ITEM 1.    BUSINESS

General

        1 ^st  Pacific Bancorp (the "Company", "we", "our", or "us") is a California corporation incorporated on August 4, 2006 and is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956, as amended. 1 ^st  Pacific Bank of California (the "Bank") is a wholly-owned bank subsidiary of the Company and was incorporated in California on April 17, 2000. The Bank is a California corporation licensed to operate as a commercial bank under the California Banking Law by the California Department of Financial Institutions (the "DFI"). In accordance with the Federal Deposit Insurance Act, the Federal Deposit Insurance Corporation (the "FDIC") insures the deposits of the Bank. The Bank is a member of the Federal Reserve System.

        A reorganization to form a holding company was completed on January 16, 2007, whereby all outstanding shares of the Bank were converted into an equal number of shares of the Company. Prior to the reorganization, the Company had minimal activity, which was primarily related to preparing for the reorganization. At present, the Company does not engage in any material business activities other than ownership of the Bank. References to the Company are references to 1 ^st  Pacific Bancorp (including the Bank), except for periods prior to January 16, 2007, in which case, references to the Company are to the Bank.

        After completing its initial public offering, the Company commenced operations on November 17, 2000, from a branch office in the Golden Triangle area of San Diego and a branch office in the Tri-Cities area of North San Diego County ("North County"). In the following years, the Company opened additional branch offices, one in the Mission Valley area of San Diego, one in the Inland North County area of San Diego and one in El Cajon.

        On July 1, 2007, the Company completed the acquisition of Landmark National Bank ("Landmark"), with assets of approximately $109 million. Landmark's two established offices became part of the Bank's branch network; one in Solana Beach and one in downtown La Jolla. As a result of the acquisition, the financial results found herein reflect the combined entity beginning July 2, 2007.

        During the third quarter of 2007, the Company moved its corporate headquarters location within the University Town Center area of San Diego and relocated the Golden Triangle branch office to the same facility. In February 2008, the Company opened a limited service branch office in downtown San Diego.

        The Company is organized as a single operating unit with eight branch offices. The Company's primary source of revenue is interest earned on loans it provides to customers. The Company funds its lending activities primarily through providing deposit products and services to customers. The Company's customers are predominately small and medium-sized businesses and professionals in San Diego County. As of December 31, 2007, the Company has grown to approximately $414.6 million in total assets.

Strategy

        The Company's mission statement is: "To build relationships that create significant results for our customers, employees, shareholders and community." The Company believes that to be successful in its competitive environment, it needs to attract and retain great people (e.g. directors and employees) to foster and grow loyal client relationships, which build enduring franchise value. This strategy is synopsized by the Company's corporate motto: People.Relationships.Results. The Company's vision of

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being a leading provider of commercial banking services in its markets is accentuated by three goals, to become:

        A compelling place to work—the Company will demonstrate a high performance and high-energy culture where the corporate values are embraced and lived out by "Gung Ho" employees.

        A compelling place to bank—clients will experience perceptive listening, active responses, and significant results that add value to their businesses and will become "Raving Fan" customers.

        A compelling place to invest—shareholders will receive outstanding shareholder value and the pride of participating in "The Company" in the San Diego region.

        The Company's strategy during its early de novo years was focused on achieving growth and market share. As the Company has matured, the strategy has progressively shifted to achieve more significant profitability. The Company intends to grow within its current equity base for the immediate future, utilizing retained earnings and debt instruments, as needed, to bolster capital ratios and minimize shareholder dilution. The Company intends to communicate regularly with its shareholders and increase awareness among the brokerage community to promote stock liquidity and market value. To be successful, the Company emphasizes systems which attract, retain, reward and develop employees, including strategies that encourage employees to think like owners, such as profit sharing plans and employee stock ownership initiatives. To foster long term, profitable customer relationships, the Company utilizes customer surveys to promote exceptional customer service and customer profitability measurement tools to identify and strengthen the most beneficial relationships; the Company's franchise value is ultimately rooted in its customer base.

Services Offered

        General.     The primary operational focus of the Company is to meet the financial services needs of its target market—small and medium-sized businesses and professionals—within its service area. Therefore, the Company offers a full line of loan and deposit products and certain related financial services designed to cater to this target market. As a community bank, the Company's personnel are actively involved in the community and an emphasis is placed on personalized "relationship banking," where the banking relationship is predicated on the banker's familiarity with the customer and its business.

        Lending Services.     As discussed in further detail below, the Company's lending activities focus on commercial and residential real estate loans, construction loans, commercial business loans and loans made or guaranteed through the Small Business Administration (the "SBA") loan program responsive to the target market's needs. The Company believes these loan products take advantage of the local economy and the consolidation of banking institutions in San Diego County and contiguous areas, which have created opportunities for an independent, service-oriented bank.

        Real Estate Loans.     The Company offers real estate loans for construction and term financing. Construction loans include loans for single-family homes (both owner occupied and speculative), small residential tract developments, commercial projects (such as multi-family housing, industrial, office and retail centers) and early stage acquisition and development loans for land and lots. Permanent financing is offered for commercial properties and single-family residential properties.

        Commercial Loans.     The Company offers the following types of commercial loans:

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Short-term working capital loans, both secured and unsecured.



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Revolving credit accounts, secured and unsecured, such as credit extensions supported by formal business assets (e.g. accounts receivable and inventory).

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Single purpose loans, such as term loans for facilities, plant and equipment.



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Stand-by letters of credit.

        SBA Loan Programs.     The SBA, headquartered in Washington, D.C., and operating in 10 regions throughout the United States, offers financial assistance to eligible small businesses in the form of partial government guarantees on loans made to such businesses by qualified participating lenders under the SBA's guaranteed loan program (the "7(a) program"). In order to be eligible for the 7(a) program, a business generally must be operated for profit and, depending on the industry of the potential borrower, must fall within specified limitations on numbers of employees or annual revenues. The Company is an SBA qualified participating lender and, in 2002, was awarded SBA's "Preferred Lender" status. This Preferred Lender status allows the Company to make loans under SBA programs without prior SBA approval.

        SBA 7(a) program loans are SBA-guaranteed loans made by approved financial institutions. For term loans, the loan guarantees vary from 75% to 85% of the loan balance, depending on the size of the loan, and terms vary from five to twenty-five years depending on the purpose of the loan. Revolving loans are limited to a maximum term of seven years and the loan guarantee may not exceed 50% of the loan amount. The aggregate balance of the SBA guaranteed portions of all outstanding SBA loans to one borrower and its affiliates may not exceed $2.0 million.

        SBA 7(a) program loans are typically written at variable rates of interest, which rates are generally limited by SBA guidelines. These guidelines limit the maximum rate for loans with maturities less than seven years to 225 basis points over the lowest prime-lending rate published in The Wall Street Journal ("WSJ Prime"). The maximum rate for loans with maturities in excess of seven years is 275 basis points over the WSJ Prime. Typically rates are adjusted on the first day of each calendar quarter.

        In addition to participation in the SBA's 7(a) programs, the Company also offers loans primarily for real estate-related projects under Section 504 of the Small Business Administration Act of 1953 ("504 loans"), such as for purchasing land and improvements, construction, modernizing or converting existing facilities and purchasing certain machinery and equipment. Under the 504 loan program, the borrower must provide at least 10% of the equity for the financing. Under a typical 504 loan, the Company will make a loan for 50% of the principal amount, which is secured by, among other assets, a first priority mortgage on the underlying property. The Company will provide the remaining amount of the funds as a short-term loan with a maturity from 90 days up to one year (the "Bridge Loan"). The borrower repays the Bridge Loan with the proceeds received from a bond issuance by a certified development company—a not-for-profit corporation established to create and issue debt securities that are fully guaranteed by the SBA. The debt securities are sold to institutional investors. Under the 504 loan program, SBA debentures may be issued for up to $4.0 million and, if a public policy is met, up to $8.0 million for manufacturers.

        Like many other government programs, the lending programs of the SBA are federal government programs authorized by legislation and uncertainties surround the SBA programs due to reliance on the United States Congress and the federal budgeting process for each fiscal year. There can be no assurance that the SBA lending program will continue in its present manner.

        Consumer Loans.     The Company loans for personal, family or household purposes. These loans represent a small portion of the Company's overall loan portfolio. However, these loans are important in terms of servicing customer needs in the market area of the Company's offices and ancillary lending needs of the Company's primary target market.

        Deposit Products and Services.     The Company's expertise is developing custom-tailored financial solutions for individuals, businesses and professionals desiring personalized banking services. The Company offers a wide range of accounts and services, designed around the needs and preferences of

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our customers. Account officers consult with the various specialists in the Company to satisfy the customer's immediate and long-range deposit and borrowing needs.

        Bank Deposits.     The Company offers personal and business checking, money market, savings and certificates of deposit accounts which can all be tied into a one-statement package. The types and terms of such accounts are offered on a competitive basis. The interest rates payable by the Company on the various types of interest-bearing deposit accounts are a function of a number of factors, including rates paid by the Company's competitors, the need for liquidity for lending operations and the changes in monetary policy as announced by the Federal Open Market Committee.

        Cash Management Services.     The Company specializes in meeting the unique banking needs of business owners. The Company accomplishes this by having developed a comprehensive set of cash management tools and services. Some of the cash management products the Company offers are online banking, automated clearing house ("ACH") origination, wire transfers, daily sweep products, lockbox processing and account transfers / management. The Company also has a wire transfer system with advanced features for business customers that, among other things, provides immediate confirmation of wire receipts. In addition to these products, the Company offers courier service to collect deposits from San Diego-area customers and has a correspondent relationship with another bank allowing the Company to accept deposits at thousands of third party locations for non-local depository needs.

        During the fourth quarter of 2006, the Company introduced a new service, Remote Deposit Capture. This service allows the customer to create and submit a deposit from its place of business. More recently, in March 2007, the Company introduced BusinessPro Deposit Link. This additional feature was added to the Company's online banking program for businesses. Deposit Link allows customers to make deposits into their checking accounts from their offices. Checks can be scanned, transmitted and deposited to their business checking accounts using office computers. This service is especially valuable to customers who frequently make deposits by reducing their courier and/or bank visit expenses. As of February 2008, twenty four customers have signed up for the Deposit Link Service.

        The Company believes that these services, as well as the other customer convenience services that it offers, allow the Company to offer a competitive and customized package of services to its customers.

        Internet Banking.     The Company utilizes technology and the Internet as a secondary means for servicing customers. Through "Internet banking" customers may conduct their banking business remotely from any location with an Internet connection. Business customers are able to access cash management products, which allow users to, among other things, originate wire transfers and ACH transactions. In addition, business customers can have multiple users access accounts via the website, and each user can have separately defined user capabilities. Despite the capabilities to access these electronic banking services, customers always have the opportunity to discuss specific banking needs with a knowledgeable service representative available in one of the Company's offices.

Marketing Focus

        The Company advertises and markets its services primarily to targeted customers in its primary service area. The Company focuses on meeting the needs of its targeted customers, as well as being knowledgeable about its competition. Among other things, the Company's key focus is to establish and build strong financial relationships with its customers using a trusted advisor approach. The Company communicates to customers and prospects through the direct business development sales force and media advertising.

        The Company also established an Advisory Board in November 2002, which consists of many local community and business leaders. In addition to their roles as advisors to the Company, the Advisory Board members represent the Company at events with the objective of increasing the Company's visibility. Furthermore, members of the Company's Board of Directors are highly visible and active in

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the San Diego community. Over time, the Company expects to continue to benefit from involvement in these civic and community activities and the positive association it provides to the Company. On-going public relations efforts emphasize the Company's local ownership, relationship-based philosophy, customer service and commitment to its community.

Service Area

        The Company considers its primary market to be the greater San Diego County region. All of the Company's offices are in this area. The Company's executive office and its original head office are both located in the Golden Triangle area of San Diego, which is the hub of the "North City" business center. The Company's second original branch office is located in the Tri-Cities area of North County (Oceanside, Carlsbad and Vista). The Company's third branch office was opened in 2003 in the Mission Valley area of San Diego. In 2005, the Company opened its fourth branch office in the Inland North County Area of San Diego along the Interstate 15 corridor. A fifth branch office was opened in April 2006 in the city of El Cajon in San Diego's East County Area. Effective July 1, 2007, the Company completed its acquisition of Landmark and added two branch offices in Solana Beach and La Jolla to the Company's branch network. In February 2008, the Company opened a limited service branch office in downtown San Diego.

        San Diego has evolved from a small military town into one of the nation's most desirable areas to live. From the beaches to the mountains and desert beyond, the region's quality of life, moderate climate, diversified economy and employment base have helped San Diego grow to a county of more than three million people.

        Additionally, the region has a rapidly growing professional, business and information services sector accounting for approximately 37.6% of the total jobs in the County according to the latest publication by the Center for Continuing Study of the California Economy. The report projects that this sector will be the fastest growing segment in San Diego County with more than 71,600 new jobs created by 2015, accounting for roughly 70% of the total economic growth during that time period.

        Some key industries in San Diego County include; agriculture, defense, high technology, international trade, manufacturing and biotechnology. At the end of the fourth quarter 2007, the unemployment rate for San Diego rose to 4.8%. Currently San Diego's unemployment rate is 0.8% lower than California's rate of 5.6% and is 0.3% higher than the overall United States rate of 4.5%.

        San Diego County's economy remains vulnerable despite a greater level of diversity and less reliance upon defense related industries than in previous decades. Many local businesses are still feeling the effects of the deployment of thousands of military personnel. The loss of military spending power combined with constrained employment growth, continued housing demand from net in-migration and the region's high cost of doing business has impacted the local economy. As of November 2007, total employment for San Diego County was estimated at 1.47 million employees as the population reached slightly above three million.

        Although the county has experienced significant growth in recent years, the Company cannot guarantee that future growth will occur and that currently unforeseen economic circumstances, such as a slow-down in one or more of the region's major industries or employers, or a change in the general economy of the region, the state or the nation, or a change in the Company's competition, as discussed below, would not reverse or slow-down these growth trends and pose new challenges to the success of the Company. Historically economic trends tend to run in cycles of varying duration and the Company will have no ability to control such cycles. The ongoing success of the Company depends in large part on the ability of the Company to adapt to such changes, utilizing such management, capital resources and business acumen as is available to the Company at such time.

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Risk Management

        As a fundamental part of its business, the Company has developed risk management practices to identify, measure, monitor and control the risks involved in its various products and lines of business. While the Company's business is dependent on taking risks, appropriate management of these business risks is critical to its success. The Company has a risk management program to evaluate a broad spectrum of risks, including, but not limited to, credit risk, market risk, liquidity risk, operational risk, legal risk and reputational risk. In assessing its risk management practices across the Company's functional areas (e.g. lending, branch operations, informational technology, asset and liability management, and administration), management considers the following elements of a sound risk management system in each critical area: the level of board and senior management oversight; the adequacy of policies, procedures and limits; the adequacy of internal controls; the results of internal monitoring and / or independent reviews and audits; and the experience of its personnel.

        In recent years, the Company has experienced strong growth in loans, deposits and total assets. Increased levels of staffing, new office space, and increased utilization of vendor services, such as data processing and professional services, have facilitated this growth. While the Company believes it has a sound risk management program that will address its future growth plans, the Company's ability to manage future growth will depend on, among other things, its ability to manage associated risks, including: monitoring operations, controlling funding costs and operating expenses, maintaining positive customer relations, and hiring and retaining qualified personnel.

Competition

        The banking business in California, generally, and specifically in the greater San Diego and adjacent areas, is highly competitive with respect to both loans and deposits. The business is dominated by a relatively small number of major banks, most of which have many offices operating over wide geographic areas. Many of the major commercial banks and their affiliates, including those headquartered outside California, offer certain services (such as trust and securities brokerage services) that are not offered directly by the Company. By virtue of their greater total capitalization, such banks have substantially higher lending limits than the Company and substantially larger advertising and promotional budgets. In addition, the Company faces competition from other community banks headquartered in the greater San Diego area that are also serving individuals and businesses.

        In recent years, a large number of mergers and consolidations of both banks and savings entities have occurred in California and throughout the nation. A substantial number of the larger banks have been involved in major mergers. The result is that these institutions generally have centralized and standardized services and some lending functions and decisions are sent outside the area. Acquisitions by major interstate bank holding companies and other large acquirers in the greater San Diego vicinity have resulted in numerous branch consolidations in the area. Many long-standing relationships have been disrupted or severed, while many other customers are now subjected to less personalized and more "standardized" services.

        As a result of this merger and consolidation activity, since 2000, community banking in San Diego has undergone a renaissance, with close to 20 new or de novo banks opening. Despite the increased competition from newer community banks, larger institutions continue to control the majority of the deposit market share in the region and the Company believes that this continues to present the Company with the opportunity to attract customers who are dissatisfied with the level of service provided by larger banks. Additionally, the Company expects that merger activity will continue to provide opportunities in its market area.

        In order to compete with the major financial institutions in the Company's primary service areas, the Company uses to the fullest extent possible the contacts of its organizers, founders, advisors, directors and officers with residents and businesses in the Company's primary service areas. The

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Company emphasizes specialized services, local promotional activity and personal contacts by the Company's officers, directors and other employees. Programs have been developed to specifically address the needs of small to medium-sized businesses, professional businesses, as well as business owners and their employees. As necessary, the Company can arrange for loans that are too large, due to legal lending limits, for the Company to make by itself, to be made on a participation basis with other financial institutions and intermediaries.

Subsidiaries

        The Bank is a subsidiary of our Company.

        On June 28, 2007, the Company formed a Delaware trust affiliate, FPBN Trust I (the "Trust") for the purpose of issuing trust preferred securities. The Company accounts for its investment in the Trust using the equity method under which the subsidiaries net earnings are recognized in the Company's statement of income, pursuant to Financial Accounting Standards Board Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." Pursuant to FIN 46, the Trust is not consolidated into the Company's financial statements. The Federal Reserve Board has ruled that subordinated notes payable to unconsolidated special purpose entities ("SPE's") such as the Trust, net of the bank holding company's investment in the SPE, qualify as Tier 1 Capital, subject to certain limits.

Employees

        Currently, the Company employs Messrs. A. Vincent Siciliano, James H. Burgess, Larry A. Prosi, and Richard H. Revier, under written employment agreements. See "Item 10, Directors, Executive Officers and Corporate Governance," below. On December 31, 2007, the Company employed 101 persons full-time and 5 persons part-time. None of the Company's employees are represented by any collective bargaining agreements. The Company considers its relations with employees to be excellent.

SUPERVISION AND REGULATION

         The following discussion of statutes and regulations affecting banks and bank holding companies is only a summary and does not purport to be complete. This discussion is qualified in its entirety by reference to such statutes and regulations. No assurance can be given that such statutes and regulations will not change in the future. Moreover, any changes may have a material effect on the business of the Company.

General

        Bank Holding Company Regulation.     The Company is a bank holding company within the meaning of the Bank Holding Company Act, and is registered as such with and subject to the supervision of the Federal Reserve Board ("FRB"). Generally, a bank holding company is required to obtain the approval of the FRB 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 bank holding company would own or control more than 5% of the voting shares of such bank. The FRB's approval is also required for the merger or consolidation of bank holding companies. The Company is required to file reports with the FRB and provide such additional information as the FRB may require. The FRB also has the authority to examine the Company and each of its subsidiaries, as well as any arrangements between it and any of its subsidiaries, with the cost of any such examination to be borne by the Company.

        Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates. Subject to certain restrictions

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set forth in the Federal Reserve Act, a bank can loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate, or issue a guarantee, acceptance, or letter of credit on behalf of an affiliate; provided that the aggregate amount of the above transactions of a bank and its subsidiaries does not exceed 10% of the capital stock and surplus of the bank on a per affiliate basis or 20% of the capital stock and surplus of the bank on an aggregate affiliate basis. In addition, such transactions must be on terms and conditions that are consistent with safe and sound banking practices and, in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as that term is defined in the Federal Reserve Act. Such restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. Further, 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.

        Under the FRB'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 FRB'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 it obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB's regulations or both. Under certain conditions, the FRB may conclude that certain actions of a bank holding company, such as payment of cash dividends, would constitute unsafe and unsound banking practices because they violate the FRB's "source of strength" doctrine.

        A bank holding company is prohibited from engaging in or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making these determinations, the FRB considers whether the performance of such activities by a bank holding company would offer advantages to the public which outweigh possible adverse effects.

        As a public company, the Company is subject to the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act amends certain parts of the Securities and Exchange Act of 1934, and is intended to protect investors by, among other things, improving the reliability of financial reporting, increasing management accountability, and increasing the independence of directors and our external accountants.

        The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which include but are not limited to the filing of annual, quarterly and other current reports with the Securities and Exchange Commission ("SEC").

        Banking Regulation.     Various requirements and restrictions under federal and state laws affect the operation of the Company. As a California state-chartered bank, the Company is regulated, supervised and regularly examined by the DFI. In addition, the FRB is the Company's primary federal regulator. Federal regulations address several areas including loans, deposits, check and item processing, investments, mergers and acquisitions, borrowings, dividends, and the number and locations of branch offices. Deposits of the Company are insured up to the maximum limits allowed by the FDIC. As a result of this deposit insurance function, the FDIC has certain supervisory authority and powers over FDIC-insured institutions.

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Proposed Legislative and Regulatory Changes

        Proposals pending in Congress would, among other things, change lending practices related to loans secured by single-family residences, restrict "predatory" and "subprime" mortgage activities, forestall foreclosures on single family homes, protect renters of foreclosed properties, license mortgage loan originators, restrict ownership of industrial banks, enhance the privacy of personal information. Certain of these proposals, if adopted, could significantly change the regulation or operations of banks and the financial services industry. The Company cannot predict whether any of these proposals will be adopted, and, if adopted, how these proposals will affect us or the Bank.

Federal Reserve Bank Regulation

        Each state-chartered bank that is a member of the FRB is referred to as a "state member bank." The Bank, like all other state member banks, subscribes to capital stock in the FRB of its district (the Federal Reserve Bank of San Francisco in the case of the Bank) in an amount equal to 6% of its combined capital and surplus (but excluding retained earnings); 3% must be paid-in and the remaining 3% is on call. The FDIC insures the deposits of the Bank and monitors the Bank in such capacity. The FRB discount window and other services are available to all depository institutions on an equivalent basis. However, being a state member bank reduces the number of federal supervisors from two to one where a bank is owned by a bank holding company.

Impact of Monetary Policies

        Banking is a business that depends on rate differentials. In general, the difference between the interest rate paid by the Company on its deposits and other borrowings and the interest rate earned by the Company on loans, securities and other interest-earning assets comprises the major source of the Company's earnings. These rates are highly sensitive to many factors which are beyond the control of the Company and, accordingly, the earnings and growth of the Company are subject to the influence of economic conditions generally, both domestic and foreign, including inflation, recession, and unemployment; and also to the influence of monetary and fiscal policies of the United States and its agencies, particularly the FRB. The FRB implements national monetary policy, such as seeking to curb inflation and combat recession, by its open-market dealings in United States government securities, by adjusting the required level of reserves for financial institutions subject to reserve requirements, by placing limitations upon savings and time deposit interest rates, and through adjustments to the discount rate applicable to borrowings by banks which are members of the Federal Reserve System. The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates. The nature and timing of any future changes in such policies and their impact on the Company cannot be predicted; however, the impact on the Company's net interest margin, whether positive or negative, depends on the degree to which the Company's interest-earning assets and interest-bearing liabilities are rate sensitive. In addition, adverse economic conditions could make a higher provision for loan losses a prudent course and could cause higher loan charge-offs, thus adversely affecting the Company's net income.

Federal Banking Loan Regulation

        On December 6, 2006, the federal bank regulatory agencies released final guidance on "Concentrations in Commercial Real Estate Lending" (the "Final Guidance"), largely consistent with the proposed guidance they released on January 10, 2006. This guidance defines commercial real estate ("CRE") loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property or the proceeds of the sale, refinancing, or permanent financing of the property. Loans on owner occupied CRE are generally excluded.

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        The Final Guidance requires that appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, CRE underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and higher capital levels may also be required. The Final Guidance is triggered when CRE loan concentrations exceed either:

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Total reported loans for construction, land development, and other land of 100% or more of a bank's total capital; or



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Total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land of 300% or more of a bank's total capital.

        Management of the Company believes that the Final Guidance applies to the Company's CRE lending activities due to its concentration in construction and land development loans. The Company has always had meaningful exposures to loans secured by commercial real estate due to the nature of its growing markets and the loan needs of both its retail and commercial customers. The Company believes its long-term experience in CRE lending, underwriting policies, internal controls, and other policies currently in place are generally appropriate in managing its concentrations as required under the Final Guidance. Furthermore, the Company has adopted additional enhancements to its analysis and review of CRE concentrations consistent with many of the requirements found in the Final Guidance.

Banking Legislation

        From time to time legislation is proposed or enacted which has the effect of increasing the cost of doing business and changing the competitive balance between banks and other financial and non-financial institutions. These laws have generally had the effect of altering competitive relationships existing among financial institutions, reducing the historical distinctions between the services offered by banks, savings and loan associations and other financial institutions, and increasing the cost of funds to banks and other depository institutions. Certain of the potentially significant changes, which have been enacted in the past several years, are discussed below.

        The Sarbanes-Oxley Act.     On July 30, 2002, in the wake of numerous corporate scandals and in an attempt to protect investors and help restore investor confidence by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Act"). The Act applies to any issuer, such as the Company, that has securities registered under, or is otherwise required to file reports under, the Exchange Act. The Act imposes new and unprecedented corporate disclosure and governance mandates on public companies, including the Company.

        While certain provisions of the Act, such as accelerated filing deadlines for periodic reports, do not currently apply to the Company, most of the Act's provisions are (or upon implementation will be) applicable. These provisions include (i) the requirement for certifications of each annual and quarterly report by the issuer's principal executive and financial officers, with criminal penalties imposed for knowing or willful violations, (ii) the forfeiture of bonuses or profits received by such officers if accounting restatements are required as a result of misconduct, (iii) disclosure of all material off-balance sheet transactions and relationships that may have a material effect upon the financial status of an issuer and of any "material correcting adjustments" in the issuer's financials, (iv) disclosure of management's assessment of internal controls and procedures, (v) disclosure as to whether the issuer has adopted a "code of ethics" for its senior financial officers and, if not, an explanation as to why not, and (vi) prohibitions or limits on loans to officers, directors and other insiders except to the extent such loans comply with FRB Regulation O. The Act also imposes certain additional regulations, such as

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accelerated filing periods for reports on Form 4 of changes in the beneficial ownership of officers, directors and principal security holders.

        The Act also imposes increased requirements on auditors and the auditing procedures of their public clients, including prohibitions on the performing of specified non-audit services contemporaneously with an audit. The Act heightens the requirements for, and the authority of, audit committees. Among other provisions, the Act vests an issuer's audit committee with direct responsibility for the appointment, compensation and oversight of any registered public accounting firm engaged to perform audit services and with the ability to hire independent outside legal counsel and other advisors.

        The Act also requires that each audit committee member be entirely "independent" (meaning that no member may be affiliated with the issuer or may accept (or have recently received) any consulting, advisory or other compensatory fees from the issuer) and be a member of the issuer's board of directors and that the committee include a designated "audit committee financial expert."

        Finally, the Act requires that legal counsel for subject companies report any evidence of material violations of securities laws or breaches of fiduciary duty to or by their client and imposes federal criminal penalties, including fines and imprisonment of up to 25 years, upon those convicted of defrauding shareholders of public companies.

        The Company has experienced increased costs associated with the increased level of disclosure and compliance required under the Act. Such increased costs are likely to continue and this diversion of resources may adversely affect the financial condition and operations of the Company.

        Gramm-Leach-Bliley Act.     The Financial Services Act of 1999, known as the Gramm-Leach-Bliley Act ("GLBA"), was signed into law on November 12, 1999 and became effective on March 11, 2000. The GLBA repeals provisions of the Glass-Steagall Act, which had prohibited commercial banks and securities firms from affiliating with each other and engaging in each other's businesses. Thus, many of the barriers prohibiting affiliations between commercial banks and securities firms have been eliminated.

        The Bank Holding Company Act ("BHCA") was amended by GLBA to allow a new "financial holding company" ("FHC") to offer banking, insurance, securities and other financial products to consumers. Specifically, the GLBA amended Section 4 of the BHCA in order to provide for a framework for the engagement in new financial activities. A bank holding company ("BHC") may elect to become an FHC if all its subsidiary depository institutions are well capitalized and well managed.

        Under the GLBA, national banks (as well as FDIC-insured state banks, subject to various requirements) are permitted to engage through "financial subsidiaries" in certain financial activities permissible for affiliates of FHCs. However, to be able to engage in such activities the bank must also be well capitalized and well managed and receive at least a "satisfactory" rating in its most recent Community Reinvestment Act examination. In addition, if the bank ranks as one of the top 50 largest insured banks in the United States, it must have an issue of outstanding long-term debt rated in one of the three highest rating categories by an independent rating agency. If the bank falls within the next group of 50, it must either meet the debt-rating test described above or satisfy a comparable test jointly agreed to by the FRB and the Treasury Department. No debt rating is required for any bank, such as the Bank, not within the top 100 largest insured banks in the United States.

        The Company cannot be certain of the effect of the foregoing legislation on its business, although there is likely to be consolidation among financial services institutions and increased competition for the Company.

        The Riegle-Neal Act.     The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), enacted on September 29, 1994, repealed the McFadden Act of 1927, which required states to decide whether national or state banks could enter their state, and allowed banks to

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open branches across state lines beginning on June 1, 1997. The Riegle-Neal Act also repealed the 1956 Douglas Amendment to the BHCA, which placed the same requirements on BHCs. The repeal of the Douglas Amendment now makes it possible for banks to buy out of-state banks in any state and convert them into interstate branches.

        The Riegle-Neal Act provides that interstate branching and merging of existing banks is permitted, provided that the banks are at least "adequately capitalized" and demonstrate good management. The states are also authorized to enact a law to permit interstate banks to branch de novo.

        On September 28, 1995, the California Interstate Banking and Branching Act of 1995 ("CIBBA") was enacted and signed into law allowing early interstate branching in California. CIBBA authorizes out-of-state banks to enter California by the acquisition of or merger with a California bank that has been in existence for at least five years, unless the California bank is in danger of failing or in certain other emergency situations.

        Federal Deposit Insurance Corporation Improvement Act of 1991.     The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was signed into law on December 19, 1991. FDICIA recapitalized the FDIC's Bank Insurance Fund, granted broad authorization to the FDIC to increase deposit insurance premium assessments and to borrow from other sources, and continued the expansion of regulatory enforcement powers, along with many other significant changes.

        FDICIA establishes five categories of capitalization: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." If a bank falls in the "undercapitalized," "significantly undercapitalized" or "critically undercapitalized" categories, it will be subject to significant enforcement actions by its primary federal regulator). See "Enforcement Powers-Corrective Measures for Capital Deficiencies," below.

        FDICIA also grants the regulatory agencies authority to prescribe standards relating to internal controls, credit underwriting, asset growth and compensation, among others, and requires the regulatory agencies to promulgate regulations prohibiting excessive compensation or fees. Many regulations have been adopted by the regulatory agencies to begin to implement these provisions and subsequent legislation (the Riegle-Neal Act, discussed above) gives the regulatory agencies the option of prescribing the safety and soundness standards as guidelines rather than regulations.

        As previously noted, FDICIA places restrictions on certain bank activities authorized under state law. FDICIA generally restricts activities through subsidiaries to those permissible for national banks, thereby effectively eliminating real estate investment powers. Insurance activities are also limited, except to the extent permissible for national banks.

        USA Patriot Act.     The United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") was signed into law on October 26, 2001. The USA Patriot Act requires financial institutions, such as the Company, to implement and follow procedures designed to help prevent, detect and prosecute international money laundering and the financing of terrorism. Title III of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA"). In general, the IMLAFATA amends current law, primarily the Bank Secrecy Act (see "—Bank Secrecy Act," below), to authorize the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks, bank holding companies and other financial institutions including enhanced record-keeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions. Among its other provisions, the IMLAFATA requires financial institutions to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to private banking accounts and correspondent banking accounts

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involving foreign individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, the IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. The IMLAFATA expands the circumstances under which deposited funds may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours. The IMLAFATA also amends the BHCA and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing an application under these Acts. Among other programs implemented to comply with the USA Patriot Act, the Company implemented a customer identification program.

        Bank Secrecy Act.     The Financial Recordkeeping and Reporting of Currency and Foreign Transactions Act of 1970 (the "Bank Secrecy Act") is a disclosure law that forms the basis of the United States federal government's framework to prevent and detect money laundering and to deter other criminal enterprises. Following the September 11, 2001 terrorist attacks, an additional purpose was added to the Bank Secrecy Act: "To assist in the conduct of intelligence or counter-intelligence activities, including analysis, to protect against international terrorism." Under the Bank Secrecy Act, financial institutions such as the Bank are required to maintain certain records and file certain reports regarding domestic currency transactions and cross-border transportations of currency. This, in turn, allows law enforcement officials to create a paper trail for tracing illicit funds that resulted from drug trafficking or other criminal activities. Among other requirements, the Bank Secrecy Act requires financial institutions to report imports and exports of currency in excess of $10,000 and, in general, all cash transactions in excess of $10,000. The Bank has established a Bank Secrecy Act compliance policy under which, among other precautions, the Bank keeps currency transaction reports to document cash transactions in excess of $10,000 or in multiples totaling more than $10,000 during one business day, monitors certain potentially suspicious transactions such as the exchange of a large number of small denomination bills for large denomination bills, and scrutinizes electronic funds transfers for Bank Secrecy Act compliance.

Administrative Actions

        Following the September 11, 2001 terrorist attacks on the United States, President George W. Bush signed an executive order on September 24, 2001 that has a number of consequences for the operations of commercial banks. First, it ordered the freezing of assets of persons on a list included in the order and requires each financial institution to monitor its deposits to determine whether they should be frozen. Second, it makes it illegal to do business with any of the persons or entities named on the list. This means that the Bank is obligated to carefully screen its customers on an ongoing basis to assure that the Bank is permitted to do business with them. These types of administrative orders and similar regulations of bank regulators may increase the cost of operating the Company and it is possible that further such orders will be made although the Company is not aware of any at this time.

Restrictions on Transactions With Insiders

        Sections 23A and 23B of the Federal Reserve Act regulate transactions between insured institutions and their "affiliates" and transactions by the Bank that benefit affiliates. For these purposes, an "affiliate" is a company under common control with the institution. In general, Section 23A imposes limits on the dollar amount of such transactions, and also requires certain levels of collateral for loans to affiliates. Section 23B generally requires that certain transactions between a bank and its respective affiliates be on terms substantially the same, or at least as favorable to such

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bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons. At this time the Bank does not have any "affiliates" other than the Company.

        The restrictions on loans to directors, executive officers, principal stockholders and their related interests (collectively referred to herein as "insiders") contained in the Federal Reserve Act and Regulation O promulgated thereunder apply to all federally insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution's total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.

Deposit Insurance Assessments

        The Bank's deposits are currently insured to a maximum of $100,000 per depositor by the FDIC except for certain retirement accounts which are insured up to $250,000. Each bank is required to pay deposit insurance premiums. The premium amount is based upon a risk classification system established by the FDIC. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. Effective January 1, 2007 the FDIC adopted a new rule for the insurance assessment on deposits. Under the new rule the charge for annual insurance deposit assessments ranges from a minimum of 5 basis points to a maximum of 43 basis points per $100 of insured deposits depending upon the risk assessment category into which the institution falls. Insured institutions are not all allowed to disclose their risk assessment classification and no assurance can be given as to what the future level of premiums will be.

        The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums could have an adverse effect on the operation expenses and result of operations of the Company. Management cannot predict what insurance assessments rates will be in the future.

        The FDIC is authorized to terminate a depository institution's deposit insurance upon a finding by the FDIC that the institution's financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution's regulatory agency.

        The Company's premium amount for the year ended December 31, 2007, was $222,912 compared to $28,370 for the year ended December 31, 2006.

Risk-Based Capital Guidelines

        The federal banking agencies have issued risk-based capital guidelines that include a definition of capital and a framework for calculating risk weighted assets by assigning assets and off-balance sheet items to broad credit risk categories. A bank's or bank holding company's risk-based capital ratio is calculated by dividing its qualifying total capital (the numerator of the ratio) by its risk-weighted assets (the denominator of the ratio).

        Qualifying total capital will consist of two types of capital components: "core capital elements" (comprising Tier 1 capital) and "supplementary capital elements" (comprising Tier 2 capital). The Tier 1 component must represent at least 50% of qualifying total capital and may consist of the following items that are defined as core capital elements: (i) common stockholders' equity; (ii) qualifying noncumulative perpetual preferred stock (including related surplus); and (iii) minority interest in the equity accounts of consolidated subsidiaries. The Tier 2 component may consist of the following items: (i) allowance for loan and lease losses (subject to limitations); (ii) perpetual preferred stock and related surplus (subject to conditions); (iii) hybrid capital instruments (as defined) and

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mandatory convertible debt securities; and (iv) term subordinated debt and intermediate-term preferred stock, including related surplus (subject to limitations).

        Assets and credit equivalent amounts of off-balance sheet items are assigned to one of several broad risk categories, according to the obligor, or, if relevant, the guarantor or the nature of collateral. The aggregate dollar value of the amount in each category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are added together, and this sum is the institution's total risk weighted assets that comprise the denominator of the risk-based capital ratio.

        A two-step process determines risk weights for all off-balance sheet items. First, the "credit equivalent amount" of off-balance sheet items is determined, in most cases by multiplying the off-balance sheet item by a credit conversion factor. Second, the credit equivalent amount is treated like any balance sheet asset and generally is assigned to the appropriate risk category according to the obligor, or, if relevant, the guarantor or the nature of the collateral.

        All banks and bank holding companies are required to meet a minimum ratio of qualifying total capital to risk weighted assets of 8%, of which at least 4% should be in the form of Tier 1 capital. The Bank's and Company's total capital and Tier 1 capital to risk weighted assets as of December 31, 2007, exceeded these requirements.

        The regulatory agencies have adopted leverage requirements that apply in addition to the risk-based capital requirements. Under these requirements, banks and bank holding companies are required to maintain core capital of at least 3% of their quarterly average assets (the "Leverage Ratio"). However, an institution may be required to maintain core capital of at least 4% or 5% or possibly higher, depending upon its activities, risks, rate of growth, and other factors deemed material by regulatory authorities. At December 31, 2007, the Bank's and Company's leverage ratio was in excess of this requirement.

Enforcement Powers

        Federal regulatory agencies have broad and strong enforcement authority reaching a wide range of persons and entities. Some of these provisions include those which: (i) establish a broad category of persons subject to enforcement under the Federal Deposit Insurance Act; (ii) establish broad authority for the issuance of cease and desist orders and provide for the issuance of temporary cease and desist orders; (iii) provide for the suspension and removal of wrongdoers on an industry-wide basis; (iv) prohibit the participation of persons suspended or removed or convicted of a crime involving dishonesty or breach of trust from serving in another insured institution; (v) require regulatory approval of new directors and senior executive officers in certain cases; (vi) provide protection from retaliation against "whistleblowers" and establish rewards for "whistleblowers" in certain enforcement actions resulting in the recovery of money; (vii) require the regulators to publicize all final enforcement orders; (viii) require each insured financial institution to provide its independent auditor with its most recent Report of Condition ("Call Report"); (ix) permit the imposition of significant penalties for failure to file accurate and timely Call Reports; and (x) provide for the assessment of significant civil money penalties and the imposition of civil and criminal forfeiture and other civil and criminal fines and penalties.

        Crime Control Act of 1990.     The Crime Control Act of 1990 further strengthened the authority of federal regulators to enforce capital requirements, increased civil and criminal penalties for financial fraud, and enacted provisions allowing the FDIC to regulate or prohibit certain forms of golden parachute benefits and indemnification payments to officers and directors of financial institutions.

        Corrective Measures for Capital Deficiencies.     The prompt corrective action regulations, which were promulgated to implement certain provisions of FDICIA, also effectively impose capital requirements

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on national banks, by subjecting banks with less capital to increasingly stringent supervisory actions. For purposes of the prompt corrective action regulations, a bank is "undercapitalized" if it has a total risk-based capital ratio of less than 8%; a Tier 1 risk-based capital ratio of less than 4%; or a leverage ratio of less than 4% (or less than 3% if the bank has received a composite rating of 1 in its most recent examination report and is not experiencing significant growth). A bank is "adequately capitalized" if it has a total risk-based capital ratio of 8% or higher; a Tier 1 risk-based capital ratio of 4% or higher; a leverage ratio of 4% or higher (3% or higher if the bank was rated a composite 1 in its most recent examination report and is not experiencing significant growth); and does not meet the criteria for a "well capitalized" bank. A bank is "well capitalized" if it has a total risk-based capital ratio of 10% or higher; a Tier 1 risk-based capital ratio of 6% or higher; a leverage ratio of 5% or higher; and is not subject to any written requirement to meet and maintain any higher capital level(s). There is no assurance as to what capital ratios the Bank will be able to maintain. As of December 31, 2007, the Bank was "well capitalized."

        Under the provisions of FDICIA and the prompt corrective action regulations, for example, an "undercapitalized" bank is subject to a limit on the interest it may pay on deposits. Also, an undercapitalized bank cannot make any capital distribution, including paying a dividend (with some exceptions), or pay any management fee (other than compensation to an individual in his or her capacity as an officer or employee of the bank). Such a bank also must submit a capital restoration plan to its primary federal regulator for approval, restrict total asset growth and obtain regulatory approval prior to making any acquisition, opening any new branch office or engaging in any new line of business. Additional broad regulatory authority is granted with respect to "significantly undercapitalized" banks, including forced mergers, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Additional mandatory and discretionary regulatory actions apply to "significantly undercapitalized" and "critically undercapitalized" banks, the latter being a bank with capital at or less than 2%. The primary federal regulator may appoint a receiver or conservator for a "critically undercapitalized" bank after 90 days, even if the bank is still solvent. Failure of a bank to maintain the required capital could result in such bank being declared insolvent and closed.

Community Reinvestment Act and Fair Lending Developments

        The Company 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 financial institutions 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.

        The federal banking agencies have adopted regulations to measure a bank's compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution's actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. In March 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact.

Allowance For Loan and Lease Losses

        On December 13, 2006, the FRB and the other federal financial institution regulatory agencies issued an interagency policy statement on the allowance for loan and lease losses (the "Policy

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Statement"). The Policy Statement replaces a 1993 policy statement, which described the responsibilities of the boards of directors and management of banks and savings associations and of examiners regarding allowance for loan and lease losses. In addition to the Policy Statement, the accounting profession groups periodically provide guidance to the banking industry on allowance for loan and lease losses ("ALLL") methodology.

        The Policy Statement outlines the responsibility of the institution's management and board of directors regarding their roles in maintaining ALLL at an appropriate level and for documenting its analysis. Management should evaluate the ALLL reported on the balance sheet as of the end of each quarter, or more frequently if warranted, and charge or credit the provision for loan and lease losses ("PLLL") to bring the ALLL to an appropriate level as of each evaluation date. The determinations of the amounts of the ALLL and PLLL should be based on management's current judgments about the credit quality of the loan portfolio, and should consider all known relevant internal and external factors that affect loan collectability as of the evaluation date.

        In carrying out its responsibility for maintaining an appropriate ALLL, management is expected to adopt and adhere to written policies and procedures that, at a minimum, ensure that: (1) the institution's process for determining an appropriate level for ALLL is based on a comprehensive, well-documented, and consistently applied analysis of its loan portfolio; (2) the institution has an effective loan review system and controls (including an effective loan classification or credit grading system) that identify, monitor, and address asset quality problems in an accurate and timely manner; (3) the institution has adequate data capture and reporting systems to supply the information necessary to support and document its estimate of an appropriate ALLL; (4) the institution evaluates any loss estimation models before they are employed and modifies the models' assumptions, as needed, to ensue that the resulting loss estimates are consistent with GAAP; (5) the institution promptly charges off loans, or portions of loans, that available information confirms to be uncollectible, and; (6) the institution periodically validates the ALLL methodology.

        The Policy Statement also provides guidance to examiners in evaluating the credit quality of an institution's loan portfolio, the appropriateness of its ALLL methodology and documentation, and the appropriateness of the reported ALLL in the institution's regulatory reports. In their review and classification or grading of the loan portfolio, examiners should consider all significant factors that affect the collectability of the portfolio, including the value of any collateral.

Other Aspects of Federal and State Law

        The Company is also subject to federal and state statutory and regulatory provisions covering, among other things, security procedures, technology and information security and risk assessment, currency and foreign transactions reporting, insider and affiliated party transactions, management interlocks, truth-in-lending, electronic funds transfers, funds availability, electronic banking, check image processing, financial privacy, truth-in-savings, home mortgage disclosure, and equal credit opportunity. There are also a variety of federal statutes that restrict the acquisition of control of the Company.

Proposed Legislation

        From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of the Company. It cannot be predicted whether any legislation currently being considered will be adopted or how such legislation or any other legislation that might be enacted in the future would affect the business of the Company.

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