**Exhibit 13.1**

 

 

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**Santa Lucia Bancorp 2008 Annual Report**

 

 
| ** **   | ** **   | **Santa Lucia Bancorp**              |
|--------------|--------------|--------------------------------------|
| **2008**     |         | 7480  El Camino Real                 |
|         |         | Atascadero,  California 93422        |
| *** *** | *** *** | *** ***                         |
| *** *** | *** *** | ***Stock Symbol*****– SLBA.OB** |
|         |         |                                 |
| ** **   | ** **   | **Santa Lucia Bank**                 |
|         |         | 7480  El Camino Real                 |
|         |         | Atascadero,  California 93422        |
|         |         |                                 |
| ** **   | ** **   | **www.santaluciabank.com**           |
| ** **   | ** **   | ** **                           |

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

 

1

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**SANTA LUCIA BANCORP**

**FINANCIAL HIGHLIGHTS**

*As of Years Ended December 31,*

 

 

 

TheCompany has two classes of stock outstanding - Common and Series APreferred. Our common stock trades over-the-counter and is quoted on the OTCBulletin Board under the symbol SLBA.OB. There is no active market for the Series APreferred and all of the outstanding preferred is held by one shareholder. Theinformation in the following table indicates the high and low bid prices of theCompany’s common stock for each quarterly period during the last two yearsbased upon information provided by the Company market makers. These prices donot include retail mark ups, mark downs or commissions, but have been adjustedto reflect the Bank’s 4-for-1 stock split that was effective June 2005.

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

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

 

2

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

 

***With Thanks and Appreciation***

 

Iwrite these comments with mixed feelings. My anticipation has been buildingover the last several years as we developed and implemented our managementsuccession plan. Santa Lucia Bank is like a family to me and not being involvedon a daily basis will be a big change and will definitely be missed.

 

Mydecision to retire at the end of 2008 was initiated several years ago by somehealth issues and a desire to retire while young enough to enjoy my hobbies andfamily. I look forward to spending more time with my wife Linda, and ourchildren and seven grandchildren.

 

Thistransition time has allowed me the opportunity to fully reflect on this greatorganization that is comprised of the very best. Our Shareholders, Customers,Directors, Officers and Employees stand well above any that I have everwitnessed or experienced in my 40+ years in banking.

 

Myassociation with Santa Lucia Bancorp and Santa Lucia Bank for the past 23 yearshas given me more joy and satisfaction than I ever expected. It is hard tobelieve how fast the time has passed, but that happens when you are doing whatyou love and are surrounded by great people in a great community. Theserelationships are beyond comprehension and will be treasured and rememberedforever.

 

Ilook forward to my continued role as a Director of both Santa Lucia Bancorp andSanta Lucia Bank. It is an honor to serve as a Director of these two greatorganizations as we continue to grow. I want to thank you all for your supportand trust over the years. My association with each of you has enriched my lifein many ways. Thanks for the ride.

 
|                                                                                                                                                                                                                                                                                                                                        |        |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                                   |   |
| **Clockwise From Above**- Executive Committe from 1985 - 1996 Bill  Reuck, Larry Putnam and Stan Cherry.

 

Larry  Putnam, Jerry DeCou and Stan Cherry 1985.

 

Jerry  DeCou, Larry Putnam and Stan Cherry at the Santa Maria Office Opening December 2002.

 

Ground  Breaking for the Atascadero Office 1987. |   |  |
|                                                                                                                                                                                                                                                                                                                                   |   |
|                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                        |        |  |

 

3

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**Santa Lucia Bancorp**

 

***Message from the President***

 

DearShareholders, Customers and Friends,

 

Aswe say farewell and wish the very best to the retiring Larry H. Putnam, I wouldlike to say how very honored I am to be appointed the new President and ChiefExecutive Officer of Santa Lucia Bank and Santa Lucia Bancorp. I have had thepleasure of knowing Larry for the past 36 years and have enjoyed working withhim for 22 of those years including the past 13 right here at Santa Lucia Bank.I joined Santa Lucia Bank in July of 1995 with the merger of Central CoastNational Bank where I was President and Chief Executive Officer. We allconsider Larry a special friend and wish him the very best in his retirementyears.

 

Aswe close the books on 2008, we reflect back on one of the most challengingyears that I can remember in my banking career. The disruption in the overallfinancial system affects each and every one of us in various ways. At SantaLucia Bank, we continue to build upon the strong foundation that we havecreated over the past 23 years.

 

 

JohnC. Hansen, President and Chief Executive Officer

 

Eventhough our net profit is lower than the previous year, we are still proud ofour achievement considering the 400 basis point drop in the bank’s primelending rate over the past year. Net Profit decreased 62.1% or $1,863,915 from$3,002,819 as of December 31, 2007 to $1,138,904 for the same period in2008.

 

Depositscontinued to be a struggle in 2008 due to the current economic conditionscoupled with the tremendous competition for deposits among the local banks. Wewere pleased that deposits remained relatively stable with only a slightdecrease of 0.2% or $401,780 from $212,718,378 as of December 31, 2007 to$212,316,598 for the same period in 2008.

 

Wehave not changed our lending practices or requirements in any significant waysince we opened our doors in 1985. The excellent growth in loans during 2008indicates the commitment that the Company has to support the communities thatwe serve. The Company increased gross loans by 12.2% or $20,684,824 from$168,968,762 as of December 31, 2007 to $189,653,586 as of December 31,2008. During these troubled times we are pleased to announce that ournon-performing loans decreased 25.8% from $2,175,694 as of December 31,2007 to $1,613,647 as of December 31, 2008.

 

4

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SantaLucia Bancorp’s Board of Directors. Standing left to right—John C. Hansen,President and Chief Executive Officer, Jerry W. DeCou III, Chairman of theBoard, Larry H. Putnam, Retiring President and Chief Executive Officer, DouglasC. Filipponi, Vice Chairman. 

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

 

Welook forward to the challenges of 2009 and remain positive about the future.The Company has a very supportive and knowledgeable Board and a seasonedmanagement team and staff that remains committed to providing the highestreturn possible to our shareholders.

 

Onbehalf of the entire Board of Directors, we extend our thanks to ourshareholders for your continued support, to our customers for your business,and to our employees for their dedication to providing the highest qualityservice to our customers. We look forward to meeting the demanding and excitingchallenges that lie ahead.

** **

** **
| ****                                   | ** ** |
|----------------------------------------|------------|
| **John C. Hansen**                     |       |
| President  and Chief Executive Officer |       |

 

 

Larry H. Putnam, Retiring President and ChiefExecutive Officer John C. Hansen, President and Chief Executive Officer

 

5

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**SANTA LUCIA BANK**

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

** **

**Senior Management Team**

** **

****

** **

JohnMcNinch, John C. Hansen, James M. Cowan

** **

**JOHN C. HANSEN**

PresidentandChief Executive Officer 

** **

**JAMES M. COWAN**

ExecutiveVice PresidentChief Administrative OfficerChief Credit Officer

** **

**JOHN McNINCH**

ExecutiveVice PresidentCredit Administrator

 

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

 

**Administrative Team**

 

** **

KristieKeller, John C. Hansen, Melodee Fontana, Julie A. Joslin, Sharon Satterthwaite,Larry Womack, James M. Cowan, John McNinch

 

**JOHN C. HANSEN**President andChief Executive Officer 

** **

**JAMES M. COWAN**

ExecutiveVice PresidentChief Administrative OfficerChief Credit Officer

** **

**JOHN McNINCH**

ExecutiveVice PresidentCredit Administrator

** **

**MELODEE FONTANA**

SeniorVice PresidentOperations Administrator

** **

**SHARON SATTERTHWAITE**

VicePresidentController

** **

**KRISTIE KELLER**

VicePresidentCentral Operations

** **

**LARRY WOMACK**

VicePresidentAssistant Credit Administrator

** **

**JULIE A. JOSLIN**

VicePresidentCashier

 

6

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**Atascadero Office**

7480 El Camino Real, Atascadero, California

 

 

**Atascadero Officer Team**

 

 

JimKelley, Karen Sampson, Kim Donaldson, J. Darren Barnes, Teri Davis

 

**TERI DAVIS**

VicePresidentLoan Officer

** **

**KIM DONALDSON**

VicePresident

OperationsOfficer

** **

**JIM KELLEY**

VicePresident

LoanOfficer

** **

**J. DARREN BARNES**

AssistantVice President

LoanOfficer

** **

**KAREN SAMPSON**

Assistant Operations Officer

 

7

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**Paso Robles Office**

1240Spring Street, Paso Robles, California

 

 

**Paso Robles Officer Team**

 

 

Robert Covarrubias, Cheryl Mumford, Ryun McCrory, Joshua R. Bivin

 

**ROBERT COVARRUBIAS**

SeniorVice PresidentManager

** **

**RYUN McCRORY**

VicePresidentLoan Officer

** **

**JOSHUA R. BIVIN**

VicePresidentLoan Officer

** **

**CHERYL MUMFORD**

Assistant Vice PresidentOperations Officer

 

8

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**Arroyo Grande Office**

1530East Grand Avenue, Arroyo Grande, California

 

 

**Arroyo Grande Officer Team**

** **

****

 

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

 

**MICHAEL W. M****c****KENZIE**Vice PresidentManager

** **

**RICHARD ALLEN**Vice PresidentLoan Officer

** **

**JENNIFER BASSI GINDER**Assistant VicePresidentOperations Officer

** **

**REGINA M. SHELDON**

AssistantVice President

LoanOfficer

 

9

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**Santa Maria Office**

1825South Broadway, Santa Maria, California

 

****

 

**Santa Maria Officer Team**

 

 

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

 

**LEAH T. WEST**

VicePresident

Manager

 

**JAMES P. BURUBELTZ**

VicePresident

LoanOfficer

 

**STELLA MARTINEZ**

OperationsOfficer

 

**ROBERT J. McCONAGHY**

Loan Officer

 

10

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**SANTA LUCIA BANCORP**

 

**SANTA LUCIA BANCORP BOARD OF DIRECTORS**
| **JERRY W. DECOU III**                    |       | CHAIRMAN                                           |
|-------------------------------------------|------------|----------------------------------------------------|
| **DOUGLAS C. FILIPPONI**                  |       | VICE CHAIRMAN                                      |
| **KHATCHIK H. ACHADJIAN**                 | ** ** | ** **                                         |
| **STANLEY R. CHERRY**                     | ** ** | ** **                                         |
| **JOHN C. HANSEN**                        | ** ** | ** **                                         |
| **JEAN HAWKINS**                          | ** ** | ** **                                         |
| **PAUL G. MOERMAN**                       | ** ** | ** **                                         |
| **LARRY H. PUTNAM**                       | ** ** | ** **                                         |
| **D. JACK STINCHFIELD**                   | ** ** | ** **                                         |
| ** **                                | ** ** | ** **                                         |
| **SANTA LUCIA BANCORP EXECUTIVE OFFICER** | ** ** | ** **                                         |
| **JOHN C. HANSEN**                        |       | PRESIDENT AND CHIEF EXECUTIVE OFFICER              |
| **JAMES M. COWAN**                        |       | EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL  OFFICER |
| ** **                                |       |                                               |
| **SANTA LUCIA BANK BOARD OF DIRECTORS**   | ** ** | ** **                                         |
| **JERRY W. DECOU III**                    |       | CHAIRMAN                                           |
| **DOUGLAS C. FILIPPONI**                  |       | VICE CHAIRMAN                                      |
| **KHATCHIK H. ACHADJIAN**                 | ** ** | ** **                                         |
| **STANLEY R. CHERRY**                     | ** ** | ** **                                         |
| **JOHN C. HANSEN**                        | ** ** | ** **                                         |
| **JEAN HAWKINS**                          | ** ** | ** **                                         |
| **PAUL G. MOERMAN**                       | ** ** | ** **                                         |
| **LARRY H. PUTNAM**                       | ** ** | ** **                                         |
| **D. JACK STINCHFIELD**                   | ** ** | ** **                                         |

 

**SANTA LUCIA BANK**

 
| **EXECUTIVE OFFICERS**        | ** ** | ** **                                                            |
|-------------------------------|------------|-----------------------------------------------------------------------|
| **JOHN C. HANSEN**            |       | President and Chief Executive Officer                                 |
| **JAMES M. COWAN**            |       | Executive Vice President, Chief Admin.  Officer, Chief Credit Officer |
| **JOHN McNINCH**              |       | Executive Vice President, Credit  Administrator                       |
| ** **                    |       |                                                                  |
| **SENIOR VICE PRESIDENTS**    | ** ** | ** **                                                            |
| **MELODEE FONTANA**           |       | Senior Vice President, Operations  Administrator                      |
| **ROBERT COVARRUBIAS**        |       | Senior Vice President, Manager                                        |
| ** **                    |       |                                                                  |
| **VICE PRESIDENTS**           | ** ** | ** **                                                            |
| **TERI DAVIS**                |       | Vice President, Loan Officer                                          |
| **SHARON SATTERTHWAITE**      |       | Vice President, Controller                                            |
| **KRISTIE KELLER**            |       | Vice President, Central Operations                                    |
| **KIM DONALDSON**             |       | Vice President, Operations Officer                                    |
| **RYUN McCRORY**              |       | Vice President, Loan Officer                                          |
| **LEAH T. WEST**              |       | Vice President, Manager                                               |
| **JIM KELLEY**                |       | Vice President, Loan Officer                                          |
| **MICHAEL W. McKENZIE**       |       | Vice President, Manager                                               |
| **LARRY WOMACK**              |       | Vice President, Assistant Credit  Administrator                       |
| **JAMES P. BURUBELTZ**        |       | Vice President, Loan Officer                                          |
| **RICHARD ALLEN**             |       | Vice President, Loan Officer                                          |
| **JULIE A. JOSLIN**           |       | Vice President, Cashier                                               |
| **JOSHUA R. BIVIN**           |       | Vice President, Loan Officer                                          |
|                          |       |                                                                  |
| **ASSISTANT VICE PRESIDENTS** | ** ** | ** **                                                            |
| **JENNIFER BASSI GINDER**     |       | Assistant Vice President, Operations  Officer                         |
| **CHERYL MUMFORD**            |       | Assistant Vice President, Operations  Officer                         |
| **J. DARREN BARNES**          |       | Assistant Vice President, Loan Officer                                |
| **REGINA M. SHELDON**         |       | Assistant Vice President, Loan Officer                                |
|                          |       |                                                                  |
| **OFFICERS**                  | ** ** | ** **                                                            |
| **KAREN SAMPSON**             |       | Assistant Operations Officer                                          |
| **STELLA MARTINEZ**           |       | Operations Officer                                                    |
| **ROBERT McCONAGHY**          |       | Loan Officer                                                          |

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

 
| **MARKET MAKERS**                                                      | ** ** | ** **                   |
|------------------------------------------------------------------------|------------|------------------------------|
| ** **                                                             | ** ** | ** **                   |
| **GEORGE CROSBY, MAGUIRE INVESTMENTS – SANTA MARIA, CA**          |       | 805/922-6901 or 800/244-4183 |
| **RANDY KRUMLAND, EDWARD JONES – ATASCADERO, CA**                 |       | 805/466-0244 or 800/467-0244 |
| **JIM MOFFATT, MORGAN STANLEY – PASO ROBLES, CA**                 |       | 805/239-0920 or 800/733-0920 |
| **TREVOR MORRIS, UBS FINANCIAL SERVICES, INC. – LOS ANGELES, CA** |       | 213/972-1511 or 800/443-5203 |
| **JOEY J. WARMENHOVEN, McADAMS WRIGHT RAGEN – PORTLAND, OR**      |       | 503/922-4888 or 866/662-0351 |

 

11

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** **

**Santa Lucia Bancorp and Subsidiary**

** **

**Consolidated Selected Financial Information**

 
| ** **                                           | ** ** | **Year Ended December 31,**                                      | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                                                        | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands, except per share data)** | ** ** |
| **Summary of Operations:**                           | * *   | * *                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest Income                                      |       | $                                                                               | 15,276     |   | $ | 17,719 |   | $ | 17,027 |   | $ | 13,546 |   | $ | 10,220 |   |
| Interest Expense                                     |       | 3,877                                                                           |       | 4,824 |   | 3,577 |   | 1,984 |   | 1,343 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Interest Income                                  |       | 11,399                                                                          |       | 12,895 |   | 13,450 |   | 11,562 |   | 8,877 |   |
| Provision for Loan Loss                              |       | 975                                                                             |       | — |   | 240 |   | 300 |   | 110 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Interest Income After Provision for  Loan Losses |       | 10,424                                                                          |       | 12,895 |   | 13,210 |   | 11,262 |   | 8,767 |   |
| Noninterest Income                                   |       | 1,111                                                                           |       | 1,071 |   | 1,010 |   | 1,052 |   | 1,191 |   |
| Noninterest Expense                                  |       | 9,763                                                                           |       | 9,029 |   | 8,590 |   | 7,808 |   | 7,060 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Income Before Income Taxes                           |       | 1,772                                                                           |       | 4,937 |   | 5,630 |   | 4,506 |   | 2,898 |   |
| Income Taxes                                         |       | 633                                                                             |       | 1,934 |   | 2,242 |   | 1,759 |   | 1,076 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Income                                           |       | $                                                                               | 1,139      |   | $ | 3,003 |   | $ | 3,388 |   | $ | 2,747 |   | $ | 1,822 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Cash Dividends Paid                                  |       | $                                                                               | 963        |   | $ | 871 |   | $ | 768 |   | $ | 730 |   | $ | 697 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Per Share Data:**                                  |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Income – Basic                              |       | $                                                                               | 0.59       |   | $ | 1.55 |   | $ | 1.77 |   | $ | 1.46 |   | $ | 0.98 |   |
| Net Income – Diluted                            |       | $                                                                               | 0.58       |   | $ | 1.51 |   | $ | 1.68 |   | $ | 1.38 |   | $ | 0.94 |   |
| Dividends                                            |       | $                                                                               | 0.50       |   | $ | 0.45 |   | $ | 0.40 |   | $ | 0.388 |   | $ | 0.375 |   |
| Book Value                                           |       | $                                                                               | 11.21      |   | $ | 11.01 |   | $ | 9.93 |   | $ | 8.35 |   | $ | 7.42 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Common Outstanding Shares:**                       |       | 1,923,053                                                                       |       | 1,924,873 |   | 1,928,097 |   | 1,899,543 |   | 1,861,764 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Statement of Financial Condition Summary:**        |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Total Assets                                         |       | $                                                                               | 251,880    |   | $ | 248,640 |   | $ | 240,738 |   | $ | 231,532 |   | $ | 211,684 |   |
| Total Deposits                                       |       | 212,317                                                                         |       | 212,718 |   | 212,988 |   | 206,879 |   | 194,868 |   |
| Total Net Loans                                      |       | 186,632                                                                         |       | 166,619 |   | 169,680 |   | 152,563 |   | 125,586 |   |
| Allowance for Loan Losses                            |       | 2,310                                                                           |       | 1,673 |   | 1,654 |   | 1,470 |   | 1,200 |   |
| Total Shareholders’ Equity                      |       | 25,551                                                                          |       | 21,189 |   | 19,137 |   | 15,866 |   | 13,807 |   |
|                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Selected Ratios:**                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Return on Average Assets                             |       | 0.46                                                                            | %          | 1.22 | % | 1.42 | % | 1.21 | % | 0.91 | % |
| Return on Average Equity                             |       | 5.19                                                                            | %          | 14.87 | % | 19.45 | % | 18.67 | % | 13.71 | % |
| Average Loans as a Percentage of Average  Deposits   |       | 83.84                                                                           | %          | 76.11 | % | 79.74 | % | 69.90 | % | 62.77 | % |
| Allowance for Loan Losses to Total Loans             |       | 1.22                                                                            | %          | 0.99 | % | 0.96 | % | 0.95 | % | 0.94 | % |
| **Company:**                                         |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Tier I Capital to Average Assets                     |       | 11.89                                                                           | %          | 10.50 | % | 10.00 | % | — |   | — |   |
| Tier I Capital to Risk-Weighted Assets               |       | 14.41                                                                           | %          | 13.20 | % | 12.70 | % | — |   | — |   |
| Total Capital to Risk-Weighted Assets                |       | 15.92                                                                           | %          | 14.60 | % | 14.40 | % | — |   | — |   |

 

12

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**Santa Lucia Bancorp and Subsidiary**

 

**General**

 

Santa Lucia Bancorp (the “Company”) (OTC Bulletin Board SLBA.OB) is aCalifornia corporation organized April 3, 2006 to act as the holdingcompany for its wholly owned subsidiary Santa Lucia Bank (the “Bank”),collectively referred to herein as the “Company.” The Bank was organized as a nationalbanking association on December 19, 1984 and commenced operations on August 5,1985. The Bank converted from a national to a California state-chartered bankon May 30, 1997.

 

The Bank is a commercial banking business, operating from officeslocated at 7480 El Camino Real, Atascadero, California, 1240 Spring Street,Paso Robles, California, 1530 East Grand Avenue, Arroyo Grande, California and1825 South Broadway, Santa Maria, California.

 

The Bank’s operating policy since its inception has emphasized generalcommercial banking. Most of the Bank’s customers are small to mid-sizedbusinesses and individuals. The business of the Bank emphasizes serving theneeds of local businesses, professionals, and wage earners. The Bank providesservices designed to meet the needs of the various segments of the markets itserves. These services include a full line of business loans, business leases,personal loans and deposit products.

 

**Management’s Discussion and Analysis and Results of Operations**

 

Certain statements contained in this report, including, withoutlimitation, statements containing the words “believes”, “anticipates”, “intends”,“expects”, and words of similar import, constitute “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934 (the “Exchange Act”). Suchforward-looking statements involve known and unknown risks, uncertainties andother factors that may cause the actual results, performance or achievements ofthe Company to be materially different from any future results, performance orachievements expressed or implied by such forward-looking statements. Suchfactors include, among others, the following: general economic and businessconditions in those areas in which the Company operates, the ongoing financialcrisis in the United States and California, and bank regulatory and governmentresponse thereto, demographic changes, competition, fluctuations in interestrates, changes in business strategy or developmental plans, changes ingovernmental regulations, credit quality, the availability of capital to fundthe expansion of the Company’s business, and other factors referenced in theCompany’s reports filed pursuant to the Exchange Act. Given these uncertainties,shareholders are cautioned not to place undue reliance on such forward-lookingstatements. The Company disclaims any obligation to update any such factors orto publicly announce the results of any revisions to any of the forward-lookingstatements contained herein to reflect future events or developments.

 

This discussion should be read in conjunction with the Company’saudited financial statements and notes thereto which appear elsewhere in thisreport.

 

***Overview***

 

The following sections set forth an analysis of the significantoperating changes, business trends, financial condition, earnings, capitalposition and liquidity that have occurred in the three-year period ended December 31,2008.

** **

**Consolidated Results of Operations**

 

In 2008 the Company recorded earnings of $1,139,000, which reflects adecrease of $1,864,000 or 62.1% over the previous year. In 2007, earnings were$3,003,000, a decrease of 11.4% from 2006’s earnings of $3,388,000, whichreflected an increase of 23.3% from earnings posted in 2005. Basic earnings pershare in 2008 were $0.59 compared with $1.55 and $1.77 for 2007 and 2006,respectively. This reflects a decrease from 2007 to 2008 of 61.9% and 12.4%from 2007 to 2006. The earnings per share (diluted) for 2008, 2007, and 2006were $0.58, $1.51, and $1.68, respectively, a 61.6% decrease from 2007 to 2008and 10.1% from 2007 to 2006. The Company paid cash dividends on its commonshares totaling $0.50 per share during 2008 compared to $0.45 paid in 2007 and$0.40 paid in 2006. Return on average shareholder’s equity was 5.2% in 2008compared to 14.9% in 2007 and 19.5% in 2006. Return on average assets was 0.46%in 2008 compared to 1.22% in 2007 and 1.42% in 2006.

 

The decrease in the Company’s net earnings from 2007 to 2008 wasprimarily due to a 400 basis point decrease in the prime lending rate during2008.

 

The Company believes that the local economies, in which it operates,Atascadero, Paso Robles, Arroyo Grande, and Santa Maria are starting to showsigns of economic stress. Competition for deposits continues to be very strongboth from traditional sources as well as alternative investments such as mutualfunds, money market accounts and the stock market. The slow down in the localeconomy is primarily attributable to the lower average balances maintained inour customers accounts.

 

13

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*** ***

***Net Interest Income***

 

Net interest income is the Company’s largest source of operating incomeand is derived from interest and fees received on interest earning assets, lessinterest expense incurred on interest bearing liabilities. The most significantimpact on the Company’s net interest income between periods is derived from theinteraction of changes in the volume of and rates earned or paid on interest earningassets and interest bearing liabilities. The volume of loans, investmentsecurities and other interest earning assets, compared to the volume ofinterest bearing deposits and indebtedness, combined with the spread, produceschanges in the net interest income between periods despite an increase of$20,000,000 in loans and approximately $18,000,000 reduction in Securities.

 

Interest income decreased $2,443,000 or 13.8% in 2008 from $17,719,000in 2007 to $15,276,000 in 2008. This is compared to an increase of $692,000 or4.1% from 2006 to 2007 and an increase of $3,481,000 or 25.7% from 2005 to2006. The decrease in 2008 was primarily due to the 400 basis point drop in theprime lending rate.

 

Total interest and fees produced a 6.8% yield on average earning assetsfor 2008, 8.1% for 2007 and 8.1% in 2006. The average loan to deposit ratio for2008 was 83.84%, which represents an increase of 10.2% over the 76.11% averagefor 2007 and a decrease of 4.6% over the 79.7% average for 2006.

 

Total interest expense decreased $947,000 or 19.6% from $4,824,000 in2007 to $3,877,000 in 2008 compared to an increase of $1,247,000 or 34.9% from2006 to 2007. The decrease in total interest expense in 2008 was due todecreasing interest rates for all deposit categories. The rate paid oninterest-bearing liabilities decreased 83 basis points from 3.41% in 2007 to2.58% in 2008.

 

Net interest margin decreased 87 basis points from 5.92% in 2007 to5.05% in 2008. As noted above, this decrease was primarily caused by the 400 basispoint drop in the prime lending rate which triggered a small reduction indeposit rates.

 

The following table shows the composition of average earning assets andaverage interest-bearing liabilities, average yields and rates, and the netinterest margin for the years ended December 31, 2008, 2007 and 2006.Nonaccrual loans are included in the calculation of the average balances ofloans, and nonaccrued interest is excluded.

 
| ** **                                               | ** ** | **Year Ended December 31** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                               | ** ** | **Average  Balance**                      | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                               | ** ** | **(dollars in thousands)**      | ** ** |
| **Assets:**                                              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                                    |       | $                                         | 177,988    |   | $ | 12,994 |   | 7.30 | % | $ | 163,741 |   | $ | 15,031 |   | 9.18 | % | $ | 169,139 |   | $ | 15,397 |   | 9.10 | % |
| Investment securities                                    |       | 46,440                                    |       | 2,258 |   | 4.86 | % | 49,024 |   | 2,438 |   | 4,97 | % | 38,573 |   | 1,485 |   | 3.85 | % |
| Federal funds  sold                                      |       | 1,309                                     |       | 24 |   | 1.83 | % | 4,954 |   | 250 |   | 5.05 | % | 2,941 |   | 145 |   | 4.93 | % |
| Total average  interest-earning assets                   |       | 225,737                                   |       | 15,276 |   | 6.77 | % | 217,719 |   | 17,719 |   | 8.14 | % | 210,653 |   | 17,027 |   | 8.08 | % |
| Other assets                                             |       | 26,120                                    |       |   |   |   |   | 29,278 |   |   |   |   |   | 28,808 |   |   |   |   |   |
| Less allowance  for loan losses                          |       | (1,739                                    | )          |   |   |   |   | (1,707 | ) |   |   |   |   | (1,593 | ) |   |   |   |   |
| Total average  assets                                    |       | $                                         | 250,118    |   |   |   |   |   | $ | 245,290 |   |   |   |   |   | $ | 237,868 |   |   |   |   |   |
|                                                     |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity:**          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  demand - NOW                           |       | $                                         | 12,636     |   | $ | 41 |   | 0.32 | % | $ | 13,391 |   | $ | 55 |   | 0.41 | % | $ | 14,696 |   | $ | 38 |   | 0.26 | % |
| Money Market                                             |       | 26,070                                    |       | 541 |   | 2.08 | % | 24,929 |   | 722 |   | 2.90 | % | 24,103 |   | 503 |   | 2.09 | % |
| Savings                                                  |       | 26,166                                    |       | 88 |   | 0.34 | % | 27,076 |   | 289 |   | 1.07 | % | 28,074 |   | 222 |   | 0.79 | % |
| Time certificate  of deposits                            |       | 71,671                                    |       | 2,605 |   | 3.63 | % | 68,019 |   | 3,157 |   | 4.64 | % | 55,853 |   | 2,316 |   | 4.15 | % |
| Total average  interest-bearing deposits                 |       | 136,543                                   | ** ** | 3,275 |   | 2.40 | % | 133,415 |   | 4,223 |   | 3.17 | % | 122,726 |   | 3,079 |   | 2.51 | % |
|                                                     |       |                                      | ** ** | ** ** |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                                   |       | 6,612                                     |       | 191 |   | 2.89 | % | 1,059 |   | 51 |   | 4.82 | % | 1,356 |   | 65 |   | 4.79 | % |
| Long-term  borrowings                                    |       | 7,160                                     |       | 411 |   | 5.78 | % | 7,155 |   | 550 |   | 7.69 | % | 5,465 |   | 433 |   | 7.92 | % |
| Total interest-bearing  liabilities                      |       | 150,261                                   |       | 3,877 |   | 2.58 | % | 141,629 |   | 4,824 |   | 3.41 | % | 129,547 |   | 3,577 |   | 2.76 | % |
| Demand deposits                                          |       | 75,752                                    |       |   |   |   |   | 81,714 |   |   |   |   |   | 89,383 |   |   |   |   |   |
| Other liabilities                                        |       | 2,170                                     |       |   |   |   |   | 1,749 |   |   |   |   |   | 1,515 |   |   |   |   |   |
| Sharholder’s  equity                                |       | 21,935                                    |       |   |   |   |   | 20,198 |   |   |   |   |   | 17,423 |   |   |   |   |   |
| Total average  liabilities and shareholders’ equity |       | $                                         | 250,118    |   |   |   |   |   | $ | 245,290 |   |   |   |   |   | $ | 237,868 |   |   |   |   |   |
| Net interest  income                                     |       |                                      |       | $ | 11,399 |   |   |   |   |   | $ | 12,895 |   |   |   |   |   | $ | 13,450 |   |   |   |
| Net interest  margin                                     |       |                                      |       |   |   | 5.05 | % |   |   |   |   | 5.92 | % |   |   |   |   | 6.38 | % |

 

14

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The Company’s net yield on interest-earning assets is affected bychanges in the rates earned and paid and the volume of interest-earning assetsand interest-bearing liabilities. The impact of changes in volume and rate onnet interest  income are shown in thefollowing table:

 
| ** **                                    | ** ** | **Year Ended December 31, 2008** | ** ** | **Year Ended December 31, 2007** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **over**                                             | ** ** | **over**                                             | ** ** |
| ** **                                    | ** ** | **Year Ended December 31, 2007** | ** ** | **Year Ended December 31, 2006** | ** ** |
| ** **                                    | ** ** | **Increase (Decrease) Due to**        | ** ** | **Increase (Decrease) Due to**        | ** ** |
| ** **                                    | ** ** | **Change in (000’s)**                 | ** ** | **Change in (000’s)**                 | ** ** |
| ** **                                    | ** ** | **Volume**                                           | ** ** | **Rate**                                             | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| **Interest-bearing Assets:**                  | ** ** | ** **                                           | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Loans                                     |       | 1,228                                                |       | (3,265                                               | )          | (2,037 | ) | (495 | ) | 129 |   | (366 | ) |
| Investment Securities                         |       | (127                                                 | )          | (53                                                  | )          | (180 | ) | 459 |   | 494 |   | 953 |   |
| Federal funds sold                            |       | (121                                                 | )          | (105                                                 | )          | (226 | ) | 102 |   | 3 |   | 105 |   |
| Interest-earning deposits                     |       | —                                               |       | —                                               |       | — |   | — |   | — |   | — |   |
| Total interest income                         |       | 980                                                  |       | (3,423                                               | )          | (2,443 | ) | 66 |   | 626 |   | 692 |   |
| **Interest-bearing Liabilities:**             |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |
| Interest bearing demand - NOW                 |       | (3                                                   | )          | (11                                                  | )          | (14 | ) | (3 | ) | 20 |   | 17 |   |
| Money Market                                  |       | 32                                                   |       | (213                                                 | )          | (181 | ) | 18 |   | 201 |   | 219 |   |
| Savings                                       |       | (1                                                   | )          | (200                                                 | )          | (201 | ) | — |   | 67 |   | 67 |   |
| Time Certificates of deposit                  |       | 163                                                  |       | (715                                                 | )          | (552 | ) | 542 |   | 299 |   | 841 |   |
| Short-term borrowings                         |       | 167                                                  |       | (27                                                  | )          | 140 |   | (14 | ) | — |   | (14 | ) |
| Long-term borrowings                          |       | 16                                                   |       | (155                                                 | )          | (139 | ) | 16 |   | 101 |   | 117 |   |
| Total interest expense                        |       | 374                                                  |       | (1,321                                               | )          | (947 | ) | 559 |   | 688 |   | 1,247 |   |
| Interest differential or net interest  income |       | $                                                    | 606        |                                                 | $          | (2,102 | ) | $ | (1,496 | ) | $ | (493 | ) | $ | (62 | ) | $ | (555 | ) |
|                                               |            |                                                      |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Noninterest Income***

 

Noninterest income totaled $1,111,000 compared to $1,071,000 for thesame period in 2007. That represents an increase of $40,000 or 3.7%. Theincrease was primarily due to the sale of $5,500,000 in mortgage backedsecurities in the first quarter of 2008 which created a net gain of $108,000.The mortgage backed securities were sold to increase liquidity for theanticipated loan funding during the second and third quarters of 2008.

 

Service charges on deposit accounts totaled $554,000, which representsa decrease of $29,000 or 5.0% over the same period in 2007. The decrease inservices charges was primarily due to the decrease in non sufficient fund feescollected.

 

Other noninterest income totaled $557,000 compared to $488,000 for thesame period in 2007. That represents an increase of $69,000 or 14.1%. Theincrease was primarily due to the sale of $5,500,000 in mortgage backedsecurities in the first quarter of 2008 which created a net gain of $108,000.

 

Refer to the “Statement of Earnings” for a breakdown of noninterestincome.

 

***Noninterest Expense***

 

Noninterest expense increased $734,000 or 8.1% in 2008 over 2007 from$9,029,000 to $9,763,000 as compared to an increase of $439,000 or 5.1% in 2007over 2006. The overall increase can be largely attributed to the continuedgrowth of the Company.

 

Salaries and related expenses increased $391,000 or 7.4% from$5,259,000 in 2007 to $5,650,000 in 2008 compared to an increase of $516,000 or10.9% between 2006 and 2007. This increase is attributed to the addition of anew senior credit administrator and normal salary and benefit relatedincreases.

 

Occupancy expense for the year ended December 31, 2008 totaled$652,000, which reflects an increase of $24,000 or 3.8% over the same period in2007. This was primarily due to an increase in maintenance and repair costscoupled with rising utility costs.

 

Equipment expense for the year ended December 31, 2008 totaled$669,000, which reflects an increase of $3,000 or 0.5% over the same period in2007.

 

Professional services for the year ended December 31, 2008 totaled$601,000, which reflects an increase of $174,000 or 40.8% over the same periodin 2007. This was primarily due to the increases in legal fees related to thecollection of non-accrual loans.

 

Data processing expense for the year ended December 31, 2008totaled $505,000, which reflects an increase of $16,000 or 3.3% from the sameperiod in 2007. This was primarily due to a 3.5% increase in contracted feeswith our data processing service company coupled with the continued growth ofthe Company.

 

Office expenses increased $30,000 from $362,000 in 2007 to $392,000 in2008.

 

Regulatory assessment fees for the year ended December 31, 2008were $168,000, which reflects an increase of $104,000 or 162.5% over the sameperiod in 2007. This was primarily due to the Federal Deposit Insurance ReformAct of 2005, which allowed the Bank to receive a one-time initial assessmentcredit to recognize its past contributions to the insurance fund. The Bank’sone-time assessment credit was $91,592. The Bank’s assessment credit was fullyused by March 2008.

 

15

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Messenger and courier expenses decreased $34,000 or 21.7% from $157,000in 2007 to $123,000 in 2008. This decrease was due to the elimination of amessenger run to Los Angeles when the Bank switched to electronic cash letters.

 

Other expense increased $23,000 or 10.2% from $225,000 in 2007 to$248,000 in 2008. This increase was due to additional loan related expensesassociated with the collection of nonaccrual loans.

 

The Company’s efficiency ratio for 2008 was 78.0%. This represents adecrease from the 2007 efficiency ratio of 64.7%, which was a decrease from the2006 ratio of 60.4%. The increase in the efficiency ratio was primarily due tothe 11.6% decrease in net interest income coupled with an 8.1% increase in noninterest expense.

 

Refer to the “Statement of Earnings” for a breakdown of noninterestexpense.

 

***Income Taxes***

 

The provision for income tax was $633,000 in 2008, $1,934,000 in 2007and $2,242,000 in 2006. The effective tax rate was 35.7% in 2008 as compared to39.1% in 2007 and 39.9% in 2006.

 

**Financial Condition**

 

In 2008, the Company’s consolidated total assets increased to$251,880,000 compared to $248,640,000 in 2007 and $240,738,000 in 2006 forincreases of 1.3%, 3.3% and 4.0% respectively.

 

Total deposits decreased $401,000 to $212,317,000 compared to$212,718,000 in 2007 and $212,988,000 in 2006 for a decrease of 0.2% for 2008,compared to a decrease of 0.1% and 3.0% for 2007 and 2006 respectively. Theslight decrease in deposits appears to be directly related to the currenteconomic cycle that we are experiencing. During 2008, the Bank increased thetotal number of deposit relationships, however the average balance for thoserelationships steadily declined throughout the year causing the decrease indeposits.

 

Securities available for sale totaled $38,470,000 at December 31,2008, compared to $56,107,000 at December 31, 2007 and $42,778,000 at December 31,2006. This represents a decrease of $17,637,000 over December 31, 2007.The decrease in securities was primarily due to the shifting of funds due tothe increase in loan demand coupled with the sale of $5,500,000 in mortgagebacked securities to created liquidity for funding loans.

 

***Loan Portfolio***

 

Total loans outstanding averaged $177,988,000 in 2008 compared to$163,741,000 in 2007. This represents an increase of $14,247,000 or 8.7% in2008 compared to a decrease of $5,398,000 or 3.2% in 2007. Actual net loans at December 31,2008 equaled $186,632,000 for an increase of $20,013,000 or 12.0% over 2007.

 

The following table sets forth the amount of total loans outstanding ineach category for the years indicated:

 
| ** **                                    | ** ** | **Year Ended December 31** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                  | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(dollars in thousands)**      | ** ** |
| Commercial                                    |       | $                                         | 41,478     |   | $ | 38,017 |   | $ | 36,407 |   | $ | 34,139 |   | $ | 32,797 |   |
| Real Estate – construction               |       | 52,389                                    |       | 47,819 |   | 55,307 |   | 52,696 |   | 29,707 |   |
| Real Estate – other                      |       | 94,372                                    |       | 81,895 |   | 78,757 |   | 66,390 |   | 63,433 |   |
| Consumer                                      |       | 1,415                                     |       | 1,237 |   | 1,604 |   | 1,533 |   | 1,570 |   |
| Total gross loans                             |       | 189,654                                   |       | 168,968 |   | 172,075 |   | 154,758 |   | 127,507 |   |
| Less: unearned fees                           |       | (712                                      | )          | (676 | ) | (741 | ) | (725 | ) | (721 | ) |
| Less: allowance for loan losses               |       | (2,310                                    | )          | (1,673 | ) | (1,654 | ) | (1,470 | ) | (1,200 | ) |
| Total net loans                               |       | $                                         | 186,632    |   | $ | 166,619 |   | $ | 169,680 |   | $ | 152,563 |   | $ | 125,586 |   |
| Weighted average yield on loans for the  year |       | 7.3                                       | %          | 9.2 | % | 9.1 | % | 8.1 | % | 7.3 | % |

 

The following table sets forth the amount of total gross loansoutstanding at December 31, 2008 by contractual maturity date:

 
| ** **                      | ** ** | ** **                           | ** ** | **After One**    | ** ** | ** **          | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|-----------------------|------------|---------------------|------------|------------|------------|
| ** **                      | ** ** | **One Year**                    | ** ** | **Year Through** | ** ** | **After**           | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **or Less**                     | ** ** | **Five Years**   | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| ** **                      | ** ** | **(dollars in thousands)** | ** ** |
| Commercial                      |       | $                                    | 23,580     |                  | $          | 10,244              |       | $          | 7,654      |   | $ | 41,478 |   |
| Real Estate – construction |       | 36,269                               |       | 12,396                |       | 3,724               |       | 52,389     |       |
| Real Estate – other        |       | 1,849                                |       | 9,103                 |       | 83,420              |       | 94,372     |       |
| Consumer                        |       | 884                                  |       | 317                   |       | 214                 |       | 1,415      |       |
|                            |       | $                                    | 62,582     |                  | $          | 32,060              |       | $          | 95,012     |   | $ | 189,654 |   |

 

16

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A significant portion of the loan portfolio of the Company is dependenton real estate. At December 31, 2008, real estate served as the principalsource of collateral with respect to 77.4% of the Company’s loan portfolio. Adecline in current economic conditions has had an adverse effect on the demandfor new loans even as rates continue to decline. It is also understood that theability of borrowers to repay outstanding loans, the value of real estate andother collateral securing loans and the value of real estate owned by theCompany, could affect the Company’s financial condition and results ofoperations in general and the market value of the Company’s common stock. Actsof nature, including earthquakes and floods, which may cause uninsured damageand other loss of value to real estate that secures these loans, may alsonegatively impact the Company’s financial condition.

 

Real estate construction and other real estate loans equaled$146,761,000 or 77.4% of the total loan portfolio and $129,714,000 or 76.8% ofthe total loan portfolio at December 31, 2008 and 2007, respectively.Other real estate loans are comprised of loans to individuals for theirbusinesses, consumer real estate loans including home equity lines of creditand loans for farmland, including vineyards. The Company has known for sometime that it has a concentration in commercial real estate loans. As a means tomore closely monitor this concentration, the Company has instituted the use ofNAICS codes to monitor industry trends within its commercial real estateportfolio. As of December 31, 2008, the Company had $82,210,000 or 43.0%of its loans in commercial real estate. Of this number, $48,175,000 or 59.0% iscommercial real estate for owners use. No industry type exceeds 10.0% of totalloans. The remaining $34,035,000 or 41.0% is commercial real estate fornon-owners use. Commercial real estate loans for non-owners use as a percentageof total loans equates to 18.0%. We watch the commercial real estate loans fornon-owners use along with changes within our owners use very closely and arefamiliar with the individuals and projects and at this time we do not foreseeany problems or undue risk in this segment of our portfolio. Total real estateloans increased $17,047,000 or 13.1% in 2008 over 2007 compared to a decreaseof $4,350,000 or 3.1% in 2007 over 2006. The increase is spread throughoutconstruction of residential units held for sale, construction of commercialproperties and commercial income properties. The Company has seen a significantdecrease in the number of residential construction loans, due to the softeningin the real estate market. The Company has loans to customers with a longhistory of successful developments in our market areas, as well as a long-termrelationship with Santa Lucia Bank. The Company has experience and knowledge inconstruction lending and does not feel that there is any undue risk to theCompany. These loans are secured by real estate, and in general, do not exceed75% of the appraised value on commercial residential real estate or 80% on anindividual’s personal residence.

 

The Company makes commercial loans to small and mid-size businesses forvarious reasons, including working capital, inventory and equipment. Commercialloans equaled $41,478,000 or 21.9% of the total loan portfolio and $38,017,000or 22.5% of the total loan portfolio at December 31, 2008 and 2007,respectively. Commercial loans increased $3,461,000 or 9.1% from 2007 to 2008compared to an increase of $1,610,000 or 4.4% in 2007 over 2006.

 

It has always been a part of our business banking practice to loan tosmall businesses for their facilities as well as their other business needs.

 

Consumer and other loans equaled $1,415,000 or 0.8% of the total loanportfolio at December 31, 2008 compared to $1,237,000 or 0.7% at December 31,2007. Consumer loans increased $178,000 or 14.4% in 2008 over 2007 compared toa decrease of $367,000 or 22.9% in 2007 over 2006.

 

The Company had undisbursed loans totaling $57,268,000, $57,326,000,and $56,557,000 as of December 31, 2008, December 31, 2007 and December 31,2006, respectively. Standby Letters of Credit accounted for $3,106,000,$4,286,000 and $2,603,000 of the undisbursed loans as of December 31,2008, December 31, 2007 and December 31, 2006, respectively. TheCompany uses the same credit policies in making these commitments as is donefor all of its lending activities. As such, the credit risk involved in thesetransactions is the same as that involved in extending loan facilities tocustomers.

 

Loans with maturities greater than one year at December 31, 2008include approximately $11,291,000 of fixed rate loans or 6.0% of the total loanportfolio compared to $7,704,000 or 4.6% of the total loan portfolio as of December 31,2007 and $11,060,000 or 6.4% of the total loan portfolio as of December 31,2006. The balance of the loans that have maturities of one year or less, or arevariable rate loans at December 31, 2008 totaled $147,856,000 or 78.0%compared to $161,265,000 or 95.4% as of December 31, 2007 and $161,015,000or 93.6% as of December 31, 2006. The $69.3 million in other real estateloans with five years or greater maturities are primarily owner occupiedcommercial properties. The Company has attempted to lengthen the maturities ofloans in its portfolio to add additional stability to the loan portfolio.

 

17

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***Nonperforming loans***

 

Interest income is accrued daily as earned on all loans. Loans on whichthe accrual of interest has been discontinued are designated as nonaccrualloans. The accrual of interest on loans is discontinued when principal orinterest is past due 90 days based on the contractual terms of the loan orwhen, in the opinion of management, there is reasonable doubt as to collectibility.When loans are placed on nonaccrual status, all interest previously accrued butnot collected is reversed against current period interest income. Income onnonaccrual loans is subsequently recognized only to the extent that cash isreceived and the loan’s principal balance is deemed collectible.

 

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

 
| ** **                                                 | ** ** | **Year Ended December 31** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                  | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | **(dollars in thousands)**      | ** ** |
| **Nonaccrual loans:**                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                 |       | $                                         | 714        |   | $ | 113 |   | $ | — |   | $ | — |   | $ | — |   |
| Real estate                                                |       | 900                                       |       | 2,062 |   | — |   | 135 |   | 758 |   |
| Consumer                                                   |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total                                                      |       | 1,614                                     |       | 2,175 |   | — |   | 135 |   | 758 |   |
| **Loans 90 days or more past due and still  accruing:**    |       |                                      |       |   |   |   |   |   |   |   |   |
| Real estate                                                |       | —                                    |       | — |   | — |   | — |   | — |   |
| Consumer                                                   |       | —                                    |       | — |   | — |   | — |   | — |   |
| Commercial                                                 |       | —                                    |       | — |   | 550 |   | — |   | — |   |
| Total                                                      |       | —                                    |       | — |   | 550 |   | — |   | — |   |
| Total nonperforming loans:                                 |       | 1,614                                     |       | 2,175 |   | 550 |   | 135 |   | 758 |   |
| OREO                                                       |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total nonperforming assets:                                |       | $                                         | 1,614      |   | $ | 2,175 |   | $ | 550 |   | $ | 135 |   | $ | 758 |   |
| Nonperforming assets as a percentage of  total gross loans |       | 0.85                                      | %          | 1.29 | % | 0.32 | % | 0.09 | % | 0.59 | % |
| Nonperforming assets as a percentage of  total assets      |       | 0.64                                      | %          | 0.87 | % | 0.23 | % | 0.06 | % | 0.36 | % |
| Allowance for loan losses to nonperforming  loans          |       | 143.12                                    | %          | 76.92 | % | 300.73 | % | 1088.89 | % | 158.31 | % |

 

The Company had three nonperforming loans totaling $1,614,000 as of December 31,2008, compared to one nonperforming loan totaling $2,175,000 at December 31,2007 and one nonperforming loan totaling $550,000 at December 31, 2006.

 

The first loan is for $900,000 and is secured by unimproved realestate. The guarantors are financially strong and overall potential for loss isfelt to be minimal. The second loan is for $581,368 and is secured by a 1stTrust Deed on a single family residence and loss potential is felt to benominal. The third loan is for $132,278 and is secured by equipment and theBank feels that there is some loss potential with this credit.

 

There were no significant loans that were current as of December 31,2008, where serious doubt existed as to the ability of the borrower to complywith the present loan repayment terms or that represent a “troubled debtrestructuring.”

 

The Company had no “Other Real Estate Owned” (OREO) property as of December 31,2008.

 

The Company experienced net charge-offs (recoveries) of $338,000,($19,000) and $56,000 in 2008, 2007 and 2006 respectively.

 

***Quality of loans***

 

Inherent in lending is the fact that loan losses will be experienced andthat the risk of loss will vary with the type of loan extended and thecreditworthiness of the borrower. To reflect the estimated risks of lossassociated with its loan portfolio, provisions are made to the Company’sallowance for possible loan losses. As an integral part of this process, theallowance for possible loan losses is subject to review and possible adjustmentas a result of regulatory examinations conducted by governmental agencies andthrough management’s assessment of risk. The Company’s entire allowance is avaluation allocation; that is, it has been created by direct charges againstoperations through the provision for possible loan losses.

 

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

 

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

 

18

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in all significant loans; known deterioration in concentrations ofcredit; certain classes of loans or pledged collateral; historical lossexperience based on volume and type of loan; the results of any independentreview or evaluation of the loan portfolio quality conducted by or at thedirection of the Company’s management or by bank regulatory agencies; trends inportfolio volume, maturity, and composition; off-balance sheet credit risk;volume and trends in delinquencies and nonaccruals; lending policies andprocedures including those for charge-off, collection, and recovery; nationaland local economic conditions and downturns in specific local industries; andthe experience, ability, and depth of the lending staff and management. TheCompany evaluates the adequacy of its allowance for possible loan lossesquarterly.

 

The following table summarizes the allocation of the allowance for loanlosses by type for the years indicated and the percent of loans in eachcategory to total loans:

 
| ** **                 | ** ** | **Year Ended December 31** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                  | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**      | ** ** |
| ** **                 | ** ** | **Amount**                                | ** ** | **Loan   Percent** | ** ** | **Amount** | ** ** | **Loan   Percent** | ** ** | **Amount** | ** ** | **Loan   Percent** | ** ** | **Amount** | ** ** | **Loan   Percent** | ** ** | **Amount** | ** ** | **Loan   Percent** | ** ** |
| Commerical                 |       | $                                         | 696        |   | 21.87 | % | $ | 525 |   | 22.50 | % | $ | 495 |   | 21.16 | % | $ | 536 |   | 22.06 | % | $ | 502 |   | 25.72 | % |
| Real Estate - construction |       | 483                                       |       | 27.62 | % | 229 |   | 28.30 | % | 126 |   | 32.14 | % | 118 |   | 34.05 | % | 71 |   | 23.30 | % |
| Real Estate - other        |       | 1,073                                     |       | 49.76 | % | 572 |   | 48.47 | % | 362 |   | 45.77 | % | 274 |   | 42.90 | % | 281 |   | 49.75 | % |
| Consumer                   |       | 39                                        |       | 0.75 | % | 32 |   | 0.73 | % | 38 |   | 0.93 | % | 36 |   | 0.99 | % | 39 |   | 1.23 | % |
| Unallocated                |       | 19                                        |       | n/a |   | 315 |   | n/a |   | 633 |   | n/a |   | 506 |   | n/a |   | 307 |   | n/a |   |
| Total                      |       | $                                         | 2,310      |   | 100.00 | % | $ | 1,673 |   | 100.00 | % | $ | 1,654 |   | 100.00 | % | $ | 1,470 |   | 100.00 | % | $ | 1,200 |   | 100.00 | % |

 

The Company increased the provision for loan loss $975,000 during thetwelve month period ending December 31, 2008 compared to no provisionduring the same period in 2007. The primary reason for this is to support the12.2% growth in the loan portfolio coupled with additional reserves that theCompany has taken for loans that are on non-accrual and those loans charged offin 2008.

 

Management views the allowance for loan losses of $2,310,000 or 1.22%of total loans as of December 31, 2008 to be adequate after consideringthe above factors. This allowance is compared to $1,673,000 or .99% in 2007 and$1,654,000 or .96% in 2006. However, there can be no assurance that in anygiven period the Company will not sustain charge-offs that are substantial inrelation to the size of the allowance.

 

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

 
| ** **                                                                   | ** ** | **Year Ended December 31** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                  | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | **(dollars in thousands)**      | ** ** |
| **Outstanding loans:**                                                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Average for the year (net)                                                   |       | $                                         | 177,988    |   | $ | 163,741 |   | $ | 169,139 |   | $ | 145,195 |   | $ | 115,255 |   |
| End of the year (net)                                                        |       | 186,632                                   |       | 166,619 |   | 169,680 |   | 152,563 |   | 125,586 |   |
| Allowance for loan losses:                                                   |       |                                      |       |   |   |   |   |   |   |   |   |
| Balance at beginning of year                                                 |       | $                                         | 1,673      |   | $ | 1,654 |   | $ | 1,470 |   | $ | 1,200 |   | $ | 1,112 |   |
| Actual charge-offs:                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                                   |       | 308                                       |       | 51 |   | 77 |   | 43 |   | 22 |   |
| Real estate                                                                  |       | —                                    |       | — |   | — |   | — |   | — |   |
| Consumer                                                                     |       | 31                                        |       | — |   | — |   | — |   | — |   |
| All other (including overdrafts)                                             |       | 13                                        |       | 10 |   | 6 |   | 3 |   | 1 |   |
| Total charge-offs                                                            |       | 352                                       |       | 61 |   | 83 |   | 46 |   | 23 |   |
| **Less Recoveries:**                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                                   |       | 12                                        |       | 4 |   | 26 |   | 15 |   | — |   |
| Real estate                                                                  |       | —                                    |       | 76 |   | — |   | — |   | — |   |
| Consumer                                                                     |       | —                                    |       | — |   | — |   | — |   | — |   |
| All other (including overdrafts)                                             |       | 2                                         |       | — |   | 1 |   | 1 |   | 1 |   |
| Total recoveries                                                             |       | 14                                        |       | 80 |   | 27 |   | 16 |   | 1 |   |
| Net loan charge-offs (recoveries)                                            |       | 338                                       |       | (19 | ) | 56 |   | 30 |   | 22 |   |
| Provision for loan loss                                                      |       | 975                                       |       | — |   | 240 |   | 300 |   | 110 |   |
| Balance at end of period                                                     |       | $                                         | 2,310      |   | $ | 1,673 |   | $ | 1,654 |   | $ | 1,470 |   | $ | 1,200 |   |
| **Ratios:**                                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Net loan charge-offs (recoveries) to  average loans                          |       | 0.19                                      | %          | -0.01 | % | 0.03 | % | 0.02 | % | 0.02 | % |
| Allowance for loan losses to end of year  loans                              |       | 1.22                                      | %          | 0.99 | % | 0.96 | % | 0.95 | % | 0.94 | % |
| Net loan charge-offs (recoveries) to  allowance for loan losses              |       | 14.63                                     | %          | -1.14 | % | 3.39 | % | 2.04 | % | 1.83 | % |
| Net loan charge-offs (recoveries) to  provision charged to operating expense |       | 34.67                                     | %          | 0.00 | % | 23.33 | % | 10.00 | % | 20.00 | % |

 

19

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***Investment Securities***

 

Theaverage balance of Federal Funds Sold (overnight investments with other banks)was $1,309,000 in 2008, $4,954,000 in 2007, and $2,941,000 in 2006. Theseinvestments are maintained primarily for the short-term liquidity needs of theCompany. The major factors influencing the levels of required liquidity are theloan demand of the Company’s customers and fluctuations in the Company’sdeposits. The Company’s loan-to-deposit ratio averaged 83.8% in 2008, comparedto 76.1% in 2007, and 79.7% in 2006.

 

Averagetotal investment securities decreased by $2,584,000 or 5.3% during 2008,compared to an increase of $10,451,000 or 27.1% in 2007. The decrease insecurities was primarily due to the shifting of funds due to the increase inloan demand coupled with the sale of $5,500,000 in mortgage backed securitiesto created liquidity for funding loans. The aggregate market value of theinvestment portfolio was $847,000 over the amortized cost as of December 31,2008. As of December 31, 2008, the Company had the ability and intent tohold securities to maturity and saw a significant market value increase of$513,000 over 2007. It is the Company’s policy not to engage in securitiestrading transactions. There are no investments in the portfolio deemed to bepermanently impaired. The Company has classified all of its investmentsecurities as available for sale. The exposure to sub prime loans in theMortgage-Backed securities portfolio is minimal due to the fact thesesecurities are guaranteed by United States Government Agencies and, as such,can be viewed as having credit risk comparable to United States Treasurysecurities.

 
| ** **                             | ** ** | **December 31**      | ** ** |
|----------------------------------------|------------|---------------------------|------------|
| ** **                             | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **Amortized   Cost** | ** ** | **Unrealized   Gains** | ** ** | **Unrealized   (Losses)** | ** ** | **Estimated   Fair Value** | ** ** | **Amortized   Cost** | ** ** | **Unrealized   Gains** | ** ** | **Unrealized   (Losses)** | ** ** | **Estimated   Fair Value** | ** ** |
| **Securities  available for sale:**    |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Government  and Agency securities |       | $                         | 16,093,125 |   | $ | 565,115 |   | $ | — |   | $ | 16,658,240 |   | $ | 24,097,314 |   | $ | 243,699 |   | $ | — |   | $ | 24,341,013 |   |
| State and  Political Subdivisions      |       | 5,742,575                 |       | 49,245 |   | (51,056 | ) | 5,740,764 |   | 6,527,226 |   | 30,399 |   | (50,333 | ) | 6,507,292 |   |
| Mortgage-Backed  Securities            |       | 15,787,914                |       | 345,063 |   | (61,505 | ) | 16,071,472 |   | 25,148,131 |   | 207,770 |   | (97,050 | ) | 25,258,851 |   |
| Total                                  |       | $                         | 37,623,614 |   | $ | 959,423 |   | $ | (112,561 | ) | $ | 38,470,476 |   | $ | 55,772,671 |   | $ | 481,868 |   | $ | (147,383 | ) | $ | 56,107,156 |   |

 

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

 
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2008**              | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | ** **            | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                     | ** ** | **Book**              | ** ** | **Market** | ** ** | **Average** | ** ** | **Book** | ** ** | **Market** | ** ** | **Average** | ** ** |
| ** **                                     | ** ** | **Value**             | ** ** | **Value** | ** ** | **Yield** | ** ** | **Value** | ** ** | **Value** | ** ** | **Yield** | ** ** |
| **Available-for-Sale Securities:**             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and Agency Securities          |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                               |       | $                     | 4,103,572  |   | $ | 4,216,776 |   | 5.11 | % | $ | 8,002,724 |   | $ | 8,026,354 |   | 5.27 | % |
| One to Five Years                              |       | 11,989,553            |       | 12,441,464 |   | 5.05 | % | 14,094,590 |   | 14,310,616 |   | 5.07 | % |
| Five to Ten Years                              |       | —                |       | — |   | 0.00 | % | 2,000,000 |   | 2,004,043 |   | 5.00 | % |
| Over Ten Years                                 |       | —                |       | — |   |   |   | — |   | — |   |   |   |
| Total U.S. Agency                              |       | 16,093,125            |       | 16,658,240 |   | 5.06 | % | 24,097,314 |   | 24,341,013 |   | 5.13 | % |
| **State and Political Subdivisions:**          |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                               |       | 2,017,532             |       | 2,028,376 |   | 4.57 | % | 1,061,296 |   | 1,070,745 |   | 6.23 | % |
| One to Five Years                              |       | 1,482,818             |       | 1,493,854 |   | 6.02 | % | 3,020,931 |   | 2,998,510 |   | 4.99 | % |
| Five to Ten Years                              |       | 2,242,225             |       | 2,218,534 |   | 6.17 | % | 2,444,999 |   | 2,438,037 |   | 6.26 | % |
| Over Ten Years                                 |       | —                |       | — |   |   |   | — |   | — |   |   |   |
| Total State & Political  Subdivisions |       | 5,742,575             |       | 5,740,764 |   | 5.57 | % | 6,527,226 |   | 6,507,292 |   | 5.67 | % |
| **Mortgage Backed Securities:**                |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                               |       | 3,797,529             |       | 3,830,610 |   | 4.35 | % | 3,430,820 |   | 3,441,374 |   | 4.70 | % |
| One to Five Years                              |       | 6,763,493             |       | 6,876,346 |   | 4.65 | % | 14,849,863 |   | 14,894,034 |   | 4.66 | % |
| Five to Ten Years                              |       | 2,069,490             |       | 2,135,980 |   | 5.05 | % | 3,869,173 |   | 3,907,814 |   | 5.05 | % |
| Over Ten Years                                 |       | 3,157,402             |       | 3,228,536 |   | 5.08 | % | 2,998,275 |   | 3,015,629 |   | 4.90 | % |
| Total Mortgage Backed Securities               |       | 15,787,914            |       | 16,071,472 |   | 4.72 | % | 25,148,131 |   | 25,258,851 |   | 4.75 | % |
| Total Available-for-Sale Securities            |       | $                     | 37,623,614 |   | $ | 38,470,476 |   | 5.00 | % | $ | 55,772,671 |   | $ | 56,107,156 |   | 5.02 | % |

 

20

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***Deposits***

 

Totalaverage deposits decreased $1,834,000 or 1.3% during 2008, compared to anincrease of $3,020,000 or 1.4% in 2007 and an increase of $4,391,000 or 2.1% in2006. Average noninterest-bearing deposits decreased $5,962,000 or 7.3% in2008, compared to a decrease of $7,669,000 or 8.6% in 2007 and an increase of$1,017,000 or 1.2% in 2006. Average interest-bearing deposits increased$3,128,000 or 2.3% in 2008 compared to an increase of $10,689,000 or 8.7% in2007 and an increase of $3,374,000 or 2.8% in 2006.

 

Thechart below indicates a shift in noninterest bearing demand deposits along withlower interest-bearing deposits (NOW, Money Market and Savings) to higherinterest rate Time Certificates of Deposit. This appears to be a trend that iscommon throughout the local banking industry and is expected to continue in2009. It was management’s strategy to retain and attract deposits to offsetloss of funds to non-bank competition. Management believes the decrease intotal average deposits is not due to the loss of accounts but is attributed tolower average balances held in the accounts.

 

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

 
| ** **                          | ** ** | **December 31**                 | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **2008**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                          | ** ** | **Average   Balance**           | ** ** | **Average   Rate** | ** ** | **Average   Balance** | ** ** | **Average   Rate** | ** ** | **Average   Balance** | ** ** | **Average   Rate** | ** ** |
| ** **                          | ** ** | **(dollars in thousands)** | ** ** |
| Noninterest-bearing demand deposits |       | $                                    | 75,752     |   | 0.00 | % | $ | 81,714 |   | 0.00 | % | $ | 89,383 |   | 0.00 | % |
| Money Market Accounts               |       | 26,070                               |       | 2.08 | % | 24,929 |   | 2.90 | % | 24,103 |   | 2.09 | % |
| NOW accounts                        |       | 12,636                               |       | 0.32 | % | 13,391 |   | 0.41 | % | 14,696 |   | 0.26 | % |
| Savings deposits                    |       | 26,166                               |       | 0.34 | % | 27,076 |   | 1.07 | % | 28,074 |   | 0.79 | % |
| Time deposits of $100,000 or more   |       | 39,021                               |       | 3.62 | % | 39,242 |   | 4.67 | % | 29,800 |   | 4.21 | % |
| Other time deposits                 |       | 32,650                               |       | 3.66 | % | 28,777 |   | 4.60 | % | 26,053 |   | 4.08 | % |
| Total deposits                      |       | $                                    | 212,295    |   | 1.54 | % | $ | 215,129 |   | 1.96 | % | $ | 212,109 |   | 1.45 | % |

 

Theremaining maturities of the Company’s certificates of deposit in the amount of$100,000 or more as of December31, 2008 are indicated in the table below. Interest expense on thesecertificates of deposit totaled $1,411,000 in 2008:

 
| **Deposits Maturing in**    | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| Three months or less                  |       | $                               | 16,157,031 |   |
| Over three months through six months  |       | 6,906,878                       |       |
| Over six months through twelve months |       | 12,265,698                      |       |
| Over twelve months                    |       | 2,563,862                       |       |
| Total                                 |       | $                               | 37,893,469 |   |

 

***Capital***

 

TheBank is required to maintain a minimum leverage-capital ratio of Tier I (asdefined to total assets based on the Bank’s ratings under the regulatory ratingsystem. At the end of 2008, all Bank capital ratios were above all currentFederal capital guidelines for a “well capitalized” bank. As of December 31,2008 the regulatory total capital to risk-weighted assets ratio was 15.17%compared to 13.8% as of December 31, 2007 and 13.1% as of December 31,2006. The regulatory Tier I capital to risk-weighted assets ratio was 13.7% on December 31,2008 compared to 12.3% on December 31, 2007 and 11.4% as of December 31,2006. The regulatory Tier I capital to average assets ratio was 11.4% as of December 31,2008 compared to 9.9% as of December 31, 2007 and 9.1% as of December 31,2006.

 

Theincrease in the capital ratios for 2008 was primarily due to the Company’sparticipation in the United States Treasury’s Capital Purchase Program. TheCompany entered into a Letter Agreement on December 19, 2008 with theUnited States Department of Treasury, where the Company agreed to issue andsell 4,000 shares of the Company’s Preferred Stock and a warrant to purchase37,360 shares of the Company’s Common Stock for an aggregate purchase price of$4,000,000 in cash. The Preferred Stock will qualify as Tier 1 capital and willpay cumulative dividends at a rate of 5% per annum for the first five years and9% per annum thereafter. It is the Company’s present intention to repay thecapital within the five year time frame. The warrant has a 10-year term and isimmediately exercisable upon its issuance, with an exercise price equal to$16.06 per share of the Common Stock.

 

Thefactors that led the Company to the decision to participate in the CapitalPurchase Program include the following:

 

1.             Replace the $2,000,000 subordinated debt that will berepaid by June of 2011.

2.             Allow the Company to continue to grow and support itscommunity.

3.             Provide for the many unknowns in the current economicenvironment.

 

***Short-term Borrowings***

 

TheBank has two borrowing arrangements with the Federal Home Loan Bank of SanFrancisco. The first allows the Bank to borrow up to approximately $43.6million against which the Bank could pledge approximately $127.5 million of itsreal estate secured loans. The second arrangement allows the Bank to borrow upto approximately $13.1 million against which the Bank has pledged approximately$13.4 million of its investment securities.

 

21

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Asof December 31, 2008 the Bank had borrowed $5,000,000 under thesearrangements. The $5,000,000 is a one year commitment that will mature on July 9,2009 at a rate of 2.91%. During 2008 the bank had average short-term borrowingsof $6,612,000 at an effective rate of 2.89%.

 

***Long-term Borrowings***

 

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

 

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

 

***Interest Rate Sensitivity and Liquidity***

 

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

 

Thefollowing table presents the Bank’s Rate Sensitivity Gap Report as of December 31,2008.

 
| ** **                             | ** ** | **0-3 months**                  | ** ** | **3-12 months** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Beyond** | ** ** | **Non-Rate   Sensitive** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|------------|------------|-------------------------------|------------|-----------|------------|
| ** **                             | ** ** | **(dollars in thousands)** | ** ** |
| **Interest sensitive assets:**         |       |                                 |       |                 |       |               |       |               |       |       |       |                          |       |      |       |
| Investment securities                  |       | $                                    | 3,310      |                 | $          | 5,530              |       | $                  | 7,257      |       | $          | 14,761                        |       | $         | 8,282      |   | $ | — |   | $ | 39,140 |   |
| Loan receivables                       |       | 78,745                               |       | 32,923               |       | 53,431             |       | 22,090             |       | 2,465      |       | —                        |       | 189,654   |       |
| Federal funds sold                     |       | —                               |       | —               |       | —             |       | —             |       | —     |       | —                        |       | —    |       |
| Non-earning assets                     |       | —                               |       | —               |       | —             |       | —             |       | —     |       | 22,210                        |       | 22,210    |       |
| **Total assets**                       |       | $                                    | 82,055     |                 | $          | 38,453             |       | $                  | 60,688     |       | $          | 36,851                        |       | $         | 10,747     |   | $ | 22,210 |   | $ | 251,004 |   |
| ** **                             |       |                                 |       |                 |       |               |       |               |       |       |       |                          |       |      |       |
| **Interest sensitive liabilities:**    |       |                                 |       |                 |       |               |       |               |       |       |       |                          |       |      |       |
| Demand deposits                        |       | $                                    | —     |                 | $          | —             |       | $                  | —     |       | $          | —                        |       | $         | —     |   | $ | 74,926 |   | $ | 74,926 |   |
| NOW accounts                           |       | 375                                  |       | 1,126                |       | 3,004              |       | 3,003              |       | 5,381      |       | —                        |       | 12,889    |       |
| Money Market Accounts                  |       | 2,596                                |       | 7,788                |       | 17,308             |       | —             |       | —     |       | —                        |       | 27,692    |       |
| Savings deposits                       |       | 934                                  |       | 2,801                |       | 7,470              |       | 7,470              |       | 7,781      |       | —                        |       | 26,456    |       |
| Time deposits                          |       | 28,617                               |       | 33,981               |       | 8,331              |       | 540                |       | 134        |       | —                        |       | 71,603    |       |
| Total saving and time deposits         |       | $                                    | 32,522     |                 | $          | 45,696             |       | $                  | 36,113     |       | $          | 11,013                        |       | $         | 13,296     |   | $ | 74,926 |   | $ | 213,566 |   |
| Short-term borrowing                   |       | —                               |       | 5,000                |       | —             |       | —             |       | —     |       | —                        |       | 5,000     |       |
| Long-term borrowing                    |       | 1,667                                |       | —               |       | —             |       | —             |       | —     |       | —                        |       | 1,667     |       |
| Non-funding liabilities and capital    |       | —                               |       | —               |       | —             |       | —             |       | —     |       | 30,771                        |       | 30,771    |       |
| Total liabilities and capital          |       | $                                    | 34,189     |                 | $          | 50,696             |       | $                  | 36,113     |       | $          | 11,013                        |       | $         | 13,296     |   | $ | 105,697 |   | $ | 251,004 |   |
| **Interest rate sensitivity gap**      |       | $                                    | 47,866     |                 | $          | (12,243            | )          | $                  | 24,575     |       | $          | 25,838                        |       | $         | (2,549     | ) |   |   |   |   |
| ** **                             |       |                                 |       |                 |       |               |       |               |       |       |       |                          |       |      |       |
| **Risk Indicators from GAP Analysis:** |       |                                 |       |                 |       |               |       |               |       |       |       |                          |       |      |       |
| Cumulative GAP                         |       | $                                    | 47,866     |                 | $          | 35,623             |       | $                  | 60,198     |       | $          | 86,036                        |       | $         | 83,487     |   |   |   |   |   |
| Cumulative GAP (% of total assets)     |       | 19.07                                | %          | 14.19                | %          | 23.98              | %          | 34.28              | %          | 33.26      | %          |                          |       |      |       |

 

22

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Theasset liability reports indicate that the Bank has an actual dollar riskexposure of -$40,000 if interest rates fall 100 basis points. This represents a-0.4% risk to interest income.

 
| ** **              | ** ** | **Interest Income and Expense Under Rate Shock** | ** ** |
|-------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **              | ** ** | **-200bp**                                                                     | ** ** | **-100bp** | ** ** | **0bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** |
|                    |       |                                                                           |       |   |   |   |   |   |   |   |   |
| **Net Interest Income** |       |                                                                           |       |   |   |   |   |   |   |   |   |
| Earnings at Risk        |       | $                                                                              | (16        | ) | $ | (40 | ) | $ | 0 |   | $ | 103 |   | $ | 333 |   |
| Percent of Risk         |       | -0.1                                                                           | %          | -4.0 | % | 0.00 | % | 0.9 | % | 3.0 | % |
| **Equity Ratio**        |       | 11.87                                                                          | %          | 13.42 | % | 14.97 | % | 16.18 | % | 17.36 | % |
|                         |            |                                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

TheCompany closely monitors its liquidity so that the cash requirements for loansand deposit withdrawals are met in an orderly manner. Management monitorsliquidity in relation to trends of loans and deposits for short term andlong-term requirements. Liquidity sources are cash, deposits with other banks,overnight Federal Fund investments, investment securities and the ability tosell loans. As of December 31, 2008, the Bank’s liquidity ratio was 20.2%compared to 25.0% at December 31, 2007 and 24.5% at December 31,2006. The 20.2% liquidity ratio at December 31, 2008 is within the Company’spolicy limit.

 

**Critical Accounting Policies**

 

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

 

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

 

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

 

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

 

***Allowance for Loan Losses***

 

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

 

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

 

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

 

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

 

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

 

23

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***Deferred Tax Assets***

 

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

 

***Deferred Compensation Liabilities***

 

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

 

**Availability of Form 10-KSB**

 

**If any shareholder would like a copy of the Company’s AnnualReport on Form 10-KSB for the fiscal year ending December 31, 2008,they can be obtained without charge by sending a written request to James M.Cowan, Executive Vice President and Chief Financial Officer, P. O. Box 6047,Atascadero, California 93423.**

 

24

----

** **

** **

**Report of Independent Registered Public Accounting Firm**

 

The Board of Directors and Shareholders 

Santa Lucia Bancorp and Subsidiary

 

We have audited theconsolidated balance sheets of Santa Lucia Bancorp and Subsidiary (the Company)as of December 31, 2008 and 2007, and the related consolidated statementsof earnings, cash flows and shareholders’ equity for the three years ended December 31,2008. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of Santa Lucia Bancorp and Subsidiary as of December 31,2008 and 2007, and the results of its operations and cash flows for the threeyears ended December 31, 2008, in conformity with accounting principlesgenerally accepted in the United States of America.

 

 

Laguna Hills, California 

January 30, 2009

 

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

 

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

 

25

----

 

**Santa Lucia Bancorp and Subsidiary**

** **

**Consolidated Balance Sheets**

 

*December 31, 2008 and 2007*

* *

**ASSETS**

 
| ** **                                                      | ** ** | **2008**    | ** **  | **2007**    | ** ** |
|-----------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| ** **                                                      | ** ** | ** **  | ** **  | ** **  | ** ** |
| Cash and due from banks                                         |       | $           | 8,220,406   |        | $          | 7,399,412 |   |
| Federal funds sold                                              |       | —      |        | —      |       |
| TOTAL CASH  AND CASH EQUIVALENTS                                |       | 8,220,406   |        | 7,399,412   |       |
| Securities available for sale                                   |       | 38,470,476  |        | 56,107,156  |       |
| Loans, net                                                      |       | 186,631,960 |        | 166,619,494 |       |
| Premises and equipment, net                                     |       | 8,624,148   |        | 8,868,507   |       |
| Deferred income tax assets                                      |       | 974,000     |        | 814,000     |       |
| Cash surrender value of life insurance                          |       | 5,194,688   |        | 5,005,357   |       |
| Federal Reserve Bank and Federal Home Loan  Bank stock, at cost |       | 1,516,850   |        | 1,453,850   |       |
| Accrued interest and other assets                               |       | 2,246,995   |        | 2,371,999   |       |
| TOTAL ASSETS                                                    |       | $           | 251,879,523 |        | $          | 248,639,775 |   |

 

**LIABILITIES & SHAREHOLDERS’ EQUITY**

 
| ** **                                                                                                                                                                          | ** ** | **2008**    | ** **  | **2007**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| Deposits                                                                                                                                                                            |       |        |        |        |       |
| Noninterest-bearing demand                                                                                                                                                          |       | $           | 75,155,323  |        | $          | 77,100,561 |   |
| Interest-bearing demand and NOW accounts                                                                                                                                            |       | 12,888,894  |        | 11,996,402  |       |
| Money market                                                                                                                                                                        |       | 26,214,153  |        | 25,440,394  |       |
| Savings                                                                                                                                                                             |       | 26,754,057  |        | 26,336,827  |       |
| Time certificates of deposit of $100,000 or  more                                                                                                                                   |       | 37,893,469  |        | 38,829,793  |       |
| Other time certificates                                                                                                                                                             |       | 33,410,702  |        | 33,014,401  |       |
| TOTAL DEPOSITS                                                                                                                                                                      |       | 212,316,598 |        | 212,718,378 |       |
| Short-term borrowings                                                                                                                                                               |       | 5,000,000   |        | 5,900,000   |       |
| Long-term borrowings                                                                                                                                                                |       | 6,821,644   |        | 7,155,000   |       |
| Accrued interest and other liabilities                                                                                                                                              |       | 2,190,584   |        | 1,677,551   |       |
| TOTAL LIABILITIES                                                                                                                                                                   |       | 226,328,826 |        | 227,450,929 |       |
| Commitments and contingencies***(Note M)*                                                                                                                                           | * *   | *—*    | * *    | *—*    | * *   |
| Shareholders’ equity                                                                                                                                                           |       |        |        |        |       |
| Preferred Stock - Series A                                                                                                                                                     |       | 3,799,003   |        | —      |       |
| Common stock – no par value; 20,000,000  shares authorized; issued and outstanding: 1,923,053 shares at  December 31, 2008 and 1,924,873 shares at December 31, 2007 |       | 9,894,507   |        | 9,851,392   |       |
| Additional paid-in capital                                                                                                                                                          |       | 676,734     |        | 358,203     |       |
| Retained earnings                                                                                                                                                                   |       | 10,682,922  |        | 10,782,741  |       |
| Accumulated other comprehensive income-net  unrealized losses on available-for-sale securities, net of taxes of $349,330  in 2008 and $137,975 in 2007                              |       | 497,531     |        | 196,510     |       |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                                                     |       | 25,550,697  |        | 21,188,846  |       |
| TOTAL LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                    |       | $           | 251,879,523 |        | $          | 248,639,775 |   |

 

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

 

26

----

 

**Santa Lucia Bancorp and Subsidiary**

** **

**Consolidated Statements of Earnings**

 

*Years Ended December 31, 2008, 2007 and 2006*

 
| ** **                                           | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                 |       |       |       |       |       |       |       |
| Interest income                                      |       |       |       |       |       |       |       |
| Interest and fees on loans                           |       | $          | 12,994,444 |       | $          | 15,030,928 |       | $ | 15,397,450 |   |
| Federal funds sold                                   |       | 24,487     |       | 249,434    |       | 145,314    |       |
| Investment securities – taxable                 |       | 2,051,637  |       | 2,232,966  |       | 1,352,675  |       |
| Investment securities – nontaxable              |       | 205,934    |       | 205,285    |       | 131,233    |       |
|                                                 |       | 15,276,502 |       | 17,718,613 |       | 17,026,672 |       |
|                                                 |       |       |       |       |       |       |       |
| Interest expense                                     |       |       |       |       |       |       |       |
| Time certificates of deposit of $100,000 or  more    |       | 1,411,081  |       | 1,833,831  |       | 1,254,951  |       |
| Other deposits                                       |       | 1,863,907  |       | 2,389,580  |       | 1,824,577  |       |
| Long-term debt and other borrowings                  |       | 602,120    |       | 600,727    |       | 497,610    |       |
|                                                 |       | 3,877,108  |       | 4,824,138  |       | 3,577,138  |       |
| Net interest income                                  |       | 11,399,394 |       | 12,894,475 |       | 13,449,534 |       |
| Provision for loan losses                            |       | 975,000    |       | —     |       | 240,000    |       |
| Net interest income after provision for  loan losses |       | 10,424,394 |       | 12,894,475 |       | 13,209,534 |       |
|                                                 |       |       |       |       |       |       |       |
| Noninterest income                                   |       |       |       |       |       |       |       |
| Service charges and fees                             |       | 554,018    |       | 583,445    |       | 615,917    |       |
| Dividends on cash surrender value of life  insurance |       | 230,010    |       | 222,071    |       | 138,181    |       |
| Gain on sale of investment securities                |       | 108,163    |       | —     |       | —     |       |
| Other income                                         |       | 218,574    |       | 265,798    |       | 256,163    |       |
|                                                 |       | 1,110,765  |       | 1,071,314  |       | 1,010,261  |       |
|                                                 |       |       |       |       |       |       |       |
| Noninterest expense                                  |       |       |       |       |       |       |       |
| Salaries and employee benefits                       |       | 5,650,160  |       | 5,259,456  |       | 4,743,094  |       |
| Occupancy                                            |       | 652,335    |       | 627,685    |       | 664,482    |       |
| Equipment                                            |       | 669,527    |       | 666,003    |       | 691,028    |       |
| Professional services                                |       | 600,977    |       | 426,667    |       | 538,282    |       |
| Data processing                                      |       | 504,688    |       | 488,636    |       | 468,211    |       |
| Office expenses                                      |       | 391,655    |       | 362,057    |       | 359,588    |       |
| Marketing                                            |       | 427,635    |       | 422,914    |       | 407,638    |       |
| Regulatory assessments                               |       | 168,090    |       | 64,436     |       | 63,851     |       |
| Directors’ fees and expenses                    |       | 326,792    |       | 328,801    |       | 263,444    |       |
| Messenger and courier expenses                       |       | 122,833    |       | 156,870    |       | 148,335    |       |
| Other                                                |       | 248,563    |       | 225,445    |       | 241,571    |       |
|                                                 |       | 9,763,255  |       | 9,028,970  |       | 8,589,524  |       |
| Earnings before income taxes                         |       | 1,771,904  |       | 4,936,819  |       | 5,630,271  |       |
| Income taxes                                         |       | 633,000    |       | 1,934,000  |       | 2,242,000  |       |
| Net earnings                                         |       | $          | 1,138,904  |       | $          | 3,002,819  |       | $ | 3,388,271 |   |
|                                                 |       |       |       |       |       |       |       |
| Per share data:                                      |       |       |       |       |       |       |       |
|                                                 |       |       |       |       |       |       |       |
| Net earnings – basic                            |       | $          | 0.59       |       | $          | 1.55       |       | $ | 1.77 |   |
|                                                 |       |       |       |       |       |       |       |
| Net earnings – diluted                          |       | $          | 0.58       |       | $          | 1.51       |       | $ | 1.68 |   |

 

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

 

27

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**Santa Lucia Bancorp and Subsidiary**

** **

**Consolidated Statements of Cash Flows**

 

*Years Ended December 31, 2008, 2007 and 2006*

 
| ** **                                                                           | ** ** | **2008**    | ** ** | **2007**    | ** ** | **2006**    | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
|                                                                                 |       |        |       |        |       |        |       |
| Cash flows from operating activities:                                                |       |        |       |        |       |        |       |
| Net earnings                                                                         |       | $           | 1,138,904  |        | $          | 3,002,819   |       | $ | 3,388,271 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities: |       |        |       |        |       |        |       |
| Depreciation and amortization                                                        |       | 643,241     |       | 652,290     |       | 669,159     |       |
| Provision for loan losses                                                            |       | 975,000     |       | —      |       | 240,000     |       |
| Loss (gain) on sale of investment  securities                                        |       | (108,163    | )          | —      |       | —      |       |
| Deferred income taxes                                                                |       | (371,000    | )          | (201,000    | )          | (147,000    | )          |
| Dividends in cash value of life insurance                                            |       | (230,010    | )          | (222,071    | )          | (138,181    | )          |
| Other items, net                                                                     |       | 789,187     |       | 1,101,676   |       | (1,126,265  | )          |
| Net cash provided by operating activities                                            |       | 2,837,159   |       | 4,333,714   |       | 2,885,984   |       |
|                                                                                 |       |        |       |        |       |        |       |
| Cash flows from investing activities:                                                |       |        |       |        |       |        |       |
| Proceeds from maturities of investment  securities                                   |       | 12,616,836  |       | 14,202,010  |       | 18,962,594  |       |
| Proceeds from sale of investment securities                                          |       | 5,513,276   |       | —      |       | —      |       |
| Purchases of investment securities                                                   |       | —      |       | (26,658,965 | )          | (19,391,969 | )          |
| Purchase of Federal Reserve Bank and  Federal Home Loan Bank stock                   |       | —      |       | —      |       | (155,550    | )          |
| Net change in loans                                                                  |       | (20,987,466 | )          | 3,060,979   |       | (17,357,365 | )          |
| Purchases of bank premises and equipment                                             |       | (398,882    | )          | (262,590    | )          | (466,782    | )          |
| Purchase of life insurance                                                           |       | —      |       | (1,485,000  | )          | —      |       |
| Net cash used in investing activities                                                |       | (3,256,236  | )          | (11,143,566 | )          | (18,409,072 | )          |
|                                                                                 |       |        |       |        |       |        |       |
| Cash flows from financing activities:                                                |       |        |       |        |       |        |       |
| Net change in deposits                                                               |       | (401,780    | )          | (270,074    | )          | 6,109,373   |       |
| Proceeds and tax benefit from exercise of  stock options                             |       | 34,390      |       | 164,275     |       | 372,781     |       |
| Proceeds from Issuance of Preferred Stock,  Net                                      |       | 3,950,000   |       | —      |       | —      |       |
| Stock repurchases                                                                    |       | (146,649    | )          | (853,351    | )          | —      |       |
| Net (repayments) proceeds from borrowings                                            |       | (1,233,356  | )          | 5,900,000   |       | (345,000    | )          |
| Cash dividends paid                                                                  |       | (962,534    | )          | (871,112    | )          | (767,587    | )          |
| Net cash provided by financing activities                                            |       | 1,240,071   |       | 4,069,738   |       | 5,369,567   |       |
| Net increase (decrease) in cash and cash  equivalents                                |       | 820,994     |       | (2,740,114  | )          | (10,153,521 | )          |
| Cash and cash equivalents at beginning of  year                                      |       | 7,399,412   |       | 10,139,526  |       | 20,293,047  |       |
|                                                                                 |       |        |       |        |       |        |       |
| Cash and cash equivalents at end of year                                             |       | $           | 8,220,406  |        | $          | 7,399,412   |       | $ | 10,139,526 |   |
|                                                                                 |       |        |       |        |       |        |       |
| Supplemental disclosure of cash flow  information:                                   |       |        |       |        |       |        |       |
| Interest paid                                                                        |       | $           | 3,925,557  |        | $          | 4,824,138   |       | $ | 3,415,383 |   |
|                                                                                 |       |        |       |        |       |        |       |
| Income taxes paid                                                                    |       | $           | 1,130,000  |        | $          | 1,865,000   |       | $ | 2,415,000 |   |
|                                                                                 |       |        |       |        |       |        |       |
| Cashless exercise of stock options                                                   |       | $           | 27,725     |        | $          | 120,554     |       | $ | 48,034 |   |

 

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

 

28

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**Santa Lucia Bancorp and Subsidiary**

 

**Consolidated Statement of Shareholders’ Equity**

 

*Years Ended December 31, 2008, 2007 and 2006*

 
|                                                                                                       | ** ** | ** **                | ** ** | ** **           | ** ** | **Common Stock**   | ** ** | **Additional** | ** ** | ** **           | ** ** | **Accumulated  Other** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|----------------------|------------|-------------------------|------------|----------------|------------|----------------------|------------|------------------------|------------|
|                                                                                                       | ** ** | **Comprehensive  Income** | ** ** | **Preferred  Stock** | ** ** | **Shares  Outstanding** | ** ** | **Amount**     | ** ** | **Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Comprehensive  Income** | ** ** |
| **Balance  at January 1, 2006**                                                                       |       |                      |       |                 |       | 1,899,543               |       | $              | 9,298,748  |                 | $          | —                 |       | $ | 7,052,289 |   | $ | (484,864 | ) |
|                                                                                                       |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| Cash dividends –  $0.40 per share                                                                     |       |                      |       |                 |       |                    |       |           |       |                 |       | (767,587               | )          |   |   |
| Exercise of stock  options, including the realization of tax benefits of $153,000                          |       |                      |       |                 |       | 28,554                  |       | 267,815        |       | 153,000              |       | (48,034                | )          |   |   |
| Stock Option  Compensation Expense                                                                         |       |                      |       |                 |       |                    |       |           |       | 63,558               |       |                   |       |   |   |
| Comprehensive  Income:                                                                                     |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| Net earnings for  the year                                                                                 |       | $                         | 3,388,271  |                 |       |                    |       |           |       |                 |       |                   | 3,388,271  |   |   |   |
| Change in  unrealized loss on available-for-sale securities, net of taxes of $150,059                      |       | 213,720                   |       |                 |       |                    |       |           |       |                 |       |                   |       | 213,720 |   |
| **Total  Comprehensive Income**                                                                            |       | $                         | 3,601,991  |                 |       |                    |       |           |       |                 |       |                   |       |   |   |   |
|                                                                                                       |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| **Balance  at December 31, 2006**                                                                     |       |                      |       |                 |       | 1,928,097               |       | 9,566,563      |       | 216,558              |       | 9,624,939              |       | (271,144 | ) |
| ** **                                                                                                 |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| Cash dividends –  $0.45 per share                                                                     |       |                      |       |                 |       |                    |       |           |       |                 |       | (871,112               | )          |   |   |
| Exercise of stock  options, including the realization of tax benefits of $19,000                           |       |                      |       |                 |       | 29,247                  |       | 284,829        |       | 19,000               |       | (120,554               | )          |   |   |
| Repurchase and  retirement of stock                                                                        |       |                      |       |                 |       | (32,471                 | )          |           |       |                 |       | (853,351               | )          |   |   |
| Stock Option  Compensation Expense                                                                         |       |                      |       |                 |       |                    |       |           |       | 122,645              |       |                   |       |   |   |
| **Comprehensive  Income:**                                                                                 |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| Net earnings for  the year                                                                                 |       | $                         | 3,002,819  |                 |       |                    |       |           |       |                 |       |                   | 3,002,819  |   |   |   |
| Change in  unrealized loss on available-for-sale securities, net of taxes of $328,353                      |       | 467,654                   |       |                 |       |                    |       |           |       |                 |       |                   |       | 467,654 |   |
| **Total  Comprehensive Income**                                                                            |       | $                         | 3,470,473  |                 |       |                    |       |           |       |                 |       |                   |       |   |   |   |
|                                                                                                       |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| **Balance  at December 31, 2007**                                                                     |       |                      |       |                 |       | 1,924,873               |       | 9,851,392      |       | 358,203              |       | 10,782,741             |       | 196,510 |   |
|                                                                                                       |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| Cash dividends –  $0.50 per share                                                                     |       |                      |       |                 |       |                    |       |           |       |                 |       | (962,534               | )          |   |   |
| Exercise of stock  options, including the realization of tax benefits of $19,000                           |       |                      |       |                 |       | 4,360                   |       | 43,115         |       | 19,000               |       | (27,725                | )          |   |   |
| Repurchase and  retirement of stock                                                                        |       |                      |       |                 |       | (6,180                  | )          |           |       |                 |       | (146,649               | )          |   |   |
| Cumulative –  effect adjustment of change in accounting for split-dollar life insurance  arrangements |       |                      |       |                 |       |                    |       |           |       |                 |       | (101,815               | )          |   |   |
| Preferred Stock –  Series A                                                                      |       |                      |       | $                    | 3,799,003  |                    |       |           |       |                 | 150,997    |                   |       |   |   |   |
| Stock Option  Compensation Expense                                                                         |       |                      |       |                 |       |                    |       |           |       | 148,534              |       |                   |       |   |   |
| **Comprehensive  Income:**                                                                                 |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| Net earnings for  the year                                                                                 |       | $                         | 1,138,904  |                 |       |                    |       |           |       |                 |       |                   | 1,138,904  |   |   |   |
| Change in  unrealized gain on available-for-sale securities, net of taxes of $255,702                      |       | 364,837                   |       |                 |       |                    |       |           |       |                 |       |                   |       | 364,837 |   |
| Less  reclassification adjustment for gains included in net income, deferred of tax  of $44,347            |       | (63,816                   | )          |                 |       |                    |       |           |       |                 |       |                   |       | (63,816 | ) |
| **Total  Comprehensive Income**                                                                            |       | $                         | 1,439,925  |                 |       |                    |       |           |       |                 |       |                   |       |   |   |   |
| ** **                                                                                                 |       |                      |       |                 |       |                    |       |           |       |                 |       |                   |       |   |   |
| **Balance  at December 31, 2008**                                                                     |       |                      |       | $                    | 3,799,003  |                    | 1,923,053  |           | $          | 9,894,507            |       | $                      | 676,734    |   | $ | 10,682,922 |   | $ | 497,531 |   |

 

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

 

29

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**Santa Lucia Bancorp and Subsidiary**

 

**NOTES TO FINANCIAL STATEMENTS**

 

*December 31, 2008, 2007 and 2006*

 

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

 

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

 

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

 

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

 

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

 

**Cash and Due From Banks –**Banking regulations require that all banksmaintain a percentage of their deposits as reserves in cash or on deposit withthe Federal Reserve Bank. The Bank was in compliance with the reserverequirements as of December 31, 2008 and 2007.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

30

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

 

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

 

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

 

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

 

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

 

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

 

**Stock-Based Compensation –**The Company has adopted SFASNo. 123(R) “Shared-Based Payment.” This Statement generally requiresentities to recognize the cost of employee services received in exchange forawards of stock options, or other equity instruments, based on the grant-datefair value of those awards. This cost is recognized over the period which anemployee is required to provide services in exchange for the award, generallythe vesting period.

 

**Change in Accounting Principle –**Effective January 1, 2008, the Companyadopted the FASB’s Emerging Issues Task Force (or EITF) consensus on EITF IssueNo. 06-4, “Accounting for Deferred Compensation and Postretirement BenefitAspects of Endorsement Split-Dollar Life Insurance Arrangements”. The EITF’sconsensus on this issue focuses on the accounting for arrangements in which acompany has agreed to share a portion of the value of the insurance policy withthe employee. These arrangements are referred to as “split-dollar”arrangements. Entities with split-dollar life insurance policies have toaccrue, for years beginning after December 15, 2007, liabilities andassociated expense for those insurance benefits under the same rules thatapply when such benefits are provided by means other than life insurance. Theprovisions of the consensus were applied through a cumulative effect adjustmentto retained earnings totaling $101,815.

 

**Fair Value Measurement –**Effective January 1, 2008, the Companyadopted SFAS No. 157, Fair Value Measurements. This Statement defines fairvalue, establishes a framework for measuring fair value and expands disclosuresabout fair value measurements. This Statement establishes a fair valuehierarchy about the assumptions used to measure fair value and clarifiesassumptions about risk and the effect of a restriction on the sale or use of anasset. The impact of adoption of SFAS No. 157 is not material. Applicabledisclosures are presented in these consolidated financial statements.

 

InFebruary 2008, the FASB issued Staff Position (FSP) 157-2, Effective Dateof FASB Statement No. 157. This FSP delays the effective date of SFAS 157for all non-financial assets and non-financial liabilities, except those thatare recognized or disclosed at fair value on a recurring basis (at leastannually) for fiscal years beginning after November 15, 2008. Majorcategories of assets that are recognized or disclosed at fair value for whichthe Company has not applied the provisions of SFAS 157 include Other RealEstate Owned, Goodwill and Intangible Assets.

 

InFebruary 2007, the FASB issued Statement 159, The Fair Value Option forFinancial Assets and Financial Liabilities. The standard provides companieswith an option to report selected financial assets and liabilities at fairvalue and establishes presentation and disclosure requirements designed tofacilitate comparisons between companies that choose different measurementattributes for similar types of assets and liabilities. The new standard waseffective for the Company on January 1, 2008. The Company did not electthe fair value option for any financial assets or financial liabilities as ofJanuary 1, 2008.

 

Statement157 defines fair value as the exchange price that would be received for anasset or paid to transfer a liability (an exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date. Statement 157 alsoestablishes a fair value hierarchy, which requires an entity to maximize theuse of observable inputs and minimize the use of unobservable inputs whenmeasuring fair value. The standard describes three levels of inputs that may beused to measure fair value:

 

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

 

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

 

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

 

SeeNote O for more information and disclosures relating to the Company’s fairvalue measurements.

 

**Reclassification –**Certain reclassifications have been made in the 2007 and 2006 financialstatements to conform to the presentation used in 2008. These reclassificationshad no impact on the Company’s previously reported financial statements.

 
|   | *Continued  on next page* |
|--------|---------------------------|

 

31

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

 
| ** **                            | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Amortized  cost**             | ** ** | **Unrealized  gains** | ** ** | **Unrealized  (losses)** | ** ** | **Estimated  fair value** | ** ** |
| U.S. Government and Agency Securities |       | $                               | 16,093,125 |   | $ | 565,115 |   | $ | — |   | $ | 16,658,240 |   |
| States and Political Subdivisions     |       | 5,742,575                       |       | 49,245 |   | (51,056 | ) | 5,740,764 |   |
| Mortgage-Backed Securities            |       | 15,787,914                      |       | 345,063 |   | (61,505 | ) | 16,071,472 |   |
|                                  |       | $                               | 37,623,614 |   | $ | 959,423 |   | $ | (112,561 | ) | $ | 38,470,476 |   |

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

 

Thecarrying value of investment securities pledged to secure public funds,borrowings and for other purposes as required or permitted by law amounts toapproximately $13,493,000 and $14,025,000 at December 31, 2008 and 2007,respectively. During 2008 the Bank had proceeds from the sale of $5,500,000 inMortgage Backed Securities and gross gains of $108,000. During 2007 and 2006the Bank had no proceeds from the sale of available for sale securities.

 

Theamortized cost and estimated fair value of debt securities at December 31,2008, by contractual maturity, are shown below. Mortgage-backed securities areclassified in accordance with their estimated lives. Expected maturities maydiffer from contractual maturities because borrowers may have the right toprepay obligations.

 
| ** **                             | ** ** | **Amortized** | ** ** | **Estimated**       | ** ** |
|----------------------------------------|------------|---------------|------------|---------------------|------------|
| ** **                             | ** ** | **cost**      | ** ** | **fair value** | ** ** |
| Securities available-for-sale:         |       |          |       |                |       |
| Due in one year or less                |       | $             | 9,918,633  |                | $          | 10,075,762 |   |
| Due after one year through five years  |       | 20,235,864    |       | 20,811,662          |       |
| Due after five years through ten years |       | 4,311,715     |       | 4,354,514           |       |
| Due after ten years                    |       | 3,157,402     |       | 3,228,538           |       |
|                                   |       | $             | 37,623,614 |                | $          | 38,470,476 |   |

 

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

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

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

 

Asof December 31, 2008, the Company has 10 investment securities whereestimated fair market value had decreased 2.9% from amortized cost. Managementevaluates investment securities for other-than-temporary impairment taking intoconsideration the extent and length of time the fair value has been less thancost, the financial condition of the issuer and whether the Bank has the intentand ability to retain the investment for a period of time sufficient to allowfor any anticipated recovery in fair value. As of December 31, 2008, nodeclines are deemed to be other than temporary.

 

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

 

Asof December 31, 2008 the Bank had pledged $109 million of loans to securethe borrowing arrangements discussed in Note G.

 

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

 
| ** **                      | ** ** | **2008**    | ** **  | **2007**    | ** ** |
|---------------------------------|------------|-------------|-------------|-------------|------------|
| Real estate – construction |       | $           | 52,388,923  |        | $          | 47,819,615 |   |
| Real estate – other        |       | 94,372,099  |        | 81,895,109  |       |
| Commercial                      |       | 41,477,697  |        | 38,016,713  |       |
| Consumer                        |       | 1,414,867   |        | 1,237,325   |       |
|                            |       | 189,653,586 |        | 168,968,762 |       |
| Deferred loan fees              |       | (711,852    | )           | (675,858    | )          |
| Allowance for loan losses       |       | (2,309,774  | )           | (1,673,410  | )          |
|                            |       | $           | 186,631,960 |        | $          | 166,619,494 |   |

 

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

 

Transactionsin the allowance for credit losses are summarized as follows:

 
| ** **                                 | ** ** | **2008** | ** ** | **2007** | ** ** | **2006**  | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Balance at beginning of year               |       | $        | 1,673,410  |     | $          | 1,653,695 |       | $ | 1,470,261 |   |
| Provision charged to expense               |       | 975,000  |       | —   |       | 240,000   |       |
| Loans charged off                          |       | (351,983 | )          | (60,779  | )          | (84,002   | )          |
| Recoveries on loans previously charged off |       | 13,347   |       | 80,494   |       | 27,436    |       |
| Balance at end of year                     |       | $        | 2,309,774  |     | $          | 1,673,410 |       | $ | 1,653,695 |   |

 

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

 
| ** **                                                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2006**  | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Recorded investment in impaired loans                        |       | $        | 1,613,647  |     | $          | 2,175,694 |       | $ | — |   |
| Related allowance for loan losses                            |       | $        | 394,000    |     | $          | 144,000   |       | $ | — |   |
| Average recorded investment in impaired  loans               |       | $        | 1,528,000  |     | $          | 591,000   |       | $ | 250,000 |   |
| Interest income recognized for cash  payments                |       | $        | —     |     | $          | —    |       | $ | 3,045 |   |
| Total nonaccrual loans                                       |       | $        | 1,613,647  |     | $          | 2,175,694 |       | $ | — |   |
| Total loans past-due ninety days or more  and still accruing |       | $        | —     |     | $          | —    |       | $ | 550,000 |   |

 

32

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

 

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

 
| ** **                          | ** ** | **2008** | ** ** | **2007**   | ** ** |
|-------------------------------------|------------|----------|------------|------------|------------|
| Beginning balance                   |       | $        | 4,764,832  |       | $          | 3,734,153 |   |
| Credits granted, including renewals |       | 599,523  |       | 5,515,322  |       |
| Repayments                          |       | (930,494 | )          | (4,484,643 | )          |
|                                |       | $        | 4,433,861  |       | $          | 4,764,832 |   |

 

Undisbursedloans amount to approximately $764,183 and $894,712 at December 31, 2008and 2007, respectively.

 

Depositsfrom related parties held by the Bank at December 31, 2008 and 2007amounted to $3,656,080 and $2,367,291 respectively.

 

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

 
| ** **                        | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
| Premises                          |       | $          | 7,753,334  |       | $          | 7,497,978 |   |
| Furniture, fixtures and equipment |       | 4,115,960  |       | 3,990,273  |       |
|                              |       | 11,869,294 |       | 11,488,251 |       |
| Less accumulated depreciation     |       | 5,275,911  |       | 4,650,509  |       |
|                              |       | 6,593,383  |       | 6,837,742  |       |
| Land                              |       | 2,030,765  |       | 2,030,765  |       |
|                              |       | $          | 8,624,148  |       | $          | 8,868,507 |   |

 

**NOTE F – DEPOSITS****–**AtDecember 31, 2008, the scheduled maturities of time deposits are asfollows:

 
| Due in one year |   | $         |  62,299,100 |   |
|--------------------------------|--------|-----------|------------------|--------|
| Due in one to three years      |   | 8,331,171 |             |
| Due after three years          |   | 673,900   |             |
|                           |   | $         | 71,304,171       |   |

 

**NOTE G – SHORT-TERM BORROWINGS****–**The Bank has two borrowing arrangements withthe Federal Home Loan Bank of San Francisco. The first allows the Bank toborrow up to approximately $43.6 million against which the Bank has pledgedapproximately $127.5 million of its real estate secured loans. The secondarrangement allows the Bank to borrow up to approximately $13.1 million againstwhich the Bank has pledged approximately $13.4 million of its investmentsecurities.

 

Asof December 31, 2008 the Bank has borrowed $5,000,000 under thesearrangements. On July 9, 2008 the Company entered into a one year advancefrom the Federal Home Loan Bank for $5,000,000 at a fixed rate of 2.91%. During2008 the bank had average borrowings outstanding of $6,612,000 at an effectiverate of 2.89%.

 

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

 

**NOTE H – LONG-TERM BORROWINGS****–**During the third quarter of 2003, the Bankissued Subordinated Debentures to nineteen investors including executive officersand members of the Bank’s Board of Directors, in the total sum of $2,000,000(“Debentures”). The total amount issued to executive officers and directors was$1,100,000. The Debentures include quarterly payment of interest at prime plus1.5% and quarterly principal installments of $166,666 commencing onSeptember 30, 2008 until paid in full on June 30, 2011. As ofDecember 31, 2008 the Debentures totaled $1,666,644 and an average rate of 5.78%.The Debentures, which are subordinated to the right of payment to depositorsand other creditors, partially qualify as Tier 2 Capital.

 

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

 

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

 

**NOTE I – INCOME TAXES****–**The asset and liability method is used inaccounting for income taxes. Under this method, deferred tax assets and liabilitiesare determined based on differences between financial reporting and tax basesof assets and liabilities and are measured using the enacted tax rates and lawsthat will be in effect when the differences are expected to reverse.

 

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

 
| ** **                                        | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|---------------------------------------------------|------------|-----------|------------|-----------|------------|
| Deferred liabilities:                        |       |      |       |      |       |
| Tax over book depreciation                        |       | $         | 369,000    |      | $          | 425,000 |   |
| Market value adjustment on investment  securities |       | 349,000   |       | 138,000   |       |
| Other                                             |       | 130,000   |       | 111,000   |       |
| Total deferred tax liabilities                    |       | 848,000   |       | 674,000   |       |
| Deferred tax assets:                              |       |      |       |      |       |
| Allowance for loan losses                         |       | 909,000   |       | 673,000   |       |
| Deferred compensation plans                       |       | 671,000   |       | 498,000   |       |
| State taxes                                       |       | 95,000    |       | 191,000   |       |
| Net loss carryforward                             |       | 28,000    |       | 41,000    |       |
| Other                                             |       | 119,000   |       | 85,000    |       |
| Total deferred tax assets                         |       | 1,822,000 |       | 1,488,000 |       |
| Net deferred tax assets                           |       | $         | 974,000    |      | $          | 814,000 |   |

 

Theprovision for income taxes consists of the following:

 
| ** **                | ** ** | **2008** | ** ** | **2007** | ** ** | **2006**  | ** ** |
|---------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Currently payable         |       | $        | 1,004,000  |     | $          | 2,135,000 |       | $ | 2,389,000 |   |
| Deferred taxes (benefits) |       | (371,000 | )          | (201,000 | )          | (147,000  | )          |
|                      |       | $        | 633,000    |     | $          | 1,934,000 |       | $ | 2,242,000 |   |

 

Theprincipal sources of deferred income taxes and the tax effect of each are asfollows:

 
| ** **                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax over  book depreciation  |       | $        | (56,000    | )        | $          | (68,000  | )          | $ | 6,000 |   |
| Provision  for loan losses   |       | (236,000 | )          | —   |       | (75,000  | )          |
| State taxes                  |       | 96,000   |       | 33,000   |       | (75,000  | )          |
| Net loss  carryforward       |       | 13,000   |       | 14,000   |       | 14,000   | )          |
| Deferred  compensation plans |       | (173,000 | )          | (108,000 | )          | (42,000  | )          |
| Other                        |       | (15,000  | )          | (72,000  | )          | 25,000   |       |
| Net deferred taxes           |       | $        | (371,000   | )        | $          | (201,000 | )          | $ | (147,000 | ) |

 
|   | *Continued  on next page* |
|--------|---------------------------|

 

33

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Asof December 31, 2008, the Bank had federal net operating losscarryforwards available to reduce future taxable income of approximately$81,000. These net operating loss carryforwards expire in 2010. The 1995 mergerwith Central Coast National Bank resulted in an ownership change as defined inthe Internal Revenue Code Section 382. Accordingly, the utilization of thenet operating loss will be subject to the limitations prescribed inSection 382.

 

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

 
| ** **                        | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal  “expected” tax |       | $        | 602,000    |     | 34.0       | %        | $          | 1,679,000 |   | 34.0 | % | $ | 1,914,000 |   | 34.0 | % |
| State  franchise tax, net         |       | 122,000  |       | 6.9      |       | 347,000  |       | 7.0 |   | 396,000 |   | 7.0 |   |
| Tax exempt  income                |       | (128,000 | )          | (7.2     | )          | (122,000 | )          | (2.5 | ) | (80,000 | ) | (1.3 | ) |
| Other                             |       | 37,000   |       | 2.1      |       | 30,000   |       | 0.6 |   | 12,000 |   | (0.2 | ) |
| Total expense                     |       | $        | 633,000    |     | 35.7       | %        | $          | 1,934,000 |   | 39.1 | % | $ | 2,242,000 |   | 39.9 | % |

 

TheCompany is subject to Federal income tax and California franchise tax. Federalincome tax returns for the years ended December 31, 2007, 2006 and 2005are open to audit by the Federal authorities and California returns for theyears ended December 31, 2007, 2006, 2005 and 2004 are open to audit bystate authorities.

 

**NOTE J – EMPLOYEE PROFIT SHARING AND DEFERRED COMPENSATION****–**The Bank sponsors a 401 (k) plan for thebenefit of its employees. In 1994 the Bank also approved the creation of anEmployee Stock Ownership Plan for the benefit of its employees. Contributionsto these plans are determined by the Board of Directors. For income taxpurposes, the annual contribution is limited to 15% of the compensation ofeligible employees. The Bank contributed $202,000 in 2008, $203,000 in 2007,and $210,000 in 2006, to the Employee Stock Ownership Plan. The Bankcontributed $58,000 to the 401 (k) plan in 2008, $57,000 to the 401 (k) planin 2007 and $50,000 in 2006.

 

TheBank has entered into deferred compensation agreements with key officers andboard members. Under these agreements, the Bank is obligated to provide, uponretirement, a lifetime benefit for the officers and directors. The annualbenefits ranging from $25,000 to $75,000 for key officers and $4,000 to $6,000for directors. The estimated present value of future benefits to be paid isbeing accrued over the period from the effective date of the agreements untilthe expected retirement dates of the participants. The expense incurred andamount accrued for this plan for the years ended December 31, 2008, 2007,and 2006 totaled $275,140, $292,385, and $131,454, respectively. The Bank is abeneficiary of life insurance policies that have been purchased as a method offinancing the benefits under the agreements.

 

**NOTE K – STOCK OPTIONS****–**The Company sponsors one compensatoryincentive and non-qualified stock option plan which provides certain keyemployees and the Board of Directors with the option to purchase shares ofcommon stock, and one Equity Based Compensation Plan which provides certain keyemployees and the Board of Directors with the award of any Option, Stock AppreciationRight, Restricted Stock Award, Restricted Share Unit, Performance Share Award,Dividend Equivalent, or any combination thereof. In 1999, the Bank adopted astock option plan (the 2000 plan) under which up to 360,000 shares of theBank’s common stock may be issued to directors, officers, and key employees. In2006, the Company adopted the 2006 Equity Based Compensation Plan (the Plan),which the maximum number of shares of common stock that may be awarded underthis Plan shall not exceed 200,000 shares, including 38,200 shares rolled overfrom the Company’s 2000 Stock Option Plan. Option prices may not be less than100% of the fair market value of the stock at the date of grant. Options becameexercisable at the rate of 20% per year beginning at various dates and expirenot more than ten years from the date of grant. The Company recognizedstock-based compensation costs of $148,534, $122,645 and $63,558 and relatedtax benefits of $41,700, $18,450 and $26,000 for 2008, 2007 and 2006,respectively.

 

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

 
| ** **                              | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|-----------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Risk-free  rates                        |       | 3.18      | %          | 4.65      | %          | 4.77      | %          |
| Expected  volatility                    |       | 20.00     | %          | 20.00     | %          | 20.00     | %          |
| Expected  dividened yield               |       | 1.40      | %          | 1.40      | %          | 1.40      | %          |
| Expected  term                          |       | 6.0 years |       | 6.0 years |       | 6.0 years |       |
| Weighted-average  grant date fair value |       | $         | 5.08       |      | $          | 6.72      |       | $ | 6.43 |   |
|                                         |            |           |            |           |            |           |            |  |  |  |

 

Asummary of the status of the Company’s fixed stock option plan as ofDecember 31, 2008 and changes during the year then ended is presentedbelow:

 
| ** **                               | ** ** | **December 31, 2008** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | ** **                      | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **Average** | ** ** | **Average** | ** ** | **Aggregate** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **Exercise** | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** |
| ** **                               | ** ** | **Shares**                      | ** ** | **Price** | ** ** | **Contractual Term** | ** ** | **Value** | ** ** |
| Outstanding at the beginning of the year |       | 223,760                         |       | $ | 17.48 |   |   |   |   |   |
| Granted                                  |       | 11,000                          |       | 23.18 |   |   |   |   |   |
| Exercised                                |       | (6,200                          | )          | 9.66 |   |   |   |   |   |
| Foreited or expired                      |       | —                          |       | — |   |   |   |   |   |
| Outstanding at the end of the year       |       | 228,560                         |       | 17.97 |   | 5.7 years |   | $ | None |   |
| Options Exercisable                      |       | 154,360                         |       | $ | 14.75 |   | 4.6 years |   | $ | None |   |

 

Thetotal intrinsic value of options exercised during the years endedDecember 31, 2008, 2007, and 2006 were approximately $92,810, $638,000,and $539,000 respectively. As of December 31, 2008 there was $411,000 oftotal unrecognized compensation cost related to the outstanding stock optionsthat will be recognized over a weighted average period of 2.1 years.

 

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

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

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

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

 

34

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**NOTE M – COMMITMENTS AND CONTINGENCIES****–**The Company’s exposure to credit loss in theevent of nonperformance by the other party to the financial instrument forcommitments to extend credit and standby letters of credit is represented bythe contractual amount of those commitments. Commitments to extend credit (suchas the unfunded portion on lines of credit and commitments to fund new loans)as of December 31, 2008 and 2007 amounts to approximately $57,168,000 and$57,326,000, respectively, of which approximately $3,106,000 and $4,286,000 arerelated standby letters of credit, respectively. The Company uses the samecredit policies in these commitments as is done for all of its lendingactivities. As such, the credit risk involved in these transactions is essentiallythe same as that involved in extending loan facilities to customers.

 

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

 

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

 

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

 

ThePreferred Stock will qualify as Tier 1 capital and will pay cumulativedividends quarterly at a rate of 5% per annum for the first five years and 9%per annum thereafter. The Preferred Stock may be redeemed by the Company afterthree years. Prior to the end of the three years, the Preferred Stock may beredeemed only with proceeds from the sale of qualifying equity securities ofthe Company.

 

TheWarrant has a 10-year term and is immediately exercisable upon its issuance,with an exercise price, subject to anti-dilution adjustments, equal to $16.06per share.

 

Ifthe Company receives aggregate gross cash proceeds of not less than $4,000,000from a Qualified Equity Offering on or prior to December 31, 2009, thenumber of shares of Common Stock issuable pursuant to Treasury’s exercise ofthe Warrant will be reduced by one half of the original number of shares,taking into account all adjustments, underlying the Warrant. Pursuant to thePurchase Agreement, the Treasury has agreed not to exercise voting power withrespect to any shares of Common Stock issued upon exercise of the Warrant.

 

Neitherthe Preferred Stock nor the Warrant will be subject to any contractualrestrictions on transfer, except that Treasury may only transfer or exercise anaggregate of one-half of the Warrant Shares prior to the earlier of theredemption of 100% of the shares of Preferred Stock and December 31, 2009.

 

Inthe Purchase Agreement, the Company agreed that, until such time as Treasuryceases to own any debt or equity securities of the Company acquired pursuant tothe Purchase Agreement, the Company will take all necessary action to ensurethat its benefit plans with respect to its senior executive officers complywith Section 111(b) of the Emergency Economic Stabilization Act of2008 (the “EESA”) as implemented by any guidance or regulation under the EESAthat has been issued and is in effect as of the date of the issuance of thePreferred Stock and the Warrant, and has agreed to not adopt any benefit planswith respect to, or which covers, its senior executive officers that do notcomply with the EESA, and the applicable executives have consented to theforegoing.

 

Thenet proceeds from the issuance of the Preferred Stock and Warrant of $3,950,000were allocated between the Preferred Stock and the Warrant based on theirestimated relative fair values. The resulting discount of $200,997 on thePreferred Stock will be accreted against retained earnings over the estimatedfive-year life of the Preferred Stock reducing the reported income availablefor common shareholders.

 

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

 

**Securities:**The fair values of securities available for sale are determined by obtainingquoted prices on nationally recognized securities exchanges (Level 1).

 

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

 

Thefollowing table provides the hierarchy and fair value for each major categoryof assets and liabilities measured at fair value at December 31, 2008:

 
| ** **                                                                      | ** ** | **Fair Value Measurements Using** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                      | ** ** | **Level 1**                                 | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Level 4** | ** ** |
| Assets and liabilities measured at fair  market value on a recurring basis)     |       |                                             |       |   |   |   |   |   |   |
| Assets:                                                                         |       |                                             |       |   |   |   |   |   |   |
| Securities Available for Sale                                                   |       | $                                                | 38,470,476 |   | $ | — |   | $ | — |   | $ | 38,470,476 |   |
| Assets and liabilities measured at fair  market value on a non-recurring basis) |       |                                             |       |   |   |   |   |   |   |
| Collateral-Dependent Impaired Loans, Net of  Specific Reserves                  |       | $                                                | —     |   | $ | — |   | $ | 1,219,647 |   | $ | 1,219,647 |   |

 

Collateral-dependentimpaired loans, which are measured for impairment using the fair value of thecollateral, had a carrying value of $1,631,647, with a specific reserve of$394,000.

 

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

 

*Continued on next page*

 

35

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

 

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

 

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

 

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

 

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

 

Theestimated fair value of financial instruments at December 31, 2008 and2007 are summarized as follows:

 
| ** **                             | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Carrying  Value**             | ** ** | **Market  Value**               | ** ** | **Carrying  Value** | ** ** | **Market  Value** | ** ** |
| Financial Assets:                 |       |                            |       |                            |       |   |   |   |   |
| Cash and cash equivalents         |       | $                               | 8,220,406  |                            | $          | 8,220,406 |   | $ | 7,399,412 |   | $ | 7,399,412 |   |
| Investment securities                  |       | 38,470,476                      |       | 38,470,476                      |       | 56,107,156 |   | 56,107,156 |   |
| Loans receivable, net                  |       | 186,631,960                     |       | 185,936,829                     |       | 166,619,494 |   | 167,422,617 |   |
| Cash surrender value of life insurance |       | 5,194,688                       |       | 5,194,688                       |       | 5,005,376 |   | 5,005,376 |   |
| Federal Reserve Bank FHLB Stock        |       | 1,516,850                       |       | 1,516,850                       |       | 1,453,850 |   | 1,453,850 |   |
| Accrued interest receivable            |       | 1,222,272                       |       | 1,222,272                       |       | 1,465,402 |   | 1,465,402 |   |
| Financial Liabilities:                 |       |                            |       |                            |       |   |   |   |   |
| Time deposits                          |       | $                               | 71,304,171 |                            | $          | 71,175,000 |   | $ | 71,844,194 |   | $ | 72,612,333 |   |
| Other deposits                         |       | 141,012,427                     |       | 140,601,598                     |       | 140,874,184 |   | 141,374,184 |   |
| Other borrowings                       |       | 5,000,000                       |       | 5,000,000                       |       | 5,900,000 |   | 5,900,000 |   |
| Long-term debt                         |       | 6,821,644                       |       | 6,821,644                       |       | 7,155,000 |   | 7,155,000 |   |
| Accrued interest and other liabilities |       | 2,190,584                       |       | 2,190,584                       |       | 1,677,551 |   | 1,677,551 |   |

 

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

 

Quantitativemeasures established by regulation to ensure capital adequacy require the Bankto maintain minimum amounts and ratios (set forth in the table below) of totaland Tier 1 capital (as defined in the regulations) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to average assets (as defined).Management believes, as of December 31, 2008, that the Bank meets allcapital adequacy requirements to which it is subject.

 

Asof December 31, 2008, the most recent notification from the FederalReserve Bank (FRB) categorized the Bank as well capitalized under theregulatory framework for prompt corrective action (there are no conditions orevents since that notification that management believes have changed the Bank’scategory). To be categorized as well capitalized, the Bank must maintainminimum ratios as set forth in the table below. The following table also setsforth the Company’s and Bank’s actual capital amounts and ratios (dollaramounts in thousands):

 
| ** **                                | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To be well**   | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **capitalized under** | ** ** |
| ** **                                | ** ** | ** **              | ** ** | ** **                 | ** ** | **For capital**       | ** ** | **prompt corrective** |
| ** **                                | ** ** | **Actual**              | ** ** | **adequacy purposes** | ** ** | **action provisions** | ** ** |
| ** **                                | ** ** | **Amount  (thousands)** | ** ** | **Ratio**                  | ** ** | **Amount  (thousands)**    | ** ** | **Ratio**                  | ** ** | **Amount  (thousands)**    | ** ** | **Ratio** | ** ** |
| **As of December 31, 2008:**         | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| **Company**                               | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets)  |       | $                       | 33,373     |                       | 15.9       | %                          | $          | 16,770                     |       | 8.0                        | %          | $ | 20,963 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                       | 30,208     |                       | 14.4       | %                          | $          | 8,385                      |       | 4.0                        | %          | $ | 12,578 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                       | 30,208     |                       | 11.9       | %                          | $          | 10,074                     |       | 4.0                        | %          | $ | 12,592 |   | 5.0 | % |
| **Bank**                                  |       |                    |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total Capital  (to Risk-Weighted Assets)  |       | $                       | 31,748     |                       | 15.2       | %                          | $          | 16,746                     |       | 8.0                        | %          | $ | 20,933 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                       | 28,583     |                       | 13.7       | %                          | $          | 8,373                      |       | 4.0                        | %          | $ | 12,560 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                       | 28,583     |                       | 11.4       | %                          | $          | 9,995                      |       | 4.0                        | %          | $ | 12,494 |   | 5.0 | % |
| **As of December 31, 2007:**         |       |                    |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **Company**                               |       |                    |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total Capital  (to Risk-Weighted Assets)  |       | $                       | 29,075     |                       | 14.6       | %                          | $          | 15,912                     |       | 8.0                        | %          | $ | 19,890 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                       | 26,147     |                       | 13.2       | %                          | $          | 7,956                      |       | 4.0                        | %          | $ | 11,934 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                       | 26,147     |                       | 10.5       | %                          | $          | 9,794                      |       | 4.0                        | %          | $ | 12,243 |   | 5.0 | % |
| **Bank**                                  |       |                    |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total Capital  (to Risk-Weighted Assets)  |       | $                       | 27,410     |                       | 13.8       | %                          | $          | 15,888                     |       | 8.0                        | %          | $ | 19,860 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $                       | 24,482     |                       | 12.3       | %                          | $          | 7,944                      |       | 4.0                        | %          | $ | 11,916 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $                       | 24,482     |                       | 9.9        | %                          | $          | 9,941                      |       | 4.0                        | %          | $ | 12,427 |   | 5.0 | % |

 

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

 

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

 

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

 

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

 

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POST OFFICE BOX 6047· 7480 EL CAMINO REAL ·ATASCADERO, CALIFORNIA 93423TELEPHONE: (805) 466-7087 · FAX: (805) 466-0402

 

 

**MEMBER FDIC**

 

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