e10qsb

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-QSB

Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2005

COMMISSION FILE No.: 333-122090

DISCOVERY BANCORP

Incorporated Under the Laws of the State of California

I.R.S. EMPLOYER IDENTIFICATION NO.: 20-1814766

338 Via Vera Cruz
San Marcos, California 92078
(760) 736-8900

Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 o No x

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 1,037,548 shares of common stock as of August 11, 2005.

Exhibit Index at page 29
Total number of pages: 34

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DISCOVERY BANCORP

CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 2005 AND DECEMBER 31, 2004


	2005			2004
ASSETS
Cash & Due From Banks	$	2,986,362		$	1,638,876
Fed Funds Sold		8,280,000			4,945,000

Cash and cash equivalents		11,266,362			6,583,876
Interest-bearing deposits at banks		2,591,941			2,691,623
Investment securities		3,827,261			2,705,734
Common stock, substantially restricted		511,900			483,000
Loans, Net		102,070,174			80,036,566
Accrued interest receivable and other assets		787,458			479,987
Deferred income tax asset		262,412			291,600
Premises and equipment, net		6,089,175			5,933,602

TOTAL ASSETS	$	127,406,683		$	99,205,988


LIABILITIES

Deposits
Non-interest-bearing demand	$	18,457,247		$	14,761,372
Interest-bearing demand		25,394,593			27,487,866
Savings		1,368,313			1,449,503
Time, under $100,000		30,190,158			18,035,413
Time, $100,000 and over		30,866,672			17,937,972

Total deposits		106,276,983			79,672,126
Borrowings		9,897,900			9,000,000
Accrued interest payable and other liabilities		733,249			234,370

TOTAL LIABILITIES		116,908,132			88,906,496


STOCKHOLDERS’ EQUITY

Common stock, no par value; authorized 10,000,000 shares, issued and outstanding 1,037,548 and 1,037,498 shares at June 30, 2005 and December 31, 2004, respectively		10,758,380			10,756,630
Accumulated deficit		(237,691	)		(447,104	)
Accumulated other comprehensive (loss)		(22,138	)		(10,034	)

		10,498,551			10,299,492

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	127,406,683		$	99,205,988

The accompanying notes are an integral part of these financial statements.

DISCOVERY BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
JUNE 30, 2005


	THREE MONTHS ENDED				SIX MONTHS ENDED
	JUNE 30,				JUNE 30,
	2005		2004		2005		2004
INTEREST INCOME
Interest and fees on loans	$	1,923,646	$	1,131,667	$	3,488,093	$	2,144,636
Interest on federal funds sold		58,329		7,217		98,158		12,426
Interest on securities		44,306		22,193		70,266		37,534
Other		17,883		10,172		35,425		26,699

TOTAL INTEREST INCOME		2,044,164		1,171,249		3,691,942		2,221,295

INTEREST EXPENSE
Deposits		610,381		239,612		1,061,742		468,480
Other		74,989		8,879		130,012		16,890

TOTAL INTEREST EXPENSE		685,370		248,491		1,191,754		485,370

NET INTEREST INCOME		1,358,794		922,758		2,500,188		1,735,925

PROVISION FOR LOAN LOSSES		123,485		117,790		282,427		151,201


NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		1,235,309		804,968		2,217,761		1,584,724
NON — INTEREST INCOME
Customer service fees & charges		29,464		1,185		40,426		21,401
Gain on sale of SBA loans		123,423		—		123,423		—
Other Income		175,449		38,568		317,789		50,396

TOTAL NON — INTEREST INCOME		328,336		39,753		481,638		71,797

NON — INTEREST EXPENSE
Salaries and employee benefits		611,317		467,240		1,122,658		883,453
Net occupancy		107,784		54,386		219,162		105,295
Furniture and equipment		72,497		44,690		139,326		89,042
Data processing		51,487		43,772		99,810		84,327
Advertising		31,840		22,526		52,347		45,323
Professional		209,916		52,341		376,683		104,354
Office supplies		17,787		11,750		34,998		26,553
Other operating		149,879		110,234		305,187		202,705

TOTAL NON — INTEREST EXPENSE		1,252,507		806,939		2,350,171		1,541,052

INCOME BEFORE INCOME TAXES		311,138		37,782		349,228		115,469

INCOME TAX PROVISION		103,075		6,899		139,815		20,494


NET INCOME	$	208,063	$	30,883	$	209,413	$	94,975


Earnings per share	$	0.20	$	0.03	$	0.20	$	0.09

Diluted Earnings per share	$	0.19	$	0.03	$	0.19	$	0.09

The accompanying notes are an integral part of these financial statements.

DISCOVERY BANCORP

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004


	Common Stock no par value;									Accumulated
	10,000,000 shares authorized									Other			Total
	Shares						Accumulated			Comprehensive			Stockholders’
	Outstanding			Amount			Deficit			Income(Loss)			Equity
Balance, January 1, 2004		1,037,298		$	10,754,630		$	(1,065,744	)	$	7,356		$	9,696,242
Net income								94,975						94,975
Unrealized losses on investment securities											(30,028	)		(30,028	)


Total comprehensive income														64,947

Balance, June 30, 2004		1,037,298		$	10,754,630		$	(970,769	)	$	(22,672	)	$	9,761,189


Balance, January 1, 2005		1,037,498		$	10,756,630		$	(447,104	)	$	(10,034	)		10,299,492
Comprehensive income:
Net income								209,413						209,413
Unrealized losses on investment securities											(12,104	)		(12,104	)

Total comprehensive income														197,309
Warrants exercised		250			3,750									3,750
Repurchase of Organizational Shares Issued		(200	)		(2,000	)								(2,000	)

Balance, June 30, 2005		1,037,548		$	10,758,380		$	(237,691	)	$	(22,138	)	$	10,498,551

The accompanying notes are an integral part of these financial statements.

DISCOVERY BANCORP

STATEMENTS OF CASH FLOWS (UNAUDITED)


FOR THE SIX MONTHS ENDED JUNE 30,	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	209,413		$	94,975
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		282,427			151,201
Depreciation and amortization		188,806			31,805
Amortization of deferred loan fees		(138,825	)		(107,309	)
Gain on sale of SBA loans		(123,423	)
Change in:
Deferred tax assets		29,188			—
Accrued interest receivable and other assets		(340,728	)		(108,199	)
Accrued interest payable and other liabilities		498,877			103,385

Net cash provided by operating activities		605,735			165,858

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of premises and equipment		(344,386	)		(135,341	)
Net change in interest bearing deposits at banks		99,682			(8,968	)
Purchase of common stock substantially restricted		(28,900	)		(49,400	)
Sales, maturities and paydowns of securities available-for-sale		617,588			2,518,955
Purchases of securities available-for-sale		(1,751,219	)		(1,746,624	)
Proceeds from sale of SBA loans		1,776,104
Net change in loans		(23,796,625	)		(14,376,056	)

Net cash used for investing activities		(23,427,756	)		(13,797,434	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings, net of repayments		897,900			1,295,000
Proceeds from warrants exercised		3,750			—
Repurchase of organizational shares issued		(2,000	)		—
Net change in deposits		26,604,857			16,688,717

Net cash provided by financing activities		27,504,507			17,983,717

Increase in cash and cash equivalents		4,682,486			4,352,141

CASH AND CASH EQUIVALENTS BALANCE

Beginning of year or period		6,583,876			2,110,388


End of year or period	$	11,266,362		$	6,462,529

Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Income taxes	$	—		$	34,852

Interest	$	1,128,035		$	475,501


Supplemental Disclosures of Noncash Activities

Total change in unrealized losses on securities available-for -sale	$	(12,104	)	$	(30,028	)

The accompanying notes are an integral part of these financial statements.

NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

Note 1 — Summary of Significant Accounting Policies

The unaudited financial information included herein has been prepared in conformity with the accounting principles and practices disclosed in the consolidated financial statements, Note 1, included in the Annual Report of Discovery Bank (the “Bank”) for the year ended December 31, 2004, which the Company has adopted and included in its Registration Statement on Form S-4. The accompanying interim consolidated financial statements contained herein are unaudited. However, in the opinion of the management of Discovery Bancorp, and subsidiary (the “Company”), all adjustments, consisting of normal recurring items necessary for a fair presentation of the operating results for the periods shown, have been made.

Note 2 — Basis of presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

On June 22, 2005, all of the outstanding shares of the Bank were converted into shares of Discovery Bancorp. The Consolidated Financial Statements as of June 30, 2005, and for the three and six month periods then ended include the Company, the Bank and its wholly owned subsidiary. The Consolidated Financial Statements as of December 31, 2004 are derived from the unaudited Bancorp Financial Statements and the audited Financial Statements of the Bank and its subsidiary. These consolidated financial statements should be reviewed in conjunction with the consolidated financial statements and notes thereto included in the Bank’s December 31, 2004 Annual Report to Stockholders. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial statements have been included. Operating results for the three and six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005.

Note 3 — Stock option plan

The Company has a stock-based employee compensation plan which replaces the stock-based compensation plan previously adopted by the Bank. The Company (and previously the Bank) accounts for this plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock as of the grant date. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock Based Compensation” (as amended by SFAS No. 148) the Company is required to disclose the pro forma effect on earnings of stock options granted, had compensation cost been recognized over the vesting period of the options based on a fair value of the options.

The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of FASB Statement No. 123(r), “Accounting for Share-Based Payments,” to stock-based employee compensation. The significant assumptions used by the Company’s management in computing these amounts are disclosed in Note 12 to the Bank’s audited financial statements.


	For the three months ended				For the six months ended
	June 30,				June 30,
	2005		2004		2005		2004
			(dollars in thousands)
Net income	$	208,063	$	30,883	$	209,413	$	94,975
Additional compensation for fair value of stock options		2,090		1,146		16,734		6,909

Pro forma net income	$	205,973	$	29,737	$	192,679	$	88,066

Basic EPS:
As reported	$	0.20	$	0.03	$	0.20	$	0.09

Pro Forma	$	0.20	$	0.03	$	0.19	$	0.09

Diluted EPS:
As reported	$	0.19	$	0.03	$	0.19	$	0.09

Pro Forma	$	0.19	$	0.03	$	0.18	$	0.09

Note 4 — Earnings Per Share

Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Bank relate solely to outstanding stock options, and are determined using the treasury stock method.


	Earnings per share calculation
	For the three months ended June 30
			2005							2004
			Weighted							Weighted
			Average							Average		Per
	Net		Shares		Per Share			Net		Shares		Share
	Income		Outstanding		Amount			Income		Outstanding		Amount
Basic EPS:
Income available to common shareholders	$	208,063		1,037,498	$	0.20		$	30,883		1,037,298	$	0.03
Effect of dilutive securities:
Stock options		—		55,449	($	0.01	)		—		56,836		—

Diluted EPS:
Income available to common shareholders	$	208,063		1,092,847	$	0.19		$	30,883		1,094,134	$	0.03


	Earnings per share calculation
	For the six months ended June 30
			2005							2004
			Weighted							Weighted
			Average							Average
	Net		Shares		Per Share			Net		Shares		Per Share
	Income		Outstanding		Amount			Income		Outstanding		Amount
Basic EPS:
Income available to common shareholders.	$	209,413		1,037,398	$	0.20		$	94,975		1,037,298	$	0.09
Effect of dilutive securities:
Stock options		—		60,391	($	0.01	)		—		56,819		—

Diluted EPS:
Income available to common shareholders.	$	209,413		1,097,789	$	0.19		$	94,975		1,094,117	$	0.09

Note 5 — Recently Issued Accounting Pronouncements

In May 2005 the FASB issued FASB 154 which replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed.

Opinion 20 previously required that most voluntary changes in accounting principles be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable.

This Statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. This Statement also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error.

This Statement requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in nondiscretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change.

This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle.

This Statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This Statement also carries forward the guidance in Opinion 20 requiring justification of a change in accounting principle on the basis of preferability.

At June 30, 2005 the Company and the Bank had no changes in accounting principles.

In June 2004, the Emerging Issues Task Force of the FASB issued final guidance on its Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” A consensus was reached regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

This EITF describes a model involving three steps: (1) determine whether an investment is impaired, (2) determine whether the impairment is other-than -temporary, and (3) recognize the impairment loss in earnings. The EITF also requires several additional disclosures for cost-method investments. The EITF’s impairment accounting guidance was effective for reporting periods beginning after June 15, 2004. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective for fiscal years ending after June 15, 2004.

The adoption of this EITF did not have a material impact on the Bank’s financial statements. At December 31, 2004 and 2003, management believes the impairments described above are temporary and, accordingly, no impairment loss has been recognized in the Company’s consolidated statement of income. As of June 30, 2005, management continues to believe these impairments are temporary in nature.

On March 9, 2004, the Staff of the Securities and Exchange Commission (the “SEC Staff”) issued Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments” (“SAB 105”). SAB 105 provides guidance on the initial recognition and measurement of loan commitments that meet the definition of a derivative, and summarizes the related disclosure requirements. SAB 105 is effective for all loan commitments accounted for as derivatives that are entered into, or substantially modified, on or after April 1, 2004. SAB 105 addresses loan commitments that the Financial Accounting Standards Board (FASB) defines as derivatives in paragraph 6 of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“FAS 133”). These loan commitments relate to the origination of mortgage loans that will be held for sale. SAB 105 does not apply to (1) commitments to purchase mortgage loans that do not meet the definition of a derivative under paragraph 6 of FAS 133 or (2) commitments that are explicitly excluded from the scope of FAS 133 (i.e., commitments to originate mortgage loans that will be held for investment purposes and loan commitments to originate other types of loans). The Bank does not currently originate mortgage loans to be held for sale. If that should change in the future, we would take SAB 105 into consideration but do not expect it to have a material impact on the Company’s financial condition or operating results.

In December 2003, under clearance of the FASB, the Accounting Standards Executive Committee (AcSEC) of the AICPA issued Statement of Position (“SOP”) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. This SOP establishes accounting standards for discounts on purchased loans when the discount is attributable to credit quality. The SOP requires that the loan discount, rather than the contractual amounts, establishes the investor’s estimate of undiscounted expected future principal and interest cash flows as a benchmark for yield and impairment measurements. The SOP prohibits the carryover or creation of a valuation allowance in the initial accounting for these loans. This SOP is effective from loans acquired in years beginning after December 15, 2004. Since this SOP applies only to transfers after 2004, this Statement will have no impact on the Company’s financial position or results of operation at adoption.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

Introduction.

Discovery Bancorp (“Bancorp” or the “Company”) is the holding company for Discovery Bank (the “Bank”), headquartered in San Marcos, California. When the holding company reorganization was consummated on June 22, 2005, Bancorp became a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and Bancorp’s principal business is serving as a holding company for the Bank and its wholly-owned subsidiary. In addition to serving as the holding company for the Bank, Bancorp, through its wholly-owned subsidiary, Celtic Merger Corp., intends to acquire certain assets and assume certain liabilities of Celtic Capital Corporation (“Celtic”). Please refer to Bancorp’s Registration Statement on Form S-4 for more information regarding the holding company reorganization, the Celtic acquisition and the proposed offering.

The following discussion is designed to provide a better understanding of significant trends related to the Company’s financial condition, results of operations, liquidity, capital resources and interest rate sensitivity. This discussion focuses primarily on the results of operations of the Company on a consolidated basis for the three and six months ended June 30, 2005 and June 30, 2004, and the financial condition of the Company as of June 30, 2005 and December 31, 2004. Comparisons of the three months ended June 30, 2005 to June 30, 2004, and comparisons of the six months ended June 30, 2005 and June 30, 2004 are primarily impacted by the Bank’s growth. For a more complete understanding of the Company and its operations, reference should be made to the financial statements included in this report and to the Bank’s audited financial statements for the years ended December 31, 2004 and 2003 and the Company’s Form 10-QSB for the quarter ended March 31, 2005.

Our continued growth since commencement of operations in September 2001 has been the primary factor impacting profitability over the periods reflected in this discussion. However, although the Company anticipates that continued growth will further enhance the results of operations, the Company’s future results of operations could materially differ from those suggested by the forward-looking statements contained in this report or the annualized results of our operations for the three months and six months ended June 30, 2005, depending upon changes to things such as:

	•		competition within the banking industry;

	•		changes in the interest rate environment;

	•		general economic conditions, nationally, regionally and in our market areas, including declines in real estate values;

	•		the effects of terrorism and the conduct of the war on terrorism by the United States and its allies;

	•		the regulatory environment;

	•		business conditions and inflation;

	•		the securities markets;

	•		technology;

	•		regulatory compliance issues;

	•		planned asset growth;

	•		unanticipated loan losses;

	•		unanticipated increases in operating expenses; and

	•		the ability to generate fee and other non-interest income.

Critical Accounting Policies.

The Company’s financial statements and the notes thereto, have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the financial statements. On an ongoing basis, the Company evaluates estimates and assumptions based upon historical experience and various other factors and circumstances. The Company believes that these estimates and assumptions are reasonable; however, actual results may differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

The Company has adopted the significant accounting policies and practices of the Bank which are described in Note 1 to the Bank’s audited financial statements as of December 31, 2004. The accounting policies that involve significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, are considered critical accounting policies. The Bank has identified the policies for allowance for loan losses, securities available for sale, and income taxes as critical accounting policies which are summarized below.

Allowance for Loan Losses. The Bank maintains an allowance for loan losses at an amount which the Bank believes is sufficient to provide adequate protection against losses in the loan portfolio. Our periodic evaluation of the adequacy of the allowance is based on such factors as our past loan loss experience, known and inherent risks in the portfolio, adverse situations that have occurred but are not yet known that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and economic conditions. As the Bank utilizes information currently available to evaluate the allowance for loan losses, the allowance for loan losses is subjective and may be adjusted in the future depending on changes in economic conditions or other factors.

During the time the Bank holds collateral, it is subject to credit risks, including risks of borrower defaults, bankruptcies and special hazard losses that are not covered by standard hazard insurance (such as those occurring from earthquakes or floods). Although the Bank has established an allowance for loan losses that the Bank considers adequate, there can be no assurance that the established allowance for loan losses will be sufficient to offset losses on loans in the future.

Securities Available-for-Sale. Securities available-for-sale are recorded at fair value, based on quoted market prices. Unrealized holding gains and losses, net of income taxes, in securities available-for-sale, based on quoted market prices, are reported as other comprehensive income (loss) in the period incurred. Premiums and discounts on purchased securities are recognized as an adjustment to yield over the term of the security. Declines in the fair value of securities available-for-sale below the original purchase price that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities available-for-sale are recorded on the trade date and are determined using the specific identification method.

Income Taxes. The Company records provision for income taxes under the asset liability method. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred taxes result from temporary differences in the recognition of certain income and expense amounts between our financial statements and our tax return. The principal items giving rise to these differences include the allowance for loan losses, unused net operating losses, and organization and start-up costs. We have recognized a deferred income tax asset as of December 31, 2004 and June 30, 2005, of $292,000 and $262,000, respectively. The Company evaluates such realizability based upon anticipated tax income from forecast models.

General.

The Company earned $208,063 for the three months ended June 30, 2005, or $0.19 per diluted share, and $209,413, or $0.19 per diluted share, for the six months ended June 30, 2005. This compares to earnings of the Bank of $30,883 or $0.03 per diluted share and $94,975 or $0.09 per diluted share for the same periods in 2004. Improved performance from June 2004 in before tax earnings is primarily related to continued growth in interest-earning assets, funded by growth in deposits, combined with increase in rental income and gain on sale of SBA loans, partially offset by increased professional expenses.

Effective December 15, 2004, the Bank terminated the lease agreement for the premises at 1145 San Marino Dr. and relocated its main office to 338 Via Vera Cruz, San Marcos. The new premises consists of a two story commercial building with approximately 28,000 square feet of usable space. The Bank occupies approximately 13,000 square feet with the remaining space leased on a short-term basis. The building was purchased by the Bank’s subsidiary, San Marcos Building, LLC, for $4,950,000 with escrow closing on July 22, 2004. The subsidiary is wholly-owned by the Bank.

Total assets increased $28.2 million or 28.4%, to $127,407,000 at June 30, 2005, from $99,206,000 at December 31, 2004. Loans, net of unearned income, increased 27.5% to $103,351,000 at June 30, 2005, from $81,035,000 at December 31, 2004. The increases in total assets and loans were primarily funded by a $26.6 million increase in deposits to $106,277,000 at June 30, 2005, from $79,672,000 at December 31, 2004.

Stockholders’ equity was $10,499,000 at June 30, 2005, compared to $10,299,000 at December 31, 2004. The increase reflects profitability during the period.

The following sections present various tables reflecting the Company’s results of operations and financial condition for the periods ended June 30, 2005 and December 31, 2004. Bank averages and rates have been calculated using daily averages. Monthly averages were used for the parent holding company and the building company; however, because these balances are small relative to the Bank, and do not impact interest-earning assets or interest-bearing liabilities, management believes the impact of using monthly versus daily average balances is not material. No assurance can be given that the annualized rates and results of operations for the three and six months ended June 30, 2005 is indicative of the rates and results of operations that may be expected for the year ending December 31, 2005.

Distribution of Assets, Liabilities and Shareholders’ Equity.

The Company’s earnings depend largely upon the difference between the income we receive from interest-earning assets, which are principally our loan portfolio and investment securities; and the interest paid on our interest-bearing liabilities, which consist of deposits and borrowings. This difference is net interest income. Net interest margin is net interest income expressed as a percentage of average total interest-earning assets. Net interest spread is the difference between the rate earned on interest-earning assets and the rate paid on interest-bearing liabilities.

The following tables provide information, for the periods indicated, on the average amounts outstanding for the major categories of interest-earning assets and interest-bearing liabilities, the amount of interest earned or paid, the yields and rates on major categories of interest-earning assets and interest-bearing liabilities, the net interest margin and net interest spread, return on assets, return on equity, and equity to assets ratio.


	Three Months Ended June 30,
	2005							2004
			Interest		Rates					Interest		Rates
	Average		Income/		Earned/			Average		Income/		Earned/
	Balance		Expense		Paid¹			Balance		Expense		Paid¹
					(dollars in thousands)
Assets
Investment securities	$	3,606	$	44		4.89	%	$	2,196	$	22		4.02	%
Interest-bearing deposits		2,862		18		2.52	%		2,506		10		1.60	%
Federal funds sold		7,490		58		3.11	%		2,826		7		0.99	%
Loans, net²		98,681		1,924		7.82	%		67,945		1,132		6.68	%

Total Interest-Earning Assets		112,639		2,044		7.28	%		75,473		1,171		6.22	%
Noninterest-earning assets		12,385							3,935

Total Assets	$	125,024						$	79,408


Liabilities
Transaction and NOW accounts	$	6,752		16		0.95	%	$	6,878		20		1.17	%
Savings and money market		20,069		110		2.20	%		12,360		44		1.43	%
Time deposits		59,443		485		3.27	%		34,622		175		2.03	%
Borrowings		9,252		75		3.25	%		3,264		9		1.11	%

Total Interest-Bearing Liabilities		95,516		686		2.88	%		57,124		248		1.74	%

Demand deposits		17,610							12,223
Other liabilities		1,565							196

Total Liabilities		114,691							69,543
Shareholders’ Equity		10,333							9,865


Total Liabilities and Shareholders’ Equity	$	125,024						$	79,408

Net interest margin³			$	1,358		4.84	%			$	923		4.91	%

Net interest spread⁴						4.40	%						4.48	%
Return on Average Assets						0.67	%						0.16	%
Return on Average Equity						8.06	%						1.25	%
Average Equity to Average Assets Ratio						8.3:1							12.4:1

Three Months Ended June 30, 2005 and 2004. Average interest-earning assets increased to $112,639,000 during the three months ended June 30, 2005, from $75,473,000 during the same period in 2004. The average yield on these assets increased to 7.28% from 6.22%. Average interest-bearing liabilities, consisting primarily of interest-bearing deposits, increased to $95,516,000 during the three months ended June 30, 2005, from $57,124,000 during the same period in 2004. The average rate paid on interest-bearing liabilities increased to 2.88% for the three months ended June 30, 2005, from 1.74% for the same period in 2004. The increase in the yield on interest-earning assets resulted from interest rate increases during the second quarter of 2005. The increase in the rate paid on interest-bearing liabilities was primarily the result of the rate increases experienced within market. Average noninterest-bearing demand deposit accounts, consisting primarily of business checking accounts, increased 44.1% for the three months ended June 30, 2005 to $17,610,000 from $12,223,000 for same period in 2004.

Net interest income for the three months ended June 30, 2005, was $1,358,000, which increased $435,000, or 47.2%, over the same period in the prior year. Our net interest margin decreased 7 basis points to 4.84% for the three months ended June 30, 2005, compared to 4.91% for the same period in 2004. The decrease in net interest margin was primarily the result of the higher rates paid on interest-bearing liabilities.


¹		The ratios have been annualized.

²		Average loans are net of unearned loan fees and allowances for loan losses. Unearned loan fees were $206,000 and $166,000 at June 30, 2005 and 2004, respectively. Allowances for loan losses were $1,280,000 and $890,000 at June 30, 2005 and 2004, respectively. Interest income from loans includes loan fees of $76,000 and $62,000 for the three months ended June 30, 2005 and 2004, respectively.

³		Net interest income as a percentage of average interest-earning assets.

⁴		Net interest spread is the absolute difference between the rate earned on interest-earning assets and the rate paid on interest-bearing liabilities.


	Six Months Ended June 30,
	2005							2004
			Interest		Rates					Interest		Rates
	Average		Income/		Earned/			Average		Income/		Earned/
	Balance		Expense		Paid¹			Balance		Expense		Paid¹
	(dollars in thousands)
Assets
Investment securities	$	3,258		70		4.33	%	$	2,385	$	37		3.11	%
Interest-bearing deposits		2,871		36		2.53	%		2,521		27		2.15	%
Federal funds sold		6,844		98		2.89	%		2,392		12		1.01	%
Loans, net²		92,483		3,488		7.61	%		64,756		2,145		6.64	%

Total Interest-Earning Assets		105,456		3,692		7.06	%		72,054		2,221		6.18	%
Noninterest-earning assets		11,803							3,819


Total Assets		117,259						$	75,873


Liabilities
Transaction and NOW accounts	$	6,749		33		0.99	%	$	5,952		33		1.11	%
Savings and money market		20,460		211		2.08	%		11,556		85		1.48	%
Time deposits		52,737		818		3.13	%		33,750		350		2.08	%
Borrowings		9,005		130		2.91	%		3,057		17		1.12	%

Total Interest-Bearing Liabilities		88,951		1,192		2.70	%		54,315		485		1.79	%

Demand deposits		17,094							11,405
Other liabilities		871							171

Total Liabilities		106,916							65,891
Shareholders’ Equity		10,343							9,982


Total Liabilities and Shareholders’ Equity	$	117,259						$	75,873

Net interest margin³			$	2,500		4.78	%			$	1,736		4.83	%

Net interest spread⁴						4.36	%						4.39	%
Return on Average Assets						0.36	%						0.25	%
Return on Average Equity						4.05	%						1.90	%
Average Equity to Average Assets Ratio						8.8:1							13.2:1

Six Months Ended June 30, 2005 and 2004. Average interest-earning assets increased to $105,456,000 during the six months ended June 30, 2005, from $72,054,000 during the same period in 2004. The average yield on these assets increased to 7.06% for the six months ended June 30, 2005 from 6.18% for the same period in 2004. This average yield increase was related to the prime rate which increased during the last twelve months. Average interest-bearing liabilities, consisting primarily of interest-bearing deposits, increased to $88,951,000 during six months ended June 30, 2005, from $54,315,000 during the same period in 2004. The average rate paid on these deposits increased to 2.70% for the six months ended June 30, 2005, from 1.79% for the same period in 2004. The increase in the rate paid on interest-bearing liabilities was primarily the result of the rate increases experienced within the market. In addition, our growth in core deposits offset the need to offer very competitive rates in the time certificate of deposit market. Average noninterest-bearing demand deposit accounts, consisting primarily of business checking accounts, increased 49.9% for the six months ended June 30, 2005 to $17,094,000 from $11,405,000 for same period in 2004.


¹		The ratios have been annualized.

²		Average loans are net of unearned loan fees and allowances for loan losses. Unearned loan fees were $206,000 and $166,000 at June 30, 2005 and 2004, respectively. Allowances for loan losses were $1,280,000 and $890,000 at June 30, 2005 and 2004, respectively. Interest income from loans includes loan fees of $139,000 and $108,000 for the six months ended June 30, 2005 and 2004, respectively

³		Net interest income as a percentage of average interest-earning assets.

⁴		Net interest spread is the absolute difference between the rate earned on interest-earning assets and the rate paid on interest-bearing liabilities.

Net interest income for the six months ended June 30, 2005, was $ 2,500,000, which increased $764,000, or 44.0%, over the same period in the prior year. Our net interest margin declined 5 basis points to 4.78% for the six months ended June 30, 2005, compared to 4.83% for the same period in 2004. The decrease in net interest margin was the result of an overall higher cost of funding loan growth.

Net Interest Income and Net Yield.

Net interest income is affected by changes in the level and the mix of interest-earning assets and interest-bearing liabilities. The changes between periods in these assets and liabilities are referred to as volume changes. The impact on net interest income from changes in average volume is measured by multiplying the change in volume between the current period and the prior period by the prior period rate.

Net interest income is also affected by changes in the yields earned on assets and rates paid on liabilities. These are referred to as rate changes and the impact on net interest income from these changes is measured by multiplying the change in rate between the current and prior period by the average volume of the prior period. Changes in rate-volume between periods, which is measured by the change in rate multiplied by the change in volume, are allocated on a pro rata basis between the volume and the rate changes. The following table reflects the rate and volume changes for the periods indicated:


	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2005 Compared to the Three Months								2005 Compared to the Six Months
	Ended June 30, 2004								Ended June 30, 2004
	Increase (Decrease) Due To Change In								Increase (Decrease) Due To Change In
						Total								Total
	Volume		Rate			Change			Volume		Rate			Change
						(dollars in thousands)
Interest-Earning Assets
Investment securities	$	20	$	2		$	22		$	20	$	13		$	33
Interest-earning deposits		1		7			8			4		5			9
Federal funds sold		12		39			51			22		64			86
Loans		512		280			792			902		441			1343

Total Interest Income		545		328			873			948		523			1471


Interest-Bearing Liabilities
Transaction and Now Accounts		—		(4	)		(4	)		4		(4	)		—
Savings and Money Market		27		39			66			65		61			126
Time Deposits		125		185			310			196		272			468
Borrowings		17		49			66			33		80			113

Total Interest Expense		169		269			438			298		409			707

Net Interest Income	$	376	$	59		$	435		$	649	$	114		$	764

Investments.

In order to maintain a reserve of readily saleable assets to meet our liquidity and loan requirements, the Bank purchases United States Treasury and Agency securities and other investments. Sales of Federal Funds and short-term loans to other banks are regularly utilized. Placement of funds in certificates of deposit with other financial institutions may be made as alternative investments pending utilization of funds for loans or other purposes. None of our securities are pledged to meet security requirements imposed as a condition to receipt of public fund deposits or for other purposes. Our policy is to stagger the maturities of our investments to meet our overall liquidity requirements.

At June 30, 2005 and December 31, 2004 our investment portfolio consisted of U.S. Agency securities and mutual funds. All of our securities are classified as available-for-sale. Available-for-sale securities are bonds, notes, debentures, and certain equity securities that are not classified as trading securities or as held-to-maturity securities. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net

amount in a separate component of capital until realized. Gains and losses on the sale of available-for-sale securities are determined using the specific identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.

The following tables summarize the amounts and the distributions of our investment securities as of the dates indicated:

Investment Portfolio


	June 30, 2005									December 31, 2004
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
	(dollars in thousands)
Available-for-Sale:
Obligations of US Govt. Agency Book	$	3,849		—	($	22	)	$	3,827	$	2,716		—	($	10	)	$	2,706

Total	$	3,849		—	($	22	)	$	3,827	$	2,716		—	($	10	)	$	2,706

As of June 30, 2005 and December 31, 2004, the Bank also owned $60,000 in Pacific Coast Bankers’ Bancorp common stock. In addition, as of June 30, 2005 and December 31, 2004, the Bank also owned $452,000 and $423,000, respectively, in Federal Home Loan Bank stock.

Loans

Loan Categories. The following table sets forth the components of total net loans outstanding in each category at the dates indicated :


	June30,						December 31,
	2005						2004
				Percent of						Percent of
	Amount			Total			Amount			Total
				(dollars in thousands)
Loan Category
Real estate loans:
Construction loans	$	20,553			20	%	$	10,420			13	%
Real estate 1st trust deeds		37,609			36			36,716			45
Other real estate mortgage		6,384			6			2,528			3

Total real estate		64,546			62			49,664			61
Business secured loans		29,982			29			24,855			31
Business unsecured loans		1,790			2			1,147			1
Consumer and other		7,238			7			5,546			7

Total Loans		103,556			100	%		81,212			100	%

Less deferred loan income		(206	)					(177	)
Less allowance for loan losses		(1,280	)					(998	)

Net Loans	$	102,070					$	80,037

The Bank provides a variety of credit products to meet the needs of borrowers in our service area. The Bank offers both secured and unsecured loans for working capital, equipment acquisition, expansion, purchase or improvement of real property, as well as seasonal loans and lines of credit. The Bank maintains a portfolio of interim construction loans. Other real estate loans primarily consist of commercial loans secured by real estate collateral and “mini-perm” real estate financing. Commercial loans are made available to business and professional customers. Consumer loans are offered for a variety of personal, family household needs, including automobiles, home equity loans and unsecured revolving lines of credit.

The Bank’s loan portfolio has consistently increased since the Bank commenced operations in September 2001. Loan growth is the result of increased lending in our immediate market area and the opening of an additional banking office in Poway in 2004, which services the nearby communities of Poway, Carmel Mountain, Rancho Bernardo, Rancho Penesquitos, Ramona and Scripps Ranch. In addition, our increasing lending limits that result from the growth of our capital allows us to make larger loans. The size of a loan that a bank can make is limited by regulation to a percentage of the institution’s regulatory capital.

Commercial and industrial loans are made for the purpose of providing working capital, financing the purchase of equipment or for other business purposes. Such loans include loans with maturities ranging from thirty days to one year and term loans, which are loans with maturities normally ranging from one to five years. Commercial loans may be unsecured or secured, including real estate collateral as well as special purpose or rapidly depreciating assets, such as equipment, inventory, receivables, and junior liens on property or personal guarantees which may not provide an adequate source of repayment in the event of default. These loans may also have partial guarantees from the Small Business Administration. A growing portion of commercial loans are asset-based loans, which are loans secured by current assets, such as receivables or inventory, or fixed assets, such as equipment. These loans are used for working capital, equipment purchases, seasonal cash shortages, and a variety of other purposes, and are structured on either a revolving or term basis.

Commercial loans secured by real estate are generally greater in amount, more difficult to evaluate and monitor and are often dependent on the successful operation and management of the properties. Repayment of such loans may be affected by adverse conditions in the real estate market or the economy. Poor location, special use characteristics and overall attractiveness of the properties may impair the value of properties in the event of foreclosure.

Commercial business loans are generally more dependent on the borrower’s continuing financial strength and management ability. The borrower’s cash flow and ability to service the debt from earnings is the primary source of repayment rather than the liquidation of any pledged collateral. Commercial business loans are generally for shorter terms and are often subject to annual review and generally require more administrative and management attention.

The Bank makes SBA guaranteed loans. The guaranteed portion of the SBA loans may be sold in the secondary market. Our SBA loans are categorized as commercial or real estate depending on the underlying collateral.

The Bank maintains a portfolio of real estate construction loans, consisting of single-family homes and commercial construction loans. At June 30, 2005 and December 31, 2004, real estate construction loans comprised approximately 20% and 13%, respectively, of our loan portfolio. Our real estate construction loans are primarily interim loans made to finance the construction of commercial and single family residential property. These loans are typically short term. Construction lending is generally considered to involve a higher degree of risk than permanent mortgage lending because of the inherent difficulty in estimating both a property’s value at completion of the project and the cost of the project. If the estimate of construction cost proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, the Bank may be confronted with a project the value of which is insufficient to assure full repayment. Disagreements between borrowers and builders and the failure of builders to pay subcontractors may also jeopardize projects. Loans to builders to construct projects for which no purchaser has been identified carry additional risk because the payoff for the loan may be dependent on the contractor’s ability to sell the property prior to the due date of the loan. The Bank addresses these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices.

The Bank’s real estate 1^st trust deed loans consist primarily of loans made based on the borrower’s cash flow and which are secured by deeds of trust on commercial and residential property to provide another source of repayment in the event of default. At June 30, 2005 and December 31, 2004, 1^st trust deed secured loans comprised approximately 36% and 45%, respectively, of our loan portfolio.

Other real estate mortgage loans consist of loans made based primarily on the borrower’s cash flow and which are secured by junior liens as secondary sources of repayments. Maturities on these loans are generally restricted to ten years (on an amortization ranging from ten to twenty-five years with a balloon payment due at maturity). Any loans extended for greater than five years have re-pricing provisions that adjust the interest rate to market rates at times prior to maturity.

Consumer loans, as well as home equity lines of credit, are made for the purpose of financing automobiles, various types of consumer goods and other personal purposes. Consumer loans generally provide for the monthly payment of principal and interest. Consumer loans are often unsecured or secured by rapidly depreciating assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Also, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

The Bank does not have any concentrations in our loan portfolio by industry or group of industries, except for the level of loans that are secured by real estate as presented in the table above. The Bank has not made loans to any foreign entities. In addition, the Bank have not made any loans to finance leveraged buyouts or for highly leveraged transactions.

Loan Origination and Underwriting. Our primary lending emphasis is in construction, commercial real estate and business loans, including SBA loans. Major credit risk factors for all categories of loans include: changes in national and local economic conditions; the experience, ability and depth of our lending staff; changes in the quality of our internal and external loan review systems; and the impact of certain external factors such as competition, legal and regulatory changes. For construction and other real estate related loans, additional major risk factors include: changes in the valuation of real property; increases in commercial, industrial and retail vacancy rates; market absorption levels; excess market supply; and rising interest rates. To address these credit risks, all loan requests require preparation of a credit commitment report that details the purpose of the loan, terms, repayment source, collateral, credit rating of the borrower and a general description of the borrower’s background and/or business. The loan request is then subjected to various levels of review to assure that larger loans are reviewed by more experienced lenders and/or the Bank’s loan committee. The Bank’s loan policy establishes criteria for various types of loans, such as loan to collateral value ratios or loan to debt ratios. Further, the Bank utilizes outside loan reviewers to review and assess the loans made on an ongoing basis.

Branch officers are assigned lending limits commensurate with their experience and skill and are capped at $5,000 for unsecured loans and $25,000 for secured loans. Loan requests exceeding branch officer limits are referred to Loan Administration for underwriting, review and approval. Lending limits for Loan Administration lenders are capped at $50,000 for unsecured and secured loan. The President/Chief Executive Officer, the Chief Administrative Officer and the Chief Credit Officer have combined lending limits when any two acting jointly of $750,000 for secured and $250,000 for unsecured loans. All requests exceeding this combined authority are submitted to the Board of Director’s Loan Committee for approval. Additionally, all new loans, regardless of amount, are reviewed by the Board of Directors monthly and all new loans of $100,000 or more or relationships that aggregate $100,000 or more are reported to the Board of Director’s Loan Committee weekly. All processing, boarding and servicing of loans are performed by Loan Administration regardless of loan amount.

Construction loans for small tract projects or non-residential properties generally require a minimum of 20% equity contribution by the borrower and a maximum advance of 75% of current appraisal. Loan terms can range from 12 to 18 months depending on the nature of the project. The Bank requires a first lien position on the property to be constructed and often take a junior lien on other real estate property as well. Land draws are generally limited to 50% of cost. Pricing is generally in the range of Wall Street Journal Prime plus 1.5% to 2.5%, loan fees of .5% to 1% and a documentation fee of $250 to $500.

Commercial real estate loans are generally underwritten at a maximum loan to appraised value of 75%; however, the Bank will often advance up to 90% of the value when using the SBA 504 or 7a loan guarantee programs as part of the financing structure for owner-users. Income property loans generally require a debt service coverage ratio of 1.25:1 to 1.30:1 depending on the type of property. Loan terms can range from 20 to 25 years with pricing adjustments at 3 or 5year intervals. The Bank requires a first lien position on the subject property and often takes a junior lien on other real estate property as well. Pricing is generally in the range of Wall Street Journal Prime plus 1% to 2% with a negotiated floor rate, loan fees of .5% to 1% and a documentation fee of $250 to $500. The Bank also offers short-term fixed rate loans when necessary.

Commercial business loans and SBA 7a loans are offered to existing and start-up businesses for various purposes. Such loans are generally collateralized with assets of the business and junior liens on personal residences. Commercial business loans are underwritten on the basis of the borrower’s cash flow and ability to service the debt from earnings rather than on the basis of the underlying collateral value. The Bank seeks to structure these loans so

that they have more than one source of repayment. The borrower is required to provide sufficient information to allow us to make an adequate credit evaluation. In most instances, this information consists of financial statements, tax returns, projected cash flows, current financial information on any guarantor and information about any collateral. Loans to closely held business borrowers typically require personal guarantees by the principals. Lines of credit and asset-based loans are written for 12 months. SBA loans can have terms of up to 25 years. Pricing is generally in the range of Wall Street Journal Prime plus 1.50% to 2.75% with a negotiated floor rate, loan fees of .5% to 1% and a documentation fee of $250 to $500. Loan fees for non-SBA loans can range from .5% to 1%.

Current appraisals, insurance and perfected liens are generally required for any collateral taken on loans.

Loan Commitments. In the normal course of business, the Bank maintains outstanding loan commitments to extend credit. The Bank uses the same credit policies in making loan commitments as the Bank does in extending loans to customers. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the customer. The types of collateral held varies, but may include accounts receivable, inventory, property, equipment and residential and income producing commercial properties. The Bank had unfunded loan commitments, including standby letters of credit, totaling $27.7 million and $22.4 million at June 30, 2005 and December 31, 2004, respectively, primarily consisting of commercial, construction and equity lines of credit. Based upon the Bank’s experience, the outstanding loan commitments and standby letters of credit are expected to grow throughout the year as loan demand continues to increase, subject to, economic conditions.

Adverse economic conditions, a decline in real estate values, or a significant increase in interest rates could negatively affect the construction loan business and require an increase in the provision for loan losses, which in turn, could adversely affect our future prospects, results of operations, and profitability.

Non-Performing Assets. It is our policy to place loans on non-accrual status when principal or interest payments are past due 90 days or more. Certain loans will be placed on nonaccrual earlier if there is a reasonable doubt as to the collectibility of principal and interest. Loans which are in the process of renewal in the normal course of business or are well secured and in the process of collection will continue to accrue interest if the Bank considers the risk of loss to be minimal.

Nonperforming assets at June 30, 2005 increased $726,000 from zero at December 31, 2004, representing 0.70% of gross loans. The increase relates to one commercial real estate construction loan, for which management believes there is no loss exposure. There were no other non-accrual loans, loans past due 90 days or more, restructured loans, or impaired loans or loans that have or had a higher than normal risk of loss.

As of June 30, 2005, the Bank has identified $1,804,000 in loans on our internal watch list for special attention by our management and board of directors, of which $1,271,000 is guaranteed by government and other agencies. These loans reflect weakened financial conditions or evidence other factors warranting closer monitoring, but are performing in accordance with their terms.

Allowance and Provision for Loan Losses

The Bank maintains an allowance for loan and lease losses to provide for probable losses in the loan portfolio. Additions to the allowance are made by charges to operating expenses in the form of a provision for loan and lease losses. All loans which are judged to be uncollectible are charged against the allowance while any recoveries are credited to the allowance. The Bank has instituted loan policies, designed primarily for internal use, to adequately evaluate and assess the analysis of risk factors associated with our loan portfolio and to enable us to assess such risk factors prior to granting new loans and to assess the sufficiency of the allowance. The Bank conducts a critical evaluation of the loan portfolio monthly. This evaluation includes an assessment of the following factors: the results of our internal loan review, any external loan review and any regulatory examination, loan loss experience, estimated potential loss exposure on each credit, concentrations of credit, value of collateral, any known impairment in the borrower’s ability to repay and present economic conditions. Until the Bank has established some historical trend of losses, it relies on industry standards to compare allowance adequacy.

Each month the Bank also reviews the allowance and makes additional transfers to the allowance as needed. For the three and six months ended June 30, 2005, the provision for loan losses was $124,000 and $282,000, respectively, as compared to $118,000 and $151,000, respectively, for the same periods in 2004.

At June 30, 2005, the allowance was 1.24% of the loans then outstanding. At December 31, 2004, the allowance for loan losses was 1.23% of loans outstanding. Although the Bank deemed these levels adequate, no assurance can be given that further economic difficulties or other circumstances which would adversely affect our borrowers and their ability to repay outstanding loans will not occur which would be reflected in increased losses in our loan portfolio, which losses could possibly exceed the amount then reserved for loan losses.

The following table summarizes our loan loss experience, transactions in the allowance for loan and lease losses and certain pertinent ratios for the periods indicated:


	June 30,						June 30,
	(unaudited)			December 31,			(unaudited)
	2005			2004			2004
				(dollars in thousands)
Outstanding loans:
End of the period	$	103,557		$	81,212		$	75,369
Average for the period	$	92,483		$	71,861		$	64,756
Allowance for loan losses:
Balance at beginning of period	$	998		$	760		$	760
Loans charged off		—			—			—
Recoveries		—			—			—
Provisions charged to operating expense		282			238			151

Balance at end of period	$	1,280		$	998		$	911

Ratios:
Net charge-offs (recoveries) to average loans		—			—			—
Allowance to loans at period end		1.24	%		1.23	%		1.21	%

The table below sets forth the allocation of the allowance for loan and lease losses by loan type as of the dates specified. The allocation of individual categories of loans includes amounts applicable to specifically identified as well as unidentified losses inherent in that segment of the loan portfolio and will necessarily change whenever management determines that the risk characteristics of the loan portfolio have changed. Management believes that any breakdown or allocation of the allowance for loan and lease losses into loan categories lends an appearance of exactness which does not exist, in that the allowance is utilized as a single unallocated allowance available for all loans and undisbursed commitments. The allocation below should not be interpreted as an indication of the specific amounts of or loan categories in which future charge-offs may occur:


	At June 30, 2005
	(unaudited)					At December 31.2004
	(dollars in thousands)
			Percent of					Percent of
			Loans in			Allowance		Loans in
	Allowance for		Category to			for Loan		Category to
	Loan Losses		Total Loans			Losses		Total Loans
Real Estate:
Construction	$	248		20	%	$	141		13	%
1^st Trust Deed R.E.		534		36	%		373		45	%
Other Real Estate		46		6	%		91		3	%

Total Real Estate		828		62	%		605		61	%
Business Secured		379		29	%		322		31	%
Business Unsecured		2		2	%		14		1	%
Consumer & other		71		7	%		57		7	%
Unallocated allowance		—		—			—		—

Total	$	1,280		100	%	$	998		100	%

Non-Interest Income.

Non-interest income increased $289,000 to $328,000 for the three months ended June 30, 2005, as compared to the three months ended June 30, 2004. The increase was primarily the result of a $136,000 increase in rental income associated with San Marcos, LLC and a $123,000 gain on the sale of SBA loans.

Non-interest income increased $410,000 to $482,000 for the six months ended June 30, 2005, as compared to the six months ended June 30, 2004. The increase was primarily the result of a $267,000 increase in rental income associated with San Marcos, LLC and a $123,000 gain on the sale of SBA loans.

Non-Interest Expense.

Non-interest expenses consist of salaries and related benefits, occupancy and equipment expense and other expenses. The tables below set forth the components of non-interest expenses as of the periods indicated:


	Three Months Ended June 30,
					Percentage
	2005		2004		Change
	(dollars in thousands)
Salaries and benefits	$	611	$	467		30.8	%
Occupancy expense		108		54		98.2	%
Furniture & Equipment		73		45		62.2	%
Data Processing		51		44		17.6	%
Advertising		32		23		41.4	%
Professional fees		210		52		301.1	%
Office supplies		18		12		51.4	%
Other expenses		150		110		36.0	%

Total	$	1,253	$	807		55.3	%


	Six Months Ended June 30,
					Percentage
	2005		2004		Change
	(dollars in thousands)
Salaries and benefits	$	1,123	$	884		27.1	%
Occupancy expense		219		105		108.1	%
Furniture & Equipment		139		89		56.5	%
Data Processing		100		84		18.4	%
Advertising		52		45		15.5	%
Professional fees		377		104		261.0	%
Office supplies		35		27		31.8	%
Other expenses		305		203		50.6	%

Total	$	2,350	$	1,541		52.5	%

Our non-interest expenses increased by $446,000, or 55.3%, for the three months ended June 30, 2005, compared to the three months ended June 30, 2004. The largest increases were in professional fees, which increased from $52,000 to $210,000, of which $128,000 was attributable to the holding company reorganization. Salaries and employee benefits increased from $467,000 to $611,000, and occupancy expense increased from $54,000 to $108,000. The increases in these categories reflected our growth.

Our non-interest expenses increased by $809,000, or 52.5%, for the six months ended June 30, 2005, compared to the six months ended June 30, 2004. The largest increases were in professional fees, which increased from $104,000 to $377,000 of which $230,000 was attributable to the holding company reorganization. Salaries and benefits increased from $884,000 to $1,123,000; occupancy expense increased from $105,000 to $219,000 and other expenses increased from $203,000 to $305,000. The increases in these categories reflected our growth.

Income Taxes.

The Company’s effective tax rates were 33.1% and 40.0% for the three months and six months ended June 30, 2005 and 18.3% and 17.7% for the three and six months ended June 30, 2004, respectively. The increase in the effective tax rate for the six months ended June 30, 2005 reflects the complete utilization of net operating loss carryforwards and the elimination of the valuation allowance against the deferred tax asset.

Cash and Cash Equivalents.

Cash and cash equivalents consist of cash on hand and due from correspondent banks and federal funds sold. The Bank maintains balances at correspondent banks adequate to cover daily clearings and other charges. Funds in excess of these needs are invested in overnight federal funds at correspondent banks. Cash and cash equivalents were $11,266,000 at June 30, 2005 and $6,584,000 at December 31, 2004. The increase from December 31, 2004 to June 30, 2005 was to provide liquidity as our asset size increased.

Deposits.

Deposits represent our primary source of funds to support our various lending and investment activities. Substantially all of our deposits are from individuals and businesses within our service area. The Bank has utilized brokered deposits from time to time, but they have never exceeded 20% of total deposits. The Bank has no known foreign deposits.

The following table sets forth the maturity of time certificates of deposit of $100,000 or more at June 30, 2005:


	June 30, 2005
	(unaudited)
	(dollars in thousands)
Three months or less	$	8,766
Over three to six months		22,101
Over six to twelve months		—
Over twelve months		—

Total	$	30,867

Borrowings.

Federal Home Loan Bank Advances at December 31, 2004 totaled $9,000,000, the highest outstanding during the year, with a rate of 2.35%. Average borrowing for the year ended December 31, 2004 was $4,723,000, with a weighted average rate of 1.59%. Federal Home Bank Loan Advances at June 30, 2005 totaled $9,898,000, the highest during the period, at a variable advance rate ranging from 2.30% to 3.44%. Average borrowing for the six month period ended June 30, 2005 was $9,005,000, with a weighted average rate of 2.91%. All advances are open-end overnight borrowings to supplement liquidity and are repaid during the periods when liquidity needs are met with deposits.

Capital Resources.

Under regulatory capital adequacy guidelines, capital adequacy is measured as a percentage of risk-adjusted assets in which risk percentages are applied to assets on as well as off-balance sheet, such as unused loan commitments and standby letters of credit. The guidelines require that a portion of total capital be core, or Tier 1, capital consisting of common shareholders’ equity and perpetual preferred stock, less goodwill and certain other deductions. Tier 2 capital consists of other elements, primarily non-perpetual preferred stock, subordinated debt and mandatory convertible debt, plus the allowance for loan losses, subject to certain limitations. The guidelines also evaluate the leverage ratio, which is Tier I capital divided by average assets. Moreover, as a new bank, the Bank was required to maintain Tier 1 capital to average assets of at least 8% during our first three years of operations.

The following table provides information regarding our regulatory capital ratios at June 30, 2005 and December 31, 2004. The decrease in the Bank’s ratios reflects increased asset growth. At June 30, 2005 and December 31, 2004, the Bank met or exceeded regulatory capital requirements to be considered “well capitalized,” as defined in the regulations issued by the FDIC, and it is the Bank’s intention to remain “well capitalized” in the future.

Risk-based capital ratios


							“Well			Minimum
							Capitalized”			Capital
	At 6/30/05			At 12/31/04			Requirement			Requirement
Discovery Bancorp:
Total Risk-Based capital ratio		10.20	%		11.59	%		10.00	%		8.00	%
Tier 1 Risk-Based capital ratio		9.07	%		10.57	%		6.00	%		4.00	%
Tier 1 Leverage Ratio		8.36	%		12.04	%		5.00	%		4.00	%

Discovery Bank:
Total Risk-Based capital ratio		10.50	%		12.41	%		10.00	%		8.00	%
Tier 1 Risk-Based capital ratio		9.36	%		11.30	%		6.00	%		4.00	%
Tier 1 Leverage Ratio		8.62	%		10.57	%		5.00	%		4.00	%

Liquidity and Liquidity Management.

Liquidity management for banks requires that funds always be available to pay deposit withdrawals and maturing financial obligations in accordance with their terms and to meet customer requests for loans. The acquisition of deposits has been our primary source of funds used to invest in earning assets. Other sources of funds have been the cash provided from operations, the proceeds of common stock sales and from borrowings. The Bank expects that deposits will continue to be the primary source of funds in future periods. The Bank emphasizes seeking demand deposits from business customers in our market area. If necessary, the Bank can also pursue the higher cost time deposits. Liquidity management for banks requires that funds always be available to pay deposit withdrawals and maturing financial obligations promptly and fully in accordance with their terms. One method banks utilize for acquiring additional liabilities is through the acceptance of “brokered deposits” (defined to include not only deposits received through deposit brokers, but also deposits bearing interest in excess of 75 basis points over market rates), typically attracting large certificates of deposit at high interest rates.

The Bank utilizes brokered deposits to facilitate liquidity needs. At June 30, 2005 and December 31, 2004, the Bank had “brokered deposits” of $21.5 million and $9.1 million, respectively. During 2005 we utilized “brokered deposits” and deposits from other financial institutions to fund our loan growth.

To meet liquidity needs, the Bank maintains a portion of our funds in cash deposits in other banks, Federal Funds sold, and investment securities. As of June 30, 2005 and December 31, 2004, our liquidity ratio was 14.89% and 13.20%, respectively (defined as liquid assets as a percentage of deposits). Liquid assets were composed of Federal Funds sold, available-for-sale investment securities less securities that are pledged to secure treasury, tax and loan deposits and other purposes as required by law, interest-bearing deposits in other financial institutions and cash and due from banks. The Bank’s liquidity ratio at December 31, 2004 and June 30, 2005 was slightly below our policy target of 15%. The Bank monitors our liquidity ratios daily and since June 30, 2005, our liquidity ratios have met our policy guidelines on average. The Bank attempts to maximize its loan to deposit ratios and minimize its liquidity ratio, consistent with its liquidity needs and policy, to maximize net interest margins.

The Bank maintains a $2.5 million line of credit with a correspondent bank for the purchase of overnight Federal funds. The Bank also has a credit line with the Federal Home Loan Bank of San Francisco which would allow us to borrow up to 15% of our assets. As of June 30, 2005, loans and securities pledged as collateral for this facility would have allowed us to borrow up to approximately $13.4 million. These facilities have been used regularly to provide funding for loans at less cost than brokered deposits. (See “Borrowings” above.)

The primary sources of liquidity for the Company, on a stand alone basis, include the receipt of dividends from the subsidiaries, borrowings, and our ability to raise capital. The ability of the Company to obtain funds for the

payment of dividends is dependent upon the subsidiaries’ earnings. The availability of dividends from the subsidiaries is also limited by various state and federal statues and regulations. At June 30, 2005, the Company had outstanding borrowings of $377,000 to cover the Company’s organizational costs, the costs of preparing for a public offering and the costs related to the proposed Celtic acquisition. The Company has recently commenced a public offering to raise $12.0 million, the proceeds of which will repay the Company’s borrowings, fund the Celtic acquisition, provide resources to enhance the Bank’s capital, and provide separate working capital for the Company.

Recent Accounting Pronouncements.

At June 30, 2005 the Company and the Bank had no changes in accounting principles.

EITF also requires several additional disclosures for cost-method investments. The EITF’s impairment accounting guidance was effective for reporting periods beginning after June 15, 2004. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective for fiscal years ending after June 15, 2004.

Quantitative And Qualitative Disclosures About Market Risk

For purposes of the following discussion, the terms “we” and “our” mean Discovery Bank on a stand-alone basis.

Our market risk arises primarily from credit risk and interest rate risk inherent in our lending and deposit taking activities and the risk of inflation. Risk management is an important part of our operations and a key element of our overall financial results. The FDIC, in recent years, has emphasized appropriate risk management, prompting banks to have adequate systems to identify, monitor and manage risks. Our board of directors and committees meet on a regular basis to oversee our operations. We monitor our business activities and apply various strategies to manage the risks to which we are exposed. We have adopted various policies and have empowered the committees of our board of directors with oversight responsibility concerning different aspects of our operations. Our Audit Committee is responsible for overseeing internal auditing functions and for interfacing with our independent outside auditors. Our Loan Committee establishes the Loan Policy, reviews loans made by management and approves loans in excess of management’s lending authority. Our Loan Committee also reviews “watch list” loans and the adequacy of our allowance for loan losses. Our Asset/Liability Risk Committee establishes our Investment Policy and our Asset/Liability Policy, reviews investments made by management, and monitors our investment portfolio, interest rate risk and liquidity planning.

Credit Risk. Credit risk generally arises as a result of our lending activities and may be present with our investment activities. To manage the credit risk inherent in our lending activities, we rely on adherence to

underwriting standards and loan policies as well as our allowance for loan losses. We employ frequent monitoring procedures and take prompt corrective action when necessary. Additionally, our loans are examined regularly by our regulatory agencies.

Interest Rate Risk. Interest rate risk is the exposure of a bank’s financial condition, both earnings and the market value of assets and liabilities, to adverse movements in interest rates. Interest rate risk results from differences in the maturity or timing of interest-earning assets and interest-bearing liabilities, changes in the slope of the yield curve over time, imperfect correlation in the adjustment of rates earned and paid on different instruments with otherwise similar characteristics (e.g. three-month Treasury bill versus three-month LIBOR) and from interest-rate-related options embedded in bank products (e.g. loan prepayments, floors and caps, callable investment securities, early withdrawal of time deposits, etc).

The potential impact of interest rate risk is significant because of the liquidity and capital adequacy consequences that reduced earnings or losses could imply. We recognize and accept that interest rate risks are a routine part of bank operations and will from time to time impact our profits and capital position. The objective of interest rate risk management is to control exposure of net interest income to risks associated with interest rate movements in the market, to achieve consistent growth in net interest income and to profit from favorable market opportunities.

The careful planning of asset and liability maturities and the matching of interest rates to correspond with this maturity matching is an integral part of the active management of an institution’s net yield. To the extent maturities of interest-earning assets and interest-bearing liabilities do not match in a changing interest rate environment (an interest rate sensitivity “gap”), net yields may be affected. Thus, if rate sensitive assets exceed rate sensitive liabilities for a given period, the interest rate would be “positively gapped” and we would benefit from an increase in interest rates. Conversely, if rate sensitive liabilities exceed rate sensitive assets for a given period, the interest rate would be “negatively gapped” and we would not benefit from an increase in interest rates. Even with perfectly matched repricing of interest-earning assets and interest-bearing liabilities, risks remain in the form of prepayment of assets, timing lags in adjusting certain assets and liabilities that have varying sensitivities to market interest rates and basis risk. In our overall attempt to match interest-earning assets and interest-bearing liabilities, we take into account rates and maturities to be offered in connection with our certificates of deposit and our variable rate loans.

The Bank’s policy quantifies acceptable gap ratios. These targets are monitored quarterly and reviewed annually by the board of directors to determine acceptable gap risks. We monitor and evaluate our gap position, but do not anticipate substantial changes in those gap ratios.

We do not engage in any hedging activities and do not have any derivative securities in our portfolio.

We utilize the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The simulation model, a third-party service, estimates the impact of changing interest rates on the interest income from all interest-earning assets and the interest expense paid on all interest-bearing liabilities reflected on our balance sheet. A parallel and pro rata shift in rates over a 12-month period is assumed. This model is reviewed annually and audited on a regular basis to determine accuracy of data and forecasts. The following reflects our net interest income sensitivity analysis as of June 30, 2005, based on the simulation. This table shows the impact of hypothetical interest rate changes on net interest income and net interest margins.


	Adjusted Net		Change
Interest Rate Scenario	Interest Income		From Base
Up 300 basis points	$	6,514		24.53	%
Up 200 basis points	$	6,134		17.26	%
Up 100 basis points	$	5,697		8.91	%
Base	$	5,231		—
Down 100 basis points	$	4,977		(4.86	)%
Down 200 basis points	$	4,747		(9.25	)%
Down 300 basis points	$	4,580		(12.45	)%

Inflation.

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

Since June 2004, the FRB has increased rates nine times to 3.25%. The nature and timing of any future changes in such policies and their impact on us cannot be predicted; however, because of our ratio of rate sensitive assets to rate sensitive liabilities, we tend to benefit slightly in the short term from an increasing interest rate market and, conversely, suffer in a decreasing interest rate market. As such, the management of the money supply by the FRB to control the rate of inflation has an impact on our earnings. The changes in interest rates may also have a corresponding impact on the ability of borrowers to repay loans with us.

ITEM 3. CONTROLS AND PROCEDURES

Bancorp maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in Bancorp’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and that such information is accumulated and communicated to Bancorp’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Bancorp’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of Bancorp’s disclosure controls and procedures as of June 30, 2005. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that Bancorp’s disclosure controls and procedures are effective, providing them with material information relating to Bancorp as required to be disclosed in the reports Bancorp files or submits under the Exchange Act on a timely basis.

There were no significant changes in Bancorp’s internal controls or in other factors that could significantly affect Bancorp’s disclosure controls and procedures subsequent to the date of their evaluation, nor were there any significant deficiencies or material weaknesses in Bancorp’s internal controls except as noted below.

Dependence on Key Employees. Like many independent financial institutions, our ability to implement our business plan is closely tied to the strengths of our chief executive officer and other senior officers. In addition, we are subject to the reporting requirements of the Securities Exchange Act of 1934, including the corporate governance requirements of the Sarbanes-Oxley Act of 2002. Management believes that the Holding Company and the Bank needed additional expertise to assist with controls over financial reporting and that a material weakness existed on a going forward basis. As a result, a new controller was hired on March 1, 2005, who assisted in the preparation of the Holding Company’s Registration Statement on Form S-4, as amended, which was filed with the SEC in connection with the bank holding company reorganization. That individual left in early May to take another position. More recently, the Holding Company’s and the Bank’s chief financial officer, Ms. Lou Ellen Ficke, tendered her resignation to be effective September 30, 2005. Therefore, management instituted a search for a new chief financial officer or similar senior financial executive and effective July 21, 2005, Mr. Martin McNabb commenced employment as the Holding Company’s and the Bank’s controller, to become the chief financial officer upon Ms. Ficke’s departure. Management believes that the hiring of Mr. McNabb along with the proposed addition of a controller when he becomes CFO, as well as other actions being taken, substantially address the material weakness.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There are no material legal proceedings to which the Company is a party or to which any of its property is subject.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the Company’s organizational stage the Company issued 200 shares of the Company’s no par value common stock to Mr. John Plavan, the Company’s Chairman of the Board, which shares were repurchased by the Company upon consummation of the bank holding company reorganization. On June 15, 2005, the Company’s then sole shareholder took action by unanimous written consent to approve the bank holding company reorganization.

ITEM 5. OTHER INFORMATION

As previously reported the Company, through its wholly-owned subsidiary, Celtic Merger Corp., intends to buy certain assets and assume certain liabilities of Celtic Capital Corporation. In connection with the proposed acquisition, the Company plans to consummate an offering intended to raise capital to cover the Company’s organizational costs, the Celtic acquisition and to provide additional capital for the Bank and for the Company. As such, on August 5, 2005, the Company’s previously filed Form SB-2, filed with the Securities and Exchange Commission, became effective.

ITEM 6. EXHIBITS


Exhibit No.	Description of Exhibit	Page
31.1	Certification of James P. Kelly, II		31

31.2	Certification of Lou Ellen Ficke		32

32.1	Section 1350 Certification of James P. Kelly, II		33

32.2	Section 1350 Certification of Lou Ellen Ficke		34


	Discovery Bancorp

Dated: August 12, 2005	By:	/s/ James P. Kelley, II

		James P. Kelley, II,
		President and Chief Executive Officer

	By:	/s/ Lou Ellen Ficke

		Lou Ellen Ficke,
		Executive Vice Presid ent and Chief Financial Officer

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		PAGE
PART I	FINANCIAL INFORMATION

ITEM 1	Financial Statements	3

ITEM 2	Management’s Discussion and Analysis or Plan of Operation	11

ITEM 3	Controls and Procedures	28

PART II	OTHER INFORMATION

ITEM 1	Legal Proceedings	29

ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	29

ITEM 3	Defaults Upon Senior Securities	29

ITEM 4	Submission of Matters to a Vote of Security Holders	29

ITEM 5	Other Information	29

ITEM 6	Exhibits	29

	Signatures	30
EX-31.1
EX-31.2
EX-32.1
EX-32.2