Note 3 Loans and Related Allowance for Loan Losses:

A summary of loans as of June 30, 2011 and December 31, 2010 is as follows:

	(dollars in thousands)						As % Gross Loans
	30-Jun-11			31-Dec-10			30-Jun-11			31-Dec-10

Real estate - construction	$	25,332		$	38,143			15.6	%		20.2	%
Real estate - other		108,066			114,332			66.4	%		60.7	%
Commercial		27,845			34,232			17.1	%		18.2	%
Consumer		1,487			1,663			0.9	%		0.9	%
Gross Loans		162,730			188,370			100.0	%		100.0	%

Deferred loan fees		(569	)		(621	)
Allowance for loan losses		(9,364	)		(10,999	)
Net Loans	$	152,797		$	176,750

The Bank’s loan portfolio consists primarily of loans to borrowers within the San Luis Obispo and northern Santa Barbara Counties, California. Although the Bank seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, real estate and real estate associated businesses are among the principal industries in the Bank’s market areas. As a result, the Bank’s loan and collateral portfolios are, to some degree, concentrated in those industries. When real estate is taken as collateral, advances are generally limited to a certain percentage of the appraised value of the collateral at the time the loan is made, depending on the type of loan, the underlying property and other factors.

Allowance for Loan Losses

The Bank’s allowance for loan losses as a percentage of total loans was 5.75% as of June 30, 2011, and reflects a decrease of 9 basis points from 5.84% at December 31, 2010, see Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion on the “Allowance for Loan Losses”. Management believes that the allowance for loan losses at June 30, 2011 is adequate after considering factors that can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Allowance for Loan Losses”. Although management believes the allowance for loan loss is adequate, there is no assurance that at any given period the Company will not sustain charge-offs that are substantial in relation to the size of the allowance.

Each segment of loans in the portfolio possess varying degrees of risk, based on, among other things, the type of loan being made, the purpose of the loan, the type of collateral securing the loan, and the sensitivity the borrower has to changes in certain external factors such as economic conditions. The following provides a summary of the risks associated with various segments of the Company’s loan portfolio, which are factors Management regularly considers when evaluating the adequacy of the allowance:

 Construction / Land segments – construction and land loans generally possess a higher inherent risk of loss than other portfolio segments. Risk arises from the necessity to complete projects within specified cost and time limits. Trends in the construction industry may also impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of future construction projects.

 Real estate secured – consist primarily of loans secured by commercial real estate, multi-family, farmland, and 1-4 family residential properties. Also included in this segment are equity lines of credit secured by real estate. As the majority of this segment is comprised of commercial real estate loans, risks associated with this segment lie primarily within that loan type. Adverse economic conditions may result in a decline in business activity and increased vacancy rates for commercial properties. These factors in conjunction with a decline in real estate prices may expose the Company to the potential for losses if a borrower cannot continue to service the loan with operating revenues, and the value of the property has declined to a level such that it no longer fully covers the Company’s recorded investment in the loan.

 Commercial and Industrial – consist primarily of commercial and industrial loans (business lines of credit), agriculture loans, and other commercial purpose loans. Repayment of commercial and industrial loans is generally provided from the cash flows of the related business to which the loan was made. Adverse changes in economic conditions may result in a decline in business activity, which can impact a borrower’s ability to continue to make scheduled payments. The risk of repayment of agriculture loans arises largely from factors beyond the control of the Company or the related borrower, such as commodity prices and weather conditions.

 Consumer – the installment loan portfolio is comprised primarily of a large number of small loans with scheduled amortization over a specific period. The majority of installment loans are made for consumer and business purchases. Weakened economic conditions may result in an increased level of delinquencies within this segment, as economic pressures may impact the capacity of such borrowers to repay their obligations.

The following table sets forth the allocation of the ALLL by loan category for the six months ended June 30, 2011:

Loan Portfolio Segement	Balance at Beginning of Year January 1, 2011		Provision for Loan Losses (Charged) Credited to expense			Less Loans Charged Off		Plus Recoveries on Loans Previously Charged Off		Balance at Year to Date June 30, 2011
	Year to Date June 30, 2011
Real Estate:
Construction and Land Development	$	3,837	$	500		$	215	$	2	$	3,124
1-4 Family Residential		681		459			-		3		225
Multifamily Residential		18		(1	)		-		-		19
Commercial Real Estate and Other		2,221		(4,221	)		2,356		2		4,088
Commercial and Industrial		4,164		2,729			531		939		1,843
Consumer and Other		78		19			11		2		50
Unallocated		-		(15	)		-		-		15
Totals	$	10,999	$	(530	)	$	3,113	$	948	$	9,364

The following table sets forth the allocation of the ALLL by loan category for the year ended December 31, 2010:

Loan Portfolio Segement	Balance at Beginning of Year January 1, 2010		Provision for Loan Losses (Charged) Credited to expense			Less Loans Charged Off		Plus Recoveries on Loans Previously Charged Off		Balance at Quarter ended December 31, 2010
	Year Ended December 31, 2010
Real Estate:
Construction and Land Development	$	784	$	(5,022	)	$	2,005	$	36	$	3,837
1-4 Family Residential		-		(900	)		261		42		681
Multifamily Residential		-		(18	)		-		-		18
Commercial Real Estate and Other		1,412		(1,153	)		345		1		2,221
Commercial and Industrial		1,145		(8,013	)		5,119		125		4,164
Consumer and Other		39		(98	)		62		3		78
Unallocated		6		6			-		-		-
Totals	$	3,386	$	(15,198	)	$	7,792	$	207	$	10,999

The following tables provide summaries and totals of loans individually and collectively evaluated for impairment as of June 30, 2011 and December 31, 2010:

June 30, 2011	Evaluated for Impairment
Allowance for Loan Losses	Individually		Collectively		Total
(dollars in thousands)
Construction and Land Development	$	2,590	$	534	$	3,124
Real Estate - Other		-		4,332		4,332
Commercial and Industrial		1		1,842		1,843
Consumer		-		65		65
	$	2,591	$	6,773	$	9,364

	Evaluated for Impairment
Loans	Individually		Collectively		Total

Construction and Land Development	$	13,624	$	11,708	$	25,332
Real Estate - Other		4,773		103,293		108,066
Commercial and Industrial		1,599		26,246		27,845
Consumer		-		1,487		1,487
	$	19,996	$	142,734	$	162,730

December 31, 2010	Evaluated for Impairment
Allowance for Loan Losses	Individually		Collectively		Total

Construction and Land Development	$	2,585	$	1,252	$	3,837
Real Estate - Other		228		2,692		2,920
Commercial and Industrial		23		4,141		4,164
Consumer		-		78		78
	$	2,836	$	8,163	$	10,999

	Evaluated for Impairment
Loans	Individually		Collectively		Total

Construction and Land Development	$	15,537	$	22,606	$	38,143
Real Estate - Other		6,496		107,836		114,332
Commercial and Industrial		2,873		31,359		34,232
Consumer		100		1,563		1,663
	$	25,006	$	163,364	$	188,370

Credit Quality and Credit Risk Management

The Company manages credit risk not only through extensive risk analyses performed prior to a loan’s funding, but through the ongoing monitoring of loans within the portfolio, and more specifically certain types of loans that generally involve a greater degree of risk, such as commercial real estate, commercial lines of credit, and construction/land loans. The Company monitors loans in the portfolio with the assistance of a semi-annual independent loan review. These reviews generally not only focus on problem loans, but also pass credits within certain pools of loans that may be expected to experience stress due to economic conditions.

This process allows the Company to validate credit ratings, underwriting structure, and the Company’s estimated exposure in the current economic environment as well as enhance communications with borrowers where necessary in an effort to mitigate potential future losses.

The Company has a Director’s Loan committee, chaired by the Chief Executive Officer and is comprised of three Bank directors. The Board of Directors establishes the Company’s desire for funding certain types of credit and regularly reviews the Company’s position with respect to credit quality pursuant to the Company’s lending policy. The Company’s lending policy is established by the Chief Credit Officer and is reviewed annually by the Board of Directors for approval. The lending policy establishes underwriting criteria, sets portfolio concentration limits, provides criteria for the proper risk grading of loans, requires internal reviews of all pass graded credits meeting certain criteria, and contains requirements concerning the identification of and regular monitoring of problem loans.

The policy also provides that analyses shall be conducted on all significant problem loans at least quarterly, in order for the Company to properly estimate its potential exposure to loss associated with such credits in a timely manner. The policy also provides that a detailed listing of all problem loans be provided to the Company’s Board of Director’s on a regular basis. Additionally, the Company maintains a subset of pass list loans designated as “watch” loans, that for any of a variety of reasons, Management believes require additional regular review. Pass graded loans which are designated as watch credits are more heavily scrutinized than other pass rated credits in the portfolio, so that any potential weaknesses that may develop in such credits are more quickly identified, thereby serving to mitigate potential losses.

Pursuant to the Company’s lending policy, all loans in the portfolio are assigned a risk rating, which allows Management, among other things, to identify the risk associated with each credit in the portfolio, and to provide a basis for estimating credit losses inherent in the portfolio. Risk grades are generally assigned based on information concerning the borrower, and the strength of the collateral. Risk grades are reviewed regularly by the Company’s Director’s Loan committee, and are scrutinized by independent loan reviews performed semi-annually, as well as by regulatory agencies during scheduled examinations. The Company grades all loans as either: (i) pass-excellent (ii) pass-good (iii) pass, (iv) pass-watch (iii) special mention, (iv) substandard, and (vi) doubtful.

The following provides brief definitions for credit ratings assigned to loans in the portfolio:

Pass Excellent - Loans classified as Excellent are risk free. Loans present no identifiable or potential adverse risk to the Bank. Documented repayment is either backed by the full faith and credit of the United Stated Government, or 115% secured by cash collateral in the possession of the Bank that is free from potential claim. In addition, these credits will conform in all aspects to established loan policies and procedures, laws, rules, and regulations.

Pass Good- Loans classified as good are those extended to the highest quality borrower. A well structured credit to a firm in existence for a minimum of five years with at least four years of consecutive profits and/or dividend payments, with a strong equity position, with good liquidity, excellent debt service ability, and credit to a reasonably strong borrower supported by a strong guarantor and/or fully secured by collateral of unquestioned value that is readily marketable.

Pass - Loans classified as Satisfactory have acceptable credit history with no apparent weaknesses. A Satisfactory rating describes the average commercial loan risk at the low end of the middle market. Any credit which we are compelled to follow monthly for borrowing base certificates and financial information fit into this category. These are credits which are reasonable risks but may require monitoring on the part of the loan officer. Credits in this category are stronger than the average borrower in our portfolio. Borrowers in our market that fit this category usually do not use their lines of credit much, if at all. They are more likely to borrow for equipment and real estate than for working capital.

Pass Watch- Loans classified as Watch indicate that although the borrower meets the rating criteria for a general risk rating of Pass, the specific credit being evaluated possesses technical deficiencies. Technical deficiencies include, but are not limited to; inadequate or improperly executed documentation, which may be material; lack of current financial information in accordance with lending policy; non receipt of financial statements within the Bank’s established policy period beyond the dates required in loan agreements; and non receipt of borrowing certificates and/or agings within 15 days of dates required. If not corrected within 60 to 90 days (15 days for borrowing certificates and agings), a more severe rating may be warranted. Once the deficiency has been cured, to the satisfaction of credit administration, a better borrower rating may be established.

Special Mention- Loans classified as Special Mention have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the bank's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification

Substandard- Loans classified as Substandard are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard credits have well-defined weaknesses that jeopardize the timely collection of principal and interest and/or the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful- A loan classified as Doubtful has the same weaknesses as Substandard credits, but those weaknesses are so much more severe that, based on current information, collection or liquidation in full is highly improbable. The Bank must expect that some portion of the loan will be loss.

Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions above and smaller, homogeneous loans not assessed on an individual basis.

Based on analysis performed, the risk category of loans by class of loans is as follows for the noted periods:

	Pass		Special Mention		Sub-standard		Impaired		Total
June 30, 2011	(dollars in thousands)
Real Estate:
Construction and Land Development	$	9,238	$	-	$	2,470	$	13,624	$	25,332
1-4 Family Residential		7,658		-		-		1,330		8,988
Multifamily Residential		2,757		-		-		-		2,757
Commercial real estate and other		86,351		4,042		2,485		3,443		96,321
Commercial and Industrial		22,555		260		3,431		1,599		27,845
Consumer and Other		1,472		-		15		-		1,487
Gross Loans	$	130,031	$	4,302	$	8,401	$	19,996	$	162,730

	Pass		Special Mention		Sub-standard		Impaired		Total
December 31, 2010
Real Estate:
Construction and Land Development	$	15,276	$	4,143	$	3,187	$	15,537	$	38,143
1-4 Family Residential		8,216		-		-		1,383		9,599
Multifamily Residential		2,783		-		-		-		2,783
Commercial real estate and other		88,731		6,569		1,537		5,113		101,950
Commercial and Industrial		30,200		174		985		2,873		34,232
Consumer and Other		1,541		-		22		100		1,663
Gross Loans	$	146,747	$	10,886	$	5,731	$	25,006	$	188,370

Impaired Loans

Impaired loans are analyzed on a loan by loan basis due to the unique characteristics of each loan. Loans are considered impaired if, based on evidence of current information and events, it is probable that we will be unable to collect the scheduled payments due according to the contractual terms of the loan agreement. Such evidence may include, but not be limited to, an updated financial statement that exhibits decreasing or negative cash flow and/or substantial change in the borrower’s net worth, chronic delinquencies, material decline in collateral value or the receipt of notification of bankruptcy. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the contractual interest rate set in the loan agreement. Collateral-dependent loans are measured for impairment based on the fair value of the collateral. A loan is considered collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. The fair value of the underlying collateral is generally determined by utilizing an appraisal of the collateral discounted for estimated costs to sell.

The following table sets forth the migration of loans classified substandard for the quarter and year-to-date period ended June 30, 2011:

	Loans Classified Substandard
Quarter to Date	(dollars in thousands)
	Balance at March 31, 2011		Added		Principal Reductions			Upgraded to Pass		Charge-Off			To OREO			Balance at June 30, 2011
Real Estate:
1-4 Family Residential - Construction	$	851	$	135		-		$	-	$	-		$	-		$	986
Other Construction/All Land Development and other		17,045		-		(645	)		-		-			(1,292	)		15,108
1-4 Family Residential		1,350		-		(20	)		-		-			-			1,330
Multi-family Residential		-		-		-			-		-			-			-
HELOCS		1,022		-		(3	)		-		-			-			1,019
Commerical Real Estate- Owner Occupied		5,998		-		(42	)		-		(1,611	)		-			4,345
Commerical Real Estate-Non Owner Occupied		572		-		(8	)		-		-			-			564
Commercial and Industrial		3,914		1,484		(283	)		-		(85	)		-			5,030
Consumer		19		-		(4	)		-		-			-			15

	$	30,771	$	1,619	$	(1,005	)	$	-	$	(1,696	)	$	(1,292	)	$	28,397

	Loans Classified Substandard
Year to Date	(dollars in thousands)
	Balance at Dec 31, 2010		Added		Principal Reductions			Upgraded to Pass			Charge-Off			To OREO			Balance at June 30, 2011
Real Estate:
1-4 Family Residential - Construction	$	557	$	482	$	-		$	-		$	(53	)	$	-		$	986
Other Construction/All Land Development and other	$	18,167		178		(1,015	)		(667	)		(163	)		(1,392	)		15,108
1-4 Family Residential		1,383		-		(53	)		-			-			-			1,330
Multi-family Residential		-		-		-			-			-			-			-
HELOCS		811		452		(244	)		-			-			-			1,019
Commerical Real Estate- Owner Occupied		5,253		2,735		(57	)		-			(2,356	)		(1,230	)		4,345
Commerical Real Estate-Non Owner Occupied		586		-		(22	)		-			-			-			564
Commercial and Industrial		3,858		2,108		(436	)		-			(500	)		-			5,030
Consumer		122		-		(106	)		-			(1	)		-			15

	$	30,737	$	5,955	$	(1,933	)	$	(667	)	$	(3,073	)	$	(2,622	)	$	28,397

Individually impaired loans were as follows as of the periods noted:

	Unpaid						Average		Interest
	Principal		Recorded		Related		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized
June 30, 2011	(dollars in thousands)
With no Related Allowance Recorded
Real Estate:
Construction and Land Development	$	11,427	$	9,876	$	-	$	10,799	$	-
1-4 Family Residential		1,801		1,330		-		1,357		-
Multifamily Residential		-		-		-		-		-
Commercial Real Estate and Other		5,262		3,443		-		4,050		-
Commercial and Industrial		2,352		1,563		-		2,014		11
Consumer		-		-		-		50		-
With an Allowance Recorded								-
Real Estate:								-
Construction and Land Development		3,748		3,748		2,590		3,782		-
1-4 Family Residential		-		-		-		-		-
Multifamily Residential		-		-		-		-		-
Commercial Real Estate and Other		-		-		-		228		-
Commercial and Industrial		36		36		1		223		-
Consumer		-		-		-		-		-
	$	24,626	$	19,996	$	2,591	$	22,503	$	11

	Unpaid						Average		Interest
	Principal		Recorded		Related		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized
December 31, 2010
With no Related Allowance Recorded
Real Estate:
Construction and Land Development	$	13,930	$	11,721	$	-	$	11,540	$	45
1-4 Family Residential		2,269		1,383		-		2,795		-
Multifamily Residential		-		-		-		-		-
Commercial Real Estate and Other		4,704		4,657		-		4,753		-
Commercial and Industrial		3,361		2,465		-		4,041		20
Consumer		100		100		-		25		-
With an Allowance Recorded
Real Estate:
Construction and Land Development		3,816		3,816		2,585		2,897		-
1-4 Family Residential		-		-		-		-		-
Multifamily Residential		-		-		-		-		-
Commercial Real Estate and Other		455		455		228		228		-
Commercial and Industrial		409		409		23		216		-
Consumer		-		-		-		-		-
	$	29,044	$	25,006	$	2,836	$	26,495	$	65

The Company typically moves to charge-off loan balances when, based on various evidence, it believes those balances are no longer collectable. Such evidence may include updated information related to a borrower’s financial condition or updated information related to collateral securing such loans. Such loans are monitored internally on a regular basis by the Chief Credit Officer or designee, who is responsible for obtaining updated periodic appraisal information for collateral securing problem loans. If a loan’s credit quality deteriorates to the point that collection of principal through traditional means is believed by Management to be doubtful, and the value of collateral securing the obligation is sufficient, the Company generally takes steps to protect and liquidate the collateral. Any loss resulting from the difference between the Company’s recorded investment in the loan and the fair market value of the collateral obtained through repossession is recognized by a charge to the allowance for loan losses.

The following table sets forth the amount of partial charge offs in nonperforming loans for the three months ended June 30, 2011:

Quarter To Date	Nonperforming Loans			Nonperforming Loans with Partial Charge Off Recorded		Partial Charge Off Recorded
June 30, 2011
Real Estate:
Construction and Land Development		13,624			-		-
1-4 Family Residential		1,330			-		-
Multifamily Residential		-			-		-
Commercial real Estate and Other		3,443			805		1,611
Commercial and Industrial		1,142			270		9
Consumer and Other		-			-		-
	$	19,539		$	1,075	$	1,620

Nonperforming loans with partial charge offs as % of total nonperforming loans		5.5	%

Partial charge offs as % nonperforming loans with partial charge offs		150.7	%

Net partial charge offs as % of ALLL		17.3	%

Past due and nonaccrual loans were as follows for the periods noted:

	Still Accruing
	30-89 Days Past Due		Over 90 Days Past Due		Non-Accrual
June 30, 2011	(dollars in thousands)
Real Estate:
Construction and Land Development	$	-	$	-		13,624
1-4 Family Residential		-		-		1,330
Multifamily Residential		-		-		-
Commercial real Estate and Other		-		-		3,443
Commercial and Industrial		83		-		1,142
Consumer and Other		-		-		-
	$	83	$	-	$	19,539

	Still Accruing
	30-89 Days Past Due		Over 90 Days Past Due		Non-Accrual
December 31, 2010
Real Estate:
Construction and Land Development	$	606	$	-		14,912
1-4 Family Residential		-		-		1,383
Multifamily Residential		-		-		-
Commercial real Estate and Other		-		-		5,113
Commercial and Industrial		-		-		2,437
Consumer and Other		-		-		100
	$	606	$	-	$	23,945

At June 30, 2011, the Bank has allocated $2.6 million of specific reserve to one customer whose loan term had been modified in a troubled debt restructuring. This compares to $2.8 million as of December 31, 2010 that included one additional customer whose loan was subsequently charged off in Q1, 2011. The Bank has not committed to lend additional amounts as of June 30, 2011 to customers with outstanding loans that are classified as troubled debt restructurings.