U.S. SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-K

x	Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee required)

for fiscal year ended December 31, 2011

o	Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required)

for the period from to

Commission File Number 0-27666

NORTHERN CALIFORNIA BANCORP, INC.

(Exact name of registrant as specified in its Charter)

Incorporated in the State of California

IRS Employer Identification Number 77-0421107

Address: 601 Munras Avenue, Monterey, CA 93940

Telephone: (831) 649-4600

Securities registered under Section 12(g) of the Exchange Act: Common stock

Securities registered under Section 12(b) of the Exchange Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during

the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Large accelerated filer o		Accelerated filer o

Non-accelerated filer o		Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes o No x

Aggregate market value of Common Stock held by non-affiliates as of the last business day of the registrant’s most recently completed second fiscal quarter ended June 30, 2011 was $801,000.

Shares of stock outstanding as of March 1, 2011: 1,785,891.

DOCUMENTS INCORPORATED BY REFERENCE

None.

Table of Contents

FORM 10-K CROSS REFERENCE INDEX

		PAGE
PART I		3
ITEM 1.	BUSINESS	3
ITEM 1A.	RISK FACTORS	29
ITEM 1B.	UNRESOLVED STAFF COMMENTS	29
ITEM 2.	PROPERTIES	29
ITEM 3.	LEGAL PROCEEDINGS	30
ITEM 4.	MINE SAFETY DISCLOSURES	30
PART II		31
ITEM 5.	MARKET FOR THE COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER OF PURCHASES OF EQUITY SECURITIES	31
ITEM 6.	SELECTED FINANCIAL DATA	33
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION	34
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	60
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	61
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE	62
ITEM 9A(T)	CONTROLS AND PROCEDURES	62
ITEM 9B.	OTHER INFORMATION	63
PART III		64
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE	64
ITEM 11.	EXECUTIVE COMPENSATION	66
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS	69
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	71
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	72
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	73

Table of Contents

Statements Regarding Forward-Looking Information

Except for historical information contained herein, the matters discussed or incorporated by reference in this report on Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate,” “believe,” “estimate,” “may,” “intend,” “expect,” and similar expressions identify certain of such forward-looking statements. Actual results of Northern California Bancorp, Inc. (the “Corporation”) could differ materially from such forward-looking statements contained herein. Factors that could cause future results to vary from current expectations include, but are not limited to, the following: changes in economic conditions (both generally and more specifically in the markets in which the Corporation operates): changes in interest rates, deposit flows, loan demand, real estate values and competition; changes in accounting principles, policies or guidelines and in government legislation and regulation (which change from time to time and over which the Corporation has no control); other factors affecting the Corporation’s operations, markets, products and services; and other risks detailed in this Form 10-K (see “Item 1A. Risk Factors”) and in the Corporation’s other reports filed with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. The Corporation undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date thereof.

PART I

ITEM 1. BUSINESS

GENERAL

Northern California Bancorp, Inc. (the “Corporation”) was incorporated on August 29, 1995, as a for-profit corporation under California law for the principal purpose of engaging in banking and non-banking activities as allowed for a bank holding company. At December 31, 2011, on a consolidated basis, the Corporation had total assets of $245,677,000, total loans of $153,925,000 and total deposits of $203,613,000. It owns 100% of the stock of Monterey County Bank, Monterey, California (the “Bank”). The Corporation’s sources of revenues at this time are dividends on investments, gains on securities transactions and potential dividends, management fees and tax equalization payments, if any, from the Bank. As a result of various regulatory orders and agreements to which the Bank and the Corporation became subject in 2010, the Bank is presently prohibited from paying dividends and the Corporation has agreed not to accept dividends from the Bank absent prior regulatory authorization to do so.

The Corporation, as a bank holding company, engages in commercial banking through the Bank. The Corporation may also engage in certain non-banking activities closely related to banking and own certain other business companies that are not banks, subject to applicable laws and regulations, although it has no current plans to do so.

Table of Contents

MONTEREY COUNTY BANK

Monterey County Bank, an independent, California chartered commercial banking corporation, was chartered by the State of California on July 30, 1976. The Bank’s customer base includes individuals, small- and medium-sized businesses and a variety of government agencies with residences, offices or other relationships located in or about the city and county of Monterey, California, including the cities of Carmel-by-the-Sea, Pacific Grove and Salinas. The Bank offers its customers a wide variety of the normal personal, consumer and commercial services expected of a locally-owned, independently operated bank. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) and, as such, the Bank is subject to supervision and regulation by that federal agency and to periodic audits of its operations and documentary compliance by FDIC personnel. As a state chartered bank that is not a member of the Federal Reserve System, it is also regulated and periodically examined by the California Department of Financial Institutions (the “CDFI”).

The Bank’s activities are conducted at its main office, 601 Munras Avenue, Monterey, California and at its three branch offices in Carmel Valley, Pacific Grove and Salinas, California and a loan production office in Monterey, California. The Bank ceased operations at its Carmel-By-The-Sea branch office effective December 30, 2011.

The Bank provides a range of competitive retail and commercial banking services. The deposit services offered include various types of personal and business checking accounts, savings accounts, money market investment accounts, certificates of deposit and retirement accounts. Lending services include consumer loans, various types of mortgage loans for residential and commercial real estate, personal lines of credit, home equity loans, real estate construction loans, accounts receivable financing and commercial loans to small- and medium-sized businesses and professionals. The Bank also provides drive-through facilities at its Monterey and Carmel offices and night depository facilities for customer convenience. The Bank offers safe deposit box facilities, cashiers’ checks, travelers’ checks, U.S. Savings Bonds and wire transfers. The Bank does not provide trust services.

While the Bank has the authority to engage in a wide range of banking activities and offers most of the types of banking services of a commercial bank, over the past three years it has derived a significant portion of its income from and differentiated itself from its competitors through: (i) commercial and real estate loans guaranteed by the Small Business Administration (“SBA”); (ii) sponsorship of credit card and debit card program; although this is declining and (iii) credit card depository services for merchants.

The primary issues that affected the Corporation in 2011 were:

(1) The continued depressed economic conditions and the related stress in real estate markets.

During 2011, the Corporation continued to focus resources on managing the deterioration of asset quality resulting from the effect that the economic recession had on loans made primarily to residential real estate development projects and assets acquired through foreclosure. Whereas the Corporation did not have a provision for loan losses in 2010, the Corporation had a $7,860,000 loan loss provision in 2011 which materially impacted the Corporation’s net income. This was partially offset by a decrease of $1,897,000 in expenses related to foreclosed assets, from $3,070,000 in 2010 to $1,173,000 in 2011, due, in large part, to property values beginning to stabilize during 2011.

Table of Contents

The Bank’s Management continued to focus their efforts on identifying potentially weak credits as early as possible, which enabled a proactive and aggressive approach to managing these credits and the development of workout strategies, as appropriate. As a result of their efforts, loans 30 days or more past due decreased from $16,117,000, or 10.4% of total loans, at December 31, 2010 to $4,399,000, or 2.9%, of total loans, at December 31, 2011. Past due loans also decreased during the same period by $11,718,000, or 72.7%, while non-performing loans (non-accrual loans and troubled debt restructurings which are not in conformity with their modified terms) decreased from $12,380,000, or 8.0% of total loans, at December 31, 2010 to $4,691,000, or 3.1% of total loans, at December 31, 2011. Of the non-performing loans outstanding at December 31, 2011 and 2010, $4,342,000, or 92.6%, and $6,241,000, or 54.4%, respectively, were secured by real estate (net of any charge-offs previously taken). Other real estate owned, net of valuation allowance, decreased $103,000 from $28,825,000, at December 31, 2010 to $28,722,000 at December 31, 2011.

Total past due loans and non-performing loans are net of the guaranteed portion of SBA loans totaling $1,249,000 and $1,608,000 at December 31, 2011 and 2010, respectively. Management believes the presence of real estate collateral mitigates the level of expected loss, although the level of mitigation is uncertain due to the difficulty in ascertaining real estate values at this time.

Management utilized a pricing discipline and other strategies to offset pressure on the Corporation’s net yield on earning assets created by the low interest rate environment and an increase in non-performing loans. To combat this and other adverse factors, Management’s efforts to improve its net yield on earning assets in 2011 included the development of a loan pricing model, establishing floors on variable rate loan products, increased investment in tax-free municipal securities, increased efforts to attract lower cost checking accounts and increased use of competitively priced out-of-area deposits and Federal Reserve Bank borrowings. The Corporation’s tax-equivalent net yield on earning assets increased to 3.63% for 2011 compared to 3.18% for 2010.

(2) Reduction in the Bank’s credit and debit card programs.

The Bank has provided sponsorship of third-party credit card and debit card programs since August 2002. The Bank gave notice in June 2008 to the third-party card vendors that it planned to reduce its sponsorship of credit card and stored value card programs and terminated sponsorship agreements on all programs except a drug manufacture’s rebate card program. The characteristics of the drug manufactures’ rebate card program significantly reduces the level of required monitoring. The Bank decided to continue its sponsorship of a debit card program which issues payroll cards and sponsorship of one credit card program in order to preserve the third party’s indemnification of the Bank against potential expenses and/or liabilities. The Bank also decided to grant extensions of its sponsorship of one credit card program to allow time for the final resolution of issues raised by the FDIC, as further discussed under “Regulatory Enforcement Powers.” Extension of the program sponsorship is considered quarterly with the third party paying an extension fee each time an extension is granted. The Bank’s sponsorship of the terminated programs ended in 2009. The Bank has been named as a defendant in a lawsuit brought by one of the third-party credit card companies, seeking to compel the Bank to continue its sponsorship for a period of time. (See “Item 3. Legal Proceedings” for further discussion.)

Table of Contents

The Bank’s revenues, consisting of a monthly fee per card or a minimum monthly fee, from the credit card programs were $721,000 and $1,246,000 in 2011 and 2010, respectively. The Bank’s revenues from credit card programs in 2011 decreased as the result of the June 30, 2011 termination of a card program sponsorship agreement. The Bank’s revenues, consisting of a monthly fee per card or a minimum monthly fee, from the debit card programs were $35,000 and $59,000 in 2011 and 2010, respectively.

NORTHERN CALIFORNIA BANCORP, INC. TRUST I

On March 27, 2003, Northern California Bancorp, Inc. Trust I, a Delaware statutory business trust and a wholly-owned subsidiary of the Corporation (“Trust I”), issued an aggregate of $3.0 million of principal amount of Floating Rate TRUPSâ (Capital Trust Pass-through Securities of the Trust) (the “Trust Preferred Securities”). The securities issued by Trust I are fully guaranteed by the Corporation with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds to Trust I from the sale of the Trust Preferred Securities were used by Trust I in order to purchase $3.0 million in principal amount of the Floating Rate Junior Subordinated Deferrable Interest Debentures due 2033 issued by the Corporation (the “Subordinated Debt Securities”).

Pursuant to Accounting Standards Codification (“ASC”) 810-10 (formerly interpretation FIN 46(R)) entitled “Consolidation of Variable Interest Entities,” Trust I is not reflected on a consolidated basis in our Consolidated Financial Statements.

The Subordinated Debt Securities bear a variable interest rate equal to the three-month London Interbank Offered Rate (“LIBOR”) plus 3.25%. The effective rate at December 31, 2011 and 2010 was 3.65% and 3.54%, respectively. Total broker and legal costs of $115,000 associated with the issuance are being amortized over a 30 year period.

The Corporation has exercised its rights in accordance with the indenture for the Subordinated Debt Securities to defer interest payments for an undetermined period of time, not to exceed twenty (20) consecutive quarterly payments. The deferral of interest payments on Trust I was effective with the October 7, 2009 interest payment. At December 31, 2011 and 2010, accrued and unpaid interest totaled $297,000 and $177,000, respectively.

NORTHERN CALIFORNIA BANCORP, INC. TRUST II

On November 13, 2003, Northern California Bancorp, Inc. Trust II, a Delaware statutory business trust and a wholly-owned subsidiary of the Corporation (“Trust II”), issued an aggregate of $5.0 million of principal amount of Floating Rate TRUPSâ (the “Trust Preferred Securities-II”). The securities issued by Trust II are fully guaranteed by the Corporation with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds to Trust II from the sale of the Trust Preferred Securities were used by Trust II in order to purchase $5.0 million in principal amount of the Floating Rate Junior Subordinated Deferrable Interest Debentures due 2033 issued by the Corporation (the “Subordinated Debt Securities-II”).

Pursuant to ASC 810-10, Trust II is not reflected on a consolidated basis in our Consolidated Financial Statements.

The Subordinated Debt Securities-II bear a variable interest rate equal to the three-month LIBOR plus 2.85%. The effective rate at December 31, 2011 and 2010 was 3.28% and 3.14%, respectively. Total broker and legal costs of $54,000 associated with the issuance are being amortized over a 30 year period.

Table of Contents

The Corporation has exercised its rights in accordance with the indenture for the Subordinated Debt Securities II to defer interest payments for an undetermined period of time, not to exceed twenty (20) consecutive quarterly payments. The deferral of interest payments on Trust II was effective with the November 8, 2009 interest payment. At December 31, 2011 and 2010, accrued and unpaid interest totaled $411,000 and $237,000, respectively.

EMPLOYEES

At December 31, 2011, the Corporation and the Bank employed a total of 48 full-time equivalent persons. Our employees are not represented by any union or other collective bargaining agreement and we consider our relations with our employees to be excellent.

COMPETITION

All phases of the Bank’s business have been, since inception, and will continue to be, subject to significant competitive forces. Although the Bank has increasing recognition in its primary service area of Monterey County as a whole, it nevertheless has to compete with other independent local banking institutions, including commercial banks and savings and loan associations, as well as branch offices of regional and national commercial banks, which have assets, capital and lending limits substantially larger than the Bank, as well as wider geographic markets, more support services and larger media advertising capabilities. The Bank competes with respect to its lending activities, as well as in attracting demand deposits, with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions, as well as securities brokerage offices which can issue commercial paper and other securities (such as shares in money market funds).

Among the advantages such institutions have over the Bank are their ability to finance wide ranging advertising campaigns and to allocate their investment assets to regions of highest yields and demand. Many institutions offer certain services, such as trust services and international banking, which the Bank does not currently offer or plan to offer. By virtue of their greater total capital, such institutions have substantially higher lending limits than the Bank (legal lending limits to an individual customer being limited to a percentage of a bank’s total capital accounts). These competitors may intensify their advertising and marketing activities to counter any efforts by the Bank to further attract new business as a commercial bank. In addition, as a result of legislation enacted earlier in the decade, there is increased competition between banks, savings and loan associations and credit unions for the deposit and loan business of individuals. These activities may hinder the Bank’s ability to capture a significant market share.

To compete with the financial institutions in its primary service area, the Bank intends to use the flexibility which its independent status permits. Its activities in this regard include an ability and intention to respond quickly to changes in the interest rates paid on time and savings deposits and charged on loans, and to charges imposed on depository accounts, so as to remain competitive in the market place. It also will continue to emphasize specialized services for the small business person and professional and personal contacts by the Bank’s officers, directors and employees. If there are customers whose loan demands exceed the Bank’s lending limits, the Bank has the ability to arrange for such loans on a participation basis with other financial institutions. No assurances can be given, however, that the Bank’s efforts to compete with other financial institutions in its primary service area will be successful.

The Bank’s earnings depend largely on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings, and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank’s portfolio,

Table of Contents

comprise the major portion of the Bank’s earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and growth of the Bank are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.

Monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board, also impact on the Bank’s business. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in U.S. Government securities, by adjusting the required level of reserves for financial intermediaries subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.

REGULATION AND SUPERVISION

General

The Corporation and the Bank are extensively regulated under Federal and State law. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable laws or regulations may have a material effect on our business and our prospective business. Our operations may be adversely affected by legislative changes and by the policies of various regulatory authorities. We are unable to predict the nature or the extent of the effects on our business and earnings that fiscal or monetary policies, economic controls, or new Federal or State legislation may have in the future.

The Corporation is a registered bank holding company under the Bank Holding Company Act of 1956 (BHCA) and, as such, is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (Federal Reserve). The Corporation is required to file annual reports with the Federal Reserve and to provide the Federal Reserve such additional information as it may require.

The Bank, as a California state bank and non- member of the Federal Reserve System, is supervised by CDFI and the FDIC. As such, the Bank is regularly examined by and subject to regulations promulgated by the CDFI and the FDIC.

Bank Holding Company Act

Under the BHCA, as amended, the Corporation’s activities are limited to business so closely related to banking, managing, or controlling banks as to be a proper incident thereto. We are also subject to capital requirements applied on a consolidated basis in a form substantially similar to those required of the Bank. The BHCA also requires a bank holding company to obtain approval from the Federal Reserve before (i) acquiring, or holding more than 5% voting interest in any bank or bank holding company, (ii) acquiring all or substantially all of the assets of another bank or bank holding company, or (iii) merging or consolidating with another bank holding company.

The BHCA also restricts non-bank activities to those which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. As discussed below, the Gramm-Leach-Bliley Act,

Table of Contents

which was enacted in 1999, established a new type of bank holding company known as a “financial holding company” that has powers that are not otherwise available to bank holding companies.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. The Dodd-Frank Act additionally creates a new independent federal regulator to administer federal consumer protection laws. The Dodd-Frank Act is expected to have a significant impact on our business operations as its provisions take effect. Among the provisions that may affect us are the following:

Holding Company Capital Requirements

The Dodd-Frank Act requires the FRB to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.

Deposit Insurance

The Dodd-Frank Act permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Effective one year from the date of enactment, the Dodd-Frank Act eliminates the federal statutory prohibition against the payment of interest on business checking accounts.

Corporate Governance

The Dodd-Frank Act will require publicly traded companies to give shareholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The new legislation also authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

Table of Contents

Prohibition Against Charter Conversions of Troubled Institutions

Effective one year after enactment, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto.

Interstate Branching

The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.

Limits on Derivatives

Effective 18 months after enactment, the Dodd-Frank Act prohibits state-chartered banks from engaging in derivatives transactions unless the loans to one borrower limits of the state in which the bank is chartered takes into consideration credit exposure to derivatives transactions. For this purpose, derivative transaction includes any contract, agreement, swap, warrant, note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities securities, currencies, interest or other rates, indices or other assets.

Transactions with Affiliates and Insiders

Effective one year from the date of enactment, the Dodd-Frank Act expands the definition of “affiliate” for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates. The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated. The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

Debit Card Interchange Fees

Effective July 21, 2011, the Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer. Within nine months of enactment, the FRB is required to establish standards for reasonable and proportional fees which may take into account the

Table of Contents

costs of preventing fraud. The restrictions on interchange fees, however, do not apply to banks that, together with their affiliates, have assets of less than $10 billion.

Consumer Financial Protection Bureau

The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

Bank Holding Company Liquidity

The Corporation is a legal entity, separate and distinct from The Bank. The Corporation has the ability to raise capital on its own behalf or borrow from external sources. The Corporation may also obtain additional funds from dividends paid by, and fees charged for services provided to, the Bank. However, regulatory constraints on the Bank preclude the payment of dividends by the Bank to the Corporation.

Limitations on Business and Investment Activities

Under the BHCA, a bank holding company must obtain the FRB’s approval before: (i) directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank; (iii) or merging or consolidating with another bank holding company.

The FRB may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, the FRB must give effect to applicable state laws limiting the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institutions in the state in which the target bank is located, provided that those limits do not discriminate against out-of-state depository institutions or their holding companies, and state laws which require that the target bank have been in existence for a minimum period of time, not to exceed five years, before being acquired by an out-of-state bank holding company.

In addition to owning or managing banks, bank holding companies may own subsidiaries engaged in certain businesses that the FRB has determined to be “so closely related to banking as to be a proper incident thereto.” As a registered bank holding company, the Corporation, therefore,

Table of Contents

will be permitted to engage in a variety of banking-related businesses. Some of the activities that the FRB has determined, pursuant to its Regulation Y, to be related to banking are:

· making or acquiring loans or other extensions of credit for its own account or for the account of others;

· servicing loans and other extensions of credit;

· performing functions or activities that may be performed by a trust company in the manner authorized by federal or state law under certain circumstances;

· leasing personal and real property or acting as agent, broker, or adviser in leasing such property in accordance with various restrictions imposed by FRB regulations;

· acting as investment or financial advisor;

· providing management consulting advice under certain circumstances;

· providing support services, including courier services and printing and selling MICR-encoded items;

· acting as a principal, agent or broker for insurance under certain circumstances;

· making equity and debt investments in corporations or projects designed primarily to promote community welfare or jobs for residents;

· providing financial, banking or economic data processing and data transmission services;

· owning, controlling or operating a savings association under certain circumstances;

· selling money orders, travelers’ checks and U.S. Savings Bonds;

· providing securities brokerage services, related securities credit activities pursuant to Regulation T and other incidental activities; and

· underwriting and dealing in obligations of the U.S., general obligations of states and their political subdivisions and other obligations authorized for state member banks under federal law.

Additionally, qualifying bank holding companies making an appropriate election to the FRB may engage in a full range of financial activities, including insurance, securities and merchant banking.

Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that:

· the customer must obtain or provide some additional credit, property or services from or to the Bank other than a loan, discount, deposit or trust services;

Table of Contents

· the customer must obtain or provide some additional credit, property or service from or to the Corporation or any subsidiaries; and

· the customer must not obtain some other credit, property or services from competitors, except reasonable requirements to assure soundness of credit extended.

Dividends and Capital Distributions

Dividends and capital distributions from the Bank constitute the principal source of cash to the Corporation. The Bank is subject to various federal or state statutory and regulatory restrictions on its ability to pay dividends and capital distributions to its shareholders.

Under California law, banks may declare a cash dividend out of their net profits up to the lesser of retained earnings or the net income for the last three fiscal years (less any distributions made to shareholders during such period), or with the prior written approval of the CDFI, in an amount not exceeding the greatest of (i) the retained earnings of the Bank, (ii) the net income of the Bank for its last fiscal year or (iii) the net income of the Bank for its current fiscal year. In addition, under federal law, banks are prohibited from paying any dividends if after making such payment they would fail to meet any of the minimum regulatory capital requirements. The federal regulators also have the authority to prohibit state banks from engaging in any business practices which are considered to be unsafe or unsound, and in some circumstances the regulators might prohibit the payment of dividends on that basis even though such payments would otherwise be permissible.

As a result of the various regulatory orders and agreements imposed upon the Corporation and the Bank in 2010, the Bank is presently unable to pay and the Corporation has agreed with its federal regulators not to accept cash dividends from the Bank in the absence of prior regulatory authorization to do so.

Regulatory Capital Guidelines

Each of the Corporation and the Bank is required to maintain certain levels of capital. The FRB and the FDIC have substantially similar risk-based capital ratio and leverage ratio guidelines for banking organizations. The guidelines are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments. Under the guidelines, banking organizations are required to maintain minimum ratios for Tier 1 capital and total capital to risk-weighted assets (including certain off-balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organization’s assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories. A depository institution’s or holding company’s capital, in turn, is classified in one of three tiers, depending on type:

· Core Capital (Tier 1). Tier 1 capital includes common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual stock at the holding company level, minority interests in equity accounts of consolidated subsidiaries, and qualifying trust preferred securities less goodwill, most intangible assets and certain other assets.

· Supplementary Capital (Tier 2). Tier 2 capital includes, among other things, perpetual preferred stock and trust preferred securities not meeting the Tier 1 definition, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for possible loan and lease losses, subject to limitations.

Table of Contents

· Market Risk Capital (Tier 3). Tier 3 capital includes qualifying unsecured subordinated debt.

The following table sets forth the regulatory capital guidelines and the actual capitalization levels for the Corporation and the Bank as of December 31, 2011:

	Minimum Acceptable Regulatory Ratios		Actual Ratios
Northern California Bancorp’s Consolidated Capital Ratios
Total capital to risk-weighted assets	8	%	6.61	%
Tier I capital to risk-weighted assets	4	%	1.49	%
Tier I capital to average total assets	4	%	1.04	%

	Minimum Acceptable Regulatory Ratios		Ratios Required to be Considered “Well Capitalized” Under Prompt Corrective Action Regulations		Monterey County Bank’s Actual Ratios
Monterey County Bank’s Regulatory Capital Ratios
Total capital to risk-weighted assets	12	%(1)	10	%	8.43	%
Tier I capital to risk-weighted assets	4	%	6	%	7.16	%
Tier I capital to average total assets	9	%(1)	5	%	5.01	%

(1) These Minimum Acceptable Regulatory Ratios have been increased above regulatory minimums pursuant to the terms of the Consent Order imposed upon the Bank by the FDIC and the CDFI, effective September 31, 2010.

The Corporation and the Bank recognize that a strong capital position is vital to growth, continued profitability, and depositor and investor confidence. The policy of the Bank is to maintain sufficient capital at not less than those required by the consent order imposed upon the Bank by the FDIC and the CDFI, effective September 1, 2010. The Corporation is exploring avenues to raise capital.

Prompt Corrective Action Requirements

The Federal Deposit Insurance Corporation Improvement Act, or FDICIA, requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The federal banking agencies possess broad powers to take prompt corrective action to resolve the problems of insured banks. Each federal banking agency has issued regulations defining five capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Under the regulations, a bank shall be deemed to be:

· “well capitalized” if it has a total risk-based capital ratio of 10.0 percent or more, has a Tier 1 risk-based capital ratio of 6.0 percent or more, has a leverage capital ratio of 5.0 percent or more, and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure;

Table of Contents

· “adequately capitalized” if it has a total risk-based capital ratio of 8.0 percent or more, a Tier 1 risk-based capital ratio of 4.0 percent or more, and a leverage capital ratio of 4.0 percent or more (3.0 percent under certain circumstances) and does not meet the definition of “well capitalized”;

· “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0 percent, a Tier 1 risk-based capital ratio that is less than 4.0 percent, or a leverage capital ratio that is less than 4.0 percent (3.0 percent under certain circumstances);

· “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0 percent, a Tier 1 risk-based capital ratio that is less than 3.0 percent or a leverage capital ratio that is less than 3.0 percent; and

· “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0 percent.

Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment, the bank would be “undercapitalized.” Asset growth and branching restrictions apply to “undercapitalized” banks. Broad regulatory authority was granted with respect to “significantly undercapitalized” banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to “critically undercapitalized” banks, those with capital at or less than 2 percent. Restrictions for these banks include the appointment of a receiver or conservator. All of the federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.

In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential enforcement actions by the federal banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency.

The CDFI, as the primary regulator for state-chartered banks, also has a broad range of enforcement measures, from cease and desist powers and the imposition of monetary penalties to the ability to take possession of a bank, including causing its liquidation.

Safety and Soundness Standards

The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide nine standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating.

Transactions with Affiliates

Under Sections 23A and 23B of the Federal Reserve Act and the FRB’s Regulation W, loans by the Bank to affiliates, investments by them in affiliates’ stock, and taking affiliates’ stock as

Table of Contents

collateral for loans to any borrower is limited to 10 percent of the Bank’s capital, in the case of any one affiliate, and is limited to 20 percent of the Bank’s capital, in the case of all affiliates. The Bank’s holding company and any subsidiaries it may purchase or organize are deemed to be affiliates of the Bank within the meaning of Section 23A and 23B and Regulation W. In addition, transactions between the Bank and other affiliates must be on terms and conditions that are consistent with safe and sound banking practices; in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. These restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. The Corporation and the Bank are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.

FDIC Insurance and Insurance Premium Assessments

Effective January 1, 2007, the FDIC adopted a risk-based assessment system to set semi-annual insurance premium assessments which categorized banks into four risk categories based on capital levels and supervisory “CAMELS” ratings and names them Risk Categories I, II, III and IV. The CAMELS rating system was based upon an evaluation of the six critical elements of an institution’s operations: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk. This rating system was designed to take into account and reflect all significant financial and operational factors financial institution examiners assess in their evaluation of an institution’s performance. The following table sets forth these four Risk Categories:

Capital Group	Supervisory Subgroup
Capital Group	A	B	C
1. Well Capitalized	I		III
2. Adequately Capitalized		II
3. Undercapitalized	III		IV

Within Risk Category I, the assessment system combined supervisory ratings with other risk measures to differentiate risk. For most institutions, the assessment system combined CAMELS component ratings with financial ratios to determine an institution’s assessment rate. For large institutions that had long-term debt issuer ratings, the new assessment system differentiated risk by combining CAMELS component ratings with those ratings. For large institutions within Risk Category I, initial assessment rate determinations were modified within limits upon review of additional relevant information. The assessment system assessed those within Risk Category I that posed the least risk a minimum assessment rate and those that posed the greatest risk a maximum assessment rate that was two basis points higher. An institution that posed an intermediate risk within Risk Category I was charged a rate between the minimum and maximum that varied incrementally by institution.

On February 27, 2009, the FDIC adopted final rules modifying the risk-based assessment system and settled initial base assessment rates beginning April 1, 2009. Under these new rules, risk assessments for small Risk Category I institutions and large Risk Category I institutions with no long-term debt rating includes a consideration of such institution’s adjusted brokered deposit ratio. These new rules also revised the method for calculating the assessment rate for a large Risk Category I institution with a long-term debt issuer rating so that it equally weights the institution’s weighted average CAMELS component ratings, its long-term debt issuer ratings and the financial

Table of Contents

ratios method assessment rate. These new rules set forth three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50 percent of an institution’s assessment rate before the increase for secured liabilities in excess of 25 percent of domestic deposits; and (iii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10 percent of domestic deposits.

Under these new rules, the FDIC adopted new initial base assessment rates as of April 1, 2011, as follows, expressed in terms of cents per $100 in insured deposits:

Initial Base Assessment Rates

Risk Category

I *

Large &
Highly
Complex

Minimum

Maximum

III

Institutions

Annual Rates (in basis points)

5 - 35

*Initial base rates that were not the minimum or maximum rates will vary between these rates.

After applying all possible adjustments, minimum and maximum total base assessment rates for each Risk Category are as follows:

Total Base Assessment Rates*

	Risk Category I	Risk Category II	Risk Category III	Risk Category IV	Large & Highly Complex Institutions
Initial base assessment rate	5 — 9	14	23	35	5 — 35
Unsecured debt adjustment**	-4.5 — 0	-5 — 0	-5 — 0	-5 — 0	-5 — 0
Brokered deposit adjustment	N/A	0 — 10	0 — 10	0 — 10	0 — 10
Total base assessment rate	2.5 — 9	9 — 24	18 — 33	30 — 45	2.5 — 45

* Total base assessment rates do not include the depository institution debt adjustment.

** The unsecured debt adjustment cannot exceed the lesser of 5 basis points or 50% of an insured depository institution’s initial base assessment rate.

In addition, on February 27, 2009, the FDIC adopted an interim rule that imposes a 20 basis point emergency special assessment on all insured depository institutions on June 30, 2009. The special assessment was collected September 30, 2009, at the same time that the risk-based assessments for the second quarter of 2009 were collected. In November, 2009, instead of imposing additional special assessments, the FDIC amended the assessment regulations to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012 on December 30, 2009. For purposes of estimating the future assessments, each institution’s base assessment rate in effect on September 30, 2009 was used, assuming a 5% annual growth rate in the assessment base and a 3 basis point increase in the assessment rate in 2011 and 2012. The prepaid assessment has been applied against actual quarterly assessments and will continue to be applied until exhausted. Any funds remaining after June 30, 2013 will be returned to the institution. Requiring this prepaid assessment did not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system.

Table of Contents

Effective November 21, 2008 and until December 31, 2009, the FDIC expanded deposit insurance limits for certain accounts under the FDIC’s Temporary Liquidity Guarantee Program, or TLGP. Provided an institution had not opted out of the TLGP, the FDIC (i) guarantees, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009 (which was subsequently extended to October 31, 2009) and (ii) provides full FDIC deposit insurance coverage for noninterest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts (IOLTAs) held at participating FDIC-insured institutions through December 31, 2009 (subsequently extended to June 30, 2010). Coverage under the TLGP was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000.

The Dodd-Frank Act requires the FDIC to take such steps as necessary to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020. In setting the assessments, the FDIC is required to offset the effect of the higher reserve ratio against insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also broadens the base for FDIC insurance assessments so that assessments will be based on the average consolidated total assets less average tangible equity capital of a financial institution rather than on its insured deposits. The FDIC has adopted a new restoration plan to increase the reserve ratio to 1.35% by September 30, 2020 and will issue additional rules regarding the method to be used to achieve a 1.35% reserve ratio by that date and offset the effect on institutions with assets less than $10 billion in assets.

The FDIC may terminate its insurance of deposits if it finds that a bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Money Laundering and Currency Controls

Various federal statutory and regulatory provisions are designed to enhance record-keeping and reporting of currency and foreign transactions. Pursuant to the Bank Secrecy Act, financial institutions must report high levels of currency transactions or face the imposition of civil monetary penalties for reporting violations. The Money Laundering Control Act imposes sanctions, including revocation of federal deposit insurance, for institutions convicted of money laundering. In addition, the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”), a part of the Patriot Act, authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks and other financial institutions to enhance record-keeping and reporting requirements for certain financial transactions that are of primary money laundering concern.

The Treasury Department’s regulations implementing IMLAFATA mandate that federally-insured banks and other financial institutions establish customer identification programs designed to verify the identity of persons opening new accounts, maintain the records used for verification, and determine whether the person appears on any list of known or suspected terrorists or terrorist organizations.

Table of Contents

Branching

With prior regulatory approval and/or notices, as applicable, California law permits banks based in the state to either establish new or acquire existing branch offices throughout California. With respect to interstate branching, bank holding companies from any state may generally acquire banks and bank holding companies located in any other state, subject in some cases to nationwide and state-imposed deposit concentration limits and limits on the acquisition of recently established banks. Banks also have the ability, subject to specific restrictions, to acquire by acquisition or merger branches located outside their home state. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to many of the laws of the states in which they are located.

The consent order imposed upon the Bank by the FDIC and the CDFI, effective September 1, 2010, prohibits the Bank from engaging in any expansionary activities, including establishing new or acquiring existing branch offices, in the absence of prior regulatory authorization to do so.

Community Reinvestment Act and Fair Lending

The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act, or CRA, activities. The CRA is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low-and moderate-income neighborhoods, consistent with safe and sound banking practices. The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. In connection with its assessment of CRA performance, the FDIC assigns a rating of “outstanding”, “satisfactory”, “needs to improve” or “substantial noncompliance”.

The Bank had a CRA rating of “Satisfactory” as of its most recent regulatory examination.

Safeguarding of Customer Information and Privacy

The FRB and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. These guidelines require financial institutions to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Bank has adopted a customer information security program to comply with such requirements. Federal banking rules also limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties.

Patriot Act

On October 26, 2001, the President signed into law comprehensive anti-terrorism legislation, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, known as the Patriot Act. The Patriot Act was designed to deny terrorists and others the ability to obtain access to the United States financial system, and has significant implications for depository institutions and other businesses involved in the transfer of money. The Patriot Act, as implemented by various federal regulatory agencies,

Table of Contents

requires financial institutions, including the Bank, to implement new policies and procedures or amend existing policies and procedures with respect to, among other matters, anti-money laundering, compliance, suspicious activity and currency transaction reporting and due diligence on customers. The Patriot Act and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB and other federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering regulatory merger applications. The Bank has augmented its systems and procedures to accomplish this. The Bank believes that the ongoing cost of compliance with the Patriot Act is not likely to be material to the Bank.

Impact of Monetary Policies

Banking is a business which depends on rate differentials. In general, the difference between the interest rate paid by a bank on its deposits and its other borrowings and the interest rate earned by a bank on its loans, securities and other interest-earning assets comprises the major source of the bank’s earnings. These rates are highly sensitive to many factors which are beyond the bank’s control and, accordingly, the earnings and growth of the bank are subject to the influence of economic conditions generally, both domestic and foreign, including inflation, recession, and unemployment; and also to the influence of monetary and fiscal policies of the United States and its agencies, particularly the FRB.

The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates. The nature and timing of any future changes in such policies and their impact on the Corporation and/or the Bank cannot be predicted; however, depending on the degree to which their respective interest-earning assets and interest-bearing liabilities are rate sensitive, increases in rates would have a temporary effect of increasing their respective net interest margin, while decreases in interest rates would have the opposite effect. In addition, adverse economic conditions, including a downturn in the local or regional economy and rising energy prices, could make a higher provision for loan losses a prudent course and could cause higher loan charge-offs, thus adversely affecting the net income or other operating costs of the Corporation and the Bank.

Other Aspects of Banking Law

The Corporation and the Bank are also subject to federal statutory and regulatory provisions covering, among other things, security procedures, insider and affiliated party transactions, management interlocks, electronic funds transfers, funds availability, and truth-in-savings. There are also a variety of federal statutes which regulate acquisitions of control and the formation of bank holding companies.

Regulatory Enforcement Powers

Commercial banking organizations, such as the Bank, may be subject to enforcement actions by the FDIC and the CDFI for engaging in unsafe or unsound practices in the conduct of their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits, the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the imposition of restrictions and sanctions under the prompt corrective action provisions of the FDICIA.

Table of Contents

The Bank has entered into a Consent Order with the FDIC and CDFI. The order became effective on September 1, 2010. The order was filed as an exhibit to the Corporation’s Current Report on Form 8-K filed on September 23, 2010.

The order requires the Bank to take corrective actions to address certain alleged violations of laws and/or regulations and imposes certain restrictions on the Bank. The following is a list of the corrective actions required of, and restrictions placed on, the Bank and the current status (in italics) of the actions taken as of the filing date hereof:

1. Have and retain qualified management having such qualifications and experience commensurate with his or her duties and responsibilities at the Bank and notify the FDIC and the CDFI prior to adding any individual to the Bank’s Board of Directors or employing any individual as a senior executive officer of the Bank.

The Board of Directors has undertaken a review of the qualifications and experience of individuals serving in key management positions. As a result of this review, the Board of Directors has initiated a search for a qualified individual to be hired to serve as President of the Bank, relieving the Chief Executive Officer of a portion of his heavy workload. Additionally, the Board of Directors initiated a search for a qualified individual to be hired as Chief Lending Officer in replacement of the Bank’s former Chief Lending Officer who resigned on February 28, 2011. A qualified individual was hired and appointed Chief Lending Officer on February 23, 2012.

2. Develop and adopt a capital plan that complies with the FDIC’s Statement of Policy on Risk-Based Capital contained in Appendix A to Part 325 of the FDIC’s rules and regulations in order to maintain Tier 1 capital in such an amount to ensure that the Bank’s leverage ratio equals or exceeds 9% and the Bank’s total risk-based capital ratio equals or exceeds 12%.

The Bank has developed a capital plan that it believes complies with the FDIC’s Statement of Policy on Risk-Based Capital contained in Appendix A of Part 325 of the FDIC’s rules and regulations to ensure that the Bank’s leverage ratio equals or exceeds 9% and the Bank’s total risk-based capital ratio equals or exceeds 12%. This capital plan was approved by the Board on October 28, 2010. The Bank’s total risk-based capital ratio was 8.13% at December 31, 2011, which was below the required 12%. The Bank’s leverage capital ratio was 5.01% at December 31, 2011, which was below the required 9%. The Bank is in the process of implementing its capital plan and engaged an outside financial advisory firm to assist the Bank in taking appropriate actions to achieve and maintain the capital requirements of the order. Appropriate actions or combinations of actions may include raising additional capital, reducing the Bank’s assets through sales of branch offices, loans or other real estate owned, merger with another financial institution or sale of the Bank.

3. Not pay cash dividends or make any other payments to the Bank’s shareholders absent the prior written consent of the FDIC and the CDFI;

The Board has acknowledged the prohibition on payment of dividends or any other payments to the Bank’s shareholder (the Corporation) without the prior written consent of the FDIC and the CDFI. The Bank has not paid any dividends to the Corporation since the effective date of the order.

Table of Contents

4. Eliminate, either by charge-off or collection, assets classified as “Loss” in the examination report of the FDIC and the CDFI relating to their examination of the Bank on February 16, 2010 the Report of Examination (the “ROE”).

Assets classified as “Loss” in the examination report of the FDIC and the CDFI relating to their examination of the Bank on February 16, 2010 have been charged-off.

5. Formulate a written plan to reduce the Bank’s risk exposure in adversely classified “Substandard” or “Doubtful” assets listed in the ROE.

A written plan to reduce the Bank’s risk exposure in adversely classified “Substandard” or “Doubtful” assets listed in the ROE was approved by the Board on November 26, 2010, and submitted to the FDIC Regional Director and CDFI Commissioner for their review and comment.

6. Not extend any additional credit to or for the benefit of any borrower who has a loan or other extension of credit that either: (a) has been charged off or classified (in whole or in part) as “Loss” and is uncollected, or (b) absent the prior approval of the Bank’s board or loan committee, has been classified (in whole or in part) as “Doubtful” or “Substandard;”

The Bank has not extended any additional credit to or for the benefit of any borrower who has a loan or other extension of credit that either has been charged off or classified (in whole or in part) as “Loss,” “Doubtful” or “Substandard” since the date of the order. The Bank also has not extended any additional credit to or for the benefit of any borrower who has a loan or other extension of credit classified (in whole or in part) as “Doubtful” or “Substandard” without the prior approval of the Bank’s Board or loan committee since the date of the order.

7. Review the appropriateness of the Bank’s allowance for loan and lease losses (the “ALLL”) and establish a comprehensive policy for determining the appropriate level of the ALLL, including documenting the analysis according to the standards set forth in the applicable policy guidelines of the FDIC.

The ALLL policy has been reviewed and revised to ensure the determination of the appropriate level of the ALLL, including documenting the analysis according to the standards set forth in the applicable policy guidelines of the FDIC. The revised policy was approved by the Board on October 14, 2010. The Board reviews the ALLL on a quarterly basis to ensure it is at an appropriate level.

8. Develop or revise, adopt, and implement a written lending and collection policy to provide effective guidance and control over the Bank’s lending functions in accordance with the requirements of the order.

The Bank’s written lending and collection policy has been revised to provide effective guidance and control over the Bank’s lending functions. The revised policy was approved by the Board on October 28, 2010. Additional revisions were approved by the Board on March 9, 2011and August 18, 2011.

9. Develop or revise, adopt, and implement a written liquidity and funds management policy that adequately addresses liquidity needs and contingency funding, appropriately reduces the Bank’s reliance on non-core funding sources and complies with FDIC’s Guidance on Liquidity Risk Management, dated August 26, 2008.

Table of Contents

A revised liquidity and funds management policy which addresses liquidity needs and contingency funding and appropriately reduces reliance on non-core funding sources was approved by the Board on October 28, 2010 and has been implemented. Bank Management believes this policy complies with the FDIC’s Guidance on Liquidity Risk Management, dated August 26, 2008.

10. Comply with the FDIC’s rules and regulations relating to brokered deposits and formulate and submit for approval, a written plan to eliminate the Bank’s reliance on brokered deposits.

The Bank believes it is in compliance with the FDIC’s rules and regulations relating to brokered deposits and has formulated and submitted to the FDIC a written plan to eliminate its reliance on brokered deposits. The plan was approved by the Board on October 28, 2010 and was submitted to the FDIC on October 29, 2010. The Bank’s total brokered deposits have been reduced to $15 million as of December 31, 2011 from $64 million as of December 31, 2009.

11. Develop or revise, adopt, and implement a written plan addressing retention of profits, reducing overhead expenses, and setting forth a comprehensive budget to cover the three-year period from January 1, 2011 to December 31, 2013, which shall include formal goals, strategies and benchmarks which are consistent with sound banking practices to improve the Bank’s net interest margin, increase interest income, reduce discretionary expenses, and improve and sustain earnings.

The Board approved a Strategic Plan and Budget for the period from January 1, 2011 through December 31, 2013 on December 30, 2010 and the plan was submitted to the FDIC Regional Director and the CDFI Commissioner for their review. The Board approved a revised Strategic Plan and Budget for the period from July 1, 2011 through December 31, 2013 on August 22, 2011.

12. Develop and submit for regulatory review and approval, a written three-year strategic plan, including a written profit plan, which includes, among other things, specific goals for the dollar volume of total loans, total investment securities and total deposits as of December 31, 2011 through December 31, 2013.

See response to Item 11.

13. Refrain from engaging in any expansionary activities, including opening any branches absent prior regulatory approval.

The Bank currently does not anticipate any expansionary activities and acknowledges the requirement for prior regulatory approval before under taking any such activities.

14. Inform the FDIC and the CDFI prior to making any planned public announcement or notification regarding changes to the Bank’s financial condition, executive management or board of directors.

The Board and management acknowledge the requirement to inform the FDIC and the CDFI prior to making any planned public announcement or notification regarding changes to the Bank’s financial condition, executive management or Board.

15. Furnish written progress reports to the FDIC and the CDFI detailing the form and manner of any actions taken to secure compliance with the order; and provide a description of the order to the Bank’s shareholders in conjunction with the Bank’s next

Table of Contents

shareholder communication and also in conjunction with the Bank’s notice or proxy statement preceding the next shareholder meeting.

The Bank filed the required progress reports with the FDIC & CDFI on October 30, 2010, January 31, 2011, April 30, 2011, July 29, 2011 October 27, 2011 and January 27, 2012.

The Bank, has stipulated to the issuance of a Consent Order, Order for Restitution and Order to Pay Civil Money Penalties with the FDIC. The orders became effective on September 29, 2010. The orders were filed as an exhibit to the Company’s Current Report on Form 8-K, filed on October 5, 2010.

In connection with the issuance of the orders, the FDIC alleged that the Bank had engaged in unsafe or unsound banking practices, deceptive practices and violations of law by:

1. offering credit cards (“Balance Transfer Credit Cards”) which are intended for the transfer and payment of charged-off consumer debt without disclosing the age of the debt and the fact that the transferred debt was time-barred and/or no longer reportable by credit reporting agencies;

2. offering Balance Transfer Credit Cards to consumers when the Bank does not have sufficient substantiation that the debtor is obligated for the amount of indebtedness subject to the balance transfer;

3. misleading consumers about the utility of Balance Transfer Credit Cards advertised as credit cards when, in fact, the consumers have no available credit at the time the credit card is issued;

4. misrepresenting debt collection programs as a credit card offer;

5. misleading consumers regarding the interest charged on debt transferred to Balance Transfer Credit Cards; and

6. misleading consumers concerning the fees associated with stored value debit cards through website solicitations for the cards.

The allegations contained in items 1 through 5 above were related to a credit card program offered to consumers under a card sponsorship agreement between the Bank and Tighorn Financial Services, LLC (“Tighorn”). Tighorn acquired consumer debt and solicited consumers as a part of its debt collection program. As an incentive to make payments, a portion of the debt was forgiven with the remainder of the debt transferred to a credit card.

The Bank agreed to issue credit cards on behalf of Tighorn to certain eligible consumers who Tighorn solicited. The card sponsorship agreement required, among other things, that Tighorn’s solicitations comply with laws, regulations and regulatory orders governing the Bank in the solicitation, issuance and administration of the credit cards.

In June 2008, the Bank provided notice of cancellation to Tighorn in accordance with provisions of the card sponsorship agreement. While the Bank continues to service existing credit card accounts, solicitations of new accounts were discontinued effective December 31, 2008.

Table of Contents

The allegation contained in item 6 above was related to a stored value card program which was canceled in June 2008 in accordance with provisions of the card sponsorship agreement. The card portfolio was transferred to another issuer on or about December 31, 2008.

Without admitting or denying any of the alleged charges of unsafe or unsound banking practices and any violations of law, the Bank has agreed to take the following corrective actions to address the foregoing alleged violations of law and/or regulation. Below each listed action is a description of the status of the Bank’s efforts to comply with the required action (in italics).

1. Provide full, accurate disclosure and refrain from making misleading statements to consumers regarding the Bank’s balance transfer credit card programs, the interest rates and fees associated with these programs, the Bank’s debt collection practices, and the Bank’s stored value card programs.

The Bank believes it has established procedures for the review of disclosures and solicitation materials for both credit card and stored value card programs which require disclosures and solicitation materials be reviewed by the Bank’s compliance department and independent legal counsel with expertise in credit card and stored value card regulations.

2. The Board of Directors to participate fully in the oversight of the Bank’s compliance management system and to assume full responsibility for the approval of sound compliance policies and objectives. The Board of Directors to establish a compliance committee comprised of at least three directors who are not Bank officers that will meet at least monthly to review among other things, compliance with consumer laws and compliance with the Order. The Board of Directors to develop and adopt a comprehensive educational program for periodic training of Board members.

A Compliance Committee, which meets on a monthly basis, was established prior to entering into the orders and is still in place. A training program for the Board was prepared and approved by the Board on October 28, 2010. Board members are participating in training as provided for in the training program.

3. Develop and maintain effective monitoring, training and audit procedures to review each aspect of the Bank’s agreement with third parties in order to ensure that third party vendors comply with consumer protection laws, regulatory guidance, regulations, and policies (“consumer laws”).

The Bank has engaged independent consultants with expertise in credit card and stored value card regulations to audit the third parties to ensure their compliance with consumer protection laws, regulatory guidance, regulations and policies.

4. Develop and maintain an adequate compliance management system that implements a written compliance program to ensure the Bank’s compliance with consumer laws.

The Bank has developed and now maintains a written compliance program which is designed to ensure compliance with consumer laws. A Compliance Committee, consisting of three outside directors, a Compliance Officer, who reports directly to the Committee, and the Chief Executive Officer, meets monthly and reports its activities to the full Board.

Table of Contents

5. Retain a qualified compliance officer with the requisite knowledge and experience to administer an effective compliance management system, including experience with third-party debit and credit card agreements.

The Bank has appointed a Compliance Officer with 19 years of banking experience and an Assistant Compliance Officer with 29 years of banking experience and has engaged legal counsel and consultants having experience with third-party debit and credit card agreements to augment staff experience.

6. Have an independent audit to ensure compliance with consumer laws.

An independent audit has been conducted and the audit report indicates that the Bank is in compliance with consumer laws.

7. Correct, to the extent possible, all violations of consumer laws and refrain from making, either directly or indirectly, any false, deceptive or misleading representations with respect to any extension of credit or other Bank product; and

The Bank continues to make efforts to correct, to the extent possible, all violations of consumer laws and refrain from and acknowledges its legal obligations to refrain from making, either directly or indirectly, any false, deceptive or misleading representations with respect to any extension of credit or other Bank product.

8. Contribute $300,000 to an established local or national non-profit organization for the specific purpose of consumer financial education and counseling.

The Bank submitted the name and qualifications of a non-profit organization meeting the specific requirements as detailed in the orders for approval, and the FDIC Regional Director subsequently granted such approval. The Bank recorded the $300,000 expense in the third quarter of 2010 and funded the donation on February 2, 2011.

9. Make restitution payments to certain consumers who had or currently have a credit card and/or a prepaid debit card issued by the Bank through agreements with certain third party vendors. In this regard, the Bank must prepare a restitution plan for regulatory approval with respect to making restitution payments to such consumers not to exceed $2.5 million in the aggregate and reserve or deposit into a segregated account for the payment of restitution an amount not less than $1.5 million. The Bank is also required to retain an independent accounting firm to determine compliance with the restitution plan.

The Bank submitted the name and qualifications of the independent accounting firm to the FDIC Regional Director for non-objection which was received on December 6, 2010. The restitution plans were submitted to the FDIC Regional Director for review and approval on November 29, 2010. On April 4, 2011 the Bank received approval from the FDIC for one of the restitution plans. The Bank completed implementation of this plan on May 2, 2011. For the remaining restitution plan, the FDIC requested that the Bank make certain revisions to the plan. The Bank resubmitted a revised plan to the FDIC Regional Director on April 18, 2011 for his review and approval. On June 7, 2011 the Bank received approval from the FDIC for the revised restitution plan. The Bank completed implementation of this plan on July 6, 2011. The Bank recorded the $1.5 million expense for the restitution payments in the third quarter of 2010.

Table of Contents

The Bank retained an independent accounting firm to determine compliance with the restitution plans. The accounting firm’s report indicated they found no exceptions.

10. Furnish written progress reports to the FDIC detailing the form and manner of any actions taken to secure compliance with the Order and provide a description of the Order to the Bank’s shareholders in conjunction with the Bank’s next shareholder communication and also in conjunction with the Bank’s notice or proxy statement preceding the next shareholder meeting.

The initial progress report was provided to the FDIC on October 29, 2010. The Bank was exempted from filing the progress report due January 30, 2011 since the FDIC performed an onsite visitation during December 2010 to monitor the Bank’s progress in complying with the orders. The Bank provided progress reports to the FDIC on April 30, 2011 and July 28, 2011. The Bank was exempted from the quarterly report due October 30, 2011 due to a recently completed compliance examination.

Additionally, as a result of the alleged violations of laws and/or regulation, the FDIC has assessed a civil money penalty in the amount of $500,000 against the Bank which has been paid to the United States Treasury. The $500,000 expense was recorded in the third quarter of 2010.

The Corporation has entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of San Francisco, effective as of October 29, 2010, pursuant to which the Corporation has agreed to take the following actions listed below. The Agreement was filed as an exhibit to the Company’s Current Report on Form 8-K, filed on November 2, 2010. Below each listed action is a description of the status of the Corporation’s efforts to comply with the required action (in italics).

1. Take appropriate steps to fully utilize the Corporation’s financial and managerial resources to serve as a source of strength to the Bank, including taking steps to ensure the Bank’s compliance with the Consent Order, dated September 1, 2010, between the Bank and the FDIC and any other supervisory action taken by the Bank’s federal and state regulators;

The Corporation provided the Bank with a capital injection of $400,000 on December 31, 2010 in order to enhance the Bank’s capital.

2. Refrain from declaring or paying dividends, taking dividends or any form of payment from the Bank representing a reduction in the Bank’s capital, or making any distributions of interest, principal or other sums on the Corporation’s subordinated debentures or trust preferred securities absent prior regulatory approval;

The Board has acknowledged the requirement of obtaining regulatory approval prior to declaring or paying dividends, taking dividends or any form of payment from the Bank representing a reduction in the Bank’s capital, or making any distributions of interest, principal or other sums on the Corporation’s subordinated debentures or trust preferred securities. No such transactions have occurred which required regulatory approval.

3. Refrain from incurring, increasing or guaranteeing any debt or repurchasing or redeeming any shares of its stock absent prior regulatory approval;

The Board has acknowledged the requirement of regulatory approval prior to incurring, increasing or guaranteeing any debt or repurchasing or redeeming any

Table of Contents

shares of its stock. No such transactions have occurred which required regulatory approval.

4. Develop and submit for regulatory approval a cash flow projection of the Company’s planned sources and uses of cash for debt service, operating expenses and other purposes;

The required cash flow projections were submitted to the Federal Reserve Bank on December 27, 2010 and November 30, 2011.

5. Comply with appropriate regulatory notice and approval requirements when appointing any new directors or senior executive officers or changing the responsibilities of any senior executive officer and comply with the limitations on indemnification and severance payments set forth in Section 18(k) of the Federal Deposit Insurance Act (12 USC 1828(i)) and Part 359 of the FDIC’s implementing regulations; and

The Board has acknowledged the notice and approval requirements when appointing any new directors or senior executive officers or changing the responsibilities of any senior executive officer and the obligation to comply with the limitations on indemnification and severance payments set forth in Section 18(k) of the Federal Deposit Insurance Act (12 USC 1828(i)) and Part 359 of the FDIC’s implementing regulations. No changes have occurred which required regulatory approval.

6. Furnish written progress reports to the Federal Reserve Bank of San Francisco detailing the form and manner of any actions taken to secure compliance with the Agreement.

The Corporation has filed the required progress reports with the Federal Reserve Bank of San Francisco on January 30, 2011, April 30, 2011, July 28, 2011, October 26, 2011 and January 27, 2011.

The Board of Directors and management believe the Corporation and the Bank are in substantial compliance or are taking steps toward compliance with all requirements of these regulatory actions.

California and Federal Change in Bank Control Laws

The Federal Change in Bank Control Act of 1978 prohibits a person or group of persons “acting in concert” from acquiring “control” of a bank or holding company unless the appropriate federal regulatory agency has been given 60 days’ prior written notice of such proposed acquisition and, within that time period, has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to the expiration of the disapproval period if the agency issues written notice of its intent not to disapprove the action. The acquisition of more than 10% of a class of voting stock of a bank (or holding company) with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (such as the Common stock), is generally presumed, subject to rebuttal, to constitute the acquisition of control.

Under the California Financial Code, no person shall, directly or indirectly, acquire control of a California licensed bank or a bank holding company unless the CDFI has approved such acquisition of control. A person would be deemed to have acquired control of the Corporation under this state law if such person, directly or indirectly, has the power (i) to vote 25% or more of the voting power of the Corporation or (ii) to direct or cause the direction of the management and

Table of Contents

policies of the Corporation. For purposes of this law, a person who directly or indirectly owns or controls 10% or more of the Common stock would be presumed to control the Corporation, subject to rebuttal.

In addition, any “company” would be required to obtain the approval of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), before acquiring 25% (5% in the case of an acquirer that is, or is deemed to be, a bank holding company) or more of the outstanding Common stock of, or such lesser number of shares as constitute control over, the Bank or the Corporation.

RESEARCH

Neither the Corporation nor the Bank makes any material expenditures for research and development.

DEPENDENCE UPON A SINGLE CUSTOMER

Neither the Corporation nor the Bank is dependent upon a single customer or very few customers. The Bank’s business is concentrated in, and largely dependent upon the strength of the local economy in, the Monterey Peninsula area of Northern California. The local economy is affected by both national trends and by local factors. Tourism and the activities at the former Fort Ord military base are among the major contributors to the local economy.

ITEM 1A. RISK FACTORS

Not Applicable.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES

The main branch office of the Bank, which also serves as the principal office of the Corporation, is located at 601 Munras Avenue, Monterey, California 93940. This facility contains a lobby, executive and customer service offices, teller stations, safe deposit boxes and related non-vault area, vault, operations area, lounge and miscellaneous areas. A drive-through facility and adequate paved parking are also on the premises. Both the land and all improvements thereto are owned by the Bank.

The Bank also owns a building located at 556 Abrego Street, Monterey, California 93940, which houses a loan production office and additional office space. The Bank currently operates three branch offices in Carmel Valley, Pacific Grove and Salinas, California, all within approximately 20 miles from the Bank’s main office. The land and improvements dedicated to the Carmel Valley, Pacific Grove and Salinas branch offices are leased. The Bank discontinued operation of the Carmel-By-The-Sea branch office on December 30, 2011. See Note 13 to the Corporation’s Consolidated Financial Statements included herein.

Generally, neither the Bank nor the Corporation may invest in equity interests in real estate, except for the direct use by the Bank or the Corporation in their business. However, the Bank acquires real estate through foreclosure or resolution of outstanding loans, which properties are treated as non-performing assets and are marketed for sale.

Table of Contents

ITEM 3. LEGAL PROCEEDINGS

For a discussion of legal proceedings see Note 14m “Commitments and Contingencies” in the Consolidated financial Statements.

Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, any such liability will not have a material effect on the consolidated financial position of the Corporation or the Bank.

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable.

Table of Contents

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Corporation’s stock is traded on the Over-the-Counter Bulletin Board, or OTCBB, under the stock symbol “NRLB,” which is a quotation service for securities not listed or traded on NASDAQ or a national securities exchange. In addition to the transactions in the common stock reported on the OTCBB, the Corporation also has knowledge of a limited number of transactions conducted between individual shareholders.

The Corporation currently is aware of one company that makes a market for its common stock, Howe Barnes Hoeffer & Arnett.

At December 31, 2011, there were 490 shareholders of record of the common stock of the Corporation. This does not reflect the number of persons or entities who hold their stock in nominee or street name through various brokerage firms.

The Corporation did not repurchase any shares of the common stock in 2011 or 2010.

The information in the following table indicates the high and low bid information and volume of trading for our common stock for each quarter since January 1, 2009, and is based upon information provided by the OTCBB. The information does not include transactions for which no public records are available. The OTCBB market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.

Quarter/Year	Price ($)	Volume
1st quarter of 2009	$2.00-4.25	7,858
2nd quarter of 2009	$1.70-6.50	28,526
3rd quarter of 2009	$2.75-5.00	3,927
4th quarter of 2009	$3.50-6.00	6,007

1st quarter of 2010	$3.55-4.74	2,006
2nd quarter of 2010	$2.50-3.60	4,574
3rd quarter of 2010	$2.50-2.50	123
4th quarter of 2010	$1.50-2.50	12,663

1st quarter of 2011	$1.15-2.20	10,473
2nd quarter of 2011	$1.06-1.70	15,038
3rd quarter of 2011	$0.61-1.06	31,856
4th quarter of 2011	$0.12-1.00	14,590

The principal source of cash flow of the Corporation, including cash flow to pay dividends on its common stock or principal and interest on debt, is from interest and dividends on investments as well as tax benefit payments and dividends received from the Bank. There are statutory and regulatory limitations on the payment of dividends by the Bank to the Corporation, as well as by the Corporation to its shareholders.

Table of Contents

If in the opinion of the applicable federal and/or state regulatory authority, a depository institution or holding company is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution or holding company, could include the payment of dividends), such authority may require, after notice and hearing (except in the case of an emergency proceeding where there is in no notice or hearing), that such institution or holding company cease and desist from such practice. Moreover, the Federal Reserve and the FDIC have issued policy statements which provide that bank holding companies and insured depository institutions generally should only pay dividends out of current operating earnings.

Under the FDICIA, an FDIC insured depository institution may not pay any dividend if payment would cause it to become undercapitalized or once it is undercapitalized.

The Bank’s payment of dividends, as a California chartered commercial banking corporation, is also regulated by the California Financial Code. Under the California Financial Code, funds available for cash dividend payments by the Bank are restricted to the lessor of: (i) retained earnings; or (ii) the Bank’s net income for its last three fiscal years (less any distributions to the shareholders made during such period). As of December 31, 2011 the Bank had $3,027,000 in retained earnings. The Bank’s net income for the last three fiscal years less distributions to shareholders was $(11,795,000).

The Corporation did not pay a cash dividend in 2011, 2010 and 2009. The Bank paid cash dividends totaling $500,000 in 2009; no dividends were paid by the Bank in 2011 or 2010. The Bank is presently prohibited from paying and the Corporation has agreed not to accept from the Bank dividends absent prior regulatory authorization to do so under the terms of the regulatory orders and agreements that they became subject in 2010, as discussed under “Regulatory Enforcement Powers” of Item 1.

The Corporation has deferred interest payments on its subordinated debt securities. Therefore it may not pay any dividends or make a distribution on its common stock until the total deferred interest is paid. Additionally, the Corporation, prior to paying any dividend or distribution, must request the prior approval of the Federal Reserve Bank.

Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

The following summary presents the Corporation’s consolidated financial data as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. The data presented are derived from the Corporation’s audited Consolidated Financial Statements. You should read this information in conjunction with Item 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS of this Annual Report on Form 10-K for the year ended December 31, 2011 and our audited Consolidated Financial Statements included herewith. The historical results presented in the following summary do not necessarily indicate expected results for future periods.

	At or for the Year Ended December 31
(Dollars in thousands except share data)	2011			2010			2009			2008			2007
Five-Year Selected Financial Data
Summary of Operating Results:
Total interest income	$	11,293		$	12,421		$	15,262		$	16,500		$	16,941
Total interest expense	4,140			5,737			8,079			9,749			8,002
Net interest income	7,153			6,684			7,183			6,751			8,939
Provision for loan losses	7,860			0			3,368			1,132			865
Net interest income (loss) after provision for loan losses	(707		)	6,684			3,815			5,619			8,074
Total non-interest income	4,190			8,553			10,120			5,031			4,336
Total non-interest expenses	13,737			17,314			12,983			8,907			9,005
Income (loss) before provision (benefit)	(10,254		)	(2,077		)	952			1,743			3,405
Income tax provision (benefit)	3,398			(1,371		)	(659		)	281			1,476
Net income (loss)	$	(13,652	)	$	(706	)	$	1,611		$	1,462		$	1,929

Per Common Share Data:
Net (loss) income - Basic (1)	$	(7.64	)	$	(0.40	)	$	0.90		$	0.80		$	1.08
Net (loss) income - Diluted (2)	(7.64		)	(0.40		)	0.90			0.79			1.03
Book value, end of period	2.01			8.01			9.06			7.77			7.82
Avg shares outstanding (3)	1,785,359			1,785,359			1,791,218			1,823,965			1,785,812

Balance Sheet Data:

Total loans, net of unearned income (4)	$	149,498		$	151,549		$	163,213		$	167,180		$	168,748
Total assets	245,677			263,617			273,295			306,201			253,865
Total deposits	203,613			207,998			202,422			189,730			167,333
Stockholders’ equity	3,596			14,307			16,150			14,352			14,434
Return (loss) on average assets (5)	(5.07		)%	(0.25		)%	0.55		%	0.54		%	0.91		%
Return (loss) on average stockholders’ equity (5)	(116.37		)%	(4.43		)%	9.98		%	10.67		%	14.09		%
Dividend payout ratio	0.00		%	0.00		%	0.00		%	30.78		%	23.90		%
Net interest spread	3.57		%	3.03		%	2.77		%	2.45		%	4.07		%
Net yield on interest earning assets (5)	3.63		%	3.18		%	3.09		%	2.87		%	4.69		%
Avg shareholders’ equity to average assets (5)	4.35		%	5.62		%	5.47		%	5.04		%	6.44		%
Risked-Based capital ratios
Tier 1	1.49		%	9.31		%	10.24		%	8.80		%	9.23		%
Total	6.61		%	12.85		%	13.51		%	12.31		%	12.63		%
Total loans to total deposits at end of period (4)	75.65		%	74.46		%	82.37		%	88.11		%	100.85		%
Allowance for loan losses to total loans at end of period (4)	2.81		%	2.04		%	2.12		%	1.42		%	1.19		%
Nonperforming loans to total loans at end of period (4)	3.86		%	7.41		%	5.33		%	4.18		%	1.98		%
Net charge-offs to average loans (4)	4.30		%	0.23		%	1.33		%	0.45		%	0.17		%

Table of Contents

(1) Basic earnings per share amounts were computed on the basis of the weighted average number of shares of common stock during the year. The weighted average number of shares used for this computation was 1,785,891 for 2011, 1,785,891 for 2010, 1,791,218 for 2009, 1,890,591 for 2008 and 1,785,812 for 2007.

(2) Fully diluted earnings per share amounts were computed on the basis of the weighted average number of shares of common stock and common stock equivalents outstanding during the year. Common stock equivalents include employee stock options. The weighted average number of shares used for this computation was 1,785,891, 1,785,359, 1,795,764, 1,848,173 and 1,881,004 in 2011, 2010, 2009, 2008 and 2007, respectively.

(3) Weighted average common shares.

(4) Includes loans being held for sale.

(5) Averages are of daily balances.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

General

The following discussion reviews and analyzes the operating results and financial condition of the Corporation, focusing on the Bank. It should be read in conjunction with the Consolidated Financial Statements and the other financial data presented elsewhere herein.

Net income (loss) for 2011, 2010 and 2009 was $(13,652,000), $(706,000), and $1,611,000, respectively. The net income (loss) per share for 2011, 2010 and 2009 was $(7.64), $(0.40), and $0.90, respectively. The diluted net income (loss) per share for the same time periods was $(7.64), $(0.40) and $0.90, respectively. Return (loss) on average shareholders’ equity was (116.37%), (4.43%), and 9.98% in 2011, 2010 and 2009, respectively. Return (loss) on average assets was (5.07%), (0.25%), and 0.55% in 2011, 2010 and 2009, respectively.

2011 vs. 2010

The increase in net loss in 2011 from 2010 levels can be attributed primarily to: (i) the decrease of $1.1 million or 9.08% in interest income from $12.4 million in 2010 to $11.3 million in 2011; (ii) the decrease in non-interest income of $4.4 million or 51.01% from $8.6 million in 2010 to $4.19 million in 2011; (iii) a $7.9 million provision for loan losses in 2011 whereas there was no provision for loan losses in 2010; and (iv) an increase in income tax provision of $4.8 million from a benefit of $1.4 million in 2010 to a provision of $3.4 million in 2011. The increase in net loss was partially offset by decreases in expenses with non-interest expenses decreasing $3.6 million or 20.66% from $17.3 million in 2010 to $13.7 million in 2011 and interest expenses decreasing $1.6 million or 27.84% from $5.7 million in 2010 to $4.1 million in 2011.

Interest income decreased primarily because average interest-earning assets decreased $18.1 million or 7.44% from $243.5 million in 2010 to $225.4 million in 2011. Interest expense decreased primarily because average interest-bearing liabilities decreased $9.3 million or 4.09% from $228.3 in 2010 to $219.0 in 2011 and the average rate paid decrease 62 basis points or 24.7% from 2.51% in 2010 to 1.89% in 2011.

The primary reasons for the decrease in non-interest income of $4.4 million or 51.0% from $8.6 million in 2010 to $4.2 million in 2011 are: (i) decreases in other income of $2.4 million; (ii) decrease in gain on sales of investment securities of $623,000; (iii) a decrease in service charges on deposit accounts of $87,000; and (iv) a gain of $1.5 million recognized in 2010 on the sale of

Table of Contents

merchant credit card processing accounts. The decreases were partially offset by an increase in income from sales and servicing of Small Business Administration loans of $146,000.

The primary reasons for the decrease in non-interest expenses of $3.6 million or 20.66% from $17.3 million in 2010 to $13.7 million in 2011 are: (i) a decrease of $353,000 or 9.91% in salaries and benefits; (ii) a decrease in expenses of $1.9 million or 61.78% associated with the Corporation’s foreclosed assets; (iii) a decrease of $1.5 million or 36.82% in other general and administrative expense; (iv) an expense of $1.8 million that was recognized in 2010 in connection with a settlement with the FDIC that resulted from the issuance of various regulatory orders and the imposition of civil money penalties associated with the Bank’s card programs. The decreases were partially offset by increases of $1.3 million or 108.61% in litigation settlement expense; $709,000 in professional fees; and $134,000 in FDIC and State assessments.

2010 vs. 2009

The decrease in net income in 2010 from 2009 levels can be attributed primarily to: (i) the decrease of $2.8 million or 18.61% in interest income from $15.3 million in 2009 to $12.4 million in 2010; (ii) the decrease in non-interest income of $1.6 million or 15.48% from $10.1 million in 2009 to $8.6 million in 2010; and (iii) the increase in non-interest expenses of $4.3 million or 33.36% from $13.0 million in 2009 to $17.3 million in 2010. The decrease in net income in 2010 from 2009 was partially offset by a decrease in interest expenses of $2,342,000, or 29.0%, a reduction of $3.4 million, or 100%, in the provision for loan losses, and an increase in income tax benefit of $712,000.

Interest income decreased primarily because average interest-earning assets decreased $21.6 million or 8.16% from $265.1 million in 2009 to $243.5 million in 2010. Interest expense decreased primarily for the same reason; however, the average balance of time deposits in excess of $100,000, which comprise approximately 29% of the Corporation’s average interest-bearing liabilities and which represent the highest cost of interest-bearing liabilities to the Corporation, increased approximately $8.5 million or 14.67% from $58.0 million in 2009 to $66.5 million in 2010.

The primary reasons for the decrease in non-interest income of $1.6 million or 15.48% from $10.1 million in 2009 to $8.6 million in 2010 are: (i) decreases in gain on sales of investment securities of $2.2 million; (ii) decrease in other income of $751,000; and (iii) a decrease in service charges on deposit accounts of $219,000. The decreases were partially offset by a gain of $1.5 million on the sale of merchant credit card processing accounts and an increase in income from sales and servicing of Small Business Administration loans.

The primary reasons for the increase in non-interest expenses of $4.3 million or 33.36% from $13.0 million in 2009 to $17.3 million in 2010 are: (i) an increase of $470,000 or 15.21% in salaries and benefits; (ii) an increase in expenses of $1.67 million or 119.13% associated with the Corporation’s foreclosed assets; (iii) an expense of $1.8 million that was recognized in 2010 in connection with a settlement with the FDIC that resulted from the issuance of various regulatory orders and the imposition of civil money penalties associated with the Bank’s card programs; and (iv) expenses of $1.1 million that were recognized in 2010 in connection with the settlement of three lawsuits.

Critical Accounting Policies

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments,

Table of Contents

estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the Corporation’s financial statements and accompanying notes. Management believes that the judgments, estimates and assumptions used in preparation of the Corporation’s financial statements are appropriate given the factual circumstances as of December 31, 2011.

Various elements of the Corporation’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Corporation’s results of operations. In particular, management has identified one accounting policy that, due to judgments, estimates and assumptions inherent in this policy, and the sensitivity of the Corporation’s Consolidated Financial Statements to those judgments, estimates and assumptions that is critical to an understanding of the Corporation’s Consolidated Financial Statements. This policy relates to the methodology that determines the allowance for loan and lease losses. Management has discussed the development and selection of this critical accounting policy with the Audit Committee of the Board of Directors. Although Management believes the level of the allowance at December 31, 2011 is at an appropriate level and is adequate to absorb losses inherent in the loan portfolio, any number of factors, including a decline in the regional economy, may result in increasing losses that cannot reasonably be predicted at this time. For further information regarding the allowance for loan losses see “Provision and Allowance for Loan and Lease Losses,” and Note 7 to the Corporation’s audited Consolidated Financial Statements included elsewhere herein.

Another critical accounting policy relates to the valuation of other real estate owned (OREO). Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell. Any write-down to fair value at the time of transfer to OREO is charged to the allowance for loan and lease losses. Property is evaluated regularly to ensure that the recorded amount is supported by its current fair value and that valuation allowances to reduce the carrying amount to fair value less estimated costs to dispose are recorded as necessary. Revenue and expenses from operations of OREO and changes in the valuation allowance are included in net expenses from OREO.

A third critical accounting policy relates to the valuation of deferred tax assets. The Corporation is permitted to recognize deferred tax assets only to the extent that they are expected to be used to reduce amounts that have been paid or will be paid to tax authorities. Management reviews this each year by comparing the amount of the deferred tax assets with amounts paid in the past that might be recovered by carryback provisions in the tax code and with anticipated taxable income expected to be generated from operations in the future. If it does not appear that the deferred tax assets are usable, a valuation allowance would be established to acknowledge their uncertain benefit.

Recently Issued Accounting Standards

Refer to Note 1 to the Consolidated Financial Statements — “Summary of Significant Accounting Policies” for discussion of the recently issued accounting standards.

NET INTEREST INCOME

Net interest income, the difference between: (i) interest and fees earned on interest-earning assets, and (ii) interest paid on interest-bearing liabilities, is the most significant component of the Bank’s earnings. Changes in net interest income from period to period result from increases or

Table of Contents

decreases in the average balances of the interest-earning assets and interest-bearing liabilities, the availability of particular sources of funds and changes in prevailing interest rates.

The following table summarizes the Corporation’s net interest income:

	Years Ended December 31,						Increase (Decrease)From Prior Year
	2011		2010		2009		2011/2010					2010/2009
							Amt			%		Amt			%
	(Dollars in thousands)
Interest Income	$	11,293	$	12,421	$	15,262	$	(1,128	)	(9.08	)	$	(2,841	)	(18.61	)
Interest Expense	4,140		5,737		8,079		(1,597		)	(27.84	)	(2,342		)	(28.99	)
	$	7,153	$	6,684	$	7,183	$	469		7.02		$	(499	)	(6.95	)

Net interest income increased $469,000 or 7.02% from 2010 to 2011. Average interest-earning assets decreased 7.44%, while the average rate earned on the Bank’s interest-earning assets decreased 8 basis points, resulting in a decrease of $1,128,000 in total interest income. Interest expense decreased $1,597,000, the result of a decrease of 4.09% in average interest-bearing liabilities, while the average rate paid decreased 62 basis points.

Net interest income decreased $499,000 or 6.95% from 2009 to 2010. Average interest-earning assets decreased 8.16%, while the average rate earned on the Bank’s interest-earning assets decreased 60 basis points, resulting in a decrease of $2,841,000 in total interest income. Interest expense decreased $2,342,000, the result of a decrease of 4.85% in average interest-bearing liabilities, while the average rate paid decreased 86 basis points.

Table of Contents

Average Balances, Interest Income and Expense, Rates and Yields

The following table shows the components of net interest income, setting forth for each of the three years ended December 31, 2011, 2010 and 2009: (i) average assets, liabilities and investments; (ii) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities; (iii) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities; (iv) the net interest spread (i.e., the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities); and (v) the net interest yield on average interest-earning assets (i.e., net interest income divided by average interest-earning assets). Yields are computed on a tax-equivalent basis, resulting in adjustments to interest earned on non-taxable securities of $1,019,000, $1,071,000 and $1,027,000 in 2011, 2010 and 2009, respectively. Interest income on loans includes loan fees of $455,000, $492,000 and $858,000 in 2011, 2010 and 2009, respectively. Non-accrual loans and overdrafts are included in average loan balances. Average loans are presented net of unearned income.

	As of and for the Years Ended December 31,
	2011							2010							2009
	Average					Yield/		Average					Yield/		Average					Yield/
(dollars in thousands)	Balance			Interest		Rate		Balance			Interest		Rate		Balance			Interest		Rate
Assets:
Loans	$	155,710		$	8,886	5.71	%	$	160,035		$	9,641	6.02	%	$	169,853		$	10,779	6.35	%
Time deposits - in other banks	19,374			45		0.23	%	24,860			58		0.23	%	12,536			27		0.22	%
Investment securities - taxable	5,058			93		1.84	%	9,895			338		3.42	%	37,936			2,171		5.72	%
Investment securities - nontaxable	45,235			3,288		7.27	%	48,701			3,454		7.09	%	44,795			3,312		7.39	%
Federal funds sold	—			—		0.00	%	—			—		0.00	%	—			—		0.00	%
Total interest-earning assets	225,377			12,312		5.46	%	243,491			13,491		5.54	%	265,120			16,289		6.14	%

Allowance for loan and lease losses	(3,168		)					(3,349		)					(2,723		)
Non-interest bearing assets:
Cash and due from banks	4,216							4,945							6,714
Bank premises and equipment	4,544							4,938							4,889
Accrued interest receivable	1,182							1,340							1,590
Other assets	37,093							32,182							19,506
Total average assets	$	269,424						$	283,547						$	295,096

Liabilities and Shareholders’ Equity:
Interest-bearing liabilities:
Interest-bearing demand	$	16,501		$	16	0.10	%	$	15,752		$	15	0.10	%	$	14,707		$	18	0.12	%
Money market savings	1,875			4		0.21	%	1,842			5		0.27	%	1,425			3		0.21	%
Savings deposits	12,069			49		0.41	%	7,730			39		0.50	%	5,856			29		0.50	%
Time deposits >$100M	56,368			1,051		1.86	%	66,459			1,616		2.43	%	57,959			2,060		3.55	%
Time deposits <$100M	95,170			1,502		1.58	%	92,996			2,063		2.22	%	95,712			3,389		3.54	%
Other Borrowings	36,978			1,518		4.11	%	43,530			1,999		4.59	%	64,295			2,580		4.01	%
Total interest-bearing liabilities	218,961			4,140		1.89	%	228,309			5,737		2.51	%	239,954			8,079		3.37	%

Non-interest bearing liabilities:
Noninterest-bearing checking	33,315							33,905							31,414
Accrued interest payable	1,423							1,443							1,485
Other liabilities	3,814							3,944							6,089
Total Liabilities	257,513							267,601							278,942
Total shareholders’ equity	11,731							15,946							16,154
Total average liabilities and shareholders’ equity	$	269,424						$	283,547						$	295,096

Net interest income				$	8,172						$	7,754						$	8,210
Interest expense as a percentage of average earning assets						1.84	%						2.36	%						3.05	%
Net yield on interest earning assets						3.63	%						3.18	%						3.10	%
Net interest spread						3.57	%						3.03	%						2.77	%

Table of Contents

Rate and Volume Analysis

The following tables show the increase or decrease in interest income, interest expense and net interest income resulting from changes in rates and volumes for the year ended December 31, 2011 compared with the same period in 2010 and for the year ended December 31, 2010 compared with the same period in 2009:

	December 31, 2011 compared with December 31, 2010
	Volume			Rate			Total
Increase (decrease) in interest income:
Loans	$	(261	)	$	(494	)	$	(755	)
Time deposits - in other banks	(13		)	—			(13		)
Investment securities - taxable	(165		)	(80		)	(245		)
Investment securities - nontaxable	(246		)	80			(166		)
	(685		)	(494		)	(1,179		)

Increase (decrease) in interest expense:
Interest-bearing demand	1			—			1
Money market savings	—			(1		)	(1		)
Savings deposits	22			(12		)	10
Time deposits >$100M	(245		)	(320		)	(565		)
Time deposits <$100M	48			(609		)	(561		)
Other Borrowing	(301		)	(180		)	(481		)
	(475		)	(1,122		)	(1,597		)
Increase (decrease) in net interest income:	$	(210	)	$	628		$	418

	December 31, 2010 compared with December 31, 2009
(dollars in thousands)	Volume			Rate			Total
Increase (decrease) in interest income:
Loans	$	(623	)	$	(515	)	$	(1138	)
Time deposits - in other banks	27			4			31
Investment securities - taxable	(1,605		)	(228		)	(1,833		)
Investment securities - nontaxable	289			(146		)	143
	1,912			(885		)	(2,797		)

Increase (decrease) in interest expense:
Interest-bearing demand	1			(4		)	(3		)
Money market savings	1			1			2
Savings deposits	9			1			10
Time deposits >$100M	302			(746		)	(444		)
Time deposits <$100M	(96		)	(1,229		)	(1,325		)
Other Borrowing	(833		)	252			(581		)
	(616		)	(1,725		)	(2,341		)
Increase (decrease) in net interest income:	$	(1296	)	$	840		$	(456	)

The affect of changes in the amount and mix of interest-eraning assets and interest-bearing liabilities is referred to as “volume change.” The affect of changes in yields on interest-earning assets and rates paid on interest-bearing liabilities is referred to as “rate change.”

Table of Contents

PROVISION AND ALLOWANCE FOR LOAN AND LEASE LOSSES

The Corporation maintains a detailed, systematic analysis and procedural discipline to determine the amount of the allowance for loan and lease losses (“ALLL”). The ALLL is based on estimates and is intended to be adequate to provide for probable losses inherent in the loan portfolio. This process involves deriving probable loss estimates that are based on individual loan loss estimation, historical loss rates and management’s judgment.

The Corporation employs several methodologies for estimating probable losses. Methodologies are determined based on a number of factors, including type of asset, risk rating, concentrations, and collateral value.

The Corporation calculates the required ALLL on a quarterly basis and makes adjusting entries as needed. The review of the adequacy of the allowance takes into consideration such factors as concentrations of credit, changes in the growth, size and composition of the loan portfolio, overall and individual portfolio quality, review of specific problem loans, collateral, guarantees and economic conditions that may affect the borrowers’ ability to pay and/or the value of the underlying collateral. Additional factors considered include: geographic location of borrowers, changes in the Corporation’s product-specific credit policy and lending staff experience. These estimates depend on subjective factors and, therefore, contain inherent uncertainties.

The Corporation’s ALLL is maintained at a level believed adequate by management to absorb known and inherent probable losses on existing loans. A provision for loan losses is charged to expense. The allowance is charged for losses when management believes that full recovery on the loan is unlikely. Generally, the Corporation charges off any loan classified as a “loss,” portions of loans which are deemed to be uncollectible, overdrafts which have been outstanding for more than 90 days, and all other unsecured loans past due 120 or more days. Subsequent recoveries, if any, are credited to the ALLL.

Although no assurances can be given that actual losses will not exceed the amount provided for in the allowance, Management believes that the level of the allowance is appropriate to provide for all estimated credit losses in light of all known relevant factors. At the end of 2011, 2010 and 2009, the Bank’s allowance stood at 2.81%, 2.04%, and 2.12% of gross loans, respectively. Provisions were made to the allowance for loan and lease losses in 2011 and 2009 of $7,860,000 and $3,368,000, respectively. No provision was made to the allowance for loan and lease losses in 2010. The primary reason no provision to the ALLL was made in 2010 was a decrease in the average loan balance of $9,818,000 resulting from the migration of loans to foreclosed assets and loan payoffs. Loans charged off in 2011, 2010 and 2009 totaled $6,703,000, $372,000 and $2,329,000, respectively. Recoveries for these same periods were $4,000, $2,000, and $77,000, respectively.

The Bank’s non-performing (delinquent 90 days or more and on non-accrual) loans as a percentage of total loans were 3.86%, 7.99% and 4.85% as of the end of 2011, 2010 and 2009, respectively. The significant increase in non-accrual loans is primarily attributable to the economic recession and the continued softening of the real estate market.

Table of Contents

NON-INTEREST INCOME

The following table presents a summary of the noninterest income:

	Years ended December 31,
	2011		2010		2009
	(Dollars in thousands)
Service charges on deposit accounts	$	321	$	408	$	627
Gain on sale of investment securities	341		964		3,189
Merchant discount fees	1,359		3,676		4,495
Credit card programs fees	756		1,246		1,075
Gain on sale of merchant credit card processing accounts	50		1,500		—
Income from sales and servicing of SBA Loans	674		528		400
Miscellaneous Income	410		2		3
Other income	279		229		331

Totasl noninterest income	$	4,190	$	8,553	$	10,120

Total noninterest income decreased $4,363,000 or 51.01% in 2011 when compared with 2010. The decrease resulted from decreases in merchant discount fees of $2,317,000, gain on sale of merchant credit card processing accounts of $1,450,000, gain on sales of investment securities of $623,000, credit card program fees of $490,000, service charges on deposit accounts of $87,000; which was partially offset by increases in miscellaneous income of $408,000 and income from sales and servicing of Small Business Administration (SBA) loans of $146,000 and other income of $50,000.

Total noninterest income decreased $1,567,000 or 15.48% in 2010 when compared with 2009. The decrease resulted from decreases in gain on sales of investment securities of $2,225,000, merchant discount fees of $819,000, service charges on deposit accounts of $219,000 and other income of $103,000; which was partially offset by a gain of $1,500,000 on the sale of merchant credit card processing accounts and increases in credit card program fees of $171,000 and income from sales and servicing of Small Business Administration (SBA) loans of $128,000.

In 2009, the Bank sold a portfolio of securities and used the proceeds to prepay borrowings. The gains on sale recorded in 2009 were partially offset by prepayment fees on the borrowings.

The sale of SBA guaranteed loans is a contributor to the Bank’s income. SBA guaranteed loans yield up to 3.75% over the New York prime rate, and the guaranteed portions can be sold at premiums which vary with market conditions. SBA loans are guaranteed by the full faith of the United States Government up to 85% of the principal amount. The guaranteed portion has risks comparable for an investor in a U.S. Government security and can usually be sold in the secondary financial market, either at a premium or at a yield which allows the Bank to maintain a significant spread for itself.

The American Recovery and Reinvestment Act provided for reductions of loan fees, higher guarantees up to ninety (90%) percent, new SBA programs, secondary market incentives, and enhancements to current SBA programs.

There can be no assurance that the gains on sale of SBA loans will continue at or above the levels realized in the past three years. The Small Business Administration has recently increased

Table of Contents

the guarantee fees borrowers must pay. Increasing competition among lenders for qualified SBA borrowers may make it difficult for the Bank to continue to expand its program in this area, and may limit the level of premium that can be earned with regard thereto.

The following table presents a summary of activity in SBA loans for the years ended December 31:

(Dollars in thousands)	2011		2010		2009

SBA loans authorized	$	2,940	$	9,275	$	8,393
SBA loans sold	$	4,970	$	4,128	$	2,740

The following table presents a summary of income from sales and servicing of SBA loans for the years ended December 31:

(Dollars in thousands)	2011		2010		2009
Income from premium	$	491	$	349	$	255
Income from servicing	193		179		145
Total income from sales and servicing of SBA loans	$	684	$	528	$	400

NON-INTEREST EXPENSES

The following table presents a summary of non-interest expenses:

	Years ended December 31,
	2011		2010		2009
	(Dollars in thousands)
Salaries and benefits	$	3,208	$	3,561	$	3,091
Occupancy and equipment expense	1,020		1,031		1,030
Foreclosed assets, net	1,173		3,070		1,401
Professional fees	2,194		1,485		1,034
Data processing	245		252		292
Prepayment fees on borrowings	—		39		888
Fdic and state assessments	865		731		535
FDIC Settlement - card programs	—		1,800		—
Litigation settlement	2,374		1,138		—
Other general and admin. expenses	2,658		4,207		4,712
	$	13,737	$	17,314	$	12,983

Salary and benefits expenses decreased $353,000 in 2011 due primarily to a vacancy in the Chief Lending Officer position and a vacancy in the commercial lending officer position, the elimination of four staff positions and a decrease of $42,000 in salary continuation/post retirement expenses; partially offset by an increase of $39,000 in recruitment expense. Salary and benefits expense increased $470,000 in 2010 due primarily to a salary continuation expense of $56,000 compared to a credit of $184,000 in 2009, and increases in salary expenses of $131,000, employee benefits and taxes of $76,000 and employee training expenses of $25,000.

Table of Contents

Occupancy and equipment expenses decreased $11,000 in 2011 due to a decrease in depreciation expense of $52,000 and a decrease of $18,000 in rental expense; partially offset by increases of $39,000 in storage expense, $5,000 in property taxes, $8,000 in equipment rental and $7,000 in maintenance and repairs. Occupancy and equipment expenses in 2010 remained at the same level as in 2009.

Foreclosed asset expense decreased $1,897,000 in 2011 due primarily to modest improvement in real estate values. Foreclosed asset expense increased $1,669,000 in 2010 due primarily to continued deterioration in real estate values.

Professional fees for 2011 increased $709,000 due primarily to increases of $816,000 in consultant and advisory fees, $133,000 in legal fees, $6,000 in audit fees; partially offset by a decrease of $246,000 in loan collection expenses. The increase in legal fees was due to ongoing litigation (See “Item 3 Legal Proceedings” for further discussion). The increase in consultant and advisory fees was due the use of consultants until qualified individuals could be hired to fill the Chief Lending Officer and commercial loan officer vacancies and to assist with meeting the requirements of the regulatory orders. The decrease in collection expense was due primarily reduced collection activities when compared to the prior year. The increase in audit fees was due to increased third-party reviews and additional reviews of compliance related matters. Professional fees for 2010 increased $451,000 due primarily to increases of $208,000 in legal fees, $201,000 in audit fees and $42,000 in loan collection expenses. The increases in legal fees and collection expenses were a result of increased collection expenses on loans and costs associated with legal proceedings. The increase in audit fees was due to increased third-party reviews and additional reviews of compliance related matters.

Data processing expenses for 2011 decreased $7,000 due primarily to decreases in the number of customer accounts and transaction volumes processed. Data processing expenses for 2010 decreased $40,000 as the Bank realized the full year benefit of a new data processing contract negotiated in 2009.

No prepayment fees on borrowings were paid in 2011. Prepayment fees on borrowings in 2010 were $39,000 compared to $888,000 in 2009, a decrease of $849,000.

FDIC and state assessments for 2011 were $865,000 compared to $731,000 in 2010, an increase of $134,000. FDIC and state assessments for 2010 were $731,000 compared to $535,000 in 2009, an increase of $137,000. The increase in assessments in 2011 was due primarily to the decrease in the Bank’s average tangible equity. The increase in assessments in 2010 was due primarily to increased FDIC insurance premium rates and the Bank’s risk-based capital level being lowered to “adequately capitalized” from “well capitalized” as a result of the issuance of various regulatory orders as more fully discussed under “ITEM 1. BUSINESS — REGULATION AND SUPRVISION - Regulatory Enforcement Powers” herein,

The Bank recognized an expense of $1,800,000 in 2010 relating to a settlement entered into with the FDIC that resulted in the issuance of a Consent Order, Order for Restitution and Order to Pay Civil Money Penalties by the FDIC. The Consent Order, Order for Restitution and Order to Pay Civil Money Penalties are more fully discussed under “ITEM 1. BUSINESS — REGULATION AND SUPRVISION - Regulatory Enforcement Powers” herein, After completion of the Bank’s restitution plans in 2011 it was determined that excess reserves in the amount of $402,000 had been established for consumer restitution. The excess reserve amount was credited to miscellaneous income during the fourth quarter of 2011.

Table of Contents

The Bank also recognized litigation settlement expense of $2,374,000 in 2011 which was incurred in connection with the resolution of a lawsuit which involved claims related to loan participations purchased from the Bank and sought rescission of the participation agreements and attorneys’ fees and costs.

The Bank also recognized litigation settlement expense of $1,138,000 in 2010 which was incurred in connection with the resolution of three lawsuits. One lawsuit involved claims related to loan participations purchased from the Bank and sought rescission of the participation agreements or damages and attorneys’ fees and costs. The parties reached a settlement of the claims raised in the litigation which resulted in a charge to earnings of $888,000. Another lawsuit sought to foreclose a mechanic’s lien in connection with a single family residence financed by the Bank. The Bank established a reserve equal to its estimated cost of settling the lawsuit. The third lawsuit alleged violations of the Fair Debt Collections Act and the Minnesota Deceptive Trade Practices Act in connection with credit card mailings sent to approximately 6,500 persons in Minnesota. The Bank, Total Card, Inc., Tighorn Financial Services, L.L.C. dba New Horizons and an individual associated with Tighorn were named as defendants in the lawsuit. The parties have reached a settlement of the claims raised in the litigation which resulted in the Bank recording a charge to earnings of $150,000.

Other general and administrative expense for 2011 totaled $2,658,000 compared with $4,207,000 for 2010, an decrease of $1,549,000. Significant changes occurred in the following categories: (i) operating losses increased $137,000; (ii) information technology expenses increased $118,000; (iii) insurance expense increased $55,000; (iv) director fees increased $35,000; (v) miscellaneous expenses increased $30,000; (vi) business development expense increased $22,000; (vii) business credit card expenses decreased $32,000; (viii) telephone expense decreased $18,000; and (ix) donations decreased $14,000; (x) merchant credit card expense decreased $1,889,000 from 2010 to 2011, reflecting the sale of the Bank’s local merchant processing account portfolio in November of 2010.

Other general and administrative expense for 2010 totaled $4,207,000 compared with $4,712,000 for 2009, an decrease of $505,000. Significant changes occurred in the following categories: (i) operational losses totaled $109,000 in 2010 compared to recoveries which totaled $174,000 in 2009; (ii) director fees increased $74,000; (iii) business credit card expenses increased $67,000; (iv) ATM expenses increased $46,000; (v) prepaid card expenses decreased $57,000; (vi) loan expenses decreased $56,000; (vii) credit card program expenses decreased $36,000; (viii) Poppy club account expenses decreased $25,000; (ix) bank security expenses decreased $18,000; (x) advertising expenses decreased $16,000 (xi) miscellaneous expenses decreased $15,000; (xii) merchant credit card processing expense declined $750,000 from 2009 to 2010.

INCOME TAXES (BENEFIT)

In 2011 a provision for federal and state income taxes was $3,398,000 compared to a tax benefit of $1,371,000 and $659,000 in 2010 and 2009, respectively. This represents (33.14%) and 66.01% of the loss before taxes in 2011 and 2010, respectively, and 69.22% of income before taxes in 2009. The provision of $3,398,000 in 2011 was the result of establishing a valuation allowance for the full amount of the deferred tax asset. The decrease in the effective tax rate for 2009 is a direct result of the Bank’s investing in tax-exempt securities, increased taxable deductions for provisions to the allowance for loan and lease losses and recognition of a tax benefit for losses on trading assets.

Table of Contents

The amount of the tax provision is determined by applying the statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income, increases in the cash surrender value of life insurance, and certain other expenses that are not allowed as tax deductions.

LOANS

Loans, the largest component of earning assets, represented 69.09% of average interest-earning assets and 57.79% of average total assets during 2011, compared with 65.73% and 56.44%, respectively, during 2010 and compared to 64.07% and 57.56%, respectively, during 2009. In 2011, average loans decreased 2.70% from $160,035,000 in 2010 to $155,710,000. Average construction loans decreased $2,060,000 or 99.50%, average real estate loans decreased $4,189,000 or 3.48%, and average consumer loans decreased $771,000 or 75.95%; while average commercial loans increased $2,695,000 or 7.35%.

In 2010, average loans decreased 5.78% from $169,853,000 in 2009 to $160,035,000. Average construction loans decreased $10,140,000 or 83.05%, average real estate loans decreased $668,000 or 0.55%, and average consumer loans decreased $945,000 or 48.21%; while average commercial loans increased $1,935,000 or 5.57%.

The Bank’s commercial and industrial loans are generally made for the purpose of providing working capital, financing the purchase of equipment or inventory, and other business purposes. Such loans generally have maturities ranging from one year to several years. Short-term business loans are generally intended to finance current transactions and typically provide for monthly interest payments with principal being payable at maturity or at 90-day intervals. Term loans (usually for a term of two to five years) normally provide for monthly installments of principal and interest. The Bank, from time to time, utilizes accounts receivable and inventory as security for loans.

The Bank is the recognized leader for SBA lending in Monterey County. Generally, SBA loans are guaranteed by the SBA for up to 85% of their principal amount, which can be retained in portfolio or sold to investors. Such loans are made at floating interest rates, but generally for longer terms (up to 25 years) than are available on a conventional basis to small businesses. The unguaranteed portion of the loans, although generally supported by collateral, is considered to be more risky than conventional commercial loans because they may be based upon credit standards the Bank would not otherwise apply, such as lower cash flow coverage, or longer repayment terms.

The Bank’s real estate loan portfolio consists both of real estate construction loans and real estate mortgage loans. The Bank has initiated a program to generate more SBA loans, which generally yield higher returns than normal commercial loans. The Bank does not make real estate development loans. Real estate construction loans are made for a much shorter term and often at higher interest rates than conventional single-family residential real estate loans. The cost of administering such loans is often higher than for other real estate loans, as principal is drawn on periodically as construction progresses.

The Bank also makes real estate loans secured by a first deed of trust on single family residential properties and commercial and industrial real estate. California commercial banks are permitted, depending on the type and maturity of the loan, to lend up to 90% of the fair market value of real property (or more if the loan is insured either by private mortgage insurers or governmental agencies). In certain instances, the appraised value may be less than the actual

Table of Contents

amount which could be realized by the Bank upon foreclosure, or declines in market value subsequent to making the loan may impair the Bank’s collateral position.

Consumer loans are made for the purpose of financing the purchase of various types of consumer goods, home improvement loans, auto loans and other personal loans. Consumer installment loans generally provide for monthly payments of principal and interest, at a fixed rate. Most of the Bank’s consumer installment loans are generally secured by the personal property being purchased. The Bank generally makes consumer loans to those customers with a prior banking relationship with the Bank.

The following table presents the composition of the loan portfolio, including loans held for sale, at December 31 for each of the last five years:

	December 31,
	2011			2010			2009			2008			2007
	(Dollars in thousands)
Commercial and industrial	$	31,183		$	33,993		$	33,605		$	29,887		$	30,197
Construction	—			1,265			8,705			16,040			23,396
Real Estate	122,518			119,093			121,887			122,951			116,625
Consumer	223			512			2,746			966			876
Government guaranteed loans purchased	1			6			16			24			32
Total Gross Loans	153,925			154,869			166,959			169,868			171,126

Allowance for loan and lease losses	(4,320		)	(3,159		)	(3,529		)	(2,413		)	(2,028		)
Deferred origination fees, net	(107		)	(161		)	(217		)	(275		)	(350		)
Loans, net	$	149,498		$	151,549		$	163,213		$	167,180		$	168,748

The following table shows the maturity distribution and repricing intervals of the Bank’s outstanding loans, excluding non-accrual loans, at December 31, 2011. Balances of fixed rate loans are displayed in the column representative of the loan’s stated maturity date. Balances for variable rate loans are displayed in the column representative of the loan’s next interest rate change.

	Within One Year		After One But Within Five Years		After Five Years		Total
Commercial and industrial	$	19,661	$	7,758	$	2,166	$	29,585
Real Estate	33,783		57,809		26,746		118,338
Consumer	74		55		94		223
Government guaranteed loans purchased	1		—		—		1
Nonaccrual loans	—		—		—		5,778
Total Gross Loans	$	53,519	$	65,622	$	29,006	$	153,925

Loans with variable (floating) interest rates	$	41,775	$	2,044	$	—	$	43,819
Loans with predetermined (fixed) interest rates	11,745		63,577		29,006		104,328
Nonaccrual loans	—		—		—		5,778
	$	53,519	$	65,622	$	29,006	$	153,925

Loan Concentrations

The Corporation has a concentration in real estate secured loans. At December 31, 2011, loans secured by real estate totaled $122,518,000, or 78.92% of the total loan portfolio, compared to $119,093,000, or 76.90%, at December 31, 2010. While there is a concentration in real estate

Table of Contents

secured loans, the risk associated with that concentration is mitigated by the diversity of types of real estate held as collateral and the variety of businesses and individuals that are borrowers. The Corporation’s lending is concentrated in its primary lending area of Monterey County, California with $128,964,000, or 83.07%, located in this area at December 31, 2011 compared to $128,421,000, or 82.92%, at December 31, 2010.

Concentration of loans for specific industries and their percentage of total loans at December 31, 2011 and 2010 are as follows:

	2011		2010
Accommodation and food	24.56	%	24.73	%
Real estate and rental and leasing	23.97	%	16.50	%
Finance and insurance	11.29	%	9.07	%
Professional, scientific, and technical services	11.15	%	12.16	%

Non-performing and Non-accrual Loans

The Bank’s present policy is to cease accruing interest on loans which are past due as to principal or interest 90 days or more, except for loans which are well secured or when collection of interest and principal is deemed likely. When a loan is placed on non-accrual, previously accrued and unpaid interest is generally reversed out of income unless adequate collateral from which to collect the principal and interest on the loan appears to be available.

The following table presents information with respect to loans which, as of the dates indicated, were past due 90 days or more or were placed on non-accrual status (referred to collectively as “non-performing loans”), loans classified as troubled debt restructurings and other real estate owned (“OREO”), which are foreclosed properties:

Table of Contents

	As of December 31,
	2011			2010			2009			2008			2007
Accruing,
past due 90 days or more:

Real Estate	$	—		$	896		$	—		$	—		$	—
Commercial	—			11			—			—			—
Consumer	—			—			—			—			—
Other	—			—			—			—			—
Total accruing	—			907			—			—			—

Troubled Debt Restructurings:

Performing loans classified as troubled debt restructurings (TDR) not in conformity with modified term	162			—			—			—			—

Nonaccrual Loans:

Real Estate	4,179			6,241			5,137			6,876			3,200
Commercial	1,599			5,219			2,943			215			41
Consumer	—			13			—			—			155
Other	—			—			—			—			—
Total nonaccrual	5,778			11,473			8,080			7,091			3,396
Total nonperforming loans	5,940			12,380			8,080			7,091			3,396
Foreclosed assets	28,722			28,825			14,333			7,364			—
Total nonperforming assets	$	34,662		$	41,205		$	22,413		$	14,455		$	3,396

Total loans end of period	$	153,925		$	154,869		$	166,959		$	169,868		$	171,126

Performing loans classified as troubled debt restructurings (TDR) in conformity with modified term	$	10,400		$	—		$	—		$	—		$	—

Ratio of nonperforming loans to total loans at end of period	3.86		%	7.99		%	4.84		%	4.17		%	1.98		%

Ratio of nonperforming assets to total loans and foreclosed assets at end of period	18.98		%	22.43		%	12.36		%	8.16		%	1.98		%

Interest income of $763,000 and $263,000 for the years ended December 31, 2011 and 2010, was recognized on the non-accruing and restructured loans listed in the table above; whereas, interest income of $871,000 and $573,000 would have been recognized under their original terms.

Performing troubled debt restructurings, or TDRs, are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed above.

Potential Problem Loans

In addition to loans classified for regulatory purposes, management also designates certain loans for internal monitoring purposes in a “watch” category. Loans may be placed on management’s watch list as a result of delinquent status, concern about the borrower’s financial condition or the value of the collateral securing the loan, substandard classification during regulatory examinations, or simply as a result of management’s desire to monitor more closely a

Table of Contents

borrower’s financial condition and performance. “Watch” category loans may include loans with loss potential that are still performing and accruing interest and may be current under the terms of the loan agreements; however, management may have a significant degree of concern about the borrowers’ ability to continue to perform according to the terms of the loans. Loss exposure on these loans is typically evaluated based primarily upon adequacy of the cash flow repaying the loan or the estimated liquidation value of the collateral securing these loans. Also, “watch” category loans may include credits which, although adequately secured and performing, have past delinquency problems or where unfavorable financial trends are exhibited by borrowers.

All watch list loans are subject to additional scrutiny and monitoring on a monthly or quarterly basis. The Corporation’s philosophy encourages loan officers to identify borrowers that should be monitored in this fashion and believes this process ultimately results in the identification of problem loans in a more timely fashion.

Management did not identify any loans on its watch list, which were not included in impaired or non-performing loans at December 31, 2011. Management identified $10,289,000 of loans, net of the SBA guaranteed portion, on its watch list, which were not included in impaired or non-performing loans at December 31, 2010.

The Bank does not have any foreign loans or loans for highly leveraged transactions.

Table of Contents

Summary of Loan Loss Experience

The following table reflects the activity in the Corporation’s allowance for loan and lease losses for the year ended December 31, 2011, 2010, 2009, 2008 and 2007:

	For the Year ended December 31,
	2011			2010			2009			2008			2007
	(Dollars in thousands)
Average loans outstanding	$	155,710		$	160,035		$	169,853		$	166,960		$	146,944

Total loans outstanding at end of the period	$	153,925		$	154,869		$	166,959		$	169,868		$	171,126

Allowance, beginning of period	3,159			3,529			2,413			2,028			1,409

Loans charged off during period:
Commercial	3,207			372			358			187			249
Consumer	113			—			37			—			1
Real Estate	3,378			—			1,908			563			—
Other	5			—			26			—			—
Total charge offs	6,703			372			2,329			750			250

Recoveries during period:
Commercial	3			2			2			3			4
Real Estate	1			—			—			—			—
Consumer	—			—			75			—			—
Other	—			—			—			—			—
Total recoveries	4			2			77			3			4

Net Loans charged off during the period	6,699			370			2,252			747			246

Additions to allowance for possible loan losses	7,860			0			3,368			1,132			865

Allowance, end of period	$	4,320		$	3,159		$	3,529		$	2,413		$	2,025

Ratio of net loans charged off to average loans outstanding during the period	4.30		%	0.23		%	1.33		%	0.45		%	0.17		%

Ratio of allowance to total loans at end of period	2.81		%	2.04		%	2.12		%	1.42		%	1.19		%

Ratio of nonperforming loans to allowance for loan losses at end of period	137.52		%	391.78		%	251.75		%	293.82		%	167.46		%

The following table summarizes the allocation of the allowance for loan and lease losses by loan type based on the Bank’s methodology for evaluating its allowance, and the percent of loans and leases in each category to total loans at the dates indicated. The allocation of individual categories of loans includes amounts applicable to specifically identified as well as unidentified losses inherent in that segment of the loan portfolio and will necessarily change whenever management determines that the risk characteristics of the loan portfolio have changed.

Table of Contents

Management believes that any breakdown or allocation of the allowance for loan losses into loan categories lends an appearance of exactness which does not exist, in that the allowance is utilized as a single allowance available for all loans. The allocation below should not be interpreted as an indication of the specific amounts of or loan categories in which future charge-offs may occur:

	December 31, 2011				December 31, 2010
	(Dollars in thousands)
	Amount		Percent of Loans in Catergory to Total Loans		Amount		Percent of Loans in Catergory to Total Loans
Commercial	$	1,936	19.69	%	$	778	21.59	%
Construction	—		0.00	%	63		0.82	%
Real Estate	2,328		79.60	%	2,195		76.90	%
Consumer	28		0.14	%	6		0.32	%
Other	13		0.57	%	8		0.38	%
Unallocated	15		N/A		109		N/A
Total	$	4,320	100	%	$	3,159	100	%

FUNDING SOURCES

Average deposits decreased 1.55% to $215,298,000 in 2011 from $218,684,000 in 2010. In 2011 average certificates of deposit decreased 4.97%, average demand deposits decreased 1.74% and average interest checking, money market savings accounts as a group increased 20.22%. Average certificates of deposit represented 70.39% of average deposits in 2011 compared with 72.92% in 2010. Average interest checking, money market and savings accounts as a group were 14.14% of average deposits in 2011 compared with 11.58% in 2010. Average demand deposits represented 15.47% of average deposits in 2011 compared with 15.50% in 2010.

Average deposits increased 5.61% to $218,684,000 in 2010 from $207,073,000 in 2009. In 2010 average certificates of deposit increased 3.76%, average demand deposits increased 7.92% and average interest checking, money market savings accounts as a group increased 15.17%. Average certificates of deposit represented 72.92% of average deposits in 2010 compared with 74.21% in 2009. Average interest checking, money market and savings accounts as a group were 11.58% of average deposits in 2010 compared with 10.62% in 2009. Average demand deposits represented 15.50% of average deposits in 2010 compared with 15.17% in 2009.

Table of Contents

The following table summarizes the distribution of average deposits and the average rates paid for the year ended December 31, 2011, 2010 and 2009:

	Average Deposits
	For the year ended				For the year ended				For the year ended
	December 31, 2011				December 31, 2010				December 31, 2009
	(Dollars in thousands)
	Average Balance		Average Rate		Average Balance		Average Rate		Average Balance		Average Rate
Noninterest-bearing checking	$	33,315			$	33,905			$	31,414

Interest-bearing demand	$	16,501	0.10	%	$	15,752	0.10	%	$	14,707	0.12	%
Money market savings	1,875		0.21	%	1,842		0.27	%	1,425		0.21	%
Savings deposits	12,069		0.41	%	7,730		0.50	%	5,856		0.50	%
Time deposits >$100M	56,368		1.86	%	66,459		2.43	%	57,959		3.55	%
Time deposits <$100M	95,170		1.58	%	92,996		2.22	%	95,712		3.54	%
	181,983		1.44	%	184,779		2.02	%	175,659		3.13	%
Total deposits	$	215,298	1.22	%	$	218,684	1.71	%	$	207,073	2.66	%

The following table sets forth the scheduled maturities of time deposits in denominations of $100,000 or greater at December 31, 2011:

Maturities of Time Deposits of $100,000 or more

At December 31, 2011

(Dollars in thousands)

Three months or less	$	9,099
Over three months through six months	7,387
Over six months through twelve months	11,817
Over twelve months	20,176
	$	48,479

The Corporation has a line of credit with BMO Harris Bank N.A, (“BMO”), as successor to M & I Marshall & Ilsley Bank, in the amount of $3,000,000, at an interest rate equal to the one month LIBOR plus 3.75% with a floor rate of 6.50%, and a maturity date of October 30, 2011. The line of credit is secured by a pledge of 100% of the common stock issued by the Bank. At December 31, 2011 and 2010, $2,700,000, was advanced on the line. At December 31, 2011 accrued and unpaid interest totaled $29,000. Management is in discussion with BMO regarding a forebearance of principal and interest payments until 2013.

Table of Contents

The loan agreement contains covenants requiring the Bank to maintain certain financial ratios. At December 31, 2011 the Bank did not satisfy the following covenants:

Finanical Covenant	Required		Actual

Return on average assets	>= 0.75	%	(4.98	%)

Non-performing loans to total loans	<= 3	%	3.86	%

Capital Raios:

Tier 1 Risk Based Capital Ratio	>= 6	%	7.16	%

Total Risk Based Capital Ratio	>= 12	%	8.43	%

Tier 1 Leverage Ratio	>=9	%	5.01	%

Non-Performing Assets to Tangible Capital plus Loan Loss Reserve	< 115	%	181.06	%

BMO has in the past agreed to the issuance of forbearance agreements for the covenant defaults, most recently as of September 29, 2011 for the quarter ended March 31, 2011. While it is anticipated that BMO will continue to forebear, no assurances can be given in that regard. If BMO chooses not to forebear, it could potentially take possession of 100% of the outstanding common stock of the Bank, thereby leaving the Corporation insolvent. Such a change in control, however, would require regulatory approval.

The Bank has lines of credit from the Federal Home Loan Bank (“FHLB”) of San Francisco and the Federal Reserve Bank with remaining available borrowing capacity on December 31, 2011 of $5,549,000 and $8,238,000, respectively. The Federal Home Loan Bank line of credit has a maximum borrowing capacity of 15% of the Bank’s total assets, adjusted quarterly. The FHLB line of credit is secured by a portion of the Bank’s real estate secured loans and securities at December 31, 2011. At December 31, 2011, the total principal balance of pledged loans and securities was $44,733,000 and $370,000, respectively. At December 31, 2010, the total principal balance of pledged loans and securities was $47,653,000 and $2,655,000, respectively. The outstanding balance of FHLB borrowed funds was $23,000,000 and $25,000,000 at December 31, 2011 and 2010, respectively.

The following table provides information on six FHLB advances outstanding at December 31, 2011:

Amount		Rate		Funding Date	Maturity Date
$	5,000,000	5.21	%	07/30/07	07/30/12
3,000,000		4.85	%	10/01/07	10/01/12
4,000,000		0.87	%	01/31/11	01/31/13
5,000,000		1.75	%	03/15/10	03/15/13
5,000,000		5.01	%	09/18/07	09/18/14
1,000,000		7.72	%	06/01/00	06/03/30
$	23,000,000

The Bank has a letter of credit issued by FHLB of San Francisco in the amount of $700,000, which expired on February 17, 2012 which has MasterCard International Inc. as the beneficiary. The letter of credit was replaced at maturity with cash collateral account in the amount of $200,000 held at another financial institution.

Table of Contents

The Federal Reserve Bank discount window line is secured by a portion the Bank’s securities. At December 31, 2011 and 2010 the total market value of securities pledged was $9,137,000 and $9,637,000, respectively. At December 31, 2011 and 2010 the remaining available credit on the line was $8,238,000, and $7,558,000, respectively. No advances were outstanding on the line at December 31, 2011 and 2010.

At December 31, 2009, the Bank had a loan from the Federal Reserve Bank in the amount of $10,000,000 with an interest rate of 0.50% and a maturity date of January 11, 2010. At maturity, the loan was paid off with cash funds and funding from a new loan in the amount of $5,000,000 with the same terms and a maturity date of February 8, 2010. The loan was paid off at maturity on February 8, 2010.

CAPITAL RESOURCES

The Corporation and the Bank maintain capital to comply with legal requirements, to provide a margin of safety for depositors and shareholders, and to provide for future growth and the ability to pay dividends. At December 31, 2011, the Corporation’s shareholders’ equity was $3,596,000 versus $14,307,000 at December 31, 2010. The Corporation paid no cash dividends in 2011, 2010 and 2009. The Bank paid no cash dividends in 2011 and 2010, whereas a cash dividend totaling $500,000 was paid to the Corporation in 2009. The Bank currently is prohibited from paying and the Corporation has agreed not to accept cash dividends from the Bank absent prior regulatory authorization to do so. The Corporation provided the Bank with a capital injection of $400,000 on December 31, 2010.

The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and, possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s and Bank’s results of operations and financial condition.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Under applicable regulatory guidelines, a portion of the Trust Preferred Securities qualify as Tier I Capital, and the remainder as Tier II Capital. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Bank regulators may also impose higher capital requirements through the imposition of formal and informal regulatory actions. For example, the Bank is required under the terms of regulatory orders it became subject to in 2010 to maintain a Tier 1 leverage ratio and a Total Risk-Based capital ratio of 9% and 12%, respectively, which is higher than the minimum capital required to be “well-capitalized.” At December 31, 2011, the Bank’s leverage capital ratio was 5.01% which represents a capital shortfall of $10,416,000 in relation to the consent order. Its total risk-based capital ratio was 8.43%, which represents a capital shortfall of $6,512,000 in relation to the consent order.

Table of Contents

In general, the risk-based capital guidelines provide detailed definitions of which obligations will be treated as capital, and assign different weights to various assets and off-balance sheet items, depending upon the perceived degree of credit risk associated with each asset. Each asset is assigned to one of four risk-weighted categories. For example, 0% for cash and unconditionally guaranteed government securities; 20% for deposits with other banks and fed funds; 50% for state bonds and certain residential real estate loans; and 100% for commercial loans and other assets. Capital is categorized as either Tier 1 capital, consisting of common shareholders equity, qualifying perpetual preferred stock to certain limits, minority interests in equity accounts of consolidated subsidiary and trust preferred securities to certain limits, less goodwill and other intangibles, or Tier 2 capital, which consists of supplementary capital including allowance for possible credit losses to certain limits, certain preferred stock, eligible subordinated debt, and other qualifying instruments). The guidelines also define and set minimum capital requirements (risk-based capital ratios). All banks are required to maintain Tier 1 capital of at least 4% and total capital of 8.0% of risk-adjusted assets. However, as a result of the regulatory orders, the Bank is required to maintain a minimum Total Risk-Based capital ratio of 12.0%. The Bank had a Tier 1 capital to total risk-adjusted assets capital ratio of 7.16% and 12.73% at December 31, 2011 and 2010, respectively. The Bank’s Tier 1 capital exceeds the minimum regulatory requirement by $5,766,000. The Bank had a Total Risk-Based capital to risk-adjusted assets ratio of 8.43% and 13.99% at December 31, 2011 and 2010, respectively. The Bank’s Total Risk-Based capital exceeds the minimum regulatory requirement by $779,000; however it represents a capital shortfall of $6,512,000 in relation to the heightened capital levels required by the regulatory orders.

The Tier 1 leverage capital ratio guidelines require a minimum leverage capital ratio of 4% of Tier 1 capital to total assets less goodwill. However, as a result of the regulatory orders, the Bank is required to maintain a minimum leverage capital ratio of 9.0%. The Bank had a leverage capital ratio of 5.01% and 9.06% at December 31, 2011 and 2010, respectively. The Bank’s Tier 1 leverage capital exceeds the minimum regulatory requirement by $2,624,000; however it represents a capital shortfall of $10,416,000 in relation to the heightened capital levels required by the regulatory orders..

As of December 31, 2011, the most recent notification from the FDIC categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action. The Bank received such notification from the FDIC in 2010. The FDIC and FRB have adopted capital adequacy guidelines for use in their examination and regulation of banks and bank holding companies. If the capital of a bank or bank holding company falls below the minimum levels established by these guidelines, it may be denied approval to acquire or establish additional banks or non-bank businesses, or the FDIC or FRB may take other administrative actions. The guidelines employ two measures of capital: (1) risk-based capital and (2) leverage capital.

On March 27, 2003, the Corporation’s wholly owned special-purpose trust subsidiary, Northern California Bancorp, Inc. Trust I (“Trust I”) issued $3 million in cumulative Trust Preferred Securities. The securities bear a floating rate of interest of 3.25% over the three month LIBOR rate, payable quarterly. The effective rate at December 31, 2011 and 2010 was 3.65% and 3.54%, respectively. Concurrent with the issuance of the Trust Preferred Securities, Trust I used the proceeds from the Trust Preferred Securities offering to purchase a like amount of Junior Subordinated Debentures of the Corporation. The Corporation pays interest on the Junior Subordinated Debentures to Trust I, which represents the sole revenue and sole source of dividend distributions to the holders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, to defer payments of interest on the Junior Subordinated Debentures at any time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on April 7, 2033, but can be redeemed at par, in whole or in part, on any

Table of Contents

January 7, April 7, July 7 or October 7 occurring after April 7, 2008. The Corporation fully and unconditionally guarantees the obligations of Trust I, on a subordinated basis.

The Corporation received $2.91 million from Trust I upon issuance of the Junior Subordinated Debentures, of which $1 million was contributed by the Corporation to the Bank to increase its capital, $1.14 million was used to retire existing Corporation debt and the remainder was held as working capital. Under applicable regulatory guidelines, a portion of the Trust Preferred Securities qualify as Tier I Capital and the remainder as Tier II Capital.

On November 13, 2003, the Corporation’s wholly owned special-purpose trust subsidiary, Northern California Bancorp, Inc. Trust II (“Trust II”) issued $5 million in cumulative Trust Preferred Securities. The securities bear a floating rate of interest of 2.85% over the three month LIBOR rate, payable quarterly. The effective rate at December 31, 2011 and 2010 was 3.28% and 3.14%, respectively. Concurrent with the issuance of the Trust Preferred Securities, Trust II used the proceeds from the Trust Preferred Securities offering to purchase a like amount of Junior Subordinated Debentures of the Corporation. The Corporation pays interest on the Junior Subordinated Debentures to Trust II, which represents the sole revenue and sole source of dividend distributions to the holders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, to defer payments of interest on the Junior Subordinated Debentures at any time for a period not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on November 8, 2033, but can be redeemed at par, in whole or in part, on any February 8, May 8, August 8 or November 8 occurring after November 8, 2008. The Corporation fully and unconditionally guarantees the obligations of Trust II on a subordinated basis.

The Corporation received $4.96 million from Trust II upon issuance of the Junior Subordinated Debentures, of which $2.5 million was contributed by the Corporation to the Bank to increase its capital and the remainder was held as working capital. Under applicable regulatory guidelines, a portion of the Trust Preferred Securities qualify as Tier I Capital and the remainder as Tier II Capital.

Issuance costs of $116,000 and $54,000 related to Trust I and Trust II, respectively, have been capitalized and are being amortized over the 30-year life of the securities.

During the years ended December 31, 2011, 2010 and 2009, interest expense on the Junior Subordinated Debentures totaled $294,000, $288,000, and $328,000, respectively. The amortization of the issuance cost totaled $6,000 for each year ended December 31, 2011, 2010 and 2009, respectively.

The Corporation exercised its rights in accordance with the indentures for Trust I and Trust II, respectively, to defer interest payments for an undetermined period of time, not to exceed twenty (20) consecutive quarterly payments. The deferral of interest payments on Trust I was effective with the October 7, 2009 interest payment. The accrued and unpaid interest totaled $297,000, $177,000 and $60,000 for each year ended December 31, 2011, 2010 and 2009, respectively. The deferral of interest payments on Trust II was effective with the November 8, 2009 interest payment. The accrued and unpaid interest totaled $411,000, $237,000 and $65,000 for each year ended December 31, 2011, 2010 and 2009, respectively.

LIQUIDITY

Liquidity represents the ability to provide sufficient cash flows or cash resources in a manner that enables an entity to meet its obligations in a timely fashion and to adequately provide for anticipated future cash needs.

Table of Contents

For the Bank, liquidity considerations involve the capacity to meet expected and potential requirements of depositors seeking access to balances and to provide for the credit demands of borrowing customers. In the ordinary course of the Bank’s business, funds are generated from the repayment of loans, maturities within the investment securities portfolio and the acquisition of deposit balances, short-term borrowings and security sales. For a discussion of the funding sources from which the Bank can derive liquidity, please see the section entitled “Funding Sources,” above.

As a matter of policy, the Bank seeks to maintain a level of liquid assets, including marketable investment securities, equal to at least 15% of total assets (“primary liquidity”), while maintaining sources of secondary liquidity (borrowing lines from other institutions) equal to at least an additional 10% of assets. In addition, it seeks to generally limit loans to not more than 110% of deposits. Within these ratios, the Bank generally has excess funds available to invest on a daily basis, and is able to fund its own liquidity needs without the need of short-term borrowing. The Bank’s total liquidity at December 31, 2011, 2010 and 2009 was 22.09%, 23.72%, and 27.94%, respectively, while its average loan to deposit ratio for such years was 85.56%, 71.68% and 82.37%, respectively.

Brokered deposits are deposit instruments, such as certificates of deposit, deposit notes, bank investment contracts and certain municipal investment contracts, that are issued through brokers and dealers who then offer and/or sell these deposit instruments to one or more investors. Additionally, deposits on which a financial institution pays an interest rate significantly higher than prevailing rates are considered to be brokered deposits. Federal law and regulation restricts banks from soliciting or accepting brokered deposits, unless the bank is well capitalized under Federal guidelines. The Bank had brokered deposits totaling $14,754,000, $39,109,000 and $63,359,000 at December 31, 2011, 2010 and 2009, respectively, which represented 7.24%, 18.77% and 31.26%, respectively, of total deposits. None of the Bank’s brokered deposits paid an interest rate significantly higher than prevailing rates. The Bank has received notice from the FDIC that its capital classification has been designated as adequately capitalized; therefore the Bank is prohibited from accepting new or renewing any brokered deposits. Further, the regulatory orders imposed on the Bank require the Bank to eliminate any reliance on brokered deposits.

The Corporation’s sources of revenues and liquidity are the dividends, tax equalization payments and management fees from the Bank and gains on securities held in a trading account and other investments. The ability of the Bank to pay such items to the Corporation is subject to limitations under state and Federal law. Currently, the Bank is prohibited from paying and the Corporation has agreed not to accept dividends from the Bank as a result of the various regulatory actions imposed on the Bank and the Corporation in 2010.

INTEREST RATE RISK

Management of interest rate sensitivity (asset/liability management) involves matching and repricing rates of interest-earning assets with interest-bearing liabilities in a manner designed to optimize net interest income within the constraints imposed by regulatory authorities, liquidity determinations and capital considerations.

The purpose for asset/liability management is to provide stable net interest income growth by protecting the Bank’s earnings from undue interest rate risk. The Bank expects to generate earnings from increasing loan volume, particularly SBA guaranteed loans, appropriate loan pricing and expense control and not from trying to accurately forecast interest rates. Another important function of asset/liability management is managing the risk/return relationships between interest rate risk, liquidity, market risk and capital adequacy. The Bank gives priority to liquidity concerns

Table of Contents

followed by capital adequacy, then interest rate risk and market risk in the investment portfolio. The policy of the Bank is to control the exposure of the Bank’s earnings to changing interest rates by generally maintaining a position within a narrow range around an “earnings neutral position.” An earnings neutral position is defined as the mix of assets and liabilities that generate a net interest margin that is not affected by interest rate changes. However, Management does not believe that the Bank can maintain a totally earnings neutral position. Further, the actual timing of repricing of assets and liabilities does not always correspond to the timing assumed by the Bank for analytical purposes. Therefore, changes in market rates of interest will generally impact the Bank’s net interest income and net interest margin for long or short periods of time.

The Bank monitors its interest rate risk on a quarterly basis through the use of a model which calculates the effect on earnings of changes in the Federal Funds rate. The model converts a fed funds rate change into rate changes for each major class of asset and liability, then simulates the Bank’s net interest margin based on the Bank’s actual repricing over a one year period, assuming that maturities are reinvested in instruments identical to those maturing during the period. The following table shows the effect on net interest income of positive 100, 200, 300 and 400 basis point rate shocks and a negative 25 basis point rate shock at December 31, 2011. The table only includes projections for a decrease of 25 basis points since the Federal Funds target rate is currently between 0% and 0.25%.

Rate Shock Increase (Decrease) in Basis Points		Percent Increase (Decrease) in Net Interest Income
(25)		0.3%
100		(0.3)%
200		0.1%
300		0.3%
400		0.6%

INVESTMENT SECURITIES

The Corporation maintains a trading account, at fair value, consisting of marketable securities. At December 31, 2011 and 2010 the account value was $17,000 and $30,000, respectively. In addition, the Corporation has investments in Northern California Bancorp Trust I of $93,000 and Northern California Bancorp Trust II of $155,000. These are special-purpose trust subsidiaries which were formed to facilitate the issuance of trust preferred securities. All other investment securities are held by the Bank.

Table of Contents

The following table sets forth the book and market value of investment securities as of December 31, 2011, 2010 and 2009:

	INVESTMENT PORTFOLIO MIX
	(Dollars in thousands)
	2011				2010				2009
	Book value		Market value		Book value		Market value		Book value		Market value
Available for sale:
Mortgage Backed Securities	$	525	$	524	$	625	$	653	$	1,534	$	1,490
State/Local Agency	39,539		41,269		43,788		41,571		53,000		53,074
U.S. government Agencies	—		—		2,000		2,002		7,988		7,849
	$	40,064	$	41,793	$	46,413	$	44,226	$	62,522	$	62,413

Other Securities
Federal Home Loan Bank stock, restricted	$	2,502	$	2,502	$	2,987	$	2,987	$	3,360	$	3,360
The Independent Bankers Financial Corporation	51		51		51		51		51		51
Northern California Bancorp, Inc. Trust I	93		93		93		93		93		93
Northern California Bancorp, Inc. Trust II	155		155		155		155		155		155
Visa, Inc Class “B” Stock	426		426		426		426		426		426
	$	3,227	$	3,227	$	3,712	$	3,712	$	4,085	$	4,085

The contractual maturities of investment securities as well as tax equivalent yields based on amortized cost of those securities at December 31, 2011 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. All investment securities are due after ten years.

	After ten years				Total
(Dollars in thousands)	Market Value		Yield		Market Value		Yield
Available-for-sale
Mortgage Backed Securities	$	524	3.01	%	$	524	3.01	%
State/Local Agency Securities	41,269		7.42	%	41,269		7.42	%
	$	41,793	7.37	%	$	41,793	7.37	%

INFLATION

The impact of inflation on a financial institution can differ significantly from that exerted on other companies. Banks, as financial intermediaries, have many assets and liabilities which may move in concert with inflation, both as to interest rates and value. However, financial institutions are affected by inflation’s impact on noninterest expenses, such as salaries and occupancy expenses.

From 2004 through mid-2006, the Bank experienced an increasing rate environment due to the actions of the Federal Reserve, which began increasing rates in mid-2004. Beginning in September 2007 the Federal Reserve began reducing rates and through the date of this Annual Report on Form 10-K, the Federal Reserve has reduced rates 10 times for an overall rate reduction of 525 basis points. Because of the Bank’s ratio of rate sensitive assets to rate sensitive liabilities, the Bank benefits in the short term from an increasing interest rate market and suffers in a decreasing interest rate market. As such, the management of the money supply by the Federal Reserve to control the rate of inflation has an impact on the earnings of the Bank. The changes in interest rates may have a corresponding impact on the ability of borrowers to repay loans with the Bank.

Table of Contents

OFF-BALANCE SHEET ARRANGEMENTS

The Bank has various “off-balance sheet” arrangements that might have an impact on its financial condition, liquidity, or results of operations. As of December 31, 2011 and 2010 the Bank had commitments to extend credit in the amount of $10,159,000 and $7,341,000, respectively. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements.

CONTRACTUAL OBLIGATIONS

The following table presents, as of December 31, 2011, the Corporation’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, or other similar carrying value adjustments.

(Dollars in thousands)	One Year or Less		After One to Three Years		After Three to Five Years		Over Five Years		Total
Deposits without a stated maturity	$	65,094	$	—	$	—	$	—	$	65,094
Time deposits	75,269		51,454		6,725		5,071		138,519
FHLB borrowing	8,000		14,000		—		1,000		23,000
Junior Subordinated Debt							8,241		8,241
Operating Leases	305		273		—		—		578
Standby Letter of Credit	700		—		—		—		700

(Dollars in thousands)
Commitments to extend credit:
Commercial and Industrial		8,359
Consumer		157
Real Estate		2,004
Revolving Home Equity and Credit Card		386

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

Not Applicable.

Table of Contents

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following consolidated financial statements included in the Consolidated Financial Report issued by Hutchinson and Bloodgood LLP, Certified Public Accountants at the pages indicated

	Page

Report of Independent Registered Public Accounting Firm	F- 1

Consolidated Balance Sheets	F- 2

Consolidated Statements of Income	F- 3-4

Consolidated Statements of Changes in Shareholders’ Equity	F- 5

Consolidated Statements of Cash Flows	F- 6-7

Notes to Consolidated Financial Statements	F- 8-74

Table of Contents

NORTHERN CALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATED FINANCIAL REPORT

December 31, 2011

Table of Contents

TABLE OF CONTENTS

	Page

Report of Independent Registered Public Accounting Firm	F-1

FINANCIAL STATEMENTS

Consolidated Balance Sheets	F-2
Consolidated Statements of Operations	F-3-4
Consolidated Statements of Changes in Shareholders’ Equity	F-5
Consolidated Statements of Cash Flows	F-6-7
Notes to Consolidated Financial Statements	F-8-74

Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors

Northern California Bancorp, Inc. and Subsidiary

Monterey, California

We have audited the accompanying consolidated balance sheets of Northern California Bancorp, Inc. and its wholly owned subsidiary, Monterey County Bank (collectively the Corporation), as of December 31, 2011 and 2010 and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to

NORTHERN CALIFORNIA BANCORP INC 10-K