRB) categorizedthe Bank as well capitalized under the regulatory framework for promptcorrective action (there are no conditions or events since that notificationthat management believes have changed the Bank’s category). To be categorizedas well capitalized, the Bank must maintain minimum ratios as set forth in thetable 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, 2009:**        |       |                   |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| **Company**                               |       |                   |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)  |       | $                      | 30,808     |                               | 13.9       | %                                                                       | $          | 17,773 |   | 8.0 | % | $ | 22,216 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                      | 27,856     |                               | 12.5       | %                                                                       | $          | 8,886 |   | 4.0 | % | $ | 13,330 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                      | 27,856     |                               | 10.3       | %                                                                       | $          | 10,834 |   | 4.0 | % | $ | 13,543 |   | 5.0 | % |
| ** **                                | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Bank**                                  | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets)  |       | $                      | 29,223     |                               | 13.2       | %                                                                       | $          | 17,740 |   | 8.0 | % | $ | 22,175 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                      | 26,276     |                               | 11.9       | %                                                                       | $          | 8,870 |   | 4.0 | % | $ | 13,305 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                      | 26,276     |                               | 9.7        | %                                                                       | $          | 10,821 |   | 4.0 | % | $ | 13,526 |   | 5.0 | % |
| ** **                                | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **As  of December 31, 2008:**        | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Company**                               | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets)  |       | $                      | 33,373     |                               | 15.9       | %                                                                       | $          | 16,770 |   | 8.0 | % | $ | 20,963 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                      | 30,208     |                               | 14.4       | %                                                                       | $          | 8,385 |   | 4.0 | % | $ | 12,578 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                      | 30,208     |                               | 11.9       | %                                                                       | $          | 10,074 |   | 4.0 | % | $ | 12,592 |   | 5.0 | % |
| ** **                                | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Bank**                                  | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets)  |       | $                      | 31,748     |                               | 15.2       | %                                                                       | $          | 16,746 |   | 8.0 | % | $ | 20,933 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                      | 28,583     |                               | 13.7       | %                                                                       | $          | 8,373 |   | 4.0 | % | $ | 12,560 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                      | 28,583     |                               | 11.4       | %                                                                       | $          | 9,995 |   | 4.0 | % | $ | 12,494 |   | 5.0 | % |

 

The California Financial Codeprovides that a bank may not make a cash distribution to its shareholders inexcess of the lesser of the Bank’s undivided profits or the Bank’s net incomefor its last three fiscal years less the amount of any distribution made by theBank to shareholders during the same period.

 

With certain exceptions theCompany may not pay a dividend to its shareholders unless its retained earningsequal at least the amount of the proposed dividend.

 

**NOTE S — HOLDING COMPANY —**On April 3, 2006 SantaLucia Bancorp acquired all the outstanding shares of Santa Lucia Bank byissuing 1,909,837 shares of common stock in exchange for the surrender of alloutstanding shares of the Bank’s common stock. There was no cash involved inthis transaction. The acquisition was accounted for like a pooling of interestand the consolidated financial statements contained herein have been restatedto give full effect to this transaction. Santa Lucia Bancorp has no significantbusiness activities other than its investment in Santa Lucia Bank and itsinvestment and related borrowings from Santa Lucia Bancorp (CA) Capital Trustas discussed in Note H.  Accordingly, noseparate financial information on the Company is provided.

 

37

----

 

 

 

**SANTA LUCIA BANK MISSION STATEMENT**

 

**Provide the best products and employ the best peopletogive the highest quality service to ourcustomers, in order to maximizeour shareholders’ value.**

 

38

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**Products and Services**

 

**FreeBusiness Checking***

·**No minimum balance**

·**No monthly servicecharge**

·**No returned item fee**

 

----

*Offermay not be available for accounts with very high volume.

 

**EZLink**

·**24 hour online Internetaccess**

·**PAYTRAXX Online BillPay**

·**ACH Origination**

** **

**24 HourTelebanking**

·**Atascadero &Paso Robles (805) 460-0125**

·**Arroyo Grande &Santa Maria (877) 475-2265**

** **

***VISA*****Credit Cards**

·**Issued in business orpersonal names**

*** ***

***VISA*****Debit Cards**

·**Use this card insteadof writing checks**

**Itdebits your designated account**

** **

**ATMs(Automatic Teller Machines)**

·**Access your accountworldwide**

** **

**MerchantCredit Card Processing**

 

**CommercialLoans**

·**Working capital**

·**Debt restructuring**

·**Equipment**

·**Facilities expansion,purchaseor relocation**

 

**GuaranteedBusiness Loans**

·**Small BusinessAdministration**

·**California CoastalRural Development Corporation**

·**United StatesDepartment of Agriculture**

·**Economic VitalityCorporation**

** **

**BusinessEquipment Leases**

·**Capital Leases**

·**Operating Leases**

** **

**ConstructionLoans**

·**Residential andCommercial**

·**Progress paymentsfunded promptly**

** **

**MortgageLoans**

·**Purchase**

·**Refinance**

·**Home Equity Line ofCredit**

** **

**Payroll TaxDepository**

 

***Plus many other personalized bankservices:***

Checking, Savings,Certificates of Deposit, Health Savings Accounts, IRA’s, Night Depository, SafeDeposit, Wire Transfers,  Moneycard, Cashiers Checks, Money Orders,Overdraft Protection, Courier Service

 

**www.santaluciabank.com**

 

| **EQUAL  OPPORTUNITY  LENDER** |   |  |   |  |
|--------------------------------|--------|--|--------|--|

 

39

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**SANTALUCIA 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 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 BANCORP EXECUTIVE OFFICERS** |                                              |
|---------------------------------------------|---------------------------------------------------|
| ** **                                  |                                              |
| **JOHN C. HANSEN**                          | PRESIDENT AND CHIEF EXECUTIVE OFFICER             |
| **JAMES M. COWAN**                          | EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL OFFICER |

 

**SANTA LUCIA BANK**

 

**EXECUTIVE OFFICERS**

 

| **JOHN C.  HANSEN** | President and Chief Executive Officer                                |
|---------------------|----------------------------------------------------------------------|
| **JAMES M.  COWAN** | Executive Vice President, Chief Admin. Officer, Chief Credit Officer |
| **JOHN  McNINCH**   | Executive Vice President, Credit Administrator                       |

 

**SENIOR VICE PRESIDENTS**

 
| **TERI DAVIS**          | Senior Vice President, Manager - Atascadero     |
|-------------------------|-------------------------------------------------|
| **MELODEE  FONTANA**    | Senior Vice President, Operations Administrator |
| **ROBERT  COVARRUBIAS** | Senior Vice President, Manager - Paso Robles    |
| **CLAUDYA  OGLESBY**    | Senior Vice President, Credit Administration    |

 

**VICE PRESIDENTS**

 
| **SHARON  SATTERTHWAITE**  | Vice President, Controller                     |
|----------------------------|------------------------------------------------|
| **JENNIFER  BASSI GINDER** | Vice President, Operations Officer             |
| **KRISTIE  KELLER**        | Vice President, Central Operations             |
| **KIM  DONALDSON**         | Vice President, Operations Officer             |
| **RYUN  McCRORY**          | Vice President, Loan Officer                   |
| **LEAH T.  WEST**          | Vice President, Manager - Santa Maria          |
| **JIM KELLEY**             | Vice President, Loan Officer                   |
| **MICHAEL W.  McKENZIE**   | Vice President, Manager - Arroyo Grande        |
| **LARRY  WOMACK**          | Vice President, Assistant Credit Administrator |
| **JAMES P.  BURUBELTZ**    | Vice President, Loan Officer                   |
| **RICHARD  ALLEN**         | Vice President, Loan Officer                   |
| **JULIE A.  JOSLIN**       | Vice President, Cashier                        |
| **JOSHUA R.  BIVIN**       | Vice President, Loan Officer                   |

 

**ASSISTANT VICE PRESIDENTS**

 
| **CHERYL  MUMFORD**    | Assistant Vice President, Operations Officer |
|------------------------|----------------------------------------------|
| **J. DARREN  BARNES**  | Assistant Vice President, Loan Officer       |
| **REGINA M.  SHELDON** | Assistant Vice President, Loan Officer       |

 

**OFFICERS**

 
| **LILA  BOGARDUS**       | Note Department Manager      |
|--------------------------|------------------------------|
| **KAREN SAMPSON**        | Assistant Operations Officer |
| **STELLA  MARTINEZ**     | Operations Officer           |
| **GEORGE  GARCIA**       | IT Manager                   |
| **ROBERT J.  McCONAGHY** | Loan Officer                 |

 

**FINANCIAL HIGHLIGHTS**

The Company has twoclasses of stock outstanding - Common and Series A Preferred. Our commonstock trades over-the-counter and is quoted on the OTC Bulletin Board under thesymbol SLBA.OB. There is no active market for the Series A Preferred andall of the outstanding preferred is held by one shareholder. The information inthe following table indicates the high and low bid prices of the Company’scommon stock for each quarterly period during the last two years based uponinformation provided by the Company market makers. These prices do not includeretail mark ups, mark downs or commissions, but have been adjusted to reflectthe Bank’s 4-for-1 stock split that was effective June 2005.

 
| **Quarter  Ended 2009** | ** ** | **Low** | ** ** | **High** | ** ** |
|-------------------------|------------|---------|------------|----------|------------|
| December 31        |       | $       | 10.10      |     | $          | 11.89 |   |
| September 30       |       | 11.55   |       | 15.00    |       |
| June 30            |       | 10.50   |       | 13.00    |       |
| March 31           |       | 8.20    |       | 14.75    |       |
|                         |            |         |            |          |            |  |  |

 
| **Quarter  Ended 2008** | ** ** | **Low** | ** ** | **High** | ** ** |
|-------------------------|------------|---------|------------|----------|------------|
| December 31        |       | $       | 13.50      |     | $          | 19.00 |   |
| September 30       |       | 14.25   |       | 21.50    |       |
| June 30            |       | 20.00   |       | 24.25    |       |
| March 31           |       | 23.25   |       | 25.00    |       |
|                         |            |         |            |          |            |  |  |

 

**MARKET MAKERS**

 
| 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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