Executive Management Overview

This overview of management's discussion and analysis highlights selected information in the financial results of the Company and may not contain all of the information that is important to you. For a more complete understanding of trends, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document. Each of these items could have an impact on the Company's financial condition and results of operations.

First PacTrust Bancorp, Inc. is a savings and loan holding company that owns one thrift institution, Pacific Trust Bank. As a unitary thrift holding company, First PacTrust Bancorp, Inc. activities are limited to banking, securities, insurance and financial services-related activities. Pacific Trust Bank is a federally chartered stock savings bank, in continuous operation since 1941 as a profitable and successful financial institution. The Company is headquartered in Chula Vista, California, a suburb of San Diego, California, and has six full service and three limited service banking offices primarily serving residents of San Diego and Riverside Counties in California. The Company's geographic market for loans and deposits is principally San Diego and Riverside counties.

The Company's principal business consists of attracting retail deposits from the general public and investing these funds and other borrowings in loans primarily secured by first mortgages on owner-occupied, one-to four-family residences in San Diego and Riverside counties, California. During 2005, the Company introduced a new lending product called the "Green Account", America's first fully transactional flexible mortgage account. The Company experienced significant growth in this product during 2008 and originated $122.7 million Green Account loans. The Company anticipates that growth in this product will continue. At December 31, 2008, one- to four-family residential mortgage loans totaled $652.9 million, or 80.7% of our gross loan portfolio including the portion of the Company's "Green" account home equity loan portfolio that are first trust deeds. If the home equity "Green" account loans in first position are excluded, total one- to four-family residential mortgage loans totaled $460.3 million, or 56.9% of our gross loan portfolio.

The Company continues to develop strong deposit relationships with customers by providing quality service while offering a variety of competitive deposit products. During 2007, the Company introduced commercial deposit accounts and had a total of $14.4 million of commercial deposit accounts at December 31, 2008. Total net deposits increased $24.0 million and consisted of growth in the Company's high yield savings and certificate of deposit accounts.

The Company's results of operations are dependent primarily on net interest income, which is the difference between interest income on earning assets such as loans and securities, and interest expense paid on liabilities such as deposits and borrowings. The Company's net interest income, which is primarily driven by interest income on residential first mortgage loans, increased by $6.0 million for the year ended December 31, 2008. The decline in interest rate levels experienced throughout the year negatively impacted loan interest income, however, positively contributed to a significant reduction in the Company's cost of funds increasing the Company's net interest margin by 65 basis points to 2.92%.

The past year proved to be an extremely challenging operating environment, as witnessed by the continued declines in the housing market along with decreasing home prices, increasing delinquencies and foreclosures and reduced availability of commercial and consumer credit, which have negatively affected the performance of consumer and commercial credit and resulted in significant write-downs of assets by the majority of financial institutions. The Company's non-performing assets have increased $32.8 million over the prior year while the provision for loan losses were $13.5 million for the year ended December 31, 2008 as a result of these factors. The Company expects that the continued economic pressures on consumers and businesses and the lack of confidence in the financial markets may continue to adversely affect the Company's results of operations in the coming year.

Future earnings of the Company are inherently tied to changes in interest rate levels, the relationship between short and long term interest rates, credit quality, and economic trends. If short term interest rates continue to decrease, the Company's interest expense on deposits will likely decrease at a faster pace than the interest income received on earning assets due to the relatively shorter term repricing characteristics of the Company's deposits than the maturity or repricing characteristics of its loan portfolio. The Company intends to continue to focus on the origination of adjustable rate loan products while securing longer term deposits and borrowings.

The plan for our on-going success is continued leveraging of the Company's assets, mostly through continued loan portfolio and deposit growth to make better use of our current relatively high capital ratios. This growth is intended to be funded with deposit growth and borrowed funds if needed with terms that are appropriate to manage interest rate risk while assuring an adequate net interest spread. The Company will continue its strategy of loan and deposit portfolio growth through high-quality customer service and the development and introduction of innovative financial products. This will be coupled with efforts to further improve our efficiency ratio through controlled operating expense growth, as well as exploring potential new sources of noninterest income. The Company continues to look for opportunities to open an additional branch location in San Diego County if the right location can be found.

The following is a discussion and analysis of the Company's financial position and results of operations and should be read in conjunction with the information set forth under "General" in Item 7A, Quantitative and Qualitative Disclosures about Market Risk, and the consolidated financial statements and notes thereto appearing under Item 8 of this report. Dollar amounts are in thousands with the exception of share and per share data.

Comparison of Financial Condition at December 31, 2008 and December 31, 2007

The Company's total assets increased by $101.8 million, or 13.1%, to $876.5 million at December 31, 2008 from $774.7 million at December 31, 2007. The increase primarily reflected the growth in the balance of net loans receivable and in the available-for-sale securities portfolio in the amounts of $82.9 million and $13.2 million, respectively.

Net loans receivable increased by $82.9 million, or 11.7%, to $793.0 million at December 31, 2008 from $710.1 million at December 31, 2007. The increase in loans resulted primarily from loan originations exceeding repayments during the year. The Company's ability to originate loans has been largely unaffected by the turmoil in the secondary mortgage markets given that all loans originated are kept in portfolio. The Company's strong capital ratios coupled with being a portfolio lender has allowed the Company to take advantage of current market conditions and compete with other lenders who have liquidity or capital constraints and have reduced lending operations. Loan production of $249.3 million during 2008 was primarily attributable to $122.7 million of originations of the Company's Green account loan product and $105.0 million of originations of the Company's one-to-four-family loans. At December 31, 2008, the Company had a total of $347.6 million in interest-only mortgage loans, $219.1 million in interest-only transactional flexible mortgage "Green account" loans and $37.3 million in loans with potential for negative amortization. At December 31, 2007, the Company had a total of $294.3 million in interest-only mortgage loans, $164.0 million in interest-only transactional flexible mortgage loans and $48.2 million in loans with potential for negative amortization. These loans could pose a higher credit risk because of the lack of principal amortization and potential for negative amortization. However, management believes the risk is mitigated through the Company's loan terms and underwriting standards, including its policies on loan-to-value ratios. The Company no longer originates negatively amortizing loans.

Securities classified as available-for-sale of $17.6 million at December 31, 2008 increased $13.2 million from December 31, 2007 primarily due to the purchase of four new collateralized mortgage obligation securities during the period totaling $17.2 million. Two agency securities totaling $4.3 million were called at par during the first quarter of 2008.

Total deposits increased by $24.0 million, or 4.2%, to $598.2 million at December 31, 2008 from $574.2 million at December 31, 2007. Deposits increased as a result of marketing efforts and newly originated business deposits and primarily reflected growth in certificates of deposit and savings accounts. Certificates of deposit increased $60.3 million or 19.8% to $365.3 million due to competitive rates offered by the Bank. The certificates of deposit growth consisted of a $20.0 million increase in brokered deposits as well as a $15.0 million increase in institutional jumbo certificates of deposit. Savings accounts increased $16.2 million, or 20.1%, to $96.9 million, chiefly in the Company's high yield savings account due to competitive rate terms. Money market accounts decreased $47.6 million or 36.8% to $81.8 million as customers moved to substantially higher rates paid by competitors. The overall increase in retail deposits was not sufficient to fund the increase in loans, and additional funding in the form of Federal Home Loan Bank advances was necessary to cover the increased loan originations. As a result, Federal Home Loan Bank advances increased by $63.3 million, or 56.7%, to $175.0 million at December 31, 2008 from $111.7 million at December 31, 2007.

Equity increased $14.6 million to $98.7 million at December 31, 2008 from $84.1 million at December 31, 2007. During the year, the company received $19.3 million from the U.S Treasury in exchange for the sale of 19,300 shares of the Company's newly authorized fixed rate cumulative perpetual preferred stock, series A, as part of the federal government's TARP capital purchase program. The increase in equity was due to the following; the issuance of preferred stock and warrants, net of filing fees and costs, in the amount of $19.1 million; ESOP shares earned of $586 thousand; and an increase in stock awards earned of $369 thousand. Equity decreased primarily due to the payment of dividends of $3.2 million, the purchase of treasury stock in the amount of $2.2 million and total net loss for the year of $529 thousand.

Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread at December 31, 2008. No tax equivalent adjustments were made. All average balances are monthly average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.

                                              At December 31,
                                                   2008                         2008                                  2007                                  2006
                                                                                            Average                               Average                               Average
                                                  Average          Average                  Yield/       Average                  Yield/       Average                  Yield/
                                                Yield/ Cost        Balance      Interest     Cost        Balance      Interest     Cost        Balance      Interest     Cost
                                                (Dollars in
                                                thousands)
INTEREST-EARNING ASSETS
Loans receivable(1)                                      5.89 %   $ 763,331     $  45,234      5.93 %   $ 713,548     $  44,632      6.25 %   $ 730,006     $  44,202      6.06 %
Securities(2)                                            4.48 %       2,219           141      6.35 %      12,789           567      4.43 %      14,307           627      4.38 %
Other interest-earning assets(3)                          .37 %      18,593           521      2.80 %      17,378           512      2.95 %      18,205           685      3.76 %

Total interest-earning assets                            5.71 %     784,143        45,896      5.85 %     743,715        45,711      6.15 %     762,518        45,514      5.97 %

Non-interest earning assets(4)                                       38,371                                36,199                                35,178

Total assets                                                      $ 822,514                             $ 779,914                             $ 797,696

INTEREST-BEARING LIABILITIES
NOW                                                      0.86 %      42,758           471      1.10 %      45,570           768      1.69 %      54,913           961      1.75 %
Money market                                             1.55 %     105,498         2,351      2.23 %     167,888         7,280      4.34 %     155,448         6,744      4.34 %
Savings                                                  1.97 %      95,724         2,225      2.32 %      54,436         1,353      2.49 %      51,668           854      1.65 %
Certificates of deposit                                  3.51 %     315,463        12,465      3.95 %     294,612        14,461      4.91 %     259,771        11,024      4.24 %
FHLB advances                                            3.49 %     157,569         5,509      3.50 %     114,562         4,985      4.35 %     176,769         7,362      4.16 %

Total interest-bearing liabilities                       2.96 %     717,012        23,021      3.21 %     677,068        28,847      4.26 %     698,569        26,945      3.86 %

Non-interest-bearing liabilities                                     19,526                                19,319                                19,336

Total liabilities                                                   736,538                               696,387                               717,905
Equity                                                               85,976                                83,527                                79,791

Total liabilities and equity                                      $ 822,514                             $ 779,914                             $ 797,696

Net interest/spread                                      2.75 %                 $  22,875      2.64 %                 $  16,864      1.89 %                 $  18,569      2.11 %

Margin(5)                                                                                      2.92 %                                2.27 %                                2.44 %
Ratio of interest-earning assets to
interest-bearing liabilities                                         109.36 %                              109.84 %                              109.15 %

(1) Calculated net of deferred fees and loss reserves.

(2) Calculated based on amortized cost.

(3) Includes FHLB stock at cost and term deposits with other financial institutions.

(4) Includes BOLI investment of $17.6 million.

(5) Net interest income divided by interest-earning assets.

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to
(1) changes in volume, which are changes in volume multiplied by the old rate, and (2) changes in rate, which are changes in rate multiplied by the old volume. Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

                                               2008 Compared to 2007                        2007 Compared to 2006
                                                      Change          Change                       Change          Change
                                       Total            Due            Due          Total            Due            Due
                                       Change        To Volume       To Rate        Change        To Volume       To Rate
                                                                         (In Thousands)
INTEREST-EARNING ASSETS
Loans receivable                      $    602      $     3,021      $ (2,419 )    $    430      $    (1,010 )    $  1,440
Securities                                (426 )           (602 )         176           (60 )            (67 )           7
Other interest-earning assets                9               35           (26 )        (173 )            (30 )        (143 )

Total interest-earning assets         $    185      $     2,454      $ (2,269 )    $    197      $    (1,107 )    $  1,304

INTEREST-BEARING LIABILITIES
NOW                                   $   (297 )    $       (45 )    $   (252 )    $   (193 )    $      (159 )    $    (34 )
Money market                            (4,929 )         (2,136 )      (2,793 )         536              539            (3 )
Savings                                    872              965           (93 )         499               48           451
Certificates of deposit                 (1,996 )            970        (2,966 )       3,437            1,585         1,852
FHLB advances                              524            1,630        (1,106 )      (2,377 )         (2,694 )         317

Total interest-bearing liabilities      (5,826 )          1,384        (7,210 )       1,902             (681 )       2,583

Net interest/spread                   $  6,011      $     1,070      $  4,941      $ (1,705 )    $      (426 )    $ (1,279 )

Comparison of Operating Results for the Years Ended December 31, 2008 and 2007

General. Net loss for the year ended December 31, 2008 was $529 thousand, a decrease of $3.5 million, or 117.9%, from net income of $3.0 million for the year ended December 31, 2007. The decrease in net income resulted primarily from an increase in the provision for loan losses and a reduction in short term interest rates as discussed below.

Interest Income. Interest income increased by $185 thousand or 0.4%, to $45.9 million for the year ended December 31, 2008 from $45.7 million for the year ended December 31, 2007. The primary factor for the increase in interest income was a $49.8 million increase in the average balance of loans receivable from $713.5 million at December 31, 2007 to $763.3 million at December 31, 2008. In addition, total interest income was reduced by $2.4 million due to a reversal of loan interest income related to loans placed on nonaccrual status during the period. Due to a general decline in market interest rates the average yield on loans receivable decreased 32 basis points to 5.9% for the year ended December 31, 2008 compared to 6.3% for the year ending December 31, 2007. Interest income was also reduced by a decrease in the average balance of securities of $10.6 million or 82.6% from $12.8 million for the year ended December 31, 2007 to $2.2 million for the year ended December 31, 2008.

The Company had originated loans with potential for negative amortization from 2000 until 2005 which had a balance of $37.3 million at December 31, 2008. The Company has mitigated the risks associated with the negatively amortizing loans by using conservative underwriting standards. The Company no longer originates loans with the potential for negative amortization. Capitalized interest recognized in earnings that resulted from negative amortization within the portfolio totaled $571 thousand or 1.3% of loan interest income for the year ended December 31, 2008 and $1.6 million or 3.6% of loan interest income for the year ended December 31, 2007.

Interest income on other interest-earning assets increased $9 thousand, or 1.8% to $521 thousand for the year ended December 31, 2008 from $512 thousand for the year ended December 31, 2007 primarily due to an increase in Federal Home Loan Bank ("FHLB") stock dividends resulting from an increase in the required average FHLB stock holdings due to an increase in FHLB advances during the year. The Federal Home Loan Bank of San Francisco has recently announced that a dividend will not be paid for the first quarter of 2009 and that future dividends will be subject to economic conditions and the ability of the FHLB to pay them.

Interest income on securities decreased $426 thousand, or 75.1% to $141 thousand for the year ended December 31, 2008 from $567 thousand for the year ended December 31, 2007. The decrease was due to the two agency securities totaling $4.3 million that were called at par during the first quarter of 2008. The average yield on the securities portfolio increased by 192 basis points from 4.4% for the year ended December 31, 2007 to 6.4% for the year ended December 31, 2008. The collateralized mortgage obligations purchased during 2008 were purchased at the end of the year and, therefore, had a minimal impact on interest income during the year.

Interest Expense. Interest expense decreased $5.8 million or 20.2%, to $23.0 million for the year ended December 31, 2008 compared to December 31, 2007 primarily due to a decrease in interest expense on deposits resulting from the overall decrease in interest rates during the period. Interest expense on deposits decreased $6.4 million, or 26.6% to $17.5 million for the year ended December 31, 2008 from $23.9 million for 2007. This resulted from a 105 basis point decrease in the Company's cost of funds due to a decrease in short term interest rates as well as a $3.1 million decrease in the average balance of deposits from $562.5 million for the year ended December 31, 2007 to $559.4 million for the year ended December 31, 2008. Interest expense on Federal Home Loan Bank advances increased approximately $524 thousand, or 10.5%, to $5.5 million for the year ended December 31, 2008 from $5.0 million for the year ended December 31, 2007 primarily due to a $43.0 million increase in the average balance of Federal Home Loan Bank advances which were used to fund loan demand. Although interest expense on Federal Home Loan Bank advances increased, rates paid on those advances decreased by 85 basis points. This decline reflected the substantial decrease in short term market interest rates as a result of the Federal Open Market Committee of the Federal Reserve Board's ("FOMC") decision to reduce the overnight lending rate in response to the continued liquidity crisis in the credit markets and recessionary concerns.

Net Interest Income. As a result of the factors mentioned above, net interest income before the provision for loan losses increased $6.0 million, or 35.6%, to $22.9 million for the year ended December 31, 2008 from $16.9 million for the year ended December 31, 2007. Due to the substantial decline in the Company's cost of funds, as a result of the decrease in short term market interest rates, the Company's margins have substantially improved over the prior period with the net interest spread increasing 75 basis points to 2.6%, and the net interest margin increasing 65 basis points to 2.9%.

Provision for Loan Losses. Management assesses the allowance for loan losses on a monthly basis. Management uses available information to recognize losses on loans, however, future loan loss provisions may be necessary based on changes in economic conditions. The allowance for loan losses as of December 31, 2008 was maintained at a level that represented management's best estimate of incurred losses in the loan portfolio to the extent they were both probable and reasonably estimable.

A provision for loan losses of $13.5 million was recorded for the year ended December 31, 2008 compared to a $1.6 million provision recorded for the year ended December 31, 2007. Increased provision levels reflect the deterioration in the housing markets during the period and the resulting increase in the Company's nonperforming loan balances, as well as an increase in loans charged off.

Total charge-offs for the year ended December 31, 2008 were $1.6 million compared to $24 thousand for the year ended December 31, 2007. The current year charge-offs consisted primarily of eight one-to four- loans totaling $658 thousand, one commercial business loan totaling $653 thousand and two home equity line of credit loans totaling $197 thousand.

Provisions for loan losses are charged to operations at a level required to reflect probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, peer group information, declining property values and prevailing economic conditions. In this regard, approximately 95% of our loans are to individuals and businesses in southern California. California, in general, and more specifically, San Diego and Riverside counties, are considered to be the most distressed real estate markets in the country. Despite current financial market and economic conditions, the Company has not experienced significant exposure in the residential loan portfolio and has actively addressed credit related issues. The Company's loss provisions have primarily been related to construction and land development loans. In assessing loan loss provisions, the Company utilizes current market values for collateral dependent loans. Large groups of smaller balance homogeneous loans, such as residential real estate, small commercial real estate, and home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions as experienced by the Company. Large balance and/or more complex loans, such as multi-family, construction, and commercial real estate loans, and classified loans, are evaluated individually for impairment. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events change.

Noninterest Income. Noninterest income decreased $189 thousand, or 7.9% to $2.2 million for the year ended December 31, 2008 from $2.4 million for the year ended December 31, 2007, primarily due to a decrease in loan prepayment penalties as well as decreased performance in the bank owned life insurance . . .