UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2010.

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 000-51901

SANTA LUCIA BANCORP

(Name of small business issuer in its charter)

State of California		35-2267934
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

7480 El Camino Real, Atascadero,		California 93422
(Address of principal executive offices)		(Zip Code)

Issuer’s telephone number (805) 466-7087

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

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

Title of each class		Name of each exchange on which registered
Common Stock (no par value)		None

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

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

Indicate by check mark whether the registrant 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 Reg 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 ¨ no

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§5229.405 of this chapter) 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 ¨.

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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨		Accelerated filer ¨

Non- accelerated filer ¨		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 ¨ No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2010 (last day of the registrant’s most recently completed second fiscal quarter) was $9,101,575.

As of February 25, 2011, the Registrant had 2,003,131 shares of Common Stock outstanding.

The information required in Part III, Items 10 through 14 are incorporated by reference to the registrant’s definitive proxy statement for the 2011 annual meeting of shareholders.

Table of Contents

TABLE OF CONTENTS

PART I
ITEM 1.	BUSINESS	3
ITEM 1A.	RISK FACTORS	18
ITEM 1B.	UNRESOLVED STAFF COMMENTS	30
ITEM 2.	PROPERTIES	30
ITEM 3.	LEGAL PROCEEDINGS	30
ITEM 4.	(REMOVED AND RESERVED)	30
PART II
ITEM 5.	MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	31
ITEM 6.	SELECTED FINANCIAL DATA	33
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	34
ITEM 7A.	QUANITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	55
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	56
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	88
ITEM 9A	CONTROLS AND PROCEDURES	88
ITEM 9B.	OTHER INFORMATION	89
PART III
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE	89
ITEM 11.	EXECUTIVE COMPENSATION	89
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	89
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE	89
ITEM 14	PRINCIPAL ACCOUNTING FEES AND SERVICES	89
PART IV
ITEM 15.	EXHIBITS, FINANCIAL STATEMENT SCHEDULES	90
SIGNATURES		97
EXHIBIT INDEX		98

PART I

Certain statements contained in this Annual Report on Form 10-K (“Annual Report”), including, without limitation, statements containing the words “estimate,” “believes,” “anticipates,” “intends,” “may,” “expects,” “could,” and words of similar import, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements relate to, among other things, our current expectations regarding future operating results, credit quality, net interest margin, strength of the local economy, and allowance for credit losses. Such forward looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in those areas in which the Company operates, the ongoing financial crisis and recession in the United States, California and foreign financial markets, the recovery, and bank regulatory and government response thereto, the increase in nonperforming loans and the decrease in real estate values collateralizing many of the Bank’s loans, demographic changes, competition, fluctuations in interest rates, changes in business strategy or developmental plans, changes in governmental regulations, credit quality, the availability of capital to fund the expansion of the Company’s business, and other factors referenced in the Company’s reports filed pursuant to the Exchange Act. These and other important factors are detailed in this report, including in “Item 1A Risk Factors.” When relying on forward-looking statements to make decisions with respect to our company, investors and others are cautioned to consider these and other risks and uncertainties. The company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

ITEM 1.

BUSINESS

General

Santa Lucia Bancorp (the “Company”) is a California corporation organized April 3, 2006 to act as the holding company for its wholly owned subsidiary Santa Lucia Bank (the “Bank”), collectively referred to herein as the “Company”. At that time shareholders of the Bank became shareholders of the Company on a one share for one share basis.

The Bank is a California banking corporation. The Bank was organized as a national banking association on December 19, 1984 and commenced operations on August 5, 1985. On May 30, 1997, the Bank converted from a national bank to a California state chartered bank licensed by the California Department of Financial Institutions (DFI”). As a California state member bank, the Bank is subject to primary supervision, examination and regulation by the DFI and the Board of Governors of the Federal Reserve System (“FRB”). The Bank is also subject to certain other federal laws and regulations. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the applicable limits thereof.

At December 31, 2010, the Company had approximately $249.8 million in assets, $176.8 million in net loans, $233.9 million in deposits, and $7.5 million in stockholders’ equity.

On April 26, 2006, the Company formed Santa Lucia (CA) Capital Trust (“Trust”). Trust is a statutory business trust formed under the laws of Delaware used to facilitate the issuance of the trust preferred securities. The Trust is a wholly owned, non-financial, non-consolidated subsidiary of the Company.

Other than holding the shares of the Bank, the Company conducts no significant activities.

Banking

The Bank is headquartered in Atascadero, with branch offices in Paso Robles, Arroyo Grande and Santa Maria. The Bank conducts a commercial banking business in San Luis Obispo and northern Santa Barbara Counties, including accepting demand, savings and time deposits, and making commercial, real estate, SBA, agricultural, credit card, and consumer loans. It also offers installment note collection, provides ATM and internet banking access, issues cashiers checks and money orders, sells travelers checks, and provides bank-by-mail, night depository, safe deposit boxes, and other customary banking services. The Bank does not offer trust services or international banking services and does not plan to do so in the near future.

The Bank’s operating policy since its inception has emphasized small business commercial banking. Most of the Bank’s customers are retail customers, and small to medium-sized businesses. The Bank takes real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery, equipment and accounts receivable as collateral for loans. The areas in which the Bank has directed virtually all of its lending activities are (i) commercial loans, (ii) installment, (iii) construction loans, and (iv) other real estate loans or commercial loans secured by real estate. As of December 31, 2010, these four categories accounted for approximately 18.2%, 0.9%, 20.2% and 60.7%, respectively, of the Bank’s loan portfolio. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Most of the Bank’s deposits are attracted by local promotional activities and advertising in the local media. A material portion of the Bank’s deposits have not been obtained from a single person or a few persons, the loss of any one or more of which would have a materially adverse effect on the business of the Bank. As of December 31, 2010, the Bank had approximately 9,800 demand deposit accounts consisting of non-interest bearing (demand), interest-bearing demand and money market accounts with balances totaling $123.2 million, for an average balance per account of approximately $12,571; 4,310 savings accounts with balances totaling $28.1 million, for an average balance per account of approximately $6,520; and 2,313 time certificate of deposit accounts with balances totaling $82.6 million, for an average balance per account of approximately $37,711.

The principal sources of the Bank’s revenues are (i) interest and fees on loans, (ii) interest on investments, (iii) service charges on deposit accounts, fees on mortgage loans and other charges and fees, and (iv) miscellaneous income. For the year ended December 31, 2010, these sources comprised 81%, 8%, 8% and 3%, respectively, of the Bank’s total operating income.

The Bank has not engaged in any material research activities relating to the development of new services or the improvement of existing bank services. There has been no significant change in the types of services offered by the Bank since its inception except as follows: The Bank previously introduced a telephone banking service named “Telebanking” which permits the customer to obtain information and perform other services over the telephone; an internet banking system named “EZLink,” which offers online banking and computer bill payment; home equity lines of credit; business equipment leasing; and home mortgage loans. In addition, the Bank introduced its new health savings account in 2005. The Bank has no present plans to add any new line of business that will require the investment of a material amount of total assets. Most of the Bank’s business originates from San Luis Obispo and northern Santa Barbara Counties, and there is no emphasis on foreign sources and application of funds. The Bank’s business, based upon performance to date, does not appear to be seasonal. Management of the Bank is unaware of any material effect upon the Bank’s capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulations.

The Bank holds no patents, licenses (other than licenses obtained from bank regulatory authorities), franchises or concessions.

Employees

As of December 31, 2010, the Bank had a total of 81 full-time equivalent employees. The Bank believes that its employee relations are satisfactory. The Company has no salaried employees.

Local Economic Climate

The Company believes that the local economies in which it operates, Atascadero, Paso Robles, Arroyo Grande, and Santa Maria continue to decline as unemployment remains high, business cash flows continue to be weak, and the real estate market remains unstable.

The state of California’s recent unbalanced budget continues to affect state employee’s monthly wages. Recent indications show the (not seasonally adjusted) unemployment rate within California as of March 31, 2010 of 13.0% compared to December 31, 2009 of 12.1%, an increase of 7.44%. However, both San Luis Obispo and Santa Barbara Counties have unemployment rates well below the State and National averages.

Beacon Economics is a Los Angeles, California based economics research firm, is forecasting that total nonfarm employment growth will be sluggish in the short-term, possibly slowing slightly in early 2011. Employment will likely find legs in 2012 as employers begin to experience stronger and sustained profits. Beacon expects the unemployment rate, which fell from its peak of 10.7% to 9.9% in August 2010, will continue to drop over the next few years. By the end of 2012 the rate will have dropped below 8%, and by the end of 2015, the rate will almost reach 6%, according to Beacon Economics.

The University of California Santa Barbara Economic Forecast Project reports that the local real estate markets will at best California show signs of slow growth averaging 1.0% to 2.0% in 2011. New construction projects, even retail sites, are being developed in the San Luis Obispo County and expansion plans for the county’s prisons will certainly create jobs, especially in the construction field where they are critically needed.

According to Beacon Economics, the housing market in the San Luis Obispo region has also begun to find some balance over the past few quarters, although the rebound remains quite fragile. While falling home prices have dramatically increased home affordability, there are many remaining issues in the mortgage market that need to be worked out. Foreclosure activity in San Luis Obispo County last peaked at 256 units in the 4th quarter of 2009 before falling back to 224 units by the 2nd quarter of 2010. Compared to the 2nd quarter of 2009, foreclosures have risen by 13.4% in San Luis Obispo County. Beacon Economics is currently forecasting that home prices will stabilize and flatten over the short-run despite recent price gains. But once the troubled inventory is processed, the region will return to more normal price growth in 2012, driven primarily by income and population growth rather than by excess debt burdens and price-to-income ratios at more than double their historic norm. Home sales will remain soft in the near term but by mid-2011, sales in San Luis Obispo should start to accelerate as problems in the mortgage market are worked through and labor markets and incomes improve further.

However, weakness in the commercial real estate sector is still intensifying. The decline in the labor market has produced a rapid decline in demand for office and industrial space and many retail store closings.

The Company believes that the local economies, in which it operates, Atascadero, Paso Robles, Arroyo Grande, and Santa Maria continue to be negatively affected as the loss of jobs increases and business cash flows continue to decline causing the rise of delinquencies and foreclosures in the loan portfolio.

Competition

The banking and financial services business in California generally, and in the Company’s service area specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers.

The Company’s business is concentrated in its service area, which encompasses primarily San Luis Obispo and northern Santa Barbara Counties. In order to compete with other financial institutions in its service area, the Company relies principally upon local advertising programs; direct personal contact by officers, directors, employees, and shareholders; and specialized services such as courier pick-up and delivery of non-cash banking items. The Company emphasizes to its customers the advantages of dealing with a locally owned and community oriented institution. The Company also seeks to provide special services and programs for individuals in its primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, tools of the trade or expansion of practices or businesses. Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns. They also perform services, such as trust services, international banking, discount brokerage and insurance services that the Company is not authorized or prepared to offer currently. The Company has made arrangements with its correspondent banks and with others to provide such services for its customers.

Commercial banks compete with savings and loan associations, credit unions, other financial institutions, securities brokerage firms, and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies, insurance companies, and other lending institutions.

Supervision and Regulation

Regulatory and Enforcement Proceedings

On December 23, 2010, the Company the Bank and the Federal Reserve Bank of San Francisco (“FRBSF”) entered into a Written Agreement (the “Written Agreement”), effective December 23, 2010, addressing, among other items, management, operations, lending, asset quality and increased capital for the Bank and the Company, as appropriate.

The Written Agreement was the result of a recent examination of the Bank and the Company by the FRBSF that resulted in certain criticisms of the Bank, particularly related to the overall quality of the Bank’s loan portfolio. Many of the requirements of the Written Agreement reflect recommendations or requirements from the Report of Examination that the Bank has been working on since the date of the examination. Subsequent to the examination and in order to enhance the Bank’s ability to remedy many of the noted criticisms, the Bank made numerous changes in the executive structure to include a newly appointed Chief Credit Officer (CCO) and Chief Financial Officer. In addition, Stanley R. Cherry, Director and former President/CEO has rejoined the Bank as a senior credit administrator and will be working closely with the CCO to manage the day-to-day credit functions. The Company and Bank will continue their efforts to comply with all provisions of the Written Agreement, and believe they are taking the appropriate steps necessary to comply in a timely fashion.

Among other things, the Written Agreement requires that:

The Company serve as a source of strength for the Bank;

The board of directors of the Bank submit a plan to strengthen board oversight of the management and operations of the Bank;

The Bank submit to the FRBSF a plan to strengthen credit risk management practices;

The Bank submit to the FRBSF revised written lending and credit administration policies and procedures;

The Bank submit to FRBSF a revised policy for the effective grading of the Bank’s loan portfolio;

The Bank submit to the FRBSF a written program for the effective, ongoing third party review of the Bank’s loan portfolio, and that the board of directors take appropriate steps to ensure that the findings of such reviews are addressed by management;

The Bank not extend, renew, or restructure any credit to any borrower (or related interest) whose loans or other extensions of credit are criticized in the FRBSF’s most recent report of examination (the “Report of Examination”), or in any subsequent examination, without the prior approval of a majority of the full board of directors or a designated committee thereof;

The Bank submit an acceptable written program to the FRBSF that is designed to improve the Bank’s position through repayment, amortization, liquidation, additional collateral, or other means on certain past due or problem loans and other real estate owned (“OREO”) identified at the date of the Written Agreement, and to develop a similar plan for any such loans or OREO identified in the future. The Bank also must submit quarterly progress reports to the FRBSF on such loans and OREO;

The Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified “loss” in the Report of Examination that have not been previously charged off;

The Bank review and revise its ALLL methodology consistent with relevant supervisory guidance and the findings and recommendations regarding the ALLL in the Report of Examination, and submit to the FRBSF a plan for maintenance of an adequate ALLL;

The Company and the Bank submit to the FRBSF an acceptable joint written plan to maintain sufficient capital at the Bank, and notify the FRBSF following any calendar quarter in which the Bank’s capital ratios fall below minimums set forth in such plan, including in such notice steps the Bank or Company intend to take to increase capital ratios;

The Bank submit to the FRBSF an acceptable written contingency funding plan;

The Bank submit to the FRBSF a written business plan for 2011 to improve the Bank’s earnings and overall condition;

The Company and the Bank not declare or pay any dividends without the prior written approval of the FRBSF and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System (the “Director”);

The Company not take any other form of payment representing a reduction in capital from the Bank without the prior written approval of the FRBSF;

The Company and its nonbank subsidiary not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the FRBSF and the Director;

The Company and its nonbank subsidiary not, directly or indirectly, incur, increase, or guarantee any debt without prior written approval of the FRBSF;

The Company not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the FRBSF;

The Bank immediately take all necessary steps to correct all violations of law and regulation cited in the Report of Examination;

The Company and the Bank submit any new officer or director, or change in any existing officer’s or director’s duties, to the FRBSF for prior approval or non-objection;

The Company and the Bank seek prior approval or non-objection from the FRBSF before making any indemnification or severance payment to an officer or director;

The Company and the Bank submit to the FRBSF joint quarterly written progress reports on efforts to comply with the Written Agreement;

The Written Agreement will remain effective and enforceable until stayed, modified, terminated or suspended in writing by the FRBSF. The foregoing description of the Written Agreement is a summary and does not purport to be a complete description of all of its terms, and is qualified in its entirety by reference to a copy of the Written Agreement, attached in an 8-K filing with the Securities and Exchange Commission (the “SEC”) filed on December 29, 2010.

The California Department of Financial Institutions (“DFI”) completed an examination of the Bank in the fourth quarter of 2010. Based upon discussion with the DFI following the examination, the Bank’s condition has been further downgraded. Further, the Bank likely will receive some form of formal enforcement action from the DFI. While we expect the action from the DFI to be similar in scope to the Written Agreement, it will differ in at least one important respect. While the Written Agreement requires the Bank to submit a capital plan to the FRBSF, the agreement does not specify a particular level of capital the Company or Bank must maintain. The DFI has indicated that its action will include specific minimum capital ratios that the Bank must meet for both the tier 1 leverage and total risk based capital ratios. At this time, the Bank has not been advised of the minimum capital ratios sought by the DFI. However, those ratios will be in excess of the Bank’s current capital ratios.

While the Company and Bank are moving diligently to comply with the Written Agreement and to respond to the criticisms of the FRBSF and DFI, there can be no assurance that full compliance will be achieved with either the Written Agreement or any formal action sought by the DFI. As a result, the Company and the Bank could become subject to further regulatory restrictions or penalties. Full satisfaction of the Written Agreement and the action to be sought by the DFI will depend in part on raising a significant amount of additional capital. The Company’s ability to raise capital will depend on market conditions, which are outside the Company’s control, and also on the Bank’s financial performance and condition. Should the Bank’s asset quality continue to erode and require significant additional provision for loan losses, resulting in additional future net operating losses at the Bank, the Company’s ability to raise capital may be impaired. In addition, further operating losses would cause the Bank’s capital levels to decline further, requiring the raising of more capital.

General

The Company and the Bank are extensively regulated under both federal and state law. Set forth below is a summary description of certain laws that relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

In addition, Congress and the executive branch are taking action to change significantly bank regulations. The recent Dodd-Frank Wall Street Reform and Consumer Protection Act was a first step in revised regulation, but many rules and regulations remain to be written or implemented under that act, and further legislation in this area is likely.

The Company

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”), and is registered as such with, and subject to the supervision of, the Federal Reserve Board. The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may conduct examinations of bank holding companies and their subsidiaries.

The Company is required to obtain the approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of any class of outstanding voting shares of such bank. Prior approval of the Federal Reserve Board is also required for the merger of consolidation of the Company and another bank holding company.

The Company is prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct of indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may, subject to the prior approval of the Federal Reserve Board, engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. See discussion under “Financial Modernization Act” below for additional information.

The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates when the Federal Reserve Board determines that the activity or the control or the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve board prior to purchasing or redeeming its equity securities.

Under the Federal Reserve Board’s regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe and unsound manner. In addition, it is the Federal Reserve Board’s policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board’s regulations or both.

The Company and the Bank are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Company nor the Bank may condition an extension of credit to a customer on either (1) a requirement that the customer obtain additional services provided by us or (2) an agreement by the customer to refrain from obtaining other services from a competitor.

The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and files reports and proxy statements pursuant to such Act with the Securities and Exchange Commission (the “SEC”).

For a discussion of restrictions on the Company’s ability to pay dividends, see “Item 5 Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities,” below.

The Bank

The Bank is chartered under the laws of the State of California and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the DFI and the FRB. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank’s business and condition. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes relate to many aspects of the Bank’s operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. Further, the Bank is required to maintain certain levels of capital.

If, as a result of an examination of a bank, the DFI or FRB should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to these regulatory agencies. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank’s deposit insurance, which for a California chartered bank would result in a revocation of the bank’s charter.

The deposits of the Bank are insured by the FDIC in the manner and to the extent provided by law. For this protection, the Bank pays a quarterly statutory assessment. The Bank is also subject to certain regulations of the Federal Reserve Board and applicable provisions of California law, insofar as they do not conflict with or are not preempted by federal banking law. Various other requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes and regulations relate to many aspects of the Bank’s operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, capital requirements and disclosure obligations to depositors and borrowers. Further, the Bank is required to maintain certain levels of capital.

Capital Standards

The FRB and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, non-cumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition, the DFI has authority to take possession of the business and properties of a bank in the event that the tangible shareholders’ equity of the bank is less than the greater of (i) 4% of the bank’s total assets or (ii) $1,000,000.

In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 4%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends. It is the Bank’s policy to remain “well capitalized” status, and review alternatives for raising capital if necessary to keep such status.

The Company is not subject to similar regulatory requirements because its consolidated assets do not exceed $500 million, the minimum asset size criteria for bank holding companies subject to those requirements. The Bank’s actual capital ratios and the required ratios for “well capitalized” and “adequately capitalized” bank are as follows:

	Regulatory Requirements						31-Dec-10
	Adequately Capitalized			Well Capitalized			Bank
Leverage Ratio		4.00	%		5.00	%		4.75	%

Tier I Risk-Based Ratio		4.00	%		6.00	%		6.85	%

Total Risk-Based Ratio		8.00	%		10.00	%		8.16	%

Under applicable regulatory guidelines, the Bank was considered “Adequately Capitalized” at December 31, 2010.

The Company issued $5.2 million in junior subordinated debt securities (the “debt securities”) to the Company (CA) Capital Trust, a statutory trust created under the laws of the State of Delaware. These debt securities are subordinated to effectively all borrowings of the Company and are due and payable on July 7, 2036. These debt securities may be redeemed for 105% of the principal balance through July 7, 2011 and then at par thereafter. Interest is payable quarterly beginning July 7, 2006 at 1.48% over the quarterly adjustable 3-month LIBOR. Of this $5.2 million, the Company contributed $3.0 million to the Bank and retained $2.2 million at the Company level. The securities do not entitle the holders to voting rights in the Company but will contain certain restrictive covenants, including restrictions on the payment of dividends to the holders of the Company’s common stock in the event that interest payments on the trust preferred securities are postponed. The capital contribution received by the Bank from the trust preferred issuance is designated as Tier 1 capital for regulatory purposes.

Following consultation with the FRBSF, on August 31, 2010 the Company elected to defer regularly scheduled payments on debt securities relating to its outstanding $5 million trust preferred security (the “Security”) for a period of up to 20 consecutive quarters (the “Deferral Period”). The terms of the Security and the trust documents allow the Company to defer payments of interest for the Deferral Period without default or penalty. During the Deferral Period, the Company will continue to recognize interest expense associated with the Security. Upon the expiration of the Deferral Period, all accrued and unpaid interest will be due and payable. During the Deferral Period, the Company is prevented from paying cash dividends to shareholders or repurchasing stock.

Under applicable regulatory guidelines, the Company’s trust preferred securities issued by our subsidiary capital trust qualify as Tier 1 capital up to a maximum limit of 25% of Tier 1 capital. Any additional portion of the trust preferred securities would qualify as Tier II capital. As of December 31, 2010 the subsidiary trust had $5.2 million in trust preferred securities outstanding, of which $2.6 million qualifies as Tier 1 capital.

In addition, the DFI has authority to take possession of the business and properties of a bank in the event that the tangible shareholders’ equity of the bank is less than the greater of (i) 4% of the bank’s total assets or (ii) $1,000,000.

During the third quarter of 2003, the Bank undertook and completed a private placement of subordinated debentures (“notes”) to augment its Tier II capital. The total principal amount of the notes issued was $2,000,000. The notes were sold pursuant to an applicable exemption from registration under the Securities Act of 1933 to certain accredited investors, including some of the Company’s directors and executive officers. The notes include quarterly payment of interest at prime plus 1.5% and quarterly principal installments of approximately $166,666 commencing on September 30, 2008 until paid in full on June 30, 2011. At December 31, 2010, the Bank prepaid the remaining $499 thousand to the holders of the notes and carried a $0 balance.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed into law the sweeping financial regulatory reform act entitled the "Dodd-Frank Wall Street Reform and Consumer Protection Act" (the "Dodd-Frank Act") that implements significant changes to the regulation of the financial services industry, including provisions that, among other things:

Centralize responsibility for consumer financial protection by creating a new agency within the Federal Reserve Board, the Bureau of Consumer Financial Protection, with broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws that would apply to all banks and thrifts. Smaller financial institutions, including the Bank, will be subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws.

Apply the same leverage and risk-based capital requirements that apply to insured depository institutions to bank holding companies.

Require the FDIC to seek to make its capital requirements for banks countercyclical so that the amount of capital required to be maintained increases in times of economic expansion and decreases in times of economic contraction.

Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital.

Implement corporate governance revisions, including executive compensation and proxy access by stockholders.

Make permanent the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000, and provide unlimited federal deposit insurance until January 1, 2013 for non-interest bearing demand transaction accounts at all insured depository institutions.

Repeal the federal prohibitions on the payment of interest on demand deposits effective July 21, 2011, thereby permitting depository institutions to pay interest on business transaction and other accounts.

Many aspects of the Dodd-Frank Act are subject to rulemaking by various regulatory agencies and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its customers or the financial industry more generally. The elimination of the prohibition on the payment of interest on demand deposits could materially increase our interest expense, depending on our competitors' responses. Provisions in the legislation that require revisions to the capital requirements of the Company and the Bank could require the Company and the Bank to seek additional sources of capital in the future.

Participation in the Capital Purchase Program of the Troubled Asset Relief Program.

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (“EESA”) enacted by the U.S. Congress in response to the financial crises affecting the banking system and financial markets and gong concern threats to investment banks and other financial institutions. On October 14, 2008, the U.S. Department of Treasury (“U.S. Treasury”) announced the Troubled Asset Relief Program Capital Purchase Program (“TARP”). This program made $250 billion of capital available to U.S. financial institutions from the initial $350 billion authorized by the EESA in the form of preferred stock investments by the U.S. Treasury in qualifying U.S. controlled banks, savings associations and certain bank and savings and loan holding companies under the following general terms:

The preferred stock issued to the U.S. Treasury would pay 5% dividends for the first five years, and then 9% dividends thereafter;

In connection with the purchase of preferred stock, the U.S. Treasury will receive warrants entitling the U.S. Treasury to buy the participating institution’s common stock equivalent in value to 15% of the preferred stock;

The preferred stock may not be redeemed for a period of three years, except with proceeds from high-quality private capital;

The consent of the U.S. Treasury will be required to increase common dividends per share or any share repurchases, with limited exceptions, during the first three years, unless the preferred stock has been redeemed or transferred to third parties; and

Participating companies must adopt the U.S. Treasury’s standard for executive compensation and corporate governance for the period during which the U.S. Treasury holds the equity issued under the TARP. At the close of Company’s TARP transaction, these executive compensation restrictions included that the Company, among other things, must:

Ensure that the incentive compensation programs for its senior executive officers do not encourage unnecessary and excessive risks that threaten the value of the Company

Implement a required clawback of any bonus or incentive compensation paid to the Company’s senior executive officers based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate;

Not make any “golden parachute” (as defined in the Internal Revenue Code) to any of the Company’s senior executive officers; and

Agree no to deduct for the tax purposes executive compensation in excess of $500,000 in any one fiscal year for each of the Company’s senior executive officers.

On December 19, 2008, the Company entered into a Purchase Agreement with the United States Department of the Treasury (the “Treasury”), pursuant to which the Company agreed to issue and sell 4,000 shares of the Company’s Preferred Stock as Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Preferred Stock) and a Warrant to purchase 38,869 shares of the Company’s Common Stock (adjusted for the 2% stock dividend) for an aggregate purchase price of $4,000,000 in cash. In connection with this transaction the Company incurred $50,000 in costs.

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

The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $15.43 per share, adjusted for the two separate 2% stock dividends declared in September 2009 and March 2010.

Following consultation with the FRBSF, on August 31, 2010 the Company elected to defer regularly scheduled dividends on the Preferred Stock. As of December 31, 2010, the Company has missed two dividend payments. By deferring the dividends on Series A Senior Preferred Stock for a total of six quarters, whether or not consecutive, the U.S. Treasury will have the right to elect two members of the Company’s Board of Directors, voting together with any other holders of preferred shares ranking pari passu with the Series A Senior Preferred Stock. These directors would serve on the Company’s Board of Directors until such time as the Company has paid in full all dividends not previously paid, at which time these directors’ terms of office would immediately terminate. Given the Company’s recent losses and accumulated deficit, it is unlikely the Company will resume payment of dividends on its Preferred Stock in 2011.

The American Recovery and Reinvestment Act of 2009

On February 17, 2009, President Obama signed into law The American Recovery and Reinvestment Act of 2009 (the “Stimulus Bill”), more commonly known as the economic stimulus or economic recovery package. The Stimulus Bill includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health and education needs. In addition, the Stimulus Bill imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including the Company, that are in addition to those previously announced by the U.S. Treasury, until the institution has repaid the U.S. Treasury, which is now permitted under the Stimulus Bill without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation with the recipient’s appropriate regulatory agency.

In addition, ARRA directs the Treasury to review previously-paid bonuses, retention awards and other compensation paid to senior executive officers and certain other highly-compensated employees of each TARP recipient to determine whether any such payments were excessive, inconsistent with the purposes of ARRA or the TARP, or otherwise contrary to the public interest. If the Treasury determines that any such payments have been made by a TARP recipient, the Treasury will seek to negotiate with the TARP recipient and the subject employee for appropriate reimbursements to the U. S. Government (not the TARP recipient) with respect to any such compensation or bonuses. ARRA also permits the Treasury, subject to consultation with the appropriate federal banking agency, to allow a TARP recipient to repay any assistance previously provided to such TARP recipient under the TARP, without regard to whether the TARP recipient has replaced such funds from any source, and without regard to any waiting period. Any TARP recipient that repays its TARP assistance pursuant to this provision would no longer be subject to the executive compensation provision under ARRA.

Homeowner Affordability and Stability Plan

On February 18, 2009, the Treasury announced the Homeowner Affordability and Stability Plan (“HASP”), which proposes to provide refinancing for certain homeowners, to support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac, and to establish a Homeowner Stability Initiative to reach at-risk homeowners. Among other things, the Homeowner Stability Initiative would offer monetary incentive to mortgage servicers and mortgage holders for certain modifications of at-risk loans, and would establish an insurance fund designed to reduce foreclosures.

Prompt Corrective Action and Other Enforcement Mechanisms

Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios described above. An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators 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. Enforcement actions may include:

the imposition of a conservator or the issuance of a cease-and-desist order that can be judicially enforced;

the termination of insurance of deposits (in the case of a depository institution);

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 enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.

Banks are also subject to certain Federal Reserve Board restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons (i.e., insiders). Extensions of credit (1) must be made on substantially the same terms and pursuant to the same credit underwriting procedures as those for comparable transactions with persons who are neither insiders nor employees, and (2) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in regulatory sanctions on the bank or its insiders.

Additionally, a holding company’s inability to serve as a source of strength to its subsidiary banking organizations could serve as an additional basis for a regulatory action against the holding company

Safety and Soundness Standards

The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) imposes certain specific restrictions on transactions and requires federal banking regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer, director, principal shareholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts. The federal banking agencies may require an institution to submit to an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of action given the specific circumstances and severity of an institution’s noncompliance with one or more standards.

Premiums for Deposit Insurance

The Bank’s deposits have historically been insured by the FDIC up to $100,000 per insured depositor, except certain types of retirement accounts, which are insured up to $250,000 per insured depositor. On October 3, 2008, the maximum amount insured under FDIC deposit insurance was temporarily increased from $100,000 to $250,000 per insured depositor and made permanent with the Dodd-Frank Wall Street Reform and Consumer Protection Act. This increase was part of the Emergency Economic Stabilization Act of 2008. Additionally, the Bank has elected to participate in the FDIC’s Temporary Liquidity Guarantee Program. Under this program, all non-interest bearing deposit transaction accounts at the Bank with balances over $250,000 were also fully insured through January 1, 2013 at an additional cost to the Bank of 10 basis points per dollar over $250,000 on a per account basis.

Until recently, the FDIC has set a designated reserve ratio of 1.25% ($1.25 against $100 of insured deposits) for the Deposit Insurance Fund (“DIF”). As discussed, the Dodd-Frank Act raised the reserve ratio to 1.35%. The Federal Deposit Insurance Reform Act of 2005 (“FDIC Act”) provides the FDIC Board of Directors the authority to set the designated reserve ratio between 1.15% and 1.50%. The FDIC must adopt a restoration plan when the reserve ratio falls below 1.15% and begin paying dividends when the reserve ratio exceeds 1.35%. The DIF reserve ratio calculated by the FDIC that was in effect at December 31, 2009 was -0.39%.

Through the later part of 2008 and through 2010 the number of bank and thrift failures rose significantly, resulting from, among other things, the U.S. financial crisis and significantly weakened economic conditions. This placed considerable strain on the FDIC’s DIF. As a result, on September 29, 2009, the FDIC adopted an Amended Restoration Plan to allow the DIF to return to a ratio of 1.15% within eight years. The FDIC also adopted higher annual risk-based assessment rates beginning in January of 2011. On November 12, 2009 the FDIC also adopted a final rule amending the assessment regulations to require insured depository institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 30, 2009, except for those institutions where the FDIC grants an exemption. Under the Dodd-Frank Act, the minimum designated reserve ratio of the DIF increased from 1.15 percent to 1.35 percent of estimated insured deposits. Additionally, the Dodd-Frank Act revised the assessment base against which an insured depository institution’s deposit insurance premiums paid to the DIF will be calculated. Under the FDIC’s proposed rules, the assessment base will change from adjusted domestic deposits to average consolidated total assets minus average tangible equity. The Bank currently anticipates its quarterly assessments will increase significantly during the next three years. It is currently estimated that assessments against the Bank for 2011 will total approximately $.9 million compared to the approximately $.7 million reported for the year ended December 31, 2010.

In 2007, FDIC regulations established a new risk-based assessment system under which deposit insurance assessments are based upon supervisory ratings for all insured institutions, financial ratios for most institutions, and long-term debt issuer ratings for large institutions that have them.

The FDIC is authorized to terminate a depository institution’s deposit insurance if it finds that the institution is being operated in an unsafe and unsound manner or has violated any rule, regulation, order or condition administered by the institution’s regulatory authorities. Any such termination of deposit insurance would likely have a material adverse effect on the Bank, the severity of which would depend on the amount of deposits affected by such a termination.

Under federal law, deposits and certain claims for administrative expenses and employee compensation against an insured depository institution are afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the liquidation or other resolution of such an institution by any receiver appointed by regulatory authorities. Such priority creditors would include the FDIC.

Sarbanes-Oxley Act of 2002

On July 30, 2002, the Sarbanes-Oxley Act of 2002 (“SOX”), was signed into law to address corporate and accounting fraud. SOX establishes a new accounting oversight board that will enforce auditing standards and restricts the scope of services that accounting firms may provide to their public company audit clients. Among other things, SOX also (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the SEC; (ii) imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and (iv) requires companies to disclose whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert.”

Under SOX, the SEC is required to regularly and systematically review corporate filings, based on certain enumerated factors. To deter wrongdoing, SOX: (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company’s financial statements was due to corporate misconduct; (ii) prohibits an officer or director from misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.

As a public reporting company, the Company is subject to the requirements of SOX and related rules and regulations issued by the SEC and applied to the Company by the FRB. The Company’s common stock is not listed on any national exchange such as the NYSE or NASDAQ. As such, the Company is not required to comply with the additional SOX requirements adopted by such exchanges. The Company anticipated additional expenses to comply with SOX in 2010 however, the requirement for compliance was delayed another year.

Financial Services Modernization Legislation

On November 12, 1999, the Gramm-Leach-Bliley Act of 1999 (the “Financial Services Modernization Act”) was signed into law. The Financial Services Modernization Act is intended to modernize the banking industry by removing barriers to affiliation among banks, insurance companies, the securities industry and other financial service providers. It provides financial organizations with the flexibility of structuring such affiliations through a holding company structure or through a financial subsidiary of a bank, subject to certain limitations. The Financial Services Modernization Act establishes a new type of bank holding company, known as a financial holding company, which may engage in an expanded list of activities that are “financial in nature,” which include securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking.

The Financial Services Modernization Act also sets forth a system of functional regulation that makes the Federal Reserve Board the “umbrella supervisor” for holding companies, while providing for the supervision of the holding company’s subsidiaries by other federal and state agencies. In addition, the Company is subject to other provisions of the Financial Services Modernization Act, including those relating to CRA, privacy and safe-guarding confidential customer information, regardless of whether the Company elects to become a financial holding company or to conduct activities through a financial subsidiary of the Company. The Company does not, however, currently intend to file notice with the Federal Reserve Board to become a financial holding company or to engage in expanded financial activities through a financial subsidiary of the Company.

The Company does not believe that the Financial Services Modernization Act will have a material adverse effect on its operations in the near-term. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Financial Services Modernization Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company faces from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company.

Community Reinvestment Act

The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (“CRA”) activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. A bank’s compliance with its CRA obligations is based on a performance-based evaluation system which based CRA ratings on an institution’s lending service and investment performance, resulting in a rating by the appropriate bank regulatory agency of “outstanding”, “satisfactory”, “needs to improve” or “substantial noncompliance.” At its last examination by the FRB, the Bank received a CRA rating of “Satisfactory.”

USA Patriot Act of 2001

On October 26, 2001, President Bush signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism, or the Patriot Act, of 2001. Among other things, the Patriot Act (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals (iii) requires financial institutions to establish an anti-money-laundering compliance program, and (iv) eliminates civil liability for persons who file suspicious activity reports. The Patriot Act also increases governmental powers to investigate terrorism, including expanded government access to account records and makes rules to implement the Patriot Act. On March 9, 2006, the President signed the USA Patriot improvement and Reauthorization Act, which extended and modified the original act. While we believe the Patriot Act may, to some degree, affect our recordkeeping and reporting expenses, we do not believe that it will have a material adverse effect on our business and operations.

Transactions between Affiliates

Transactions between The Company and its “affiliates” are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The FRB issued Regulation W on October 31, 2002, which comprehensively implements sections 23A and 23B of the Federal Reserve Act. Sections 23A and 23B and Regulation W restrict loans by a depository institution to its affiliates, asset purchases by a depository institution from its affiliates, and other transactions between a depository institution and its affiliates. Regulation W unifies in one public document the FRB’s interpretations of sections 23A and 23B. Regulation W had an effective date of April 1, 2003.

Privacy

Federal banking rules limit the ability of banks and other financial institutions to disclose non-public information about consumers to non-affiliated third parties. Pursuant to these rules, financial institutions must provide:

initial notices to customers about their privacy policies, describing the conditions under which they may disclose non-public information to non-affiliated third parties and affiliates;

annual notices of their privacy policies to current customers; and

a reasonable method for customers to “opt out” of disclosures to non-affiliated third parties.

These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. We have implemented our privacy policies in accordance with the law.

In recent years, a number of states have implemented their own versions of privacy laws. For example, in 2003, California adopted standards that are more restrictive than federal law, allowing bank customers the opportunity to bar financial companies from sharing information with their affiliates.

Predatory Lending

The term “predatory lending”, much like the terms “safety and soundness” and “unfair and deceptive practices”, is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. But typically predatory lending involves at least one, and perhaps all three, of the following elements:

making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation or asset-based lending;

inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced or loan flipping; and

engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower.

Federal Reserve Board regulations aimed at curbing such lending significantly widened the pool of high-cost home-secured loans covered by the home Ownership and Equity Protection Act of 1994, a federal law that requires extra disclosures and consumer protections to borrowers. The following triggers coverage under the home ownership and Equity Protection Act of 1994:

interest rates for first lien mortgage loans in excess of 8 percentage points above comparable Treasury securities,

subordinate lien loans of 10 percentage points above Treasury securities, and

fees such as optional insurance and similar debt protection costs paid in connection with the credit transaction when combined with points and fees if deemed excessive.

In addition, the regulation bars loan flipping by the same lender of loan servicer within a year. Lenders also will be presumed to have violated the law; which says loans shouldn’t be made to people unable to repay them; unless they document that the borrower has the ability to repay. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid. The Company does not expect these rules and potential state action in this area to have a material impact on our financial condition or results of operations.

Bank Secrecy Act and Anti Money Laundering Legislation

In 1970, Congress passed the Currency and Foreign Transactions Reporting Act, otherwise known as the Bank Secrecy Act (the “BSA”), which established requirements for recordkeeping and reporting by banks and other financial institutions. The BSA was designed to help identify the source, volume and movement of currency and other monetary instruments into and out of the United States in order to help detect and prevent money laundering connected with drug trafficking, terrorism and other criminal activities. The primary tool used to implement BSA requirements is the filing of Suspicious Activity Reports. Today, the BSA requires that all banking institutions develop and provide for the continued administration of a program reasonable designed to assure and monitor compliance with certain recordkeeping and reporting requirements regarding both to domestic and international currency transactions. These programs must, at a minimum, provide for a system of internal controls to assure ongoing compliance, provide for independent testing of such systems and compliance, designate individuals responsible for such compliance and provide appropriate personnel training.

Commercial Real Estate Lending

Federal banking regulators recently issued final guidance regarding commercial real estate lending to address a concern that rising commercial real estate lending concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the general commercial real estate market. This guidance suggests that institutions that are potentially exposed to significant commercial real estate concentration risk will be subject to increased regulatory scrutiny. Institutions that have experienced rapid growth in commercial real estate lending, have notable exposure to specific types of commercial real estate lending, or are approaching or exceed certain supervisory criteria that measure an institution’s commercial real estate portfolio against its capital levels, may be subject to such increased regulatory scrutiny. Our commercial real estate portfolio may be viewed as falling within one or more of the foregoing categories, and accordingly we may become subject to increased regulatory scrutiny because of our commercial real estate portfolio. If it is determined by our regulator that we have an undue concentration in commercial real estate lending, we may be required to maintain increased levels of capital and/or be required to reduce our concentration in commercial real estate loans.

Monetary Policy and Economic Controls

The Company and the Bank are directly affected by governmental policies and regulatory measures affecting the banking industry in general. Of primary importance is the Federal Reserve, whose actions directly affect the money supply which, in turn, affects banks’ lending abilities by increasing or decreasing the cost and availability of funds to banks. The Federal Reserve regulates the availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in United States government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against bank deposits, and limitations on interest rates that banks may pay on time and savings deposits.

Deregulation of interest rates paid by banks on deposits and the types of deposits that may be offered by banks has eliminated minimum balance requirements and rate ceilings on various types of time deposit accounts. The effect of these specific actions and, in general, the deregulation of deposit interest rates has generally increased banks’ cost of funds and made them more sensitive to fluctuations in money market rates. In view of the changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and earnings of the Bank or the Company. As a result, banks, including the Bank, face a significant challenge to maintain acceptable net interest margins.

Future Legislation and Regulatory Initiatives

Various other legislative and regulatory initiatives, including proposals to overhaul the banking regulatory system are from time to time introduced in Congress and state legislatures, as well as regulatory agencies. Currently, the Congress is actively considering significant changes to the manner of regulating financial institutions. The Dodd-Frank Act was an initial legislative act in this regard, but much of its impact cannot be understood until numerous rulemakings are completed. The current rulemakings and regulations being prepared under the Dodd-Frank Act and other future legislation regarding financial institutions may change banking statutes and the operating environment of the Company and the Bank in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation will be enacted, and if enacted, the effect that it or any implementing regulations, would have on the financial condition or results of operations of the Company or the Bank. The nature and extent of future legislative and regulatory changes affecting financial institutions is unpredictable at this time. We cannot determine the ultimate effect that such potential legislation, if enacted, would have upon our financial condition of operations.

Where You Can Find More Information

Under the Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current reports must be filed with the SEC. The Company electronically files the following reports with the SEC: Form 10-K (Annual Report), Form ARS (Annual Report to Shareholders), Form 10-Q (Quarterly Report), Form 8-K (Current Report), insider ownership reports and Form DEF 14A (Proxy Statement). The Company may file additional forms. The SEC maintains an Internet site, www.sec.gov. in which all forms filed electronically may be accessed. Additionally, all forms filed with the SEC and additional shareholder information is available free of charge using the Link on the Company’s website: www.santaluciabank.com. The Company makes these reports available to the website as soon as reasonable practicable after filing them with the SEC. None of the information on or hyperlinked from the Company’s website is incorporated into this Annual Report on Form 10-K.

ITEM 1A.

RISK FACTORS

An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that Management believes may affect our business are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this Annual Report. The risks and uncertainties described below are not the only ones facing our business. Additional risks and uncertainties that Management is not aware of or focused on or that Management currently deems immaterial may also impair our business operations. This Annual Report is qualified in its entirety by these risk factors.

If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.

Risks Associated With Our Business

The California Department of Financial Institutions will likely institute an enforcement action against our banking subsidiary, thereby materially impacting our operations.

The California Department of Financial Institutions (the “DFI”), the Bank’s primary state regulator, commenced its regular examination of the Bank on November 29, 2010 and completed said examination in the fourth quarter of 2010. Based on discussions the Bank had with the DFI following the examination, the Bank’s condition has been downgraded and it is expected that an enforcement action in the form of a Consent Order will be sought against the Bank (the “Anticipated Consent Order”). While it is expected that the content of the Anticipated Consent Order will be substantially similar to that of the Written Agreement, we anticipate that there will be one material difference. We expect that the Anticipated Consent Order will include specific minimum capital ratios that the Bank must meet for both tier 1 leverage and total risk-based capital ratios. At this time, the Bank has not been advised of the minimum capital ratios. However, those ratios will be in excess of the Bank’s current capital ratios. There can be no assurance that we will be able to comply fully with the Anticipated Consent Order. While we do not believe that compliance with the Anticipated Consent Order will materially impact our operations beyond the Written Agreement, a failure to comply fully with the Anticipated Consent Order could trigger further enforcement proceedings against the Bank that would materially impact our financial condition and results of operation.

We may be subject to ongoing regulation, including restrictions on our lending activities, all of which will materially impact our operations.

Even though the Bank remains adequately capitalized as of December 31, 2010, the regulatory agencies have the authority to restrict our operations to those consistent with under-capitalized institutions. For example, the regulatory agencies could impose restrictions that place limitations on our lending activities. The regulatory agencies also have the power to limit the rates paid by the Bank to attract retail deposits in its local markets. The Bank will likely be required to reduce our levels of non-performing assets within specified time frames. These time frames might not necessarily result in maximizing the price that might otherwise be received for the underlying properties. In addition, if such restrictions were also imposed upon other institutions that operate in the Bank’s markets, multiple institutions disposing of properties at the same time could further diminish the potential proceeds received from the sale of these properties.

Both the Company and the Bank are operating under a Written Agreement with the FRBSF to address, among other things, lending, credit and capital related issues.

In light of the current challenging operating environment, along with our elevated level of non-performing assets, delinquencies, and adversely classified assets, we are subject to increased regulatory scrutiny and additional regulatory restrictions, and have become subject to certain enforcement actions under a Written Agreement issued by the FRBSF on December 23, 2010. This enforcement action follows the FRBSF’s regularly scheduled examination of our banking subsidiary during the second and third quarter of 2010 and is based on discussions the Bank had following the examination. Such enforcement action places limitations on our business and may adversely affect our ability to implement our business plans. This enforcement action requires, among other things, the Bank to take certain steps to strengthen its balance sheet, such as reducing the level of classified assets, increasing capital levels, and addressing other criticisms of the examination. This enforcement action is more fully discussed under “Supervision and Regulation” of Part 1 Business of this Form 10-K, Note 25. Subsequent Events of the consolidated financial statements included in this Form 10-K as well as “Recent Developments” under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. If the Company fails to comply with these enforcement actions, it may become subject to further regulatory enforcement actions up to and including the appointment of a conservator or receiver for the Bank.

The FRBSF has imposed restrictions that place limitations on our lending activities. They also have the power to limit the rates paid by the Bank to attract retail deposits in its local markets. The Bank is required to reduce the level of non-performing assets and if such were also imposed upon other institutions that operate in the Bank’s markets, multiple institutions disposing of properties at the same time could further diminish the potential proceeds received from the sale of these properties.

We Cannot Accurately Predict the Effect of the Current Economic Downturn on Our Future Results of Operations or Market Price of Our Stock

The national economy and the financial services sector in particular, are currently facing challenges of a scope unprecedented in recent history. We cannot accurately predict the severity or duration of the current economic downturn, which has adversely impacted the markets we serve. Any further deterioration in the economies of the nation as a whole or in our markets would have an adverse effect, which could be material, on our business, financial condition, results of operations and prospects, and could also cause the market price of our stock to decline.

Our Level of Classified Assets Expose Us to Increased Lending Risk. Further, if Our Allowance for Loan Losses is Insufficient to Absorb Losses in Our Loan Portfolio, Our Earnings Could Decrease

At December 31, 2010, loans that we have categorized as doubtful and substandard totaled $30.7 million of which approximately $23.9 million were non-accruing. These loans represent 16.3% of total gross loans as of December 31, 2010. If these loans do not perform according to their terms and / or the collateral is insufficient to pay any remaining loan balance, we may experience loan losses, which could have a material effect on our operating results. Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. At December 31, 2010, our allowance for loan losses totaled $11.0 million, which represented 5.84% of total loans and 45.9% of non-performing loans. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and their probability of making payment, as well as the value of real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, significant factors we consider include loss experience in particular segments of the portfolio, trends and absolute levels of classified loans, trends and absolute levels in delinquent loans, trends in risk ratings, trends in industry charge-offs by particular segments and changes in existing general economic and business conditions affecting our lending areas and the national economy. If our assumptions are incorrect, our allowance for loan losses may be insufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. Material additions to our allowance could materially decrease our net income. Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations. Please also refer to “Regulatory and Enforcement Proceedings” under the section “Supervision and Regulation” of Item 1. Business of this Form 10-K for additional information on regulatory requirements regarding the Bank’s allowance for loan losses.

We Are Highly Dependent On Real Estate and Any Further Downturn in the Real Estate Market May Hurt Our Business

A significant portion of our loan portfolio is dependent on real estate. At December 31, 2010, real estate served as the principal source of collateral with respect to approximately 80.9% of our loan portfolio. A decline in current economic conditions, a decline in the local housing market, both of which we are experiencing currently, or rising interest rates could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and the value of real estate owned by us, as well as our financial condition and results of operations in general and the market value of our common stock. Acts of nature, including earthquakes, floods and fires, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

We Also Have a Concentration in Higher Risk Commercial Real Estate Loans

We also have a high concentration in commercial real estate (“CRE”) loans. CRE loans as defined by final guidance issued by Bank regulators are defined as construction, land development, other land loans, loans secured by multifamily (5 or more) residential properties, and loans secured by non-farm nonresidential properties. Following this definition, approximately 43.3% of our lending portfolio can be classified as CRE lending as of December 31, 2010. CRE loans generally involve a higher degree of credit risk than residential mortgage lending due, among other things, to the large amounts loaned to individual borrowers. Losses incurred on loans to a small number of borrowers could have a material adverse impact on our income and financial condition. In addition, unlike residential mortgage loans, commercial real estate loans generally depend on the cash flow from the property to service the debt. Cash flow may be significantly affected by general economic conditions. Losses incurred on loans to a small number of borrowers could have a material adverse impact on our financial condition and results of operations. Also, many of our commercial real estate and commercial and industrial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a 1-4 family residential mortgage loan.

Additionally, federal banking regulators recently issued final guidance regarding commercial real estate lending. This guidance suggests that institutions that are potentially exposed to significant commercial real estate concentration risk will be subject to increased regulatory scrutiny. Institutions that have experienced rapid growth in commercial real estate lending, have notable exposure to a specific type of commercial real estate lending, or are approaching or exceed certain supervisory criteria that measure an institution’s commercial real estate portfolio against its capital levels, may be subject to such increased regulatory scrutiny. We have become subject to increased regulatory scrutiny because of our real estate portfolio and as a result the Bank must develop or revise, adopt, and implement a plan to systematically reduce the amount of loans within this category as outlined in the Written Agreement issued to the Bank on December 23, 2010.

Liquidity Risk Could Impair Our Ability to Fund Operations and Jeopardize Our Financial Condition

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Additionally, we regularly monitor certain larger deposit relationships that we determine are not suitable for any form of long-term investment or that possess a higher risk of leaving us. These balances are disclosed in “Deposits” under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations on this Form 10-K. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry in general.

We Depend On Cash Dividends From Our Subsidiary Bank To Meet Our Cash Obligations, but Our Written Agreement Prohibit the Payment of Such Dividends Without Prior Regulatory Approval, Which May Impair Our Ability to Fulfill Our Obligations

As a holding company, dividends from our subsidiary bank provide a substantial portion of our cash flow used to service the interest payments on our trust preferred securities, our preferred stock and other obligations, including any cash dividends. Various statutory provisions restrict the amount of dividends our subsidiary bank can pay to us without regulatory approval. As outlined in the Written Agreement previously mentioned, the Bank cannot pay any cash dividends or other payments to the holding company without prior written consent of the regulatory authorities. Additionally, the Company cannot declare or pay any dividends (including those on outstanding preferred stock issued to the U.S. Treasury under the TARP Capital Purchase Program) or make any distributions of principal, interest or other sums on its trust preferred securities without prior written approval of the Federal Reserve.

The Recession and Changes in Domestic and Foreign Financial Markets Have Adversely Affected Our Industry and May Have a Material Negative Impact on Our Results of Operations and Financial Condition

Economic indices have shown that since the fourth quarter of 2007, the United States economy has been in a recession. Although the recession technically ended in 2009, the recovery remains tepid and the economy strained. This has been reflected in significant business failures and job losses. Further, dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit and increased unemployment, have negatively impacted the performance of commercial and consumer credit resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions have experienced decreased access to deposits and borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. We do not expect that the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:

We potentially face increased regulation of our industry, compliance with which may increase our costs and limit our ability to pursue business opportunities.

The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process.

The value of the portfolio of investment securities that we hold may be adversely affected.

We may be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.

If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our business, financial condition and results of operations.

Recently Enacted Legislation and Other Measures Undertaken by the U.S. Treasury, the FRB and Other Governmental Agencies May Not Help Stabilize the U.S. Financial System or Improve the Housing Market

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”), which, among other measures, authorized the Treasury Secretary to establish the Troubled Asset Relief Program (“TARP”). EESA gives broad authority to Treasury to purchase, manage, modify, sell and insure the troubled mortgage related assets that triggered the current economic crisis as well as other “troubled assets.” EESA includes additional provisions directed at bolstering the economy, including:

Authority for the FRB to pay interest on depository institution balances;

Mortgage loss mitigation and homeowner protection;

Temporary increase in FDIC insurance coverage from $100,000 to $250,000 through December 31, 2013; (this increase was subsequently made permanent on July 21, 2010 when President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.) and

Authority to the SEC to suspend mark-to-market accounting requirements for any issuer or class of category of transactions.

Pursuant to the TARP, the Treasury has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Under the TARP, the Treasury has created a capital purchase program, pursuant to which it is providing access to capital to financial institutions through a standardized program to acquire preferred stock (accompanied by warrants) from eligible financial institutions that will serve as Tier 1 capital.

EESA also contains a number of significant employee benefit and executive compensation provisions, some of which apply to employee benefit plans generally, and others which impose on financial institutions that participate in the TARP program restrictions on executive compensation.

EESA followed, and has been followed by, numerous actions by the FRB, Congress, Treasury, the SEC and others to address the liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; coordinated international efforts to address illiquidity and other weaknesses in the banking sector.

On October 14, 2008, the FDIC announced the establishment of a temporary liquidity guarantee program to provide insurance for all non-interest bearing transaction accounts and guarantees of certain newly issued senior unsecured debt issued by financial institutions (such as the Bank) and bank holding companies (such as the Company). Under the program, newly issued senior unsecured debt issued on or before June 30, 2009 will be insured in the event the issuing institution subsequently fails, or its holding company files for bankruptcy. The debt includes all newly issued unsecured senior debt (e.g., promissory notes, commercial paper and inter-bank funding). The aggregate coverage for an institution may not exceed 125% of its debt outstanding on December 31, 2008 that was scheduled to mature before June 30, 2009. The guarantee will extend to June 30, 2012 even if the maturity of the debt is after that date.

The actual impact that EESA, the Stimulus Bill and such related measures undertaken to alleviate the credit crisis will have generally on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced, is unknown. The failure of such measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

Current Levels of Market Volatility are Unprecedented

The capital and credit markets have been experiencing volatility and disruption for more than two years. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced significant downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

FDIC Deposit Insurance Assessments Will Increase Substantially, Which Will Adversely Affect Our Net Earnings

FDIC deposit insurance expense for the year ended December 31, 2010 was approximately $.7 million. Deposit insurance assessments will increase in 2011 due to the condition of the Bank and recent strains on the FDIC deposit insurance fund resulting from the cost of recent bank failures and an increase in the number of banks likely to fail over the next few years. The Bank currently anticipates these costs to total approximately $.9 million for 2011. During the last two quarters of 2009 the FDIC further levied a prepayment assessment on banks to be paid in December 2009 for the periods of January 2010 to December of 2012.

Declines in Asset Values May Result in Impairment Charges and Adversely Affect the Value of Our Investments, Financial Performance and Capital

We maintain an investment portfolio that includes, but is not limited to, mortgage-backed securities. The market value of investments in our portfolio had become increasingly volatile in 2009 but has stabilized in 2010. The market value of investments may be affected by factors other than the underlying performance of the servicer of the securities or the mortgages underlying the securities, such as ratings downgrades, adverse changes in the business climate and a lack of liquidity in the secondary market for certain investment securities. On a quarterly basis, we evaluate investments and other assets for impairment indicators. We may be required to record impairment charges if our investments suffer a decline in value that is considered other-than-temporary. If we determine that a significant impairment has occurred, we would be required to charge against earnings the credit-related portion of the other-than-temporary impairment, which may have a material adverse effect on our results of operations in the periods in which the write-offs occur. During 2010, the Bank determined that there was no other than temporarily impaired (“OTTI”) bonds within the investment portfolio.

Our Real Estate Lending Also Exposes Us to the Risk of Environmental Liabilities

In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.

Our Business Is Subject To Interest Rate Risk and Changes in Interest Rates May Adversely Affect Our Performance and Financial Condition

Our earnings and cash flows are highly dependent upon net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Our net interest income (including net interest spread and margin) and ultimately our earnings are impacted by changes in interest rates and monetary policy. Changes in interest rates and monetary policy can impact the demand for new loans, the credit profile of our borrowers, the yields earned on loans and securities and rates paid on deposits and borrowings. Given our current volume and mix of interest-bearing liabilities and interest-earning assets, we would expect our interest rate spread (the difference in the rates paid on interest-bearing liabilities and the yields earned on interest-earning assets) as well as net interest income to increase if interest rates rise and, conversely, to decline if interest rates fall. Additionally, increasing levels of competition in the banking and financial services business may decrease our net interest spread as well as net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates. Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates (such as a sudden and substantial increase in Prime and Overnight Fed Funds rates) as well as increasing competition may require the Bank to increase rates on deposits at a faster pace than the yield it receives on interest-earning assets increases. The impact of any sudden and substantial move in interest rates and/or increased competition may have an adverse effect on our business, financial condition and results of operations, as the Bank’s net interest income (including the net interest spread and margin) may be negatively impacted.

Additionally, a sustained decrease in market interest rates could adversely affect our earnings. When interest rates decline, borrowers tend to refinance higher-rate, fixed-rate loans at lower rates, prepaying their existing loans. Under those circumstances, we would not be able to reinvest those prepayments in assets earning interest rates as high as the rates on the prepaid loans. In addition, our commercial real estate and commercial loans, which carry interest rates that, in general, adjust in accordance with changes in the prime rate, will adjust to lower rates. We are also significantly affected by the level of loan demand available in our market. The inability to make sufficient loans directly affects the interest income we earn. Lower loan demand will generally result in lower interest income realized as we place funds in lower yielding investments.

Failure to Successfully Execute Our Strategy May Adversely Affect Our Performance

Our financial performance and profitability depends on our ability to execute our corporate growth strategy. Continued growth, however, may present operating and other problems that could adversely affect our business, financial condition and results of operations. Accordingly, there can be no assurance that we will be able to execute our growth strategy or maintain the level of profitability that we have recently experienced. Factors that may adversely affect our ability to attain our long-term financial performance goals include those stated elsewhere in this section, as well as:

Inability to control non-interest expense, including, but not limited to, rising employee, regulatory compliance, and healthcare costs;

Limitations imposed on us in the Consent Order and/or Written Agreement.

Inability to increase non-interest income; and

Continuing ability to expand, through de novo branching or finding acquisition targets at valuation levels we find attractive.

Economic Conditions in the Central Coast of California Area May Adversely Affect Our Operations and / or Cause Us to Sustain Losses

Our retail and commercial banking operations are concentrated primarily in San Luis Obispo and Santa Barbara Counties. As a result of this geographic concentration, our results of operations depend largely upon economic conditions in this area. A significant source of risk arises from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. This risk increases when the economy is weak. The industries of tourism, agriculture (specifically that related to the production of wine) and hospitality represent a significant portion of economic activity in our primary market area have been impacted to some degree by the current economic downturn. Although the Company has not seen any significant increase in non-performing assets related to loans the Bank has made to borrowers in these industries, the Company believes a prolonged economic downturn may have an impact on such borrowers, which may result in further increases in the level of our non-performing assets.

We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses that Management believes is appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our loan portfolio. These policies and procedures, however, may not prevent unexpected losses that may have material adverse affects on our results of operations in general and the market value of our stock.

Additionally, our primary market area is an increasingly competitive and overcrowded banking market. Our ability to achieve the growth outlined in our corporate strategic goals may be dependent in part on an ability to grow through the successful addition of new branches or the identification and acquisition of potential targets at acceptable pricing levels either inside or outside of our primary market. If we are unable to attract significant new business through strategic branching, or acquire new business through the acquisition of other banks, our growth in loans and deposits and, therefore, our earnings, may be adversely affected.

We Face Strong Competition from Financial Service Companies and Other Companies That Offer Banking Services, Which May Hurt Our Business

As previously mentioned, the financial services business in our market areas is highly competitive. It is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. We face competition both in attracting quality assets and deposits and in making loans. We compete for loans principally through the interest rates and loan fees we charge and the efficiency and quality of services we provide. Increasing levels of competition in the banking and financial services business may reduce our market share, decrease loan demand, cause the prices we charge for our services to fall, or decrease our net interest margin by forcing us to offer lower lending interest rates and pay higher rates on our deposits. Therefore, our results may differ in future periods depending upon the nature or level of competition.

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

We May Not Be Able to Attract and Retain Skilled People

Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most of our activities can be intense and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Because of Our Participation in the Troubled Asset Relief Program (‘‘TARP’’), We Are Subject to Several Restrictions, Including Restrictions on Compensation Paid to Our Executives

Certain standards for executive compensation and corporate governance apply to us for the period during which the U.S. Treasury holds an equity position in us. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include, among other things, (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes, executive compensation in excess of $500,000 for each senior executive. In particular, the change to the deductibility limit on executive compensation may increase the overall cost of our compensation programs in future periods. Pursuant to the American Recovery and Reinvestment Act of 2009 (the ‘‘Stimulus Bill’’), more commonly known as the economic stimulus recovery package, further compensation restrictions, including significant limitations on incentive compensation, have been imposed on our senior executive officers and most highly compensated employees. Such restrictions and any future restrictions on executive compensation, which may be adopted, could adversely affect our ability to hire and retain senior executive officers.

Our Internal Operations Are Subject to a Number of Risks

We are subject to certain operations risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.

Information Systems

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

Technological Advances

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Severe Weather, Natural Disasters, Acts of War or Terrorism and Other External Events

Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. For example, the Central Coast of California is subject to earthquakes and fires. Operations in our market could be disrupted by both the evacuation of large portions of the population as well as damage and or lack of access to our banking and operation facilities. While we have not experienced such an occurrence to date, other severe weather or natural disasters, acts of war or terrorism or other adverse external events may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

We Depend On Cash Dividends From Our Subsidiary Bank To Meet Our Cash Obligations

As a holding company, dividends from our subsidiary bank provide a substantial portion of our cash flow used to service the interest payments on our trust preferred securities and other obligations, including any cash dividends. See Item 5. Market for Common Equity and Related Stockholder Matters. Various statutory provisions restrict the amount of dividends our subsidiary bank can pay to us without regulatory approval. Additionally, the Written Agreement we are operating under prohibit our banking subsidiary from paying dividends or any form of payment to the Holding Company that would represent a reduction in the subsidiary bank’s capital. For more information regarding the Written Agreement, please see the discussion titled “Written Agreement” under the section “Supervision and Regulation” of Item 1. Business, “Recent Developments” under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 25. Subsequent Events of the consolidated financial statements, filed on this Form 10-K.

Risks Associated With Our Industry

We Are Subject to Government Regulation That May Limit or Restrict Our Activities, Which in Turn May Adversely Impact Our Operations

The financial services industry is regulated extensively. Federal and State regulation is designed primarily to protect the deposit insurance funds and consumers, and not to benefit our shareholders. These regulations can sometimes impose significant limitations on our operations. New laws and regulations or changes in existing laws and regulations or repeal of existing laws and regulations may adversely impact our business. We anticipate that continued compliance with various regulatory provisions will impact future operating expenses. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects economic conditions for us.

New Legislative and Regulatory Proposals May Affect Our Operations and Growth

Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, banks and other financial institutions and companies that control such institutions are frequently raised in the U.S. Congress, state legislatures and before bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes might have on us or our subsidiaries are impossible to determine. Similarly, proposals to change the accounting treatment applicable to banks and other depository institutions are frequently raised by the SEC, the federal banking agencies, the IRS and other appropriate authorities. The likelihood and impact of any additional future changes in law or regulation and the impact such changes might have on us or our subsidiaries are impossible to determine at this time.

Risks Associated With Our Stock

Our Participation in the U.S. Treasury’s Capital Purchase Program (“CPP”) May Pose Certain Risks to Holders of Our Common Stock

On December 19, 2008, the Company entered into a Purchase Agreement with the United States Department of the Treasury (the “Treasury”), pursuant to which the Company agreed to issue and sell 4,000 shares of the Company’s Preferred Stock as Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Preferred Stock) and a Warrant to purchase 38,869 shares of the Company’s Common Stock (adjusted for the two subsequent 2% stock dividends) for an aggregate purchase price of $4,000,000 in cash. In connection with this transaction the Company incurred $50,000 in costs.

Under the terms of the CPP, the Company sold to the U.S. Treasury $4.0 million in preferred stock and a warrant to purchase approximately $.2 million of the Company’s common stock. Although the Company believes that its participation in the CPP is in the best interests of our shareholders in that it will enhance Company and Bank capital and provide additional funds for future growth, it may pose certain risks to the holders of our common stock such as the following:

Under the terms outlined by the U.S. Treasury for participants in the CPP, the Company issued a warrant to the U.S Treasury to purchase shares of its common stock. The issuance of this warrant is dilutive to current common stockholders in that it reduces earnings per common share. Additionally, the ownership interest of the existing holders of our common stock will be diluted to the extent the warrant is exercised. The shares of common stock underlying the warrant represent approximately 2.0% of the shares of our common stock outstanding as of December 31, 2010 (including the shares issuable upon exercise of the warrant in total shares outstanding).

Although the U.S. Treasury has agreed not to vote any of the shares of common stock it receives upon exercise of the warrant, a transferee of any portion of the warrant or of any shares of common stock acquired upon exercise of the warrant is not bound by this restriction and therefore may become a significant holder of the Company’s common stock and possess significant voting power.

Although the preferred equity issued to the U.S. Treasury is non-voting, the terms of the CPP stipulate that the U.S. Treasury may vote their senior equity in matters deemed by the U.S. Treasury to have an impact on their holdings.

Although the Company does not foresee any material changes to the terms associated with its participation in the CPP, the U.S. Government, as a sovereign body, may at any time change the terms of our participation in the CPP and or significantly influence Company policy.

For more information about the Company’s participation in the CPP, see “Note O - Preferred Stock and Related Warrant,” of the consolidated financial statements filed on this Form 10-K.

Our Outstanding Preferred Stock Impacts Net Income Available to Our Common Stockholders and Earnings Per Common Share and Other Potential Issuances of Equity Securities May be Dilutive to Holders of Our Common Stock

The dividends declared and the accretion on our outstanding preferred stock will reduce the net income available to common stockholders and our earnings per common share. The preferred stock will also receive preferential treatment in the event of the Company’s liquidation, dissolution or winding-down. In addition, to the extent options to purchase common stock under our employee and director stock option plans are exercised, holders of our common stock will incur additional dilution. Further, if the Company sells additional equity or convertible debt securities, such sales may result in increased dilution to our shareholders.

Our Stock Trades Less Frequently Than Others

Although our common stock is quoted on the over-the-counter market, the trading volume in our common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.

Our Stock Price is affected by a Variety of Factors

Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors discussed in this section, including, among other things:

Actual or anticipated variations in quarterly results of operations;

Recommendations by securities analysts;

Operating and stock price performance of other companies that investors deem comparable to our company;

News reports relating to trends, concerns and other issues in the financial services industry; and

Perceptions in the marketplace regarding our company and/or its competitors and the industry in which we operate.

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent you from selling your common stock at or above the public offering price. In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance.

Holders of Our Junior Subordinated Debentures Have Rights That Are Senior to Those of Our Common Shareholders

We have supported our continued growth through the issuances of trust preferred securities from one special purpose trust. At December 31, 2010, we had outstanding trust preferred securities totaling $5.0 million. Payments of the principal and interest on the trust preferred security of this special purpose trust is fully and unconditionally guaranteed by us. Further, the accompanying junior subordinated debenture we issued to the special purpose trust is senior to our shares of common stock. As a result, we must make payments on the junior subordinated debenture before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debenture must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on our junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no cash dividends may be paid on our common stock.

Following consultation with the Federal Reserve Bank of San Francisco (the “FRB”), on August 31, 2010 the Company elected to defer regularly scheduled payments on its outstanding junior subordinated debenture relating to its outstanding $5 million trust preferred security (the “Security”) for a period of up to 20 consecutive quarters (the “Deferral Period”). The terms of the Security and the trust documents allow the Company to defer payments of interest for the Deferral Period without default or penalty. During the Deferral Period, the Company will continue to recognize interest expense associated with the Security. Upon the expiration of the Deferral Period, all accrued and unpaid interest will be due and payable. During the Deferral Period, the Company is prevented from paying cash dividends to shareholders or repurchasing stock.

Our Common Stock is Not an Insured Deposit

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

Our Articles of Incorporation and By-Laws, As Well As Certain Banking Laws, May Have an Anti-Takeover Effect

Provisions of our articles of incorporation, bylaws and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may hinder a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

ITEM 1B. Unresolved Staff Comments

The Company has no unresolved comments received from staff at the SEC.

ITEM 2.

PROPERTIES

The Company conducts its banking operations from four offices. The Bank owns the land and building of its office located at 7480 El Camino Real, in Atascadero, California. The building is a two-story building of approximately 16,500 square feet.

The Bank owns the land and building of its office located at 1240 Spring Street, Paso Robles, California. The Bank occupies approximately 7,200 square feet on the ground floor of the building and 2,800 square feet in the basement is used for records storage and as a staff room.

The Bank owns the land and building of its office located at 1530 East Grand Avenue in Arroyo Grande. The building is a two-story building of approximately 10,200 square feet.

The Bank owns the land and a two-story building of approximately 10,000 square feet which houses its office located at 1825 South Broadway, Santa Maria, California.

The Company believes that all of its properties are well maintained and are suitable for their respective present needs and operations.

ITEM 3.

LEGAL PROCEEDINGS

The Company is, from time to time, subject to various pending and threatened legal actions which arise out of the normal course of its business. The Company is not a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company’s business) and no such proceedings are known to be contemplated.

There are no material proceedings adverse to the Company to which any director, officer, affiliate of the Company or 5% shareholder of the Company, or any associate of any such director, officer, affiliate or 5% shareholder of the Company is a party, and none of the above persons has a material interest adverse to the Company.

There are no material proceedings adverse to the Company to which any Director, Officer or affiliate of the Company is a party.

ITEM 4.

(REMOVED AND RESERVED)

PART II

ITEM 5.

MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The Company’s Common Stock is not listed on any exchange or market. However, Morgan Stanley, Howe Barnes Hoefer & Arnett, Inc., Edward Jones, Wedbush Morgan Securities, UBS Financial Services, Inc., and McAdams Wright and Ragen each actively make a market in the Company’s Common Stock. Certain information concerning the Common Stock is quoted on the OTC Bulletin Board under the symbol “SLBA.OB”

The information in the following table indicates the high and low bid prices of the Company’s Common Stock for each quarterly period during the last two years based upon information provided by certain of the firms mentioned above who serve as the Company’s market makers. These prices do not include retail mark-ups, mark-downs or commission.

	Quarter Ended	Bid Prices
		Low		High
2010
	December 31	$	1.20	$	2.95
	September 30	$	1.90	$	6.70
	June 30	$	6.60	$	8.20
	March 31	$	7.35	$	11.76

2009
	December 31	$	10.10	$	11.89
	September 30	$	11.55	$	15.00
	June 30	$	10.50	$	13.00
	March 31	$	8.20	$	14.75

The foregoing table is based on data reported by the market makers named above and does not include information on shares traded directly by shareholders or through other dealers.

Holders

The Company has two classes of stock outstanding — Common and Preferred Stock. As of February 23, 2011 there were approximately 371 record holders of the Company’s Common Stock.

Dividends

The following table sets forth the per share amount and month of payment for all cash dividends paid since January 1, 2008:

Month Paid	Amount Per Share
March 2008	$	0.25
September 2008	$	0.25
March 2009	$	0.25

The Company had paid a cash dividend for 20 years however, it issued a 2% stock dividend in October 2009 and March 2010. As of August 2010, all dividend activity has been suspended.

The Company is a legal entity separate and distinct from the Bank. The Company’s shareholders are entitled to receive dividends when declared by its Board of Directors, out of funds legally available therefore, subject to the restrictions set forth in the California General Corporation Law (the Corporation law). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation’s retained earnings equal at least the amount of the proposed distribution. The Corporation Law also provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may, nevertheless, make a distribution to its shareholders if it meets two conditions, which generally are as follows: (i) the corporation’s assets equal 1-1/4 times its liabilities, and (ii) the corporation’s current assets equal at least its current liabilities or, if the average of the corporation’s earnings before taxes on income and before interest expenses for the two preceding fiscal years was less than the average of the corporation’s interest expenses for such fiscal years, then the corporation’s interest expenses for such fiscal years, then the corporation’s current assets must equal at least 1-1/4 times its current liabilities. As a regulated bank holding company, the Federal Reserve Board’s restrictions may also limit the Company’s ability to pay cash dividends. Generally, a bank holding company must consult with the Reserve Board prior to payment of a proposed cash dividend, if the company did not have sufficient earnings in the prior four quarters at least equal to the proposed dividend and other holding company obligations.

The ability of the Company to pay a cash dividend depends largely on the Bank’s ability to pay a cash dividend to the Company. The payment of cash dividends by the Bank is subject to restrictions set forth in the California Financial Code (the Financial Code). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank’s retained earnings; or (b) the bank’s net income for its last three fiscal years, less the amount of any distributions made by the bank or by an majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the DFI, make a distribution to its shareholders in an amount not exceeding the greater of (x) its retained earnings; (y) its net income for its last fiscal year; or (z) its net income for its current fiscal year. In the event that the DFI determines that the shareholders’ equity of the bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the DFI may order the bank to refrain from making a proposed distribution. The FDIC may also restrict the payment of dividends if by payment of such dividends, the bank would be included in one of the “undercapitalized” categories for capital adequacy purposes pursuant to federal law (See, “Item 1 — Supervision and Regulation Prompt Corrective Action and Other Enforcement Mechanisms.”) Additionally, while the Federal Reserve Board has no general restriction with respect to the payment of cash dividends by an adequately capitalized bank to its parent holding company, the Federal Reserve Board might, under certain circumstances, place restrictions on the ability of a particular bank to pay dividends based upon peer group averages and the performance and maturity of the particular bank, or object to management fees to be paid by a subsidiary bank to its holding company on the basis that such fees cannot be supported by the value of the services rendered or are not the result of an arm’s length transaction.

The Company’s junior subordinated debt agreements contain provisions which prohibit the paying of dividends if it defers payment of interest on outstanding trust preferred securities (See “Item I. Business — Supervision and Regulation — Capital Standards”)

The Company’s participation in the TARP Capital Purchase Program includes restrictions on the amount of dividends that can be paid to common shareholders. The Company can not pay a dividend greater than the prior dividend declared unless prior approval from the United States Treasury is granted. Additionally, the Company will be prohibited from continuing to pay dividends on its common stock unless the Company has fully paid all required dividends on the preferred stock issued to the Treasury.

Following consultation with the Federal Reserve Bank of San Francisco (the “FRB”), on August 31, 2010 the Company elected to defer regularly scheduled dividends on the Preferred Stock. As of December 31, 2010, the Company has missed two dividend payments. By deferring the dividends on Series A Senior Preferred Stock for a total of six quarters, whether or not consecutive, the U.S. Treasury will have the right to elect two members of the Company’s Board of Directors, voting together with any other holders of preferred shares ranking pari passu with the Series A Senior Preferred Stock. These directors would serve on the Company’s Board of Directors until such time as the Company has paid in full all dividends not previously paid, at which time these directors’ terms of office would immediately terminate.

Further, under the Written Agreement with the FRBSF the Bank may not pay cash dividends or make other payments to the holding company without prior written consent of the regulatory authorities. Additionally, the Company may not receive any dividends or other forms of payment from the Bank representing a reduction in the Bank’s capital or make payments to its shareholders without the prior approval of the FRBSF and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.

ITEM 6.

SELECTED FINANCIAL DATA

The table below provides selected financial data that highlights the Company’s performance results for the five years ended December 31, 2010, 2009, 2008, 2007 and 2006:

				Year Ended December 31,
	2010			2009			2008			2007			2006

	(dollars in thousands except per share data)
Summary of Operations:
Interest Income	$	12,587		$	13,851		$	15,276		$	17,719		$	17,027
Interest Expense		2,291			3,021			3,877			4,824			3,577

Net Interest Income		10,296			10,830			11,399			12,895			13,450
Provision for Loan Loss		15,198			5,460			975			-			240

Net Interest Income After Provision for Loan Losses		(4,902	)		5,370			10,424			12,895			13,210
Noninterest Income		1,610			1,236			1,111			1,071			1,010
Noninterest Expense		10,655			9,865			9,763			9,029			8,590

Income Before Income Taxes		(13,947	)		(3,259	)		1,772			4,937			5,630
Income Tax, expense(benefit)		807			(1,434	)		(633	)		(1,934	)		(2,242	)

Net Income (loss)	$	(14,754	)	$	(1,825	)	$	1,139		$	3,003		$	3,388

Dividends and Accretion on Preferred Stock	$	240		$	240		$	-		$	-		$	-

Net (losses)/income Applicable to Common Shareholders	$	(14,994	)	$	(2,065	)	$	1,139		$	3,003		$	3,388

Cash Dividends Paid	$	-		$	483		$	963		$	871		$	768

Per Common Share Data:
Net Income - Basic	$	(7.49	)	$	(1.05	)	$	0.59		$	1.55		$	1.77
Net Income - Diluted	$	(7.49	)	$	(1.05	)	$	0.58		$	1.51		$	1.68
Dividends	$	-		$	0.25		$	0.50		$	0.45		$	0.40
Book Value	$	1.86		$	9.58		$	11.21		$	11.01		$	9.93

Common Outstanding Shares:		2,003,131			1,961,334			1,923,053			1,924,873			1,928,097

Statement of Financial Condition Summary:
Total Assets	$	249,801		$	269,923		$	251,880		$	248,640		$	240,738
Total Deposits		233,867			238,723			212,317			212,718			212,988
Total Net Loans		176,750			198,099			186,632			166,619			169,680
Allowance for Loan Losses		10,999			3,386			2,310			1,673			1,654
Total Shareholders' Equity		7,545			23,030			25,551			21,189			19,137

Asset Quality:
Loan on Non-Accrual	$	23,945		$	6,407		$	1,614		$	2,176		$	-
Loans Past Due >90 days and still accruing	$	-		$	-		$	-		$	-		$	550
OREO	$	2,123		$	428		$	-		$	-		$	-
Loans Past Due 30-89 days	$	606		$	5		$	2,674		$	-		$	-

Selected Ratios:
Return on Average Assets		-5.65	%		-0.69	%		0.46	%		1.22	%		1.42	%
Return on Average Equity		-107.53	%		-7.18	%		5.19	%		14.87	%		19.45	%
Net Interest Margin		4.16	%		4.49	%		5.05	%		5.92	%		6.38	%
Average Loans as a Percentage of Average Deposits		82.46	%		87.82	%		83.84	%		76.11	%		79.74	%
Allowance for Loan Losses to Total Loans		5.84	%		1.67	%		1.22	%		0.99	%		0.96	%
Company
Tier I Capital to Average Assets		4.02	%		10.28	%		11.89	%		10.50	%		10.00	%
Tier I Capital to Risk-Weighted Assets -		5.72	%		12.54	%		14.41	%		13.20	%		12.70	%
Total Capital to Risk-Weighted Assets -		8.30	%		13.87	%		15.92	%		14.60	%		14.40	%
Bank
Tier I Capital to Average Assets		4.75	%		9.71	%		11.44	%		9.85	%		9.11	%
Tier I Capital to Risk-Weighted Assets -		6.85	%		11.85	%		13.65	%		12.33	%		11.43	%
Total Capital to Risk-Weighted Assets -		8.16	%		13.18	%		15.17	%		13.80	%		13.13	%

ITEM 7.

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

The following is an analysis of the financial condition and results of operations of the Company as of and for years ended December 31, 2010, 2009 and 2008. The analysis should be read in connection with the consolidated financial statements and notes thereto appearing elsewhere in this report.

Financial Overview

For the years ended December 31, 2010 and 2009, the Company recorded a net loss of approximately $15.0 million or ($7.49) per common share and $2.1 million or ($1.05) per common share, respectively. On a year over year basis, the net loss increased by approximately $12.9 million. The primary factor behind the increase in the loss can be attributed to substantial provisions the Bank made to the allowance for loan losses during 2010, resulting from, among other things, increases in non-performing loans due in part to continued weaknesses in local, state and economic conditions. For the year ended December 31, 2008, the Company earned $1.1 million or $0.58 per diluted common share.

2010 proved to be a challenging year as the Company’s results of operations were significantly impacted by a number of factors including, most notably, the additional provisions the Bank made to the allowance for loan losses. A challenging credit environment and continued economic weakness, among other things, led the Bank to increase its allowance for loan losses by approximately $7.6 million, net of charge-offs and recoveries, to $11.0 million or 5.84% of total gross loans. This compares to an allowance of $3.4 million or 1.67% of total gross loans as of December 31, 2009. During 2010 the Bank also saw a considerable increase in the level of criticized and classified loans as well as “watch list” loan balances, resulting in part from continued economic stresses. As the level of criticized, classified and watch list balances increased, so also did the level of non-accruing balances and ultimately charge-offs. For the year ended December 31, 2010 net charge-offs totaled approximately $7.6 million, representing 3.77% of average loan balances. This compares to net charge-offs of $4.4 million for 2009, representing 2.20% of average loan balances. The Bank recorded net charge offs of approximately $.3 million for 2008.

Operating results for 2010 were also impacted by the write-down and expense for OREO property in the approximate amount of $.6 million.

Although 2010 marked a year of significant challenges with respect to the Company’s profitability, Management took considerable steps during the year to reinforce the oversight of the loan portfolio, specifically with respect to problem assets. The Bank’s problem credit department was expanded and the independent loan review was enhanced and moved to a bi-annual basis to augment Management’s ongoing internal review. Additionally, In August 2010, the Company announced that Claudya Ross was promoted to Executive Vice President and Chief Credit Officer. Ms. Ross brings over 24 years of banking experience to the Bank. Management believes the actions taken in 2010 to further enhance the Bank’s oversight of credit quality will enhance the Company’s ability to navigate through the continued weakened economy.

The following provides a summary of operating results for the year ended December 31, 2010:

Interest income for the year ended December 31, 2010 was approximately $12.6 million, which represents a decline of approximately $1.3 million or 9.1% from the same period in 2009. Lower earning asset yields during 2010, resulting from the current interest rate environment compounded by the large amount of loans on non-accrual, contributed significantly to the year over year decline.

Interest expense for the year ended December 31, 2010 was approximately $2.3 million, which represents a decline of approximately $.7 million or 24.2% from the same period in 2009. Lower offering rates in conjunction with the re-pricing of floating rate deposit balances during 2010 contributed significantly to the decline in interest expense.

As a result of the items mentioned above, net interest income for the year ended December 31, 2010 was approximately $10.3 million compared to $10.8 million for the same period in 2009. This represents a decrease of approximately $.5 million or 5.0%. For the year ended December 31, 2010 the Company’s net interest margin was 4.16% compared to the 4.49% reported for 2009, representing a decline of 33 basis points.

For the year ended December 31, 2010, non-interest income totaled approximately $1.6 million, compared to $1.2 million for the same period in 2009. During 2010, the Bank recognized gains on sales of investments of $.6 million compared to $.2 million in 2009. Thee gains account for the majority of the variance on a year over year basis.

Non-interest expenses for the year ended December 31, 2010 were approximately $10.7 million or $.8 million higher than the $9.9 million reported for the same period ended a year earlier. Contributing to the increase in non-interest expense in 2010 were higher FDIC assessment costs, $.6 million in OREO expense including write-downs and higher costs incurred related to the management of problem assets. For a more detailed discussion regarding non-interest expense please see “Non-Interest Expense” of Management’s Discussion and Analysis filed on this Form 10-K.

The operating efficiency ratio for the year ended December 31, 2010 was 89.5% compared to 81.8% for the year ended December 31, 2009.

The following provides a summary of significant year to date changes in financial condition balances as of December 31, 2010:

Total assets at December 31, 2010 were approximately $249.8 million, approximately $20.1 million or 7.5% less than that report at December 31, 2009.

Fed Funds sold and interest bearing due from balances totaled approximately $15.5 million at December 31, 2010, approximately $13.0 million or 520.0% higher than that reported at December 31, 2009. A significant decrease in total loans along with the Bank’s plan to increase liquidity in response to our Written Agreement with the FRBSF accounts for the high balances in this category.

Available for sale investment securities totaled approximately $32.5 million at December 31, 2010, approximately $8.4 million or 20.6% less than that reported at December 31, 2009. As mentioned, the Bank’s current plan is to retain excess liquidity in the overnight interest bearing due from balances until such time that there is trending evidence of no reputation risk as the result of regulatory action. The Bank has not experienced any such reputation risk to date.

Gross loans totaled approximately $188.4 million at December 31, 2010, representing a decrease of approximately $13.8 million or 6.8% over that reported at December 31, 2009. In addition to loan demand being soft throughout the year, the Bank was also restricted by regulatory CRE levels as the result of the significant losses experienced during the year. For a more detailed discussion regarding the loan portfolio, please see “Loans” of Management’s Discussion and Analysis filed on this Form 10-K.

Total deposits were approximately $233.9 million at December 31, 2010, approximately $4.9 million or 2.0% less than that reported at December 31, 2009. Time certificates of deposits decreased by $7.2 million or 8.4% due to the reshaping of the balance sheet in the absence of loan demand. Core deposits (defined as total deposits less time certificates of deposit of $100,000 or more) represented 78.1% and 78.2% at December 31, 2010 and 2009, respectively. For a more detailed discussion regarding deposits, please see “Deposits” of Management’s Discussion and Analysis filed on this Form 10-K.

Shareholders’ equity totaled approximately $7.5 million at December 31, 2010, representing a decrease of approximately $15.5 million or 67.2% from that reported at December 31, 2009. The primary factor for the decrease is the net loss of $15.0 million reported for 2010.

The following provides an overview of asset quality as of and for the year ended December 31, 2010:

At December 31, 2010 non-performing assets totaled approximately $26.1 million, an increase of approximately $19.3 million or 281.4% over that reported at December 31, 2009. The ratio of non-performing assets to total assets was 10.44% at December 31, 2010 compared to the 2.53% reported at December 31, 2009.

Non-performing loans totaled approximately $23.9 million at December 31, 2010, an increase of approximately $17.5 million or 273.7% over that reported at December 31, 2009. Non-performing loans represented 12.71% of total gross loans as of December 31, 2010 compared to 3.17% reported for December 31, 2009. At December 31, 2010 non-performing loans as a percent of the allowance for loan losses was 217.7% compared to 189.2% reported at December 31, 2009.

The allowance for loan losses was approximately $11.0 million at December 31, 2010, approximately $7.6 million higher than that reported at December 31, 2009. During 2010, the Bank made approximately $15.2 million in provisions to the allowance for loan losses and charged-off approximately $7.8 million in loan balances. At December 31, 2010 the allowance as a percentage of total gross loans was 5.84% compared to the 1.67% reported at December 31, 2009.

Net charge-offs for 2010 totaled approximately $7.6 million compared to the $4.4 million reported for 2009. Net charge-offs to average loans was 3.77% for 2010 compared to 2.20% reported for 2009.

Other real estate owned totaled approximately $2.1 million at December 31, 2010, compared to $0.4 million reported at December 31, 2009.

For additional information regarding asset quality, the allowance for loan losses and provisions for loan losses, please see “Troubled Debt Restructurings,” “Non-Performing Assets,” and “Allowance for Loan Losses” of Management’s Discussion and Analysis filed on this Form 10-K.

Recent Regulatory Developments

As discussed previously, on December 23, 2010, the Company the Bank and the FRBSF entered into the Written Agreement (the “Written Agreement”), effective December 23, 2010, addressing, among other items, management, operations, lending, asset quality and increased capital for the Bank and the Company, as appropriate.

In addition, the DFI completed an examination of the Bank in the fourth quarter of 2010. Based upon discussion with the DFI following the examination, the Bank’s condition has been further downgraded. Further, the Bank likely will receive some form of formal enforcement action from the DFI. While we expect the action from the DFI to be similar in scope to the Written Agreement, it will differ in at least one important respect. While the Written Agreement requires the Bank to submit a capital plan to the FRBSF, the agreement does not specify a particular level of capital the Company or Bank must maintain. The DFI has indicated that its action will include specific minimum capital ratios that the Bank must meet for both the tier 1 leverage and total risk based capital ratios. At this time, the Bank has not been advised of the minimum capital ratios sought by the DFI. However, those ratios will be in excess of the Bank’s current capital ratios.

Many of the requirements of the Written Agreement reflect recommendations or requirements from the examination that the Bank has been working on since the date of the examination. Subsequent to the examination and in order to enhance the Bank’s ability to remedy many of the noted criticisms, the Bank made several changes in the executive structure to include a newly appointed Chief Credit Officer (CCO) and Chief Financial Officer. In addition, Stanley R. Cherry, Director and former President and CEO rejoined the Bank as SVP- credit administration and will be working closely with the CCO to manage the day-to-day credit functions. The Company and Bank will continue their efforts to comply with all provisions of the Written Agreement, and believe they are taking the appropriate steps necessary to comply in a timely fashion.

Our capital has been significantly reduced as a result of the losses in 2009 and 2010. We must now recapitalize the Company and the Bank. As discussed previously, the Written Agreement requires the Company and Bank to submit a capital plan to the FRBSF containing minimum capital ratios for the Bank that would raise them above their current levels. In addition, the Anticipated Consent Order will, among other things, require that the Bank achieve and then maintain certain capital ratios significantly in excess of current capital levels. Although we have not yet received the Anticipated Consent Order, as of December 31, 2010, based on our capital plan submitted to the FRBSF we estimate that we needed to achieve a combination of new equity capital and earnings of approximately $8.7 million in order to appropriately recapitalize the Company and Bank. To achieve such a result, we must:

increase the Bank’s capital through a combination of new equity capital and its earnings;

minimize future losses from the $23.9 million in non-performing loans we had at December 31, 2010 or from other assets; and/or

reduce assets from the amount at year end 2010.

If we do not achieve all these goals, we will not be able to adequately recapitalize the Company, which would have a material adverse effect on the Company and the Bank and our ability to continue as a going concern. In addition, until we receive the Anticipated Consent Order we will not know if $8.7 million will be adequate to satisfy the DFI, and the FRBSF has not yet approved our capital plan. Failing to adequately recapitalize the Company or satisfy our regulatory capital requirements could lead to, among other things, additional regulatory enforcement actions including the imposition of civil monetary penalties against the Company, the Bank or both, the termination of insurance of the Bank’s deposits by the FDIC or the closing of the Bank with the imposition of a conservator or receiver.

We currently hold in escrow approximately $1.2 million through our efforts in a recent private placement (the “Private Placement”). While this amount of capital would be a material addition to the Company’s capital levels, we believe this amount of capital will not adequately recapitalize the Bank, bring the Bank into compliance with any capital ratio requirement the DFI will set, nor will it be sufficient for purposes of satisfying the Written Agreement. Because of this likely shortfall in the Private Placement, the Company has elected to keep those proceeds in escrow, and is contemplating a rights offering to its current common shareholders in an effort to further augment capital. There can be no assurance that such a rights offering will be successful, or raise enough capital when combined with the net proceeds of the Private Placement to fully satisfy the capital requirements imposed by our regulators.

We view satisfying our capital requirements as only the first step in our recapitalization. We anticipate that further capital will be necessary in order to (i) execute our growth strategy once our financial position improves and (ii) keep us in compliance with the written agreement and likely consent order. The economic recession has provided a number of opportunities for expansion for a well-capitalized institution which is in satisfactory regulatory condition.

Results of Operations

The Company reported a net loss of $15.0 million for the year ended December 31, 2010 compared to a net loss of $2.1 million and income of $1.1 million for the years 2009 and 2008, respectively. For the years ended December 31, 2010 and 2009, the Company reported a net loss of $7.49 and $1.05 per common share, respectively. For the year ended 2008 the Company reported basic and diluted earnings per share of $0.59 and $0.58, respectively. Earnings were negatively impacted on a year over year basis due in large part to the substantial increase in provisions the Bank made to the allowance for loan losses. Provision for loan losses was $15.2 million for the year ended December 31, 2010 compared to $5.5 million for the same period for 2009. The Allowance for Loan and Lease Losses (the “ALLL”) was $11.0 million and $3.4 million at December 31, 2010 and December 31, 2009, respectively. As a percent of total gross loans, the ALLL was 5.84% and 1.67% at December 31, 2010 and December 31, 2009, respectively.

Net Interest Income

Net interest income is the Company’s largest source of operating income and is derived from interest and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. The net interest margin (NIM) is the amount of net interest income expressed as a percentage of average earning assets. The most significant impact on the Company’s net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities. Factors considered in the analysis of net interest income are the composition and volume of earning assets and interest-bearing liabilities, the amount of non-interest-bearing liabilities, non-accruing loans, and changes in market interest rates.

Net interest income for the year ended December 31, 2010 was $10.3 million compared to $10.8 million and $11.4 million for the years ended December 31, 2009 and December 31, 2008, respectively. This represents a year over year decrease of 4.9% and 5.0%. Total interest income decreased $1.3 million in 2010 and interest expense decreased $.7 million compared to the same period in 2009. The decrease in interest income was primarily due to a 50 basis point decrease in the yield on average loans and to the decrease of 116 basis points in the yield on investment securities. The volume of average loans remained relatively static with only an average increase of $1.8 million, however, the average amount of loans on non-accrual increased by more than $18.9 million. The foregone interest on this level of loans in 2010 and 2009 was approximately $1.0 million and $.1 million, respectively. The impact of the large amount of average non-accrual loans in 2010 to the yield on average loans represents the entire 50 basis point decrease in yield over the previous year. Further, this created a negative impact to the NIM of 41 basis points which is 8 basis points higher than the variance on a year over year basis.

The net interest margin decreased 33 basis points from 4.49% in 2009 to 4.16% in 2010. The primary reason for this decrease was the decline in the yield on average earning assets noted in the paragraph above that was offset to some degree by the decrease in total interest bearing liabilities. Further, lower interest rates on new investments that were purchased to replace previous investments that were either sold, matured or called, decreased the average investment yield 116 basis points from 4.03% at December 31, 2009 to 2.87% for the same period in 2010.

Total interest income and fees produced a 5.08% yield on average earning assets for 2010, 5.74% for 2009 and 6.77% in 2008. The average loan to average deposit ratio for 2010 was 82.5%, which represents a decrease of 5.3% over the 87.8% average for 2009, which was an increase of 4.0% over the 83.8% average for 2008.

Total interest expense decreased $.7 million or 24.2% from $3.0 million in 2009 to $2.3 million in 2010 and also decreased from $3.9 million in 2008 to $3.0 million in 2009. The decrease in total interest expense in 2010 was due to management action to re-price all deposit categories while remaining competitive in the primary market. The soft loan demand and decreasing loan portfolio allowed management to aggressively re-price with the anticipation of some decrease in higher cost deposits. While average deposits increased overall in 2010 from 2009, actual balances decreased by approximately $4.9 million with time deposits decreasing by $7.2 million. This would be reflective of management’s re-pricing actions that occurred in the last four months of 2010. The rate paid on interest-bearing liabilities decreased 55 basis points from 1.82% in 2009 to 1.27% in 2010.

The following table shows the composition of average earning assets and average interest-bearing liabilities, average yields and rates, and the net interest margin for the years ended December 31, 2010, 2009 and 2008.

	Year Ended December 31
	2010								2009								2008
	(dollars in thousands)								(dollars in thousands)								(dollars in thousands)
	Average					Yield/			Average					Yield/			Average					Yield/
	Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate
Assets:
Loans	$	201,037		$	11,456		5.70	%	$	199,228		$	12,355		6.20	%	$	177,988		$	12,994		7.30	%
Investment securities		38,978			1,117		2.87	%		37,019			1,491		4.03	%		46,440			2,258		4.86	%
Federal funds sold		7,554			14		0.19	%		5,082			5		0.10	%		1,309			24		1.83	%

Total average interest-earning assets		247,569			12,587		5.08	%		241,329			13,851		5.74	%		225,737			15,276		6.77	%
Other assets		25,967								25,402								26,120
Less allowance for loan losses		(8,082	)							(2,407	)							(1,739	)
Total average assets	$	265,454							$	264,324							$	250,118

Liabilities and Shareholders' Equity:
Interest Bearing Liabilities:
Deposits
Interest-bearing demand – NOW	$	13,517		$	32		0.24	%	$	13,628		$	49		0.36	%	$	12,636		$	41		0.32	%
Money Market		44,133			539		1.22	%		32,196			589		1.83	%		26,070			541		2.08	%
Savings		28,195			65		0.23	%		27,387			68		0.25	%		26,166			88		0.34	%
Time certificate of deposits		89,371			1,523		1.70	%		82,723			2,046		2.47	%		71,671			2,605		3.63	%
Total average interest-bearing deposits		175,216			2,159		1.23	%		155,934			2,752		1.76	%		136,543			3,275		2.40	%

Short-term borrowings		19			-		0.00	%		3,177			79		2.49	%		6,612			191		2.89	%
Long -term borrowings		5,883			132		2.24	%		6,555			190		2.90	%		7,106			411		5.78	%
Total interest-bearing liabilities		181,118			2,291		1.26	%		165,666			3,021		1.82	%		150,261			3,877		2.58	%

Demand deposits		68,590								70,935								75,752
Other liabilities		1,802								2,281								2,170
Shareholders' equity		13,944								25,442								21,935
Total average liabilities and shareholders' equity	$	265,454							$	264,324							$	250,118

Net interest income				$	10,296							$	10,830							$	11,399
Net interest margin							4.16	%							4.49	%							5.05	%

Nonaccrual loans are included in the calculations of the average balances of loans and non-accrued interest is excluded.

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

	Year Ended December 31, 2010									Year Ended December 31, 2009									Year Ended December 31, 2008
	over									over									over
	Year Ended December 31, 2009									Year Ended December 31, 2008									Year Ended December 31, 2007
	Increase (Decrease) Due to									Increase (Decrease) Due to									Increase (Decrease) Due to
	Change in (000's)									Change in (000's)									Change in (000's)
	Volume			Rate			Change			Volume			Rate			Change			Volume			Rate			Change
Interest-bearing Assets:
Net Loans		111			(1,010	)		(899	)		1,421			(2,060	)		(639	)		1,228			(3,265	)		(2,037	)
Investment Securities		75			(449	)		(374	)		(415	)		(352	)		(767	)		(127	)		(53	)		(180	)
Federal funds sold		3			6			9			20			(39	)		(19	)		(121	)		(105	)		(226	)
Interest-earning deposits		-			-			-			-			-			-			-			-			-
Total interest income		189			(1,453	)		(1,264	)		1,026			(2,451	)		(1,425	)		980			(3,423	)		(2,443	)

Interest-bearing Liabilities:
Interest-bearing demand – NOW		-			(17	)		(17	)		3			5			8			(3	)		(11	)		(14	)
Money Market		180			(230	)		(50	)		117			(69	)		48			32			(213	)		(181	)
Savings		2			(5	)		(3	)		8			(28	)		(20	)		(1	)		(200	)		(201	)
Time Certificates of deposit		154			(676	)		(522	)		360			(919	)		(559	)		163			(715	)		(552	)
Short-term borrowings		(79	)		-			(79	)		(88	)		(24	)		(112	)		167			(27	)		140
Long-term borrowings		(20	)		(38	)		(58	)		16			(237	)		(221	)		16			(155	)		(139	)

Total interest expense		237			(966	)		(729	)		416			(1,272	)		(856	)		374			(1,321	)		(947	)

Interest differential or net interest income	$	(48	)	$	(487	)	$	(535	)	$	610		$	(1,179	)	$	(569	)	$	606		$	(2,102	)	$	(1,496	)

Noninterest Income

Noninterest income totaled $1.6 million for the year ended December 31, 2010 compared to $1.2 million for the same period in 2009. That represents an increase of $.4 million or 30.3%. The increase was primarily due to the gain on sale of investment securities totaling $.6 million in 2010 compared to a gain on sale of investment securities of $.2 million in 2009. The Bank also had a gain on sale of securities in 2008 of $.1 million.

Service charges on deposit accounts totaled $.5 million, which represents a decrease of $38 thousand or 7.4% for the year ended December 31, 2010 compared to the same period in 2009. This category also experienced a $37 thousand decrease in 2009 from that reported in 2008. The decrease in services charges was primarily due to the decrease in non sufficient fund fees collected.

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

Noninterest Expense

Noninterest expense increased $.8 million or 8.0% in 2010 over 2009 from $9.9 million to $10.7 million as compared to an increase of $.1 million or 1.0% in 2009 over 2008. The overall increase can be largely attributed to the $.2 million increase in FDIC premiums and $.6 million increase in costs associated with OREO including the write down of value.

Regulatory assessment fees for the year ended December 31, 2010 were $.7 million which reflects an increase of $.2 million or 40.3% compared to $.5 million for the same period in 2009. The increase in premiums on a year over year basis is even in the absence of a special one-time fee assessed in June 2009 of $.1 million. The special assessment was levied against all financial institutions to replenish the FDIC’s deposit insurance fund. The FDIC increased the deposit insurance premium during the last two quarters of 2010 as a result of the Written Agreement. The Bank expects to have premiums of up to $.9 million in 2011.

Salaries and related expenses decreased $.2 million or 3.4% from $5.4 million in 2009 to $5.2 million in 2010 compared to a decrease of $.3 million or 5.2% between 2009 and 2008. The decrease in 2010 compared to 2009 is the result of a continued salary freeze and the reduction of staff through attrition. The decrease for 2009 over 2008 is attributed to the retirement of Larry H. Putnam, the freezing of officer salaries and the reduction in salary continuation plan expense due to the retirement of Mr. Putnam.

Occupancy expense remains relatively static with only a minor decrease of $16 thousand in 2010 compared to 2009. For the year ended December 31, 2009 occupancy expense was $11 thousand greater compared to the same period in 2009. The Bank owns all four facilities and provides for the appropriate upkeep to maintain the value of the properties.

Equipment expense for the years ended December 31, 2010, 2009 and 2008 totaled $.6 million, $.6 million and $.7 million, respectively. The Bank has not made any major purchases of equipment over the past three years and the declining expense associated with equipment is reflective of full depreciation for older items.

Professional services for the years ended December 31, 2010, 2009 and 2008 totaled $.8 million, $.6 million and $.6 million, respectively. During 2010, the Bank increased the scope and frequency of independent third party loan quality review that accounted for approximately $42 thousand in expense. In addition, with the regulatory issues facing the Bank, additional costs of $177 thousand over that experienced in 2009 were incurred for legal services.

Data processing expense for the years ended December 31, 2010, 2009 and 2008 remained static at approximately $.5 million for each year.

Office expenses for the years ended December 31, 2010, 2009 and 2008 experienced only small increases of $7 thousand and $21 thousand, respectively. These small increases were driven primarily by telephone expenses.

Messenger and courier expenses decreased for the years ended December 31, 2010, 2009 and 2008 have been decreasing by small amounts primarily due to the Bank switching to electronic cash letters.

Other expense increased $124 thousand or 44.3% for the year ended December 31, 2010 compared to the same period in the 2009. This was driven by increased loan related costs of $55 thousand, the valuation of repossessed other assets of $28 thousand and the excise tax cost for three surrendered BOLI policies insuring terminated employees of $24 thousand. Most other line items within the category had smaller increases on a year over year basis.

The Company’s efficiency ratio for 2010 was 89.5% compared to 81.8% and 78.0% in 2009 and 2008, respectively. The negative impact to the efficiency ratio is driven by the decrease in net interest income along with increases in non-interest expense.

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

Income Taxes

As a result of the increase in the Bank’s reported losses, during the first quarter of 2010 we increased the valuation allowance on deferred tax assets because the benefit of such assets is dependent on future taxable income. As a result, income tax expense for the year ended December 31, 2010 was $807,000 despite the pre-tax losses reported. As the Company implements plans to return to profitability, future operating earnings, if any, would benefit from significant net operating loss carry-forwards.

The income tax expense (benefit) was ($1.4) million in 2009 and $.6 million 2008. The effective tax rate was 44.0% in 2009 as compared to 35.7% in 2008.

Financial Condition

At December 31, 2010 and 2009, the Company’s consolidated total assets totaled $249.8 million and $269.9 million, respectively. This represents a decrease of $20.1 million or 7.5% that was driven by a decreasing loan portfolio as the result of soft demand, net charge-offs and the Bank’s restrictions to make loans that would exacerbate the already high regulatory CRE levels.

At December 31, 2010 and 2009, the Company’s total deposits totaled $233.9 million and $238.7 million, respectively. This represents a decrease of $4.9 million or 2.0%. This decrease was the result of a planned effort to reduce high cost deposit products, specifically in the absence of the need for funding loan demand. The re-pricing efforts extended to all interest bearing deposit products in the last four months of the year while continuing to remain competitive with rates in the primary market.

Securities available for sale totaled $32.5 million and $41.0 million at December 31, 2010 and 2009, respectively. The decrease was the result of principal pay downs, maturities, calls and sales, net of new purchases.

Loan Portfolio

At December 31, 2010 and 2009, total gross loans outstanding were $188.4 million and $202.2 million, respectively. This represents a decrease of $13.8 million or 6.8% in 2010 compared to 2009. The decrease is the direct result of soft loan demand and $7.6 million in net charge offs. A decline in current economic conditions has had an adverse effect on the demand for new loans even as rates declined. It is also understood that the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans has had a negative impact on the origination of quality loans.

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

	Year Ended December 31
	2010			2009			2008			2007			2006
	(dollars in thousands)
Commercial	$	34,232		$	41,744		$	41,478		$	38,017		$	36,407
Real Estate – construction		38,143			47,458			52,389			47,819			55,307
Real Estate – other		114,332			111,183			94,372			81,895			78,757
Consumer		1,663			1,783			1,415			1,237			1,604

Total gross loans		188,370			202,168			189,654			168,968			172,075
Less: unearned fees		(621	)		(683	)		(712	)		(676	)		(741	)
Less: allowance for loan losses		(10,999	)		(3,386	)		(2,310	)		(1,673	)		(1,654	)

Total net loans	$	176,750		$	198,099		$	186,632		$	166,619		$	169,680

Weighted average yield on loans for the year		5.7	%		6.2	%		7.3	%		9.2	%		9.1	%

A significant portion of the loan portfolio of the Company is collateralized by real estate. At December 31, 2010, real estate served as the principal source of collateral with respect to 80.9% of the Company’s loan portfolio.

Real estate construction and other real estate loans equaled $152.5 million or 80.9% of the total loan portfolio and $158.6 million or 78.5% of the total loan portfolio at December 31, 2010 and 2009, respectively. Other real estate loans are comprised of loans to individuals for their businesses, consumer real estate loans including home equity lines of credit and loans for farmland. The Company has known for some time that it has a concentration in commercial real estate loans. As a means to more closely monitor this concentration, the Company has instituted the use of NAICS codes, individual commercial real estate stress tests and an overall portfolio stress test to monitor industry trends within its commercial real estate portfolio. As of December 31, 2010, the Company had $92.5 million or 49.1% of its loans in commercial real estate. Of this number, $51.8 million or 56.0% is commercial real estate for owners use. No industry type exceeds 11.0% of total loans. The remaining $40.7 million or 44.0% is commercial real estate for non-owners use. Commercial real estate loans for non-owners use as a percentage of total loans equates to 21.6%. We watch the commercial real estate loans for non-owners use along with changes within our owners use very closely and are familiar with the individuals and projects.

Total real estate loans decreased $6.2 million or 3.9% in 2010 over 2009 compared to an increase of $11.9 or 8.1% in 2009 over 2008. The decrease in total real estate related loans in 2010 is attributable to the construction and land portfolio of the Bank. The loan category of 1-4 family residential construction decreased from $8.1 million at December 31, 2009 to $4.8 million for the same period in 2010. All other construction and land loans decreased from $40.1 million at December 31, 2009 to $33.3 million for the same period in 2010. This aggregate decrease of $10.0 million for the two categories is the net result of $2.0 million in charge-offs net of recoveries, $1.5 migration to OREO and pay downs in the normal course of projects finalizing. The Bank has seen a significant decrease in the number of construction loans in general due to the softening in the real estate market and the Bank’s concentration in real estate loans that due to capital levels are outside of regulatory guidelines and places limits on the Bank’s ability to make originations. Because of the deteriorating economic environment over the past several years, almost half of all construction/land related loans are classified as having some form of credit weakness. This will be discussed further in the section regarding “Nonperforming loans” found elsewhere in this document. The construction loans that are in the portfolio are to customers with a long history of successful developments in our market areas, as well as a long-term relationships with the Bank.

The Company makes commercial loans to small and mid-size businesses for various reasons, including working capital, inventory and equipment. Commercial loans equaled $34.2 million or 18.2% of the total loan portfolio and $41.7 million or 20.6% of the total loan portfolio at December 31, 2010 and 2009, respectively. Commercial loans decreased $7.5 million or 18.0% from 2009 to 2010 compared to an increase of $266 thousand or 0.6% in 2009 over 2008. The decrease for 2010 is the result of $5.0 million in charge-offs net of recoveries and pay downs in the normal course of business and the lack of demand during distressed economic times. This area of the portfolio has experienced the largest dollar and percentage of charge offs due to the economic stress on borrowers combined with the typical lack of real property as collateral. This will be discussed further in the section regarding “Nonperforming loans” found elsewhere in this document.

Consumer and other loans equaled $1.7 million or 0.9% of the total loan portfolio at December 31, 2010 compared to $1.8 million or 0.9% at December 31, 2009. Consumer loans increased $368 thousand or 26.0% in 2009 over 2008.

The Company had undisbursed loans totaling $31.6 million, $43.1 million, and $57.2 million as of December 31, 2010, December 31, 2009 and December 31, 2008, respectively. Standby Letters of Credit accounted for $1.6 million, $1.3 million and $3.1 million of the undisbursed loans as of December 31, 2010, December 1, 2009 and December 31, 2008, respectively. The Company uses the same credit policies in making these commitments as is done for all of its lending activities. As such, the credit risk involved in these transactions is the same as that involved in extending loan facilities to customers.

The following table sets forth the amount of total gross loans outstanding at December 31, 2010 by contractual maturity date:

			After One
	One Year		Year Through		After
	or Less		Five Years		Five Years		Total
	(dollars in thousands)
Commercial	$	16,986	$	9,363	$	7,883	$	34,232
Real Estate - construction		19,512		14,204		4,427		38,143
Real Estate - other		4,226		14,958		95,148		114,332
Consumer		966		274		423		1,663
Total Gross Loans	$	41,690	$	38,799	$	107,881	$	188,370

The following table sets forth the amount of total gross loans outstanding at December 31, 2010 by sensitivity to interest rates and re-pricing opportunities:

			After One
	One Year		Year Through		After
	or Less		Five Years		Five Years		Total
	(dollars in thousands)
Commercial	$	24,041	$	10,009	$	182		34,232
Real Estate - construction		34,054		4,089		-		38,143
Real Estate - other		61,883		52,309		140		114,332
Consumer		419		480		764		1,663
Total Gross Loans	$	120,397	$	66,887	$	1,086	$	188,370

Fixed Rate Loans	$	10,912	$	7,837	$	1,086	$	19,835
Variable Rate Loans		109,485		59,050		-		168,535
Total Gross Loans	$	120,397	$	66,887	$	1,086	$	188,370

Total loans on non-accrual at $23.9 million are considered to be immediately re-priceable in the table above.

The Bank has access to an Asset/Liability Management system that models various interest rate environments for all rate sensitive assets and liabilities. At December 31, 2010, the simulation indicated that a +100 basis point move in rates would increase interest income on loans by approximately $.5 million. This is primarily the result of a considerable number of loans currently at floors significantly higher that the current prime rate.

Troubled Debt Restructurings

The Bank has twenty-five loans to fourteen borrowers totaling $16.0 million which were considered Troubled Debt Restructurings (TDR’s) as of December 31, 2010.

The loan categories and Interest Income received during 2010 are as follows:

	Principal Balance		Interest Paid			Interest Earned
	(dollars in thousands)
Residential Real Estate	$	614	$	-		$	21
Commercial Property for Owners Use		1,282		-			35
Offsite Development		2,279		-			176
Land		5,632		45			197
Residential Construction 1-4 SFR		557		-			8
Construction-Owner Use		4,343		-			156
Commercial and Industrial		1,269		20			45
Consumer, Other		21		-	#		-

	$	15,997	$	65	#	$	638

As of December 31, 2010 all loans with the exception of three that were considered TDR’s were on non-accrual status. The Bank generally returns loans to accrual status after six monthly payments are made on a timely basis.

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

Typically Real Estate loans considered TDR’s are measured for impairment utilizing current appraisals to determine the fair value of the collateral with any deficiency charged off during the period of measurement. The Bank has complied with this in all cases but one where the borrower had additional means of repayment and the discounted cash flow method was used to determine impairment. The deficiency as a result of the measurement at December 31, 2010 was $2.5 million and is carried as a valuation allowance within the allowance for loan losses.

Nonperforming loans

Interest income is accrued daily as earned on all loans. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. The accrual of interest on loans is discontinued when principal or interest is past due 90 days based on the contractual terms of the loan or when, in the opinion of management, there is reasonable doubt as to collectibility. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on nonaccrual loans is subsequently recognized only to the extent that cash is received and the loan’s principal balance is deemed collectible.

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

	Year Ended December 31
	2010			2009			2008			2007			2006
	(dollars in thousands)
Nonaccrual loans:
Commercial	$	2,437		$	221		$	714		$	113		$	-
Real estate		21,408			6,186			900			2,062			-
Consumer		100			-			-			-			-

Total		23,945			6,407			1,614			2,175			-

Loans 90 days or more past due and still accruing:
Real estate		-			-			-			-			-
Consumer		-			-			-			-			-
Commercial		-			-			-			-			550

Total		-			-			-			-			550

Total nonperforming loans		23,945			6,407			1,614			2,175			550
OREO		2,123			428			-			-			-

Total nonperforming assets:	$	26,068		$	6,835		$	1,614		$	2,175		$	550

Nonperforming assets as a percentage of total gross loans		13.84	%		3.38	%		0.85	%		1.29	%		0.32	%

Nonperforming assets as a percentage of total assets		10.44	%		2.53	%		0.64	%		0.87	%		0.23	%

Allowance for loan losses to nonperforming loans		45.93	%		52.85	%		143.12	%		76.92	%		300.73	%

The Company had forty-three nonperforming loans totaling $23.9 million at December 31, 2010, compared to eight nonperforming loans totaling $6.4 million at December 31, 2009. The increase in nonperforming loans as of December 31, 2010 was a result of the current economic downturn, a reduction in real estate collateral values, recent regulatory examinations and the Bank’s increased efforts to identify problem credits promptly given the continued economic weakness in our markets.

On at least a quarterly basis or more frequently if warranted, loans that were considered to be impaired are reviewed to determine the fair value of the real estate collateral and the Bank charges-off the portions of such loans considered uncollectible based on these analyses.

The table below sets forth more information regarding the stratification of non-accrual loans at December 31, 2010:

(in thousands)	31-Dec-10
Type of Loan	# Loans		# Borrowers			Amount		Single Largest
Construction-Spec- SFR		5		1		$	557	$	116
Construction-Comml-Owner Occupied		1		1			4,343	$	4,343
Land		8		7			10,012	$	3,816
SFR		5		3			1,383	$	532
HELOC		2		2			415	$	244
CRE-Owner Occupied		6		5			4,112	$	1,854
CRE		2		2			586	$	433
Commercial & Industrial		13		8			2,437	$	685
Consumer		1		1			100	$	100

Total Non-Accrual Loans		43		20	a)	$	23,945

a)	Adjusted by 10 borrowers with loans in various categories

The Bank had total nonaccrual loans of approximately $23.9 million at December 31, 2010 that consisted of forty-three loans to twenty borrowers. This compares to eight loans totaling approximately $6.4 million at December 31, 2009. The increase in nonperforming loans as of December 31, 2010 was a result of the current economic downturn, a reduction in real estate collateral values, recent regulatory examinations and the Bank’s increased efforts to identify problem credits promptly given the continued economic weakness in our markets.

Of the loans on non-accrual, approximately $18.6 million or 77.5% are current and not past due with scheduled payments. Many of the loans that are not past due but have been placed on non-accrual are recognized to have weakness in cash flow and/or decreases in collateral value thereby creating impairment in the credit.

All non-accrual and certain other classified loans that in the aggregate totaled approximately $24.6 million at December 31, 2010, have been analyzed under FAS 114 with appropriate reserves established or, in the case of collateral dependent loans, loans were written down to fair market value. Management is diligently working through each situation and the loans are in various stages of resolution. A detailed action plan is in place for all classified credits.

In addition to the internal efforts expended to identify problem credits, late in the third quarter of 2010 the Bank contracted with a highly skilled and regarded independent third party to review a significant portion of the loan portfolio. The primary focus and scope was to determine if the Bank was properly identifying problem credits under enhanced guidelines developed by the Bank earlier this year. With approximately 73% of the total loan balances outstanding reviewed within the scope of the external audit, the final results confirmed management’s identification of risk grades with the exception of one credit. The early identification of problem credits begins the eventual resolution of these weak credits. The Bank has made a significant amount of progress in this regard as is evidenced by the increased recognition of non-performing credits and the provision to loan loss that goes hand in hand with this process. Management remains vigilant in this process even though we know that not all situations will have a favorable outcome.

OREO

At December 31, 2010, the Bank had four Other Real Estate Owned (“OREO”) properties at a carrying value of approximately $2.1 million. This compares to one property at a carrying value of $.4 million at the prior year end. The following table outlines activity in OREO from the previous year end:

OREO
Description	31-Dec-09		Sold			Write-Down			Added		31-Dec-10		# Properties
Single Family Residential	$	428	$	(372	)		(56	)		973	$	973		1
Commerical Property		-		(582	)		(62	)		958		314		1
Land		-		(491	)		(203	)		694		-
Land		-		-			-			836		836		2

	$	428	$	(1,445	)	$	(321	)	$	3,461	$	2,123		4

Updated appraisals have been obtained for all OREO properties and the appropriate charge offs were processed at the time they were transferred to OREO. One of the land properties at the carrying value of $580 thousand is in escrow that is scheduled to close early in the second quarter of 2011. All other properties are being actively marketed and have listing agreements in place.

Allowance for Loan Losses

Inherent in lending is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan extended and the creditworthiness of the borrower in addition to broader economic forces in our markets. To reflect the estimated risks of loss associated with its loan portfolio, provisions are made to the Company's allowance for loan losses. As an integral part of this process, the allowance for loan losses is subject to review and possible adjustment as a result of regulatory examinations conducted by governmental agencies and through management's assessment of risk. The Company's entire allowance is a valuation allocation; that is, it has been created by direct charges against operations through the allowance for loan losses.

The Company evaluates the allowance for loan losses based upon an individual analysis of specific categories of loans, specific categories of classified loans and individual classified assets. The adequacy of the allowance is determinable only on an approximate basis, since estimates as to the magnitude and timing of loan losses are not predictable because of the impact of external events. In addition, the Company contracts with an independent loan review firm to evaluate new loans on a monthly basis and an overall credit quality examination on an annual basis. Management then considers the adequacy of the allowance quarterly for possible loan losses in relation to the total loan portfolio.

The allowance for loan losses charged against operating expense is based upon an analysis of the actual migration of loans to losses plus an amount for other factors that, in management's judgment, deserve recognition in estimating possible loan losses. These factors include numerous items, among which are: specific loan conditions as determined by management; the historical relationship between charge-offs and the level of the allowance; the estimated future loss in all significant loans; known deterioration in concentrations of credit; certain classes of loans or pledged collateral; historical loss experience based on volume and type of loan; the results of any independent review or evaluation of the loan portfolio quality conducted by or at the direction of the Company's management or by bank regulatory agencies; trends in portfolio volume, maturity, and composition; volume and trends in delinquencies and nonaccruals; lending policies and procedures including those for charge-off, collection, and recovery; national and local economic conditions and downturns in specific local industries; and the experience, ability, and depth of the lending staff and management. The Company evaluates the adequacy of its allowance for loan losses at least quarterly.

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

	December 31, 2010					December 31, 2009					December 31, 2008					December 31, 2007					December 31, 2006
			Loan					Loan					Loan					Loan					Loan
(in thousands)	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent

Commercial	$	4,164		37.86	%	$	1,145		20.65	%	$	696		21.87	%	$	525		22.50	%	$	495		21.16	%
Real Estate - construction		3,837		34.88	%		784		23.47	%		483		27.62	%		229		28.30	%		126		32.14	%
Real Estate - other		2,920		26.55	%		1,412		55.00	%		1,073		49.76	%		572		48.47	%		362		45.77	%
Consumer		78		0.71	%		39		0.88	%		39		0.75	%		32		0.73	%		38		0.93	%
Unallocated		-		n/a			6		n/a			19		n/a			315		n/a			633		n/a

	$	10,999		100.00	%	$	3,386		100.00	%	$	2,310		100.00	%	$	1,673		100.00	%	$	1,654		100.00	%

The Company experienced charge-offs net of recoveries of $7.6 million, $4.4 million and $.3 million in 2010, 2009 and 2008 respectively.

The Company increased the allowance for loan losses $15.2 million during the twelve month period ending December 31, 2010 compared to $5.5 million for the same period in 2009. The primary reasons for the increase was the amount of net loan charge-offs creating a higher historical charge off factor, the increase in non-performing loans and the write-downs of several loans to the fair value due to the downturn in the real estate market.

Management views the allowance for loan losses of $11.0 million 5.847% of total loans as of December 31, 2010 to be adequate after considering the above factors. This allowance is compared to $3.4 million or 1.67% in 2009. However, there can be no assurance that in any given period the Company will not sustain charge-offs that are substantial in relation to the size of the allowance.

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

	Year Ended December 31
	2010			2009			2008			2007			2006
	(dollars in thousands)
Outstanding loans:
Average for the year (net)	$	201,037		$	199,228		$	177,988		$	163,741		$	169,139
End of the year (net)	$	176,750		$	198,099		$	186,632		$	166,619		$	169,680

Allowance for loan losses:
Balance at beginning of year	$	3,386		$	2,310		$	1,673		$	1,654		$	1,470

Actual charge-offs:
Commercial		5,119			1,080			308			51			77
Real estate		2,611			3,262			-			-			-
Consumer		62			38			31			-			-
All other (including overdrafts)		-			6			13			10			6

Total charge-offs		7,792			4,386			352			61			83

Less Recoveries:
Commercial		125			1			12			4			26
Real estate		79			-			-			76			-
Consumer		3			-			-			-			-
All other (including overdrafts)		-			1			2			-			1

Total recoveries		207			2			14			80			27

Net loan charge-offs (recoveries)		7,585			4,384			338			(19	)		56
Provision for loan loss		15,198			5,460			975			-			240

Balance at end of period	$	10,999		$	3,386		$	2,310		$	1,673		$	1,654

Ratios:
Net loan charge-offs (recoveries) to average loans		3.77	%		2.20	%		0.19	%		-0.01	%		0.03	%

Allowance for loan losses to end of year loans		5.84	%		1.67	%		1.22	%		0.99	%		0.96	%

Net loan charge-offs (recoveries) to allowance for loan losses		68.96	%		129.47	%		14.63	%		-1.14	%		3.39	%

Net loan charge-offs (recoveries) to provision charged to operating expense		49.91	%		80.29	%		34.67	%		0.00	%		23.33	%

Interest Reserves

It is not the Bank’s policy to currently grant interest reserves with loans. At December 31, 2010, the Bank had one remaining construction loan with an interest reserve whose balance was less than $3 thousand.

Investment Securities

The average balance of Federal Funds Sold/Excess Balance Account (EBA) at the FRB (overnight investments with other banks) was $7.5 million, $5.1 million and $1.3 million in 2010, 2009 and 2008, respectively. These investments are maintained primarily for the short-term liquidity needs of the Company. The major factors influencing the levels of required liquidity are the loan demand of the Company's customers, fluctuations in the Company's deposits and consideration for reputation risk associated with current regulatory action.

Average total investment securities increased by $2.0 million 5.3% during 2010, compared to a decrease of $9.4 million or 20.3% in 2009. The increase in securities was primarily due to the net effect of excess funds due to a significantly decreasing loan portfolio. During 2010, Management implemented balance sheet strategies to augment capital ratios that included taking gains on sales of securities and also reinvesting in 0% risk weighted securities.

The aggregate market value of the investment portfolio was $343 thousand under the amortized cost as of December 31, 2010. It is the Company's policy not to engage in securities trading transactions. There are no investments in the portfolio deemed to be permanently impaired. The Company has classified all of its investment securities as available for sale. The exposure to sub prime loans in the mortgage-backed securities portfolio is minimal due to the fact these securities are guaranteed by United States Government Agencies and, as such, can be viewed as having credit risk comparable to United States Treasury securities.

	December 31, 2010
	(dollars in thousands)
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		(Losses)			Fair Value
Securities available-for-sale:
U.S. Government and Agency Securities	$	10,212	$	28	$	(198	)	$	10,042
State and Political Subdivisions		1,818		9		(28	)		1,799
SBA Cert of Prticipation		7,793		-		(177	)		7,616
Mortgage-Backed Securities		13,062		103		(80	)		13,085
Total	$	32,885	$	140	$	(483	)	$	32,542

	December 31, 2009
	(dollars in thousands)
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		(Losses)			Fair Value
Securities available-for-sale:
U.S. Government and Agency Securities	$	21,825	$	217	$	(9	)	$	22,033
State and Political Subdivisions		3,714		95		(5	)		3,804
Mortgage-Backed Securities		14,891		295		(33	)		15,153
Total	$	40,430	$	607	$	(47	)	$	40,990

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

	Year Ended December 31,							Year Ended December 31,
	2010							2009
	(dollars in thousands)
					Weighted							Weighted
	Book		Market		Average			Book		Market		Average
	Value		Value		Yield			Value		Value		Yield
Available-for-Sale Securities:
U.S. Government and Agency Securities:
One Year or Less	$	-	$	-		0.00	%	$	3,996	$	4,081		3.14	%
One to Five Years		6,026		6,014		1.36	%		17,829		17,952		2.61	%
Five to Ten Years		-		-		0.00	%		-		-
Over Ten Years		4,186		4,028		2.43	%		-		-
Total U.S. Agency		10,212		10,042		1.80	%		21,825		22,033		2.71	%

State and Political Subdivisions:
One Year or Less		-		-		0.00	%		762		769		5.26	%
One to Five Years		544		553		6.11	%		1,208		1,239		5.96	%
Five to Ten Years		882		867		6.28	%		1,744		1,796		5.91	%
Over Ten Years		392		379		5.51	%		-		-
Total State and Political Subdivisions		1,818		1,799		6.06	%

Santa Lucia Bancorp 10-K