UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549








FORM
10-Q








QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (d)


OF THE
SECURITIES EXCHANGE ACT OF 1934








For the
quarterly period ended March 31, 2008





Commission
file number: 000-51765











Bay
National Corporation


(Exact
name of registrant as specified in its charter)





Maryland
            
            52-2176710(State
      or other jurisdiction of
            
            (I.R.S.
      Employerincorporation
      or organization)
            
            Identification
      No.)





2328 West Joppa Road,
Lutherville, MD 21093


Address
of principal executive offices





(410)
494-2580


Registrant’s
telephone number





Indicate
by checkmark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.





Yes
            X
            
            No




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See definition of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.





Large
accelerated filer o                                                                                                          Accelerated
filer o





Non-accelerated
filer o (Do
not check if a smaller reporting
company)               Smaller
reporting company þ





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes ____No X__





State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date:





At May 13, 2008, the issuer had
2,140,933 shares of Common Stock outstanding.












PART
I  -                      FINANCIAL
INFORMATION





Item
1.                 Financial
Statements





BAY
NATIONAL CORPORATION





CONSOLIDATED BALANCE
SHEETS


As of
March 31, 2008 and December 31, 2007





March
      31,
              2008
            
            
            December
      31,
              2007ASSETS
            
            
            
            
            (Unaudited)Cash
      and due from banks
            
            
            
            $
            485,226
            
            $
            2,314,423Federal
      funds sold and other overnight investments
            
            
            
            
            14,374,017
            
            
            4,859,248Investment
      securities available for sale (AFS) - at fair value
            
            
            
            
            -
            
            
            399,529Other
      equity securities
            
            
            
            
            1,157,100
            
            
            1,715,000Loans
      held for sale
            
            
            
            
            5,475,582
            
            
            11,601,070Loans,
      net of unearned fees
            
            
            
            
            239,159,138
            
            
            229,355,171Total
      Loans
            
            
            
            
            244,634,720
            
            
            240,956,241Less: Allowance for credit
      losses
            
            
            
            
            (6,700,000
            )
            
            (5,000,000
            )Loans, net
            
            
            
            
            237,934,720
            
            
            235,956,241Other
      real estate owned, net
            
            
            
            
            1,765,648
            
            
            946,431Premises
      and equipment, net
            
            
            
            
            1,306,647
            
            
            1,210,787Investment
      in bank owned life insurance
            
            
            
            
            5,097,619
            
            
            5,041,662Accrued
      interest receivable and other assets
            
            
            
            
            4,902,844
            
            
            4,092,538Total Assets
            
            
            
            $
            267,023,821
            
            $
            256,535,859LIABILITIESNon-interest-bearing
      deposits
            
            
            
            $
            38,214,215
            
            $
            31,044,172Interest-bearing
      deposits
            
            
            
            
            192,934,947
            
            
            170,937,293Total deposits
            
            
            
            
            231,149,162
            
            
            201,981,465Short-term
      borrowings
            
            
            
            
            8,312,459
            
            
            25,371,508Subordinated
      debt
            
            
            
            
            8,000,000
            
            
            8,000,000Accrued
      expenses and other liabilities
            
            
            
            
            1,081,562
            
            
            1,262,334Total
    Liabilities
            
            
            
            
            248,543,183
            
            
            236,615,307STOCKHOLDERS'
      EQUITYCommon stock - $.01 par value,
      authorized:9,000,000 shares authorized,
      2,140,933 and 2,137,633 issued and
              outstanding as of March 31, 2008 and December 31, 2007,
      respectively:
            
            
            
            
            21,409
            
            
            21,376Additional paid in
      capital
            
            
            
            
            17,835,060
            
            
            17,788,833Retained
    earnings
            
            
            
            
            624,169
            
            
            2,110,343Total Stockholders'
      Equity
            
            
            
            
            18,480,638
            
            
            19,920,552Total Liabilities and
      Stockholders' Equity
            
            
            
            $
            267,023,821
            
            $
            256,535,859




See
accompanying notes to consolidated financial statements.




2




BAY
NATIONAL CORPORATION





CONSOLIDATED STATEMENTS OF
OPERATIONS


For the
three-month periods ended March 31, 2008 and 2007


(Unaudited)





Three
      Months Ended
              March
      312008
            
            
            2007INTEREST
      INCOME:Interest and fees on
      loans
            
            
            
            
            
            
            $
            4,311,466
            
            $
            5,084,808Interest
      on federal funds sold and other overnight investments
            
            
            
            
            
            
            
            45,391
            
            
            242,286Taxable interest and dividends
      on investmentsecurities
            
            
            
            
            
            
            
            11,988
            
            
            16,120Total interest
    income
            
            
            
            
            
            
            
            4,368,845
            
            
            5,343,214INTEREST
      EXPENSE:Interest
      on deposits
            
            
            
            
            
            
            
            1,618,193
            
            
            2,029,447Interest
      on short-term borrowings
            
            
            
            
            
            
            
            114,365
            
            
            21,181Interest
      on subordinated debt
            
            
            
            
            
            
            
            149,991
            
            
            148,454Total
      interest expense
            
            
            
            
            
            
            
            1,882,549
            
            
            2,199,082Net
      interest income
            
            
            
            
            
            
            
            2,486,296
            
            
            3,144,132Provision
      for credit losses
            
            
            
            
            
            
            
            2,467,700
            
            
            -Net
      interest income after provision forcredit losses
            
            
            
            
            
            
            
            18,596
            
            
            3,144,132NON-INTEREST
      INCOME:Service charges on deposit
      accounts
            
            
            
            
            
            
            
            56,251
            
            
            36,941Gain
      on sale of mortgage loans
            
            
            
            
            
            
            
            79,644
            
            
            135,449Other income
            
            
            
            
            
            
            
            72,458
            
            
            19,838Total non-interest
      income
            
            
            
            
            
            
            
            208,353
            
            
            192,228NON-INTEREST
      EXPENSES:Salaries and employee
      benefits
            
            
            
            
            
            
            
            1,558,957
            
            
            1,497,189Occupancy
    expenses
            
            
            
            
            
            
            
            186,711
            
            
            157,214Furniture and equipment
      expenses
            
            
            
            
            
            
            
            96,402
            
            
            85,237Legal and professional
      fees
            
            
            
            
            
            
            
            165,193
            
            
            63,861Data processing and other
      outside services
            
            
            
            
            
            
            
            253,600
            
            
            186,656Advertising
      and marketing related expenses
            
            
            
            
            
            
            
            148,876
            
            
            125,582Other expenses
            
            
            
            
            
            
            
            272,384
            
            
            179,152Total non-interest
      expenses
            
            
            
            
            
            
            
            2,682,123
            
            
            2,294,891(Loss)
      Income before income taxes
            
            
            
            
            
            
            
            (2,455,174
            )
            
            1,041,469Income
      tax (benefit) expense
            
            
            
            
            
            
            
            (969,000
            )
            
            422,000NET
      (LOSS) INCOME
            
            
            
            
            
            
            $
            (1,486,174
            )
            $
            619,469Per
      Share Data:Net (Loss) Income (basic) (1)
            
            
            
            
            
            
            $
            (.69
            )
            $
            .29Net (Loss) Income (diluted)(1)
            
            
            
            
            
            
            $
            (.69
            )
            $
            .28Weighted Average shares
      outstanding (basic) (1)
            
            
            
            
            
            
            
            2,139,845
            
            
            2,128,876Effect
      of Dilution – Stock options and Restricted shares (1)
            
            
            
            
            
            
            
            -
            
            
            82,200Weighted Average shares
      outstanding (diluted) (1)
            
            
            
            
            
            
            
            2,139,845
            
            
            2,211,076


(1)
Adjusted to reflect 1.1 stock split in the form of a dividend recorded on June
29, 2007.





See
accompanying notes to consolidated financial statements.




3


BAY
NATIONAL CORPORATION





CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY


For the
three months ended March 31, 2008 and 2007


(Unaudited)





Common
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Retained
              Earnings
            
            
            Total
              Stockholders’
              EquityBalances
      at January 1, 2008
            $
            21,376
            
            $
            17,788,833
            
            $
            2,110,343
            
            $
            19,920,552Stock-based
      compensation expense
            
            -
            
            
            23,520
            
            
            -
            
            
            23,520Issuance
      of Common Stock
            
            33
            
            
            22,707
            
            
            -
            
            
            22,740Net
      Loss
            
            -
            
            
            -
            
            
            (1,486,174
            )
            
            (1,486,174
            )Balances
      at March 31, 2008
            $
            21,409
            
            $
            17,835,060
            
            $
            624,169
            
            $
            18,480,638Common
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Retained
              Earnings
            
            
            Total
              Stockholders’
              EquityBalances
      at January 1, 2007
            $
            19,354
            
            $
            17,649,678
            
            $
            1,173,461
            
            $
            18,842,493Stock-based
      compensation expense
            
            -
            
            
            16,500
            
            
            -
            
            
            16,500Net
      Income
            
            -
            
            
            -
            
            
            619,469
            
            
            619,469Balances
      at March 31, 2007
            $
            19,354
            
            $
            17,666,178
            
            $
            1,792,930
            
            $
            19,478,462




























See
accompanying notes to consolidated financial statements.




4


BAY
NATIONAL CORPORATION





CONSOLIDATED STATEMENTS OF
CASH FLOWS


For the
three months ended March 31, 2008 and 2007


(Unaudited)





2008
            
            
            2007Cash
      Flows From Operating Activities:Net (Loss)
Income
            
            
            
            $
            (1,486,174
            )
            $
            619,469Adjustments to reconcile net
      (loss) income to net cash provided (used) by operating
      activities:Depreciation
            
            
            
            
            73,074
            
            
            65,297Accretion
      of investment discounts
            
            
            
            
            (471
            )
            
            (8,672
            )Provision for credit
      losses
            
            
            
            
            2,467,700
            
            
            -Provision
      for losses on other real estate owned
            
            
            
            
            67,181
            
            
            -Stock-based
      compensation
            
            
            
            
            23,520
            
            
            16,500Increase
      in cash surrender of  bank owned life insurance
            
            
            
            
            (55,957
            )
            
            -Deferred
      income taxes
            
            
            
            
            (977,000
            )
            
            -Gain
      on sale of loans held for sale
            
            
            
            
            (79,644
            )
            
            (135,449
            )Origination
      of loans held for sale
            
            
            
            
            (27,780,911
            )
            
            (26,902,721
            )Proceeds
      from sale of loans
            
            
            
            
            33,986,043
            
            
            21,651,823Net
      decrease (increase) in accrued interest receivable and other
      assets
            
            
            
            
            166,694
            
            
            (23,842
            )Net decrease in accrued
      expenses and other liabilities
            
            
            
            
            (180,772
            )
            
            (473,683
            )Net
      cash provided by (used in) operating activities
            
            
            
            
            6,223,283
            
            
            (5,191,278
            )Cash
      Flows From Investing Activities:Purchases of investment
      securities available for sale
            
            
            
            
            -
            
            
            (691,194
            )Maturities of investment
      securities available for sale
            
            
            
            
            400,000
            
            
            700,000Redemption
      (purchase) of Federal Home Loan Bank of AtlantaStock
            
            
            
            
            557,900
            
            
            (38,700
            )Loan
      disbursements in excess of principal payments
            
            
            
            
            (11,454,977
            )
            
            (3,696,725
            )Expenditures
      for other real estate owned
            
            
            
            
            (3,088
            )
            
            -Expenditures
      for premises and equipment
            
            
            
            
            (168,934
            )
            
            (65,518
            )Net cash used in investing
      activities
            
            
            
            
            (10,669,099
            )
            
            (3,792,137
            )Cash
      Flows From Financing Activities:Net increase (decrease) in
      deposits
            
            
            
            
            29,167,697
            
            
            (5,886,594
            )Net
      (decrease) increase in short-term borrowings
            
            
            
            
            (17,059,049
            )
            
            1,136,000Net proceeds from issuance of
      common stock
            
            
            
            
            22,740
            
            
            -Net cash provided by (used in)
      financing activities
            
            
            
            
            12,131,388
            
            
            (4,750,594
            )Net
      increase (decrease) in cash and cash equivalents
            
            
            
            
            7,685,572
            
            
            (13,734,009
            )Cash
      and cash equivalents at beginning of year
            
            
            
            
            7,173,671
            
            
            33,898,204Cash
      and cash equivalents at end of year
            
            
            
            $
            14,859,243
            
            $
            20,164,195





Supplemental
      information:Interest
      paid
            
            
            
            $
            1,920,193
            
            $
            2,180,100Income
      taxes paid
            
            
            
            $
            -
            
            $
            215,000Amount
      transferred from loans to other real estate owned
            
            
            
            $
            883,310
            
            $
            -










See
accompanying notes to consolidated financial statements.








5





BAY
NATIONAL CORPORATION





NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


For the
Three Months Ended March 31, 2008 and 2007


(Unaudited)





1.      GENERAL





Organization





Bay
National Corporation (the “Company”) was incorporated on June 3, 1999 under the
laws of the State of Maryland to operate as a bank holding company of a national
bank with the name Bay National Bank (the “Bank”). On May 12, 2000, the Company
purchased all the shares of common stock issued by the Bank. The Bank commenced
operations on May 12, 2000 after successfully meeting the conditions of the
Office of the Comptroller of the Currency (the “OCC”) to receive its charter
authorizing it to commence operations as a national bank, obtaining the approval
of the Federal Deposit Insurance Corporation to insure its deposit accounts, and
meeting certain other regulatory requirements.





Basis
of Presentation





The
accompanying consolidated financial statements include the activity of Bay
National Corporation and its wholly owned subsidiary, Bay National Bank. All
significant intercompany transactions and balances have been eliminated in
consolidation.





The
foregoing consolidated financial statements are unaudited; however, in the
opinion of management, all adjustments (comprising only normal recurring
accruals) necessary for a fair presentation of the results of the interim
periods have been included. The balances as of December 31, 2007 have been
derived from audited financial statements. These consolidated financial
statements should be read in conjunction with the financial statements and
accompanying notes included in Bay National Corporation’s 2007 Annual Report on
Form 10-K. There have been no significant changes to the Company’s accounting
policies as disclosed in the 2007 Annual Report. The results shown in this
interim report are not necessarily indicative of results to be expected for the
full year 2008 or any other interim period.





The
accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices in the banking industry.





Reclassifications





Certain reclassifications have been
made to amounts previously reported to conform to the current presentation.
These reclassifications had no effect on previously reported results of
operations or retained earnings.





2.      REGULATORY
MATTERS





The Bank
is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank’s
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weighting and other factors.






6





Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios. Management believes, as of March 31,
2008, that the Bank meets all capital adequacy requirements to which it is
subject.





As of
March 31, 2008, the Bank has been categorized as “Well Capitalized” by the OCC
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized, the Bank must maintain minimum total risk-based, Tier I
risk-based, and Tier I leverage ratios.





3.
FAIR VALUE MEASUREMENTS





Effective
January 1, 2008, the Company adopted SFAS No. 157 (SFAS 157), “Fair Value Measurements.”
SFAS 157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS 157 applies whenever other standards require (or
permit) assets or liabilities to be measured at fair value but does not expand
the use of fair value in any new circumstances. In this standard, the FASB
clarifies the principle that fair value should be based on the assumptions
market participants would use when pricing the asset or liability. In support of
this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. The fair value hierarchy is as
follows:





Level 1
inputs – Unadjusted quoted prices in active markets for identical assets or
liabilities that the entity has the ability to access at the measurement
date.





Level 2
inputs - Inputs other than quoted prices included in Level 1 that are observable
for the asset or liability, either directly or indirectly. These might include
quoted prices for similar assets and liabilities in active markets, and inputs
other than quoted prices that are observable for the asset or liability, such as
interest rates and yield curves that are observable at commonly quoted
intervals.





Level 3
inputs - Unobservable inputs for determining the fair values of assets or
liabilities that reflect an entity’s own assumptions about the assumptions that
market participants would use in pricing the assets or liabilities.





As of
March 31, 2008, the Company had no balance sheet categories that are required by
generally accepted accounting principles to be recorded at fair
value.





Loans
held for sale and loans held in the Company’s loan portfolio are valued at cost.
Any impairment of the value of these loans is reflected in the allowance for
credit losses.





Other
real estate owned (“OREO”) property is valued at the time of foreclosure and
transferred to OREO from loans. Generally, the value of OREO is based upon the
lower of cost or net realizable value as determined by third party real estate
appraisals less the cost of disposal.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115.” This Statement permits entities to choose to measure many financial
instruments and certain other items at fair value. Unrealized gains and losses
on items for which the fair value option has been elected will be reported in
earnings. The objective is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. This Statement is expected to expand the
use of fair value measurement, which is consistent with the FASB’s long-term
measurement objectives for accounting for financial instruments.  SFAS No.
159 is effective for fiscal years beginning after November 15, 2007. The Company
has not elected the fair value option for any financial assets or liabilities at
March 31, 2008.







7


4.      INCOME
TAXES





The
Company employs the liability method of accounting for income taxes as required
by Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for
Income Taxes.” Under the liability method, deferred-tax assets and liabilities
are determined based on differences between the financial statement carrying
amounts and the tax basis of existing assets and liabilities (i.e., temporary
differences) and are measured at the enacted rates that will be in effect when
these differences reverse.  The Company adopted the provisions of FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” in the
first quarter of 2007.  The Company utilizes statutory requirements
for its income tax accounting and avoids risks associated with potentially
problematic tax positions that may incur challenge upon audit, where an adverse
outcome is more likely than not.  Therefore, no provisions are made
for either uncertain tax positions nor accompanying potential tax penalties and
interest for underpayments of income taxes in the Company’s tax
reserves.





5.      EARNINGS
PER SHARE





Earnings per common share are
computed by dividing net income by the weighted average number of common shares
outstanding during the period. Diluted earnings per common share is computed by
dividing net income by the weighted average number of common shares outstanding
during the period, including any potential dilutive common shares outstanding,
such as options. The Company’s common stock options were not considered in the
computation of diluted earnings per share for the three months ended March 31,
2008 because the result would have been anti-dilutive.  There were no
shares or options as of March 31, 2007 excluded from the diluted net income per
share computation because their inclusion would be anti-dilutive.  All
shares and per share data have been adjusted to reflect the 1.1 stock split in
the form of a dividend recorded on June 29, 2007.





6.    STOCK-BASED
COMPENSATION





Effective
January 1, 2006, the Company adopted SFAS No. 123(R), Share-based Payment,and has
included the stock-based employee compensation cost in its income statements for
the three-month periods ended March 31, 2008 and 2007. Amounts recognized in
the financial statements with respect to stock-based compensation are as
follows:





Three
      Months Ended
              March
      312008
            
            
            2007Amounts
      charged against income, before tax
              benefit
            
            
            
            
            
            
            $
            23,520
            
            $
            16,500Amount
      of related income tax benefit recognized in income
            
            
            
            
            
            
            $
            8,123
            
            $
            5,610





The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants during the year ended December 31,
2002:





Dividend
      yield
            
            
            
            
            -Expected
      volatility
            
            
            
            
            20.00
            %Risk-free
      interest rate
            
            
            
            
            4.17
            %Expected
      lives (in years)
            
            
            
            
            8







8


No stock
options have been issued since 2002.





The Bay
National Corporation 2007 Stock Incentive Plan (the “Incentive Plan”) was
established effective May 22, 2007 and provides for the granting of incentive
stock options intended to comply with the requirements of Section 422 of the
Internal Revenue Code (“incentive stock options”), non-qualified stock options,
stock appreciation rights (“SARs”), restricted or unrestricted stock awards,
awards of phantom stock, performance awards, other stock-based awards, or any
combination of the foregoing (collectively “Awards”).  Awards will be
available for grant to officers, employees and directors of the Company and its
affiliates, including the Bank, except that non-employee directors will not be
eligible to receive awards of incentive stock options.




The
Incentive Plan authorizes the issuance of up to 200,000 shares of common stock
plus any shares that were available under the Company’s 2001 Stock Option Plan
(“Option Plan”) that terminated as of May 22, 2007 and shares subject to options
granted under the Option Plan that expire or terminate without having been fully
exercised.  The Incentive Plan has a term of ten years and is
administered by the Compensation Committee of the Board of Directors. The
Compensation Committee consists of at least three non-employee directors
appointed by the Board of Directors. In general, the options have an exercise
price equal to 100% of the fair market value of the common stock on the date of
the grant.  As of March 31, 2008, twelve Awards had been granted under
the Incentive Plan.  Five of these Awards included an unrestricted
stock grant of 550 shares to five employees in August 2007 based on their 2006
performance.  The Awards vested immediately upon issuance and the
closing stock price on the grant date was $15.46.  The remaining seven
Awards represent restricted stock awards and are discussed in more detail below
in the section entitled “Restricted Stock Units.”





The
unrecognized compensation cost related to unvested stock option awards was
$12,716 for the quarter ended March 31, 2008 based upon a weighted average fair
value of $2.75.





The
following is a summary of changes in outstanding options for the three-month
periods ended March 31, 2008 and 2007 (amounts previously reported have been
adjusted to reflect a 1.1 to 1 stock split in the form of a dividend recorded on
June 29, 2007):





Number
      of Shares
            
            Weighted
      Average Exercise PriceBalance,
      January 1, 2007
            
            141,446
            
            $        6.98Granted
            
            -
            
            -Cancelled
            
            -
            
            -Exercised
            
            -
            
            -Balance,
      March 31, 2007
            
            141,446
            
            $        6.98Balance,
      January 1, 2008
            
            138,741
            
            $        6.99Granted
            
            -
            
            -Cancelled
            
            -
            
            -Exercised
            
            (3,300
            )
            $        6.89Balance,
      March 31, 2008
            
            135,441
            
            $        6.99Weighted
      average fair value of options
              granted
      during 2002
            $
            2.75







9





The
following table summarizes information about options outstanding at March 31,
2008:





Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Price
            
            Number
            
            Weighted
              Average
              Remaining
              Contractual
      Life
              (in
      years)
            
            Weighted
      Average Exercise Price
            
            
            Number
            
            Weighted
      Average Exercise Price$6.89
            
            116,945
            
            1
            
            $6.89
            
            
            116,945
            
            $6.89$7.61
            
            18,496
            
            2
            
            $7.61
            
            
            13,872
            
            $7.61135,441
            
            
            
            $6.99
            
            
            130,817
            
            $6.97





The
aggregate intrinsic value of options outstanding and exercisable as of March 31,
2008 was $211,388 and $207,037, respectively, based upon a closing price of
$8.55 per share.





Restricted Stock
Units





The
following table summarizes the changes in outstanding shares under restricted
stock grants for the three-month periods ended March 31, 2008 and
2007.  Amounts have been adjusted to reflect a 1.1 to one stock split
in the form of a dividend recorded on June 29, 2007.





Number
      of Shares
            
            Weighted
      Value at Issuance DateUnvested
      grants at January 1, 2008
            
            24,000
            $
            15.91Granted
            
            7,500
            
            10.25Vested
            
            -
            
            -Cancelled
            
            -
            
            -Unvested
      grants at March 31, 2008
            
            31,500
            $
            14.56Unvested
      grants at January 1, 2007
            
            13,200
            $
            17.23Granted
            
            -
            
            -Vested
            
            -
            
            -Cancelled
            
            -
            
            ­-Unvested
      grants at March 31, 2007
            
            13,200
            $
            17.23




During the three-month period ending
March 31, 2008, a total of 7,500 shares of the Company’s common stock had been
awarded to three employees.  These awards vest 20% on each anniversary
of the employee’s hiring date over 5 years.





The
Company incurred compensation expense of $23,520 associated with restricted
stock for the three-month period ending March 31, 2008.






10




Item
2.                      Management's
Discussion and Analysis of Financial Condition and Results of
Operations





This
discussion and analysis provides an overview of the financial condition and
results of operations of Bay National Corporation (the “Parent”) and its
national bank subsidiary, Bay National Bank (the “Bank”), collectively (the
“Company”), as of March 31, 2008 and December 31, 2007 and for the three-month
periods ended March 31, 2008 and 2007.





Overview





The
Parent was incorporated on June 3, 1999 under the laws of the State of Maryland
to operate as a bank holding company of the Bank. The Bank commenced operations
on May 12, 2000.





The
principal business of the Company is to make loans and other investments and to
accept time and demand deposits. The Company’s primary market areas are in the
Baltimore Metropolitan area, Baltimore-Washington corridor and on Maryland’s
Eastern Shore, although the Company’s business development efforts generate
business outside of these areas. The Company offers a broad range of banking
products, including a full line of business and personal savings and checking
accounts, money market demand accounts, certificates of deposit, and other
banking services. The Company funds a variety of loan types including commercial
and residential real estate loans, commercial term loans and lines of credit,
consumer loans, and letters of credit with an emphasis on meeting the borrowing
needs of small businesses. The Company’s target customers are small and
mid-sized businesses, business owners, professionals and high net worth
individuals.





The
Company experienced a significant operating loss during the quarter ended March
31, 2008 resulting from difficulties in its portfolio of investor owned
residential real estate loans. Asset growth was strong, lead by growth in the
commercial loan portfolio. Key measurements for the three-month period ended
March 31, 2008 include the following:





·
            Total
      assets at March 31, 2008 increased to $267.0 million from $256.5 million
      as of December 31, 2007.





·
            Net
      loans outstanding increased from $236.0 million as of December 31, 2007 to
      $237.9 million as of March 31,
2008.





·
            There
      was approximately $10.5 million in non-accrual loans as of March 31,
      2008.  In addition, the Company foreclosed on five pieces of
      residential real estate related to investor-owned residential real estate
      during the quarter. These properties were placed into other real estate
      owned at estimated net realizable value of approximately
      $883,310.  There were no other non-performing assets as of March
      31, 2008. There was one loan, of approximately $37,000, that was
      considered a nonperforming loan as of March 31, 2007.  The
      Company continues to maintain appropriate reserves for credit
      losses.





·
            Deposits
      at March 31, 2008 increased to $231.1 million from $202.0 million as of
      December 31, 2007.





·
            The
      net loss for the period ended March 31, 2008 was $1.5 million, compared to
      net income of $619,469 for the same period in
  2007.







11





·
            Net
      interest income, the Company’s main source of income, was $2.5 million
      during the three-month period ended March 31, 2008, compared to $3.1
      million for the same period in
2007.





·
            The
      Company added $2.5 million to the allowance for credit losses in order to
      replenish the allowance for first quarter 2008 net charge-offs totaling
      $767,700 and provide $1.7 million of additional reserves against the
      portfolio of residential real estate construction and reconstruction
      loans. The charge-offs were primarily a result of weaknesses in the
      Company’s portfolio of residential construction and reconstruction loans
      arising from problems in the housing market in the Company’s target
      markets. There were no charge-offs for the three-month period ended March
      31, 2007.





·
            Non-interest
      income increased by $16,125, or 8.4%, for the three-month period ended
      March 31, 2008, as compared to the same period in
  2007.





·
            Non-interest
      expenses increased by $387,232, or 16.9%, for the three-month period ended
      March 31, 2008, as compared to the same period in
  2007.





·
            The
      Company’s common stock closed at $8.55 on March 31, 2008, which
      represented a 49.8% decline from its closing price of $17.04 on March 31,
      2007.





·
            During
      the quarter, the Company added four seasoned commercial bankers in its
      effort to capitalize on the disruption created by bank mergers in the
      metropolitan Baltimore market.





A
detailed discussion of the factors leading to these changes can be found in the
discussion below.





Results
of Operations





General





The
Company recorded a net loss of $1.5 million for the three-month period ended
March 31, 2008. This compares to net income of $619,469 for the same period in
2007. This is a decrease of $2.1 million, or 339.9% for the three-month period.
The decrease in year-over-year results is due primarily to a $2.5 million
provision for credit losses recorded against the Bank’s portfolio of residential
construction and reconstruction loans due to charge-offs of $767,700 and
management’s decision to record an additional $1.7 million provision. In
addition, there was an increase in non-interest expenses related to the
expansion of the Bank’s commercial business development staff which commenced in
the third quarter of 2007, and a declining rate environment and increased
non-accrual loans have combined to create pressure on the Bank’s interest
margins.





The
Bank’s mortgage origination operations, located in Towson and Salisbury,
Maryland, originate conventional first and second lien residential mortgage
loans. The Bank sells most of its first and second lien residential mortgage
loans in the secondary market and typically recognizes a gain on the sale of
these loans after the payment of commissions to the loan origination officer.
For the three-month periods ended March 31, 2008 and 2007, net gains on the sale
of mortgage loans totaled $79,644 and $135,449, respectively.






12





Gains on
the sale of mortgage loans have decreased for the three-month period ended March
31, 2008 as compared to the same period in 2007 due to a slowdown in the real
estate market in the Company’s markets.





During
the second quarter of 2004, the Company began purchasing 100% participations in
mortgage loans originated by a mortgage company in the Baltimore metropolitan
area. These participations are for loans which a secondary market investor has
committed to purchase. The participations are typically held for a period of
three to four weeks before being sold to the secondary market investor. This
holding period represents the amount of time taken by the secondary market
investor to review the loan files for completeness and accuracy. During this
holding period, the Company earns interest on these loans at a rate indexed to
the prime rate.





As of
March 31, 2008, the Company held $1.7 million of these loans which were
classified as held for sale. The Company earned $47,618 of interest on this
program for the three-month period ended March 31, 2008. This compares to
$59,335 for the same period in 2007. The decrease in interest from this program
is due to a decrease in the prime rate of interest in effect for the period
ended March 31, 2008.





Management
expects the remainder of 2008 to continue to be challenging for earnings and
asset growth as a result of the slowing economy, the weakness in the residential
real estate market and the Company’s decision to continue to invest in personnel
to support its long-term growth.  Actual results will be subject to
the volatility of the provision for credit losses, which is related to loan
growth, the volatility of volume in the mortgage participations purchasing
program, the volatility of mortgage loan production, which is sensitive to
economic and interest rate fluctuations and other competitive pressures that
arise in a slowing economy.





Net
Interest Income





Net
interest income is the difference between income on earning assets and the cost
of funds supporting those assets. Earning assets are composed primarily of
loans, investments, and federal funds sold. Interest-bearing deposits, other
short-term borrowings and subordinated debt make up the cost of funds.
Non-interest bearing deposits and capital are also funding sources. Changes in
the volume and mix of earning assets and funding sources along with changes in
associated interest rates determine changes in net interest income.





As
previously stated, net interest income was $2.5 million for the three-month
period ended March 31, 2008 as compared to $3.1 million for the same period in
2007. This represents a decrease of 20.9% for the three-month period ended March
31, 2008, as compared to the same period in 2007.





Interest
income from loans and investments for the three-month period ended March 31,
2008 was $4.4 million, compared to $5.3 million for the same period ended March
31, 2007.  The 18.2% decrease for the three-month period over the same
period in 2007 was primarily attributed to lost interest from $10.5 million of
non-accrual loans and the decline in residential construction loan
originations.   In addition, the target federal funds rate
decreased from 5.25% as of March 31, 2007 to 2.25% effective March 18,
2008.  The yields on interest earning assets decreased from 8.77% for
the three months ended March 31, 2007 to 6.98% for the three months ended March
31, 2008.





The
percentage of average interest-earning assets represented by loans was 94.8% and
90.0% for the three-month periods ended March 31, 2008 and 2007, respectively.
The high percentage of loans to earning assets is consistent with management’s
strategy to maximize net interest income by maintaining a higher concentration
of loans, which typically earn higher yields than investment securities. For the
three-month period ended March 31, 2008, the average yield on the loan portfolio
decreased to 7.27% from 9.28% for the three-month period ended March 31,
2007.






13





The
average yield on the investment portfolio and other earning assets, such as
federal funds sold, was 1.75% for the three-month period ended March 31, 2008 as
compared to 4.25% for the same period in 2007. This decline in the average yield
was a direct result of a decrease in the rates paid on these investments for the
majority of the 2008 period.  The percentage of average
interest-earning assets represented by investments was 5.2% and 10.0% for the
three-month periods ended March 31, 2008 and 2007, respectively.





Interest
expense from deposits and borrowings for the three-month period ended March 31,
2008 was $1.9 million compared to $2.2 million for the same period in 2007. The
14.4% decrease for the three-month period is the result of the previously
discussed reduction in the target federal funds rate as well as reduction in the
mix of deposits held in the form of Certificates of Deposit (“CDs”). CDs are the
Bank’s most expensive form of deposits. As of March 31, 2008, these deposits
comprised 52.2% of average interest-bearing liabilities compared to 57.5% of
average interest-bearing liabilities as of March 31, 2007. Average rates paid on
all interest-bearing liabilities decreased from 4.54% for the three-month period
ended March 31, 2007 to 3.73% for the three-month period ended March 31,
2008.





As a
result of the factors discussed above, net interest margins decreased to 3.97%
for the three-month period ended March 31, 2008 from 5.16% for the same period
in 2007. Although management has been able to implement deposit rate decreases,
the yield on loans and investments decreased at a higher rate than the cost of
funds. Management has observed ongoing pressure to offer lower rates on loans as
the market for loans has become more competitive.  In addition, the
market is very competitive for deposits, which, as is typical, has limited
management’s ability to maintain margins through reductions in the interest
rates on deposit accounts.






14




The
following tables set forth, for the periods indicated, information regarding the
average balances of interest-earning assets and interest-bearing liabilities,
the amount of interest income and interest expense and the resulting yields on
average interest-earning assets and rates paid on average interest-bearing
liabilities. Average balances are also provided for non-interest-earning assets
and non-interest-bearing liabilities.





No tax
equivalent adjustments were made and no income was exempt from federal income
taxes. All average balances are daily average balances. The amortization of loan
fees is included in computing interest income; however, such fees are not
material.





Three Months Ended
      March 31, 2008Average
              Balance
            
            
            Interestand fees
            
            
            Yield/
              RateASSETSLoans
      and loans held for sale
            
            $
            238,645,097
            
            $
            4,311,466
            
            
            7.27
            %Investment
      securities
            
            
            1,423,112
            
            
            11,988
            
            
            3.39Federal
      funds sold and other overnight investments
            
            
            11,779,081
            
            
            45,391
            
            
            1.55Total
      earning assets
            
            
            251,847,290
            
            
            4,368,845
            
            
            6.98
            %Less:
      Allowance for credit losses
            
            
            (5,015,269
            )Cash
      and due from banks
            
            
            728,732Other
      real estate owned
            
            
            959,659Premises
      and equipment, net
            
            
            1,230,823Investment
      in bank owned life insurance
            
            
            5,060,880Accrued
      interest receivable and other assets
            
            
            3,529,583Total
      assets
            
            $
            258,341,698LIABILITIES
      AND STOCKHOLDERS’ EQUITYInterest-bearing
      demand deposits
            
            $
            72,426,639
            
            
            441,993
            
            
            2.45
            %Regular
      savings deposits
            
            
            1,905,918
            
            
            2,220
            
            
            .47Time
      deposits
            
            
            105,959,645
            
            
            1,173,980
            
            
            4.46Short-term
      borrowings
            
            
            14,539,853
            
            
            114,365
            
            
            3.16Subordinated
      debt
            
            
            8,000,000
            
            
            149,991
            
            
            7.54Total
      interest-bearing liabilities
            
            
            202,832,055
            
            
            1,882,549
            
            
            3.73
            %Net
      interest income and spread
            
            
            
            
            $
            2,486,296
            
            
            3.25
            %Non-interest-bearing
      demand deposits
            
            
            34,527,128Accrued
      expenses and other liabilities
            
            
            916,788Stockholders’
      equity
            
            
            20,065,727Total
      liabilities and stockholders’ equity
            
            $
            258,341,698Interest
      and fee income/earning assets
            
            
            6.98
            %Interest
      expense/earning assets
            
            
            3.01Net
      interest margin
            
            
            3.97
            %Return
      on Average Assets (Annualized)
            
            
            (2.31)
            %Return
      on Average Equity (Annualized)
            
            
            (29.79)
            %Average
      Equity to Average Assets
            
            
            7.77
            %














15







Three Months Ended
      March 31, 2007Average
              Balance
            
            
            Interestand fees
            
            
            Yield/
              RateASSETSLoans
      and loans held for sale
            
            $
            222,318,445
            
            $
            5,084,808
            
            
            9.28
            %Investment
      securities
            
            
            1,813,643
            
            
            16,120
            
            
            3.60Federal
      funds sold and other overnight investments
            
            
            22,834,795
            
            
            242,286
            
            
            4.30Total
      earning assets
            
            
            246,966,883
            
            
            5,343,214
            
            
            8.77
            %Less:
      Allowance for credit losses
            
            
            (3,184,310
            )Cash
      and due from banks
            
            
            2,154,643Premises
      and equipment, net
            
            
            1,112,504Accrued
      interest receivable and other assets
            
            
            2,774,005Total
      assets
            
            $
            249,823,725LIABILITIES
      AND STOCKHOLDERS’ EQUITYInterest-bearing
      demand deposits
            
            $
            67,345,355
            
            
            588,386
            
            
            3.54
            %Regular
      savings deposits
            
            
            6,191,421
            
            
            33,456
            
            
            2.19Time
      deposits
            
            
            112,854,354
            
            
            1,407,605
            
            
            5.06Short-term
      borrowings
            
            
            1,935,300
            
            
            21,181
            
            
            4.44Subordinated
      debt
            
            
            8,000,000
            
            
            148,454
            
            
            7.53Total
      interest-bearing liabilities
            
            
            196,326,430
            
            
            2,199,082
            
            
            4.54
            %Net
      interest income and spread
            
            
            
            
            $
            3,144,132
            
            
            4.23
            %Non-interest-bearing
      demand deposits
            
            
            32,355,446Accrued
      expenses and other liabilities
            
            
            1,822,967Stockholders’
      equity
            
            
            19,318,882Total
      liabilities and stockholders’ equity
            
            $
            249,823,725Interest
      and fee income/earning assets
            
            
            8.77
            %Interest
      expense/earning assets
            
            
            3.61Net
      interest margin
            
            
            5.16
            %Return
      on Average Assets (Annualized)
            
            
            1.01
            %Return
      on Average Equity (Annualized)
            
            
            13.00
            %Average
      Equity to Average Assets
            
            
            7.73
            %





Provision
for Credit Losses





There was
a $2.5 million provisionfor
credit losses for the three-month period ended March 31, 2008. There was no
provision required for the same period in 2007. The provision for credit losses
is reflective of the ongoing decline in the residential real estate market
resulting in difficulty on the part of borrowers to refinance or sell
residential real estate. For additional information regarding the methodology
used to determine the provision for credit losses, see the Management Discussion
and Analysis section entitled “Allowance for Credit Losses and Credit Risk
Management.”





Non-Interest
Income





Non-interest
income consists primarily of gains on the sale of mortgage loans, deposit
account service charges, income on bank owned life insurance and cash management
fees. For the three-month period ended March 31, 2008, the Company realized
non-interest income of $208,353 as compared to $192,228 for the same period in
2007. Gains on the sale of mortgage loans of $79,644 comprised 38.2% of the
total for the three-month period ended March 31, 2008. This compares to gains on
the sale of mortgage loans of $135,449, or 70.5%, of total non-interest income
for the three-month period ended March 31, 2007.





16


The level
of gains on the sale of mortgage loans decreased for the three-month period
ended March 31, 2008 due to a general decrease in home purchase and refinance
activity in the Company’s markets.





Service
charges on deposit accounts totaled $56,251 for the three-month period ended
March 31, 2008 as compared to $36,941 for the same period in 2007. The increase
of 52.3% is attributable to an increase in overdraft fees charged on transaction
accounts as well as an increase in analysis fees charged on business checking
accounts. Although overdraft fees increased, the Company continues to maintain a
very low level of average overdrafts. Analysis fees have increased as a result
of the previously discussed Federal Reserve actions, which reduced the rates
used to calculate credits available to customers to offset any analysis fees
they incurred.





Other
income totaled $72,458 for the three-month period ended March 31, 2008, as
compared to $19,838 for the same period in 2007. The increase of 265.2% is
attributable to the Company’s investment in bank owned life insurance (“BOLI”),
which was purchased during the fourth quarter of 2007.  The initial
investment totaled $5.0 million and the Company recognized income of $55,957
related to increases in this investment during the three months ended March 31,
2008.





The
Company will continue to seek ways to expand its sources of non-interest income.
In the future, the Company may enter into fee arrangements with strategic
partners that offer investment advisory, risk management and employee benefit
services. No assurance can be given that such fee arrangements will be obtained
or maintained.





Non-Interest
Expense





Non-interest
expense for the three-month period ended March 31, 2008 totaled $2.7 million.
This compares to non-interest expense for the comparable period in 2007 of $2.3
million. The increase of $387,232, or 16.9%, is spread across almost all expense
categories and resulted from the growth of the business development staff as
well as the costs associated with managing the portfolio of investor owned
residential real estate loans.





The
increases in salaries and benefits of $61,768 for the three-month period related
to staffing growth, including the expansion into the Baltimore-Washington
Corridor with the January 2008 opening of an office in Columbia staffed with
seven experienced commercial relationship managers, a cash management specialist
and a commercial account manager. In addition, an experienced commercial
relationship manager was added in the Lutherville office and additional account
managers were hired to manage the anticipated growth in business from these
offices. These additions were made to continue to expand the Bank’s market
presence, as well as to manage the growth of the loan and deposit portfolios and
support increased operational volume. The cost of this additional staffing was
somewhat offset by a reduction in commissions paid due to a significant decline
in the origination of residential construction and reconstruction loans. The
Company’s strategy to continue to pursue additional markets may have a
short-term impact on operating results.





Occupancy
expenses increased by $29,497 for the three months ended March 31, 2008 as
compared to the same period in 2007. The 18.8% increase for the period was due
to scheduled rent increases and the acquisition of new space obtained in
December 2007 for the Company’s Baltimore-Washington Corridor office located in
Columbia, Maryland.







17


Legal and
professional fees increased $101,332, or 158.7%, for the three months ended
March 31, 2008 as compared to the same period in 2007. The increase was related
to legal fees and other costs incurred to manage the collection and foreclosure
process on loans in the Company’s residential real estate
portfolio.





Data
processing and other outside services expense increased $66,944, or 35.9%, for
the three months ended March 31, 2008 as compared to the same period in 2007.
The increase for the period is due to the cost of implementing and supporting a
computer infrastructure at an additional location, the costs associated with
implementation and expansion of the Company’s remote deposit capture product, an
increase in outsourced data and item processing costs that are a function of the
growth of the Bank, recruiting expenses associated with hiring new staff and an
increased use of outsourced administrative services to accommodate the growth of
the Company in lieu of adding additional administrative staff.





Advertising
and marketing-related expenses increased $23,294, or 18.5%, for the three months
ended March 31, 2008 as compared to the same period in 2007. The increase is a
result of the expansion of the business development staff and the opening of the
office in the Baltimore-Washington Corridor.





The
$104,397, or 39.5%, increase in all other non-interest expense items for the
three-month period ended March 31, 2008 related to a $67,181 reduction in the
value of two properties in other real estate owned as well as increases in other
various costs associated with the increased size and complexity of the
Company.





The
banking industry utilizes an “efficiency ratio” as a key measure of expense
management and overall operating efficiency. This ratio is computed by dividing
non-interest expense by the sum of net interest income, before the loan loss
provision, and non-interest income. The Company’s efficiency ratio was 99.5% for
the three-month period ended March 31, 2008. This compares to 68.8% for the same
period in 2007. The increase in the efficiency ratio from the prior year is a
result of the previously discussed decline in revenue as well as management’s
decision to continue to invest in personnel to support the long-term growth of
the Company.





Management
will continue to focus on leveraging its cost structure to generate profitable
growth.The Company
will continue to seek opportunities to capitalize on market disruption created
by the continued fallout from the consolidations of regional and national banks,
most notably, the recent merger of one of the last independent Baltimore-based
banks, Mercantile-Safe Deposit and Trust with Pittsburgh-based PNC. The Company
will continue to pursue experienced commercial bankers in order to expand its
footprint in thriving markets. This strategy may have a short-term impact on
operating results; however, management and the Board of Directors believe it is
in the best long-term interests of the Company and its
shareholders.





Income
Taxes





For the
three-month period ended March 31, 2008, the Company recorded an income tax
benefit of $969,000. This compares to income tax expense of $422,000 recorded
for the same period in 2007.  The change is a direct result of the
significant decline in taxable income between the periods.





18




Financial
Condition





Composition
of the Balance Sheet





As of
March 31, 2008, total assets were $267.0 million. This represents an increase of
$10.5 million, or 4.1%, since December 31, 2007. The change in total assets
includes increases of $9.5 million in Federal funds sold and other overnight
investments, $2.0 million in loans net of the allowance for credit losses,
$819,217 in other real estate owned, $55,957 in bank owned life insurance and
approximately $906,166 in other non-earning assets. These increases were offset
by decreases of $1.8 million in cash and due from banks, $399,529 in investment
securities available for sale and $557,900 in other equity
securities.





Under a
program introduced during the second quarter of 2004, the Company purchases a
100% participation in mortgage loans originated by a mortgage company in the
Baltimore metropolitan area. These participations are for loans that a secondary
market investor has committed to purchase. The participations are typically held
for a period of three to four weeks before being sold to the secondary market
investor, during which time the secondary market investor reviews the files for
completeness and accuracy. The Company earns interest on these loans at a rate
indexed to the prime rate. The primary risk of this program is that the
secondary market investor may decline to purchase the loans due to documentary
deficiencies or errors. The Company attempts to manage this risk by conducting a
thorough review of the documentation prior to purchasing the participation. If
the secondary market investor declines to purchase the loan, the Company could
attempt to sell the loan to other investors or hold the loan in its loan
portfolio.





As of
March 31, 2008, the Company held $1.7 million of these loans which were
classified as held for sale. There were $8.2 million of loans outstanding under
this program as of December 31, 2007. This fluctuation in balances is indicative
of the cyclical nature of mortgage lending and the mortgage company’s ability to
use other funding sources as its volume fluctuates. This decrease was somewhat
offset by strong mortgage production by the Company’s Salisbury mortgage
operation in March 2008.  As of May 13, 2008, the Company sold $4.5
million of loans classified as held for sale that were outstanding as of March
31, 2008.  One loan of approximately $972,000 could not be sold and is
likely to be transferred to the Company’s portfolio.  This loan is
past due as of May 13, 2008 and the Bank is pursuing restructuring or
foreclosure. Management believes that it has established an adequate allowance
for credit loss against this loan.





As of
March 31, 2008, loans, excluding loans held for sale, totaled $239.2 million.
This represents an increase of $9.8 million, or 4.3%, from a balance of
$229.4 million as of December 31, 2007. Loan growth was particularly strong in
the Company’s Lutherville office and its newly opened Baltimore-Washington
Corridor office. This growth resulted from the addition of experienced
Commercial Relationship Managers that were well positioned to take advantage of
market disruptions caused by turnover in the lending staffs of two institutions
in the Company’s markets.





The
composition of the loan portfolio as of March 31, 2008 was approximately $113.0
million of commercial loans, $2.7 million of consumer loans, and $123.5 million
of real estate loans (excluding mortgage loans held for sale). The composition
of the loan portfolio as of December 31, 2007 was approximately $102.7 million
of commercial loans, $4.1 million of consumer loans, and $122.6 million of real
estate loans (excluding mortgage loans held for sale). Mortgage loans held for
sale were $5.5 million and $11.6 million as of March 31, 2008 and December 31,
2007, respectively.






19




The
Company has experienced ongoing weakness in its portfolio of residential
construction and reconstruction loans. The total portfolio as of March 31, 2008
was approximately $50.8 million of which $10.5 million was classified as
non-accrual and an additional $10.0 million was 30 days or more past due.
Management is proactively and aggressively addressing the problems in this
portfolio by reviewing the specific credits more frequently, consulting with
legal counsel when necessary, working with borrowers for potential restructure
or working with potential investors to facilitate the sale of the property. In
addition, the Company has significantly tightened underwriting standards for
these types of loans and is currently originating very little of this
business.  Resolving these issues will take time as the residential
real estate market works through its downturn and housing inventories return to
normal levels; therefore, there can be no assurance that management’s actions
will result in decreases in the rate of non-accrual and past due
loans.





During
the three-month period ending March 31, 2008, the Company foreclosed on five
pieces of residential real estate related to investor owned residential real
estate. These properties were placed into other real estate owned at estimated
net realizable value of approximately $883,310. The difference between the
related loan balances totaling approximately $1.6 million and the net realizable
value was charged off to the allowance for credit losses during the period.
These foreclosures combined with additional write-downs and reserves of $67,181
on properties already held in other real estate owned brought the total other
real estate owned to approximately $1.8 million as of March 31,
2008.





Funds not
extended in loans are invested in cash and due from banks and various
investments including federal funds sold and other overnight investments, U.S.
Treasury securities, Federal Reserve Bank stock, Federal Home Loan Bank stock
and bank owned life insurance. These investments totaled approximately $21.1
million as of March 31, 2008 compared to approximately $14.3 million as of
December 31, 2007.





At March
31, 2008, the Company had cash and due from banks of $485,226 as compared to
$2.3 million as of December 31, 2007. Management attempts to limit the amount of
these funds since they are non-interest bearing. As of March 31, 2008, the
Company had federal funds sold and other overnight investments totaling $14.4
million as compared to $4.9 million as of December 31, 2007. The increase is a
result of management’s decision to gather relatively low cost funds in the
national market for CDs in order to fund current and anticipated loan growth as
well as pay down short-term borrowings. The Company held $607,300 of Federal
Reserve Bank stock as of both March 31, 2008 and December 31, 2007. The Company
also held Federal Home Loan Bank of Atlanta (“FHLB”) stock of $549,800 and
$1,107,700 as of March 31, 2008 and December 31, 2007, respectively. The
decrease in FHLB stock is a result of reduced borrowings under FHLB lines of
credit which require the purchase of stock equivalent to 4.5% of outstanding
borrowings. As of December 31, 2007, the Company held U.S. Treasury bills with a
maturity value of $400,000, none of which was held as of March 31,
2008.





Deposits
at March 31, 2008 were $231.1 million of which approximately $6.9 million, or
3.0%, was related to one customer. Deposits at December 31, 2007 were $202.0
million of which deposits for the same customer stood at approximately $6.2
million, or 3.1%, of total deposits. The deposits for this customer tend to
fluctuate significantly; as a result, management monitors these deposits on a
daily basis to ensure that liquidity levels are adequate to compensate for these
fluctuations.  The increase in total deposits from December 31, 2007
was related to replenishment of core deposits that were drawn down in the fourth
quarter of 2007 as well as the previously discussed effort to gather reasonably
priced national market CDs to fund current and anticipated loan growth as well
as pay down short-term borrowings. National market certificates of deposit are
discussed in more detail below.






20





In the
first quarter of 2006, the Company began using brokered certificates of deposit
through the Promontory Financial Network. Through this deposit matching network
and its certificate of deposit account registry service (CDARS), the Company has
the ability to offer its customers access to FDIC-insured deposit products in
aggregate amounts exceeding current insurance limits. When the Company places
funds through CDARS on behalf of a customer, it receives matching deposits
through the network. The Company also has the ability to raise deposits directly
through the network.  These deposits are also considered “Brokered
Deposits” for bank regulatory purposes. As of March 31, 2008, the Company had
approximately $2.3 million of CDARS deposits outstanding of which $2.1 million
were placed on behalf of customers and $228,781 was raised by the Company. As of
December 31, 2007, the Company had approximately $27.0 million of CDARS deposits
outstanding of which $1.0 million were placed on behalf of customers and $26.0
million were raised by the Company. The decrease in CDARS deposits from December
31, 2007 reflects management’s decision to payoff short-term funding sources and
use the national market for CDs to extend the terms on time deposits at
favorable rates.





The
market in which the Company operates is very competitive; therefore, the rates
of interest paid on deposits are affected by rates paid by other depository
institutions. Management closely monitors rates offered by other institutions
and seeks to be competitive within the market. The Company has chosen to
selectively compete for large certificates of deposit. The Company will choose
to pursue such deposits when expected loan growth provides for adequate spreads
to support the cost of those funds or when the cost of funds for these deposits
is determined to be low enough to lock in for longer term funding needs. As of
March 31, 2008, the Company had outstanding certificates of deposit of
approximately $50.7 million that were obtained through the listing of
certificate of deposit rates on two Internet-based listing services (such
deposits are sometimes referred to herein as national market certificates of
deposit). The national market certificates of deposit were issued with an
average yield of 3.59% and an average term of 17 months. Included in the $50.7
million are national market certificates of deposit totaling approximately $30.4
million that have been classified as “Brokered Deposits” for bank regulatory
purposes. These “Brokered Deposits” were issued with an average yield of 3.4%
and an average term of 13 months.  As of December 31, 2007, the total
certificates of deposit obtained through the listing of certificate of deposit
rates on the Internet-based listing services were approximately $4.6 million.
Included in the $4.6 million were national market certificates of deposit
totaling $199,000 that had been classified as “Brokered Deposits” for bank
regulatory purposes.





Core
deposits, which management categorizes as all deposits other than national
market certificates of deposit, CDARS deposits and $3.0 million of the $6.9
million of deposits from the large customer described above, stood at $176.4
million as of March 31, 2008. The $10.3 million, or 6.2%, increase from the
total as of December 31, 2007 of $166.1 million represented a return to more
normal levels after unusual liquidity draw downs by customers during the fourth
quarter of 2007. The Company successfully competed for new deposits during the
period ended March 31, 2008 and restored liquidity in order to pay down
short-term borrowings and fund loan growth. Core deposits are closely monitored
by management because they consider such deposits not only a relatively stable
source of funding but also reflective of the growth of commercial and consumer
depository relationships.





As of
March 31, 2008, short-term borrowings consisted of $8.3 million borrowed under
an Overnight Commercial Paper program. Borrowings under the Overnight Commercial
Paper are unsecured and are subordinated to all deposits. While these amounts
are not classified as deposits, they do represent customer relationships with
commercial enterprises.





Included
in short-term borrowings as of December 31, 2007 is $7.3 million of borrowings
under the previously-mentioned Overnight Commercial Paper program and $3.6
million borrowed under Federal Funds lines of credit. These borrowings are
unsecured and are subordinated to all deposits. In addition, the Company
borrowed $14.4 million under its secured FHLB credit facility.







21


Subordinated
debt consists of $8 million of fixed interest rate trust preferred securities
issued through a Delaware trust subsidiary, Bay National Capital Trust I (the
“Trust”). The Company formed the Trust on December 12, 2005, and the Trust
issued $8 million of trust preferred securities to investors at a fixed interest
rate of 7.20%. The trust preferred securities bear a maturity date of February
23, 2036, but may be redeemed at the Company’s option on any February 23, May
23, August 23 or November 23 on or after February 23, 2011, and require
quarterly distributions by the trust to the holder of the trust preferred
securities. The securities are subordinated to the prior payment of any other
indebtedness of the Company that, by its terms, is not similarly subordinated
securities. The trust preferred securities qualify as Tier 1 capital, subject to
regulatory guidelines that limit the amount included to an aggregate of 25% of
Tier 1 capital.





Allowance
for Credit Losses and Credit Risk Management





Originating
loans involves a degree of risk that credit losses will occur in varying amounts
according to, among other factors, the type of loans being made, the
credit-worthiness of the borrowers over the term of the loans, the quality of
the collateral for the loan, if any, as well as general economic
conditions.  The Company charges the provision for credit losses to
earnings to maintain the total allowance for credit losses at a level considered
by management to represent its best estimate of the losses known and inherent in
the portfolio that are both probable and reasonable to estimate, based on, among
other factors, prior loss experience, volume and type of lending conducted,
estimated value of any underlying collateral, economic conditions (particularly
as such conditions relate to the Company’s market area), regulatory guidance,
peer statistics, management’s judgment, past due loans in the loan portfolio,
loan charge off experience and concentrations of risk (if any).  The
Company charges losses on loans against the allowance when it believes that
collection of loan principal is unlikely.  Recoveries on loans
previously charged off are added back to the allowance.





Management
uses a loan grading system where all loans are graded based on management's
evaluation of the risk associated with each loan. A factor, based on the loan
grading, is applied to the loan balance to reserve for potential losses. In
addition, management judgmentally establishes an additional nonspecific reserve.
The nonspecific portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates and risk factors that have not yet manifested themselves in loss
allocation factors.





The
reserve factors used are based on management’s judgment as to appropriate
reserve percentages for various categories of loans, and those values are
adjusted based on the following: historical losses in each category, historical
and current delinquency in each category, underwriting standards in each
category, comparison of losses and delinquencies to peer group performance and
an assessment of the likely impact of economic and other external conditions on
the performance of each category.





A test of
the adequacy of the allowance for credit losses is performed and reported to the
Board of Directors on a monthly basis.  Management uses the
information available to make a determination with respect to the allowance for
credit losses, recognizing that the determination is inherently subjective and
that future adjustments may be necessary depending upon, among other factors, a
change in economic conditions of specific borrowers, or generally in the
economy, and new information that becomes available.  However, there
are no assurances that the allowance for credit losses will be sufficient to
absorb losses on nonperforming assets or that the allowance will be sufficient
to cover losses on nonperforming assets in the future.







22


The
allowance for credit losses as of March 31, 2008 and December 31, 2007 was $6.7
million and $5.0 million, respectively. These amounts equated to 2.74% and 2.08%
of outstanding loans, including loans held for sale, as of March 31, 2008 and
December 31, 2007, respectively. Excluding loans held for sale, the allowance
for credit losses equated to 2.80% and 2.18% of outstanding loans as of March
31, 2008 and December 31, 2007, respectively. The increased percentage was due
to an additional provision of $1.7 million recorded in the first quarter of 2008
due to ongoing weaknesses in the Company’s portfolio of residential construction
and reconstruction loans.  This is a direct result of weaknesses in
the housing markets in its target markets.  Bay National Corporation
has no exposure to foreign countries or foreign borrowers. Management believes
that the allowance for credit losses is adequate for each period
presented.





As of
March 31, 2008, the Company had non-accrual loans totaling $10.5 million,
all of which were included in the residential real estate construction and
reconstruction loan portfolio. This is a direct result of the slowdown in the
real estate market, which has resulted in an increase in loan extensions and
delinquencies due to the inability of borrowers to refinance or sell properties
as quickly as anticipated.  These nonperforming loans represented 4.3%
of total outstanding loans, including loans held for sale, as of March 31,
2008.  All of these loans are at least partially collateralized by
real estate. As of December 31, 2007, the Company had $9.4 million of
non-accrual loans representing 3.9% of total outstanding
loans.  Management will continue to closely monitor these loans and
the overall level of delinquencies; however, management believes that the
allowance for credit losses is adequate for these loans.  Any losses
on these loans will be charged off as soon as the amount of loss is
determinable.





The
Company recorded $767,700 of net charge-offs during the three-month period ended
March 31, 2008. The Company recovered $27,930 of 2006 charge-offs during the
three-month period ended March 31, 2007.





Management
believes that the overall allowance for credit losses is adequate for each
period presented.





Liquidity





The
Company’s overall asset/liability strategy takes into account the need to
maintain adequate liquidity to fund asset growth and deposit runoff. Management
monitors the liquidity position daily.





The
Company’s primary sources of funds are deposits, short-term borrowings in the
form of borrowings under the Overnight Commercial Paper program, Federal funds
and FHLB credit facilities, scheduled amortization and prepayment of loans,
funds provided by operations and capital. While scheduled principal repayments
on loans are a relatively predictable source of funds, deposit flows and loan
prepayments are greatly influenced by economic conditions and rates offered by
our competition.





The
Company's most liquid assets are cash and assets that can be readily converted
into cash, including investment securities maturing within one year. As of March
31, 2008, the Company had $485,226 in cash and due from banks, $14.4 million in
federal funds sold and other overnight investments and $5.5 million in loans
expected to be sold within 60 days. As of December 31, 2007, the Company had
$2.3 million in cash and due from banks, $4.9 million in federal funds sold and
other overnight investments, $399,529 in three-month U.S. Treasury Securities
and $11.6 million in loans expected to be sold within 60 days.







23


The
relative stability in the overall level of liquid assets was the result of a
deliberate effort by management to tightly manage liquidity by maintaining a
high loan to deposit ratio and the use of short-term borrowings to meet unusual
draws on liquidity if the cost of using short-term borrowings is more
advantageous than issuing certificates of deposit. The goal of this strategy is
to maximize net interest margin. Growth in the Company’s loan portfolio, without
corresponding growth in deposits, would reduce liquidity as would reductions in
the level of customer deposits.





The
Company has commitments for a total of $9 million of borrowing availability
under unsecured Federal funds lines of credit with three separate financial
institutions. The Company also has approximately $25 million of borrowing
capacity with the Federal Home Loan Bank of Atlanta as of March 31, 2008. These
credit facilities can be used in conjunction with the normal deposit strategies,
which include pricing changes to increase deposits as necessary. From time to
time, the Company may sell or participate out loans to create additional
liquidity as required.





The
Company has sufficient liquidity to meet its loan commitments as well as
fluctuations in deposits. The Company will choose to retain maturing
certificates of deposit, when necessary, by offering competitive
rates.





Management
is not aware of any known trends, events or uncertainties, not otherwise
discussed above, that will have or are reasonably likely to have a material
effect on liquidity, capital or operations, nor is management aware of any
current recommendation by regulatory authorities, which if implemented, would
have a material effect on liquidity, capital or operations.





Interest
      Rate Sensitivity





The
primary objective of asset/liability management is to ensure the steady growth
of the Company’s primary earnings component, net interest income. Net interest
income can fluctuate with significant interest rate movements. To minimize the
risk associated with these rate swings, management works to structure the
Company’s balance sheet so that the ability exists to adjust pricing on
interest-earning assets and interest-bearing liabilities in roughly equivalent
amounts at approximately the same time intervals. Imbalances in these repricing
opportunities at any point in time constitute interest rate
sensitivity.





The
measurement of the Company’s interest rate sensitivity, or “gap,” is one of the
principal techniques used in asset/liability management. The gap is the dollar
difference between assets and liabilities subject to interest rate pricing
within a given time period, including both floating rate or adjustable rate
instruments and instruments which are approaching maturity.






24





The
following table sets forth the amount of the Company's interest-earning assets
and interest-bearing liabilities as of March 31, 2008, which are expected to
mature or reprice in each of the time periods shown:









Maturity
      or repricing withinAmount
            
            Percent
      ofTotal
            
            
            0
      to 3Months
            
            4
      to 12Months
            
            
            1
      to 5
              Years
            
            Over
      5YearsInterest-earning
      assetsFederal
      funds sold and
              otherovernight
      investments
            $
            14,374,017
            
            5.52
            %
            $
            14,374,017
            $
            -
            
            $
            -
            $
            -Loans
      held for sale
            
            5,475,582
            
            2.10
            
            
            5,475,582
            
            -
            
            
            -
            
            -Loans
      – Variable rate
            
            119,987,514
            
            46.12
            
            
            119,987,514
            
            -
            
            
            -
            
            -Loans
      – Fixed rate
            
            119,171,624
            
            45.81
            
            
            36,648,553
            
            18,598,590
            
            
            54,029,420
            
            9,895,061Other
      earning assets
            
            1,157,100
            
            .45
            
            
            -
            
            -
            
            
            -
            
            1,157,100Total
      interest-earning assets
            $
            260,165,837
            
            100.00
            %
            
            176,485,666
            $
            18,598,590
            
            
            54,029,420
            
            11,052,161Interest-bearing
      liabilitiesDeposits
      – Variable rate
            $
            76,428,068
            
            36.53
            %
            $
            76,428,068
            $
            -
            
            $
            -
            $
            -Deposits
      – Fixed rate
            
            116,506,879
            
            55.68
            
            
            22,234,072
            
            57,886,441
            
            
            36,386,366
            
            -Short-term
      borrowings –
              Variablerate
            
            8,312,459
            
            3.97
            
            
            8,312,459
            
            -
            
            
            -
            
            -Subordinated
      debt
            
            8,000,000
            
            3.82
            
            
            -
            
            -
            
            
            -
            
            8,000,000Total
      interest-bearing liabilities
            $
            209,247,406
            
            100.00
            %
            $
            106,974,599
            $
            57,886,441
            
            $
            36,386,366
            $
            8,000,000Periodic
      repricing differencesPeriodic
      gap
            
            
            
            
            
            $
            69,511,067
            $
            (39,287,851
            )
            $
            17,643,054
            $
            3,052,161Cumulative
      gap
            
            
            
            
            
            $
            69,511,067
            $
            30,223,216
            
            $
            47,866,270
            $
            50,918,431Ratio
      of rate sensitive assets to
              ratesensitive
      liabilities
            
            
            
            
            
            
            164.98
            %
            32.13
            %
            
            148.49
            %
            138.15
            %





The
Company has 53.74% of its interest-earning assets and 44.32% of its
interest-bearing liabilities in variable rate balances. Interest-earning assets
exceed interest-bearing liabilities by $50.9 million. The majority of this gap
is concentrated in items maturing or repricing within five years. This gap is
generally reflective of the Company’s effort, over the past six months, to
maintain flexibility in the balance sheet in a declining interest rate
environment. As rates have dropped over the past six months, the Company has
begun to extend the term on time deposits in order to lock in lower deposit
rates for a longer period of time. This analysis indicates that the Company will
benefit from increasing market rates of interest. However, since all interest
rates and yields do not adjust at the same pace, the gap is only a general
indicator of interest rate sensitivity. The analysis of the Company's
interest-earning assets and interest-bearing liabilities presents only a static
view of the timing of maturities and repricing opportunities, without taking
into consideration the fact that changes in interest rates do not affect all
assets and liabilities equally. Net interest income may be affected by other
significant factors in a given interest rate environment, including changes in
the volume and mix of interest-earning assets and interest-bearing
liabilities.





Management
constantly monitors and manages the structure of the Company's balance sheet,
seeks to control interest rate exposure, and evaluates pricing strategies.
Strategies to better match maturities of interest-earning assets and
interest-bearing liabilities include structuring loans with rate floors and
ceilings on variable-rate notes and providing for repricing opportunities on
fixed-rate notes. Management believes that a lending strategy focusing on
variable-rate loans and short-term fixed-rate loans will best facilitate the
goal of minimizing interest rate risk. However, management will
opportunistically enter into longer term fixed-rate loans and/or investments
when, in management’s judgment, rates adequately compensate the Company for the
interest rate risk. The Company's current investment concentration in Federal
funds sold and other overnight investments provides the most flexibility and
control over rate sensitivity, since it generally can be restructured more
quickly than the loan portfolio. On the liability side, deposit products can be
restructured so as to offer incentives to attain the maturity distribution
desired; although, competitive factors sometimes make control over deposit
maturity difficult.






25





In
theory, maintaining a nominal level of interest rate sensitivity can diminish
interest rate risk. In practice, this is made difficult by a number of factors,
including cyclical variation in loan demand, different impacts on interest
sensitive assets and liabilities when interest rates change and the availability
of funding sources. Management generally attempts to maintain a balance between
rate-sensitive assets and liabilities as the exposure period is lengthened to
minimize the overall interest rate risk to the Company.





Off-Balance
Sheet Arrangements





In the
normal course of business, the Company is a party to financial instruments with
off-balance sheet risk. These financial instruments primarily include
commitments to extend credit, lines of credit and standby letters of credit. The
Company uses these financial instruments to meet the financing needs of its
customers. These financial instruments involve, to varying degrees, elements of
credit, interest rate, and liquidity risk.





Outstanding
loan commitments and lines and letters of credit as of March 31, 2008 and
December 31, 2007 are as follows:





March
      31,
              2008
            
            
            December
      31, 2007Loan
      commitments
            
            $
            37,658,688
            
            
            $
            35,114,676Unused
      lines of credit
            
            
            85,653,922
            
            
            
            85,999,686Letters
      of credit
            
            
            3,620,314
            
            
            
            3,564,927





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have interest rates fixed at current market amounts, fixed expiration
dates or other termination clauses and may require payment of a fee. Unused
lines of credit represent the unused portion of lines of credit previously
extended and available to the customer as long as there is no violation of any
contractual condition. These lines generally have variable interest rates. Since
many of the commitments are expected to expire without being drawn upon, and
since it is unlikely that customers will draw upon their line of credit in full
at any time, the total commitment amount or line of credit amount does not
necessarily represent future cash requirements. The Company is not aware of any
loss it would incur by funding its commitments or lines of credit.





Standby
letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The Company’s exposure to credit
loss in the event of nonperformance by the customer is the contract amount of
the commitment.





In
general, loan commitments, lines of credit and letters of credit are made on the
same terms, including with respect to collateral, as outstanding loans. Each
customer’s credit-worthiness and collateral requirement is evaluated on a
case-by-case basis.





The
stability in the overall level of loan commitments as of March 31, 2008 as
compared to December 31, 2007 is reflective of the ongoing efforts to maintain a
steady flow of commercial and industrial loans in order to sustain loan growth
and increase revenue in order to leverage the investment made in additional
business development staff.







26


Capital
Resources





The
Company had stockholders’ equity at March 31, 2008 of $18.5 million as compared
to $19.9 million at December 31, 2007. The decrease in capital is a result of
the operating loss incurred for the three months ended March 31, 2008.
Management is pursuing alternatives to ensure that the Company has adequate
capital to support projected asset growth over the next 12 months.





Banking
regulatory authorities have implemented strict capital guidelines directly
related to the credit risk associated with an institution’s assets. Banks and
bank holding companies are required to maintain capital levels based on their
"risk adjusted” assets so that categories of assets with higher "defined” credit
risks will require more capital support than assets with lower risks. The Bank
has exceeded its capital adequacy requirements to date.





Banking
regulations also limit the amount of dividends that may be paid without prior
approval of the Bank's regulatory agencies. Regulatory approval is required to
pay dividends that exceed the Bank’s net profits for the current year plus its
retained net profits for the preceding two years. The Bank could have paid
dividends to the Company without approval from bank regulatory agencies at March
31, 2008; however, such payments are not currently planned.





Reconciliation
of Non-GAAP Measures





Below is
a reconciliation of total deposits to core deposits as of March 31, 2008 and
December 31, 2007, respectively:





March
      31,
              2008
            
            
            December
      31, 2007Total
      deposits
            
            $
            231,149,162
            
            
            $
            201,981,465National
      market certificates of deposit (includes CDARS deposits)
            
            
            (50,889,243
            )
            
            
            (32,661,081
            )Variable
      balance accounts (1 customer at March 31, 2008 and December 31,
      2007)
            
            
            (6,898,442
            )
            
            
            (6,230,689
            )Portion
      of variable balance accounts considered to be core
            
            
            3,000,000
            
            
            
            3,000,000Core
      deposits
            
            $
            176,361,477
            
            
            $
            166,089,695





Application
of Critical Accounting Policies





The
Company’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industries in which it operates. Application
of these principles requires management to make estimates, assumptions and
judgments that affect the amounts reported in the consolidated financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions and judgments. Certain policies inherently have
a greater reliance on the use of estimates, assumptions and judgments and as
such, have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability must be recorded contingent upon a
future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.







27


Based on
the valuation techniques used and the sensitivity of financial statement amounts
to the methods, assumptions and estimates underlying those amounts, management
has identified the determination of the allowance for credit losses as the
accounting area that requires the most subjective or complex judgments, and as
such could be most subject to revision as new information becomes
available.





Management
has significant discretion in making the judgments inherent in the determination
of the provision and allowance for credit losses. The establishment of allowance
factors is a continuing exercise and allowance factors may change over time,
resulting in an increase or decrease in the amount of the provision or allowance
based upon the same volume and classification of loans. Changes in allowance
factors or in management’s interpretation of those factors will have a direct
impact on the amount of the provision and a corresponding effect on income and
assets. Also, errors in management’s perception and assessment of the allowance
factors could result in the allowance not being adequate to cover losses in the
portfolio, and may result in additional provisions or charge-offs, which would
adversely affect income and capital.





For
additional information regarding the allowance for loan and lease losses, see
“Allowance for Credit Losses and Credit Risk Management.”







28


Item
3.  Quantitative and Qualitative Disclosures About Market
Risk





Not applicable.





Item
4.   Controls and Procedures





As of the
end of the period covered by this quarterly report on Form 10-Q, Bay National
Corporation’s Chief Executive Officer and Chief Financial Officer evaluated the
effectiveness of Bay National Corporation’s disclosure controls and
procedures.  Based upon that evaluation, Bay National Corporation’s
Chief Executive Officer and Chief Financial Officer concluded that Bay National
Corporation’s disclosure controls and procedures are effective as of March 31,
2008.  Disclosure controls and procedures are controls and other
procedures that are designed to ensure that information required to be disclosed
by Bay National Corporation in the reports that it files or submits under the
Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission’s rules and forms.





In addition, there were no changes in
Bay National Corporation’s internal control over financial reporting (as defined
in Rule 13a-15 under the Exchange Act) during the quarter ended March 31, 2008,
that have materially affected, or are reasonably likely to materially affect,
Bay National Corporation’s internal control over financial
reporting.





Information
Regarding Forward-Looking Statements





This
report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Exchange Act of 1933, as amended and
Section 21E of the Exchange Act.  Forward-looking statements also
may be included in other statements that we make.  All statements that
are not descriptions of historical facts are forward-looking statements.
Forward-looking statements often use words such as “believe,” “expect,” “plan,”
“may,” “will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,”
“intend” or other words of similar meaning. You can also identify them by the
fact that they do not relate strictly to historical or current
facts.





The
statements presented herein with respect to, among other things, the Company’s
plans, objectives, expectations and intentions, including statements regarding
market expansion, earnings, asset and business growth, hiring intentions, future
sources of income, operating results and profitability, liquidity, allowance for
credit losses, interest rate sensitivity, future market conditions, market
opportunities and financial and other goals, as well as statements with respect
to the future status of our loan portfolio are forward-looking. These statements
are based on the Company’s beliefs and assumptions, and on information available
to it as of the date of this filing, and involve risks and uncertainties. These
risks and uncertainties include, among others, those discussed in this report on
Form 10-Q; the Company’s dependence on key personnel; risks related to the
Bank’s choice of loan portfolio; continuing declines in the real estate market
in the Company’s markets and in the economy generally; risks related to the
Bank’s lending limit; risks of a competitive market; the impact of any new or
amended government regulations on operating results; and the effects of
developments in technology. For a more complete discussion of these risks and
uncertainties, see the discussion under the caption “Risk Factors” in Bay
National Corporation’s Form 10-K for the year ended December 31, 2007. The
Company’s actual results and the actual outcome of our expectations and
strategies could differ materially from those anticipated or estimated because
of these risks and uncertainties and you should not put undue reliance on any
forward-looking statements. All forward-looking statements speak only as of the
date of this filing, and the Company undertakes no obligation to update the
forward-looking statements to reflect factual assumptions, circumstances or
events that have changed after the forward-looking statements are
made.






29




PART
II – OTHER INFORMATION





Item
1.        Legal
Proceedings.





None





Item
1A.     Risk Factors





There have been no material changes in
the risk factors from those disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2007.





Item
2.         Unregistered Sales of
Equity Securities and Use of Proceeds.





On
February 26, 2008, the Parent’s Board of Directors authorized the issuance of a
total of 8,148 shares of unregistered shares of Parent common stock, $.01 par
value per share, to the Parent’s current directors in lieu of cash fees owed for
services as directors during the year ended December 31, 2007.  This
issuance is exempt from registration by Section 4(2) of the Securities Act
of 1933, as a transaction not involving a public offering.





Item
3.         Defaults Upon Senior
Securities.





Not applicable.





Item
4.         Submission of Matters to
a Vote of Securities Holders.





None





Item
5.         Other
Information.





None





Item
6.         Exhibits.





(a)
            Exhibits.31.1
            Rule 13a-14(a)Certification of
      Chief Executive Officer31.2
            Rule 13a-14(a)Certification of
      Chief Financial Officer32
            Rule 13a-14(b)Certification of
      Chief Executive Officer and Chief Financial
  Officer






30





SIGNATURES





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








Bay
      National CorporationDate:
      May 14, 2008
            
            By:
            /s/
      Hugh W. MohlerHugh
      W. Mohler, President(Principal
      Executive Officer)Date:
      May 14, 2008
            
            By:
            /s/
      Mark A. SemanieMark
      A. Semanie, Treasurer(Principal
      Accounting and Financial Officer)





31