General

The Company's results include the operations of CalFirst Leasing and CalFirst Bank. The Company's direct finance, loan and interest income includes interest income earned on the Company's investment in lease receivables, residuals, commercial loans and investment securities. Other income primarily includes gains realized on the sale of leased property, income from sales-type and operating leases and gains realized on the sale of leases, and other income or loss. Income from sales-type leases relates to the re-lease of off-lease property ("lease extensions") and new lease transactions that qualify as sales-type leases, generally where the fair value of the property subject to the lease differs from the Company's carrying cost. Income from operating leases generally involves lease extensions that do not meet the accounting treatment required for sales-type leases.

The Company's operating results are subject to quarterly fluctuations resulting from a variety of factors, including the size and credit quality of the lease portfolio, the volume and profitability of leased property being re-marketed through re-lease or sale, the interest rate environment, the volume of new lease or loan originations, including variations in the mix and funding of such originations, the market for investment securities and economic conditions in general. The Company's principal market risk exposure is interest rate risk, which is the exposure due to differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. The Company's balance sheet structure historically has been short-term in nature, with a greater portion of assets that reprice or mature within one year.With the increased investment in commercial loans and investment securities with longer maturities, this maturity gap has diminished. The Company's interest margin also is susceptible to timing lags related to varying movements in market interest rates. Many of Company's leases, loans and liquid investments are tied to U.S. treasury rates and the fed funds rate that often do not move in step with bank deposit rates. As a result, this can result in a greater change in net interest income than indicated by the repricing asset and liability comparison.

The Company conducts its business in a manner designed to mitigate risks. However, the assumption of risk is a key source of earnings in the leasing and banking industries and the Company is subject to risks through its investment in leases and loans held in its own portfolio, securities, lease transactions-in-process, and residual investments. The Company takes steps to manage risks through the implementation of strict credit and risk management processes and on-going risk management review procedures.

Critical Accounting Policies and Estimates

The preparation of the Company's financial statements requires management to make certain critical accounting estimates that impact the stated amount of assets and liabilities at a financial statement date and the reported amount of income and expenses during a reporting period. These accounting estimates are based on management's judgment and are considered to be critical because of their significance to the financial statements and the possibility that future events may differ from current judgments, or that the use of different assumptions could result in materially different estimates. The following is a description of the most critical accounting policies management applies, all of which require the use of accounting estimates and management's judgment, based on the relevant information available at the end of each period.

Allowance for Credit Losses -- The allowance for credit losses provides coverage for probable and estimatable losses in the Company's lease and commercial loan portfolios. The allowance recorded is based on a quarterly review of all leases and loans outstanding, loan commitments and transactions-in-process. The determination of the appropriate amount of any provision is based on management's judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease and loan portfolio, including levels of non-performing leases and loans, customers financial condition, leased property values as well as general economic conditions and credit quality indicators. The Company's allowance includes an estimate of reserves needed to cover specifically identified lease and loan losses and certain unidentified but inherent risks in the portfolio.

Fair Value of Investments - Investment securities are characterized as available-for-sale or held-to maturity based on managements ability and intent regarding such investment at acquisition. On an ongoing basis, management must estimate the fair value of its investment securities based on information and assumptions it deems reliable and reasonable, which may be quoted market prices or if quoted market prices are not available, fair values extrapolated from the quoted prices of similar instruments. Based on this information, an assessment must be made as to whether any decline in the fair value of an investment security should be considered an other-than-temporary impairment and recorded in non-interest income as a loss on investments. The determination of such impairment is subject to a variety of factors, including management's judgment and experience.

Residual Values -- For capital leases that qualify as direct financing leases, the aggregate lease payments receivable and estimated residual value, if any, are recorded on the balance sheet, net of unearned income and allowances, as net investment in leases. Of the volume of leases booked during the fiscal years ended June 30, 2009, 2008 and 2007, approximately 30.6%, 29.2% and 25.3%, respectively, were structured such that the Company owns the leased asset at the end of the term and therefore, the Company recorded a residual value. The residual value is an estimate for accounting purposes of the fair value of the leased property at lease termination and is determined at the inception of the lease based on the property leased and the terms and conditions of the underlying lease contract. The realizability of any estimated residual value depends on future collateral values, contractual options available to the lessee, the credit of the lessee, market conditions and other subjective and qualitative factors. The estimated residual values established at lease inception are periodically reviewed to determine if values are realizable and any identified losses are recognized at such time.

Deferred S,G&A Expenses - A portion of the Company's selling, general and administrative expenses (S.G&A") that management estimates is directly related to originating lease and loan transactions is deferred through a reduction to SG&A expenses recognized in a period. The amount deferred reflects management's estimate of the expenses applicable to the origination process, taking into account a variety of factors including sales productivity, credit and documentation efficiency and estimates of completion percentages.

Deferred Income Taxes and Valuation Allowance -- Deferred tax assets and liabilities result from temporary differences between the time income or expense items are recognized for financial statement purposes and for tax reporting. Such amounts are calculated using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of Federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversals of temporary differences and current financial accounting standards. A valuation allowance is established if, based upon the relevant facts and circumstances, management believes that some or all of certain tax assets will not be realized. The Company has open tax years that may in the future be subject to examination by Federal and state taxing authorities. Management periodically evaluates the adequacy of related valuation allowances, taking into account our open tax return positions, tax assessments received and tax law changes. The process of evaluating allowance accounts involves the use of estimates and a high degree of management judgment. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities and reserves.

The Company's estimates are reviewed continuously to ensure reasonableness. However, the amounts the Company may ultimately realize could differ from such estimated amounts.

Overview of Results, Trends and Outlook

Net earnings for the year ended June 30, 2009 of $9.3 million were up 33.2% from $7.0 million for the prior year. The improvement in earnings is primarily attributable to a reduction in selling, general and administrative ("S,G&A") expenses along with higher income earned on the commercial loan and investment portfolios. For the year ended June 30, 2009, new lease bookings of $143.7 million were 5% above the $137.3 million booked in the prior year, and with commercial loans boarded of $51.5 million contributed to an overall 8% increase in leases and loans booked to $195.1 million. The net investment in leases and loans of $284.8 million at June 30, 2009 was up 9% from June 30, 2008, however the increase was primarily due to the 70% growth in commercial loan portfolio to $71.1 million as the investment in leases declined 3% to $213.6 million. The Bank accounted for almost all of the growth in assets, with the Bank's investment in leases and loans of $202.1 million at June 30, 2009 increasing from 64% to 71% of the Company's consolidated investment.

Growth in net direct finance, loan and interest income was constrained by the decline in the investment in leases and lower yields earned, which was offset by increased income from loans and investments. The Company's average investment portfolio increased over 100% to over $115 million for the year ended June 30, 2009 as the Company diversified into higher yielding investments and increased the average yield earned by 65 basis points. To fund the asset growth, the Bank's demand, money market and time deposits increased by 41% to $220.9 million at June 30, 2009 from $156.2 million at June 30, 2008 but the average rate paid for deposits declined 136 basis points. Initial borrowings from the Federal Home Loan Bank ("FHLB") and Federal Reserve of $45.4 million during the year contributed to lowering of CalFirst Bank's funding costs by 167 basis points and improved the Bank's net interest margin to 4.2% from 3.4% in fiscal 2008.

Looking forward to fiscal 2010, management will continue to look for opportunities for growth through investment in assets that meet its risk/reward requirements. New lease and loan transactions approved ("lease and loan originations") of approximately $159 million during fiscal 2009 were down 12% from the level in fiscal 2008 and the backlog of approved but un-booked leases and loans at June 30, 2009 is about 24% below the level of a year ago. Property acquired for transactions-in-process of $12.4 million was 57% below the level at June 30, 2008. While management has seen some improvement in demand from leasing customers, the projected volume is still below the level needed to expand the portfolio. As a result, the Company expects direct finance and loan income to be lower in fiscal 2010, unless the business climate improves materially in the next few months. With the diversified investment portfolio at June 30, 2009, interest income on investments should be up, but is dependent on the securities markets and interest rates. The ultimate growth in direct finance and loan income or outcome with respect to the investment in securities is subject to a variety of factors including the impact of credit markets, interest rates, as well as customers' financial condition and choices. All these factors are beyond management's control and therefore any expectations are subject to change.

Consolidated Statement of Earnings Analysis

Summary -- For the fiscal year ended June 30, 2009, net earnings increased 33.2% to $9.3 million, compared to $7.0 million for fiscal 2008. Diluted earnings per share increased 47.4% to $0.89 for fiscal year ended June 30, 2009, compared to $0.61 per share for fiscal 2008. Net earnings reflect a 15% decrease in S,G&A expenses, 11% increase in other income and 3% increase in net direct finance, loan and interest income. Growth in diluted earnings per share benefited from the Company's August 2008 purchase of common stock pursuant to a modified Dutch auction tender offer that reduced the fully diluted shares outstanding for the year by 10% to 10.4 million.

Net Direct Finance, Loan and Interest Income -- Net direct finance, loan and interest income is the difference between interest earned on the investment in leases, loans, securities and other interest earning assets and interest paid on deposits or other borrowings. Net direct finance, loan and interest income is affected by changes in the volume and mix of interest earning assets and liabilities, the movement of interest rates, and funding and pricing strategies.

Net direct finance, loan and interest income was $23.2 million for the fiscal year ended June 30, 2009 compared to $22.1 million for fiscal 2008 and $22.2 million in fiscal 2007. The increase in fiscal 2009 from fiscal 2008 was due to an increase of $2.7 million in interest earned on investments and $3.1 million increase in commercial loan income, offset by a decline of $3.8 million in direct finance income. These changes are primarily the result of changing lease and loan opportunities and the Company's shift of available liquidity to higher yielding investments. The decrease in direct finance income reflects a 7.0% decline in the average investment in leases directly held by the Company and a 96 basis point decline in average yields on such investments. Commercial loan income growth reflects an almost 500% increase in average commercial loan balances, offset somewhat by an 86 basis point decline in the average yield earned. Higher interest expense on deposits reflects a 56% increase in average deposit balances to $183.8 million while the average rate paid decreased by 136 basis points. Borrowings from the FHLB and Federal Reserve averaged $23.7 million for the year at an average cost of 0.8%, which helped reduce the Company's overall interest expense costs.

The slight decrease in net direct finance, loan and interest income in fiscal 2008 from fiscal 2007 was due to a $1.0 million increase in interest expense paid on deposits that exceeded the increase of $336,000 in direct finance income and addition of $745,000 in interest income recognized on the commercial loan portfolio. Higher interest expense on deposits reflected a 23% increase in average deposit balances to $118.1 million while the average rate paid decreased by 5 basis points. The increase in direct finance income reflected a 3.0% increase in the average investment in leases directly held by the Company, offset by a 17 basis point decline in average yields on such investments. A $143,000 decrease in interest income on cash and investments also contributed to the decline and resulted from a 78 basis point decrease in average yields earned offset by a 34% increase in the average balances.

               California First National Bancorp and Subsidiaries

The following table presents the components of the increases (decreases) in net
direct finance, loan and interest income by volume and rate:

(in thousands)                   2009 compared to 2008                     2008 compared to 2007
                          Volume         Rate          Total        Volume         Rate          Total
Direct finance, loan
and interest income
Net investment in
leases                   $  (1,749 )   $  (2,076 )   $  (3,825 )   $     743     $    (407 )   $     336
Commercial loans             3,636          (502 )       3,134           745             -           745
Discounted lease
rentals                        187           (33 )         154           (99 )         (26 )        (125 )
Federal funds sold            (474 )        (384 )        (858 )         419          (533 )        (114 )
Investment securities        2,437         1,344         3,781           136           (33 )         103
Interest-earning
deposits with banks            493          (704 )        (211 )        (109 )         (23 )        (132 )
  Total finance, loan
and interest income          4,530        (2,355 )       2,175         1,835        (1,022 )         813

Interest expense
Non-recourse debt              187           (33 )         154           (99 )         (26 )        (125 )
Demand and savings
deposits                     1,635          (723 )         912           183           (65 )         118
Time deposits                1,192        (1,408 )        (216 )         899            12           911
Short and long term
borrowings                     186             -           186             -             -             -
  Total interest
expense                      3,200        (2,164 )       1,036           983           (79 )         904
Net direct finance,
loan and interest
income                   $   1,330     $    (191 )   $   1,139     $     852     $    (943 )   $     (91 )

The following table presents the Company's average balance sheets, direct finance and loan income and interest earned or interest paid, the related yields and rates on major categories of the Company's interest-earning assets and interest-bearing liabilities:

(dollars in thousands)        Year ended June 30, 2009                Year ended June 30, 2008                Year ended June 30, 2007
                          Average                    Yield/       Average                    Yield/       Average                    Yield/
Assets                    Balance      Interest       Rate        Balance      Interest       Rate        Balance      Interest       Rate
Interest-earning
assets
  Interest-earning
deposits with
   banks                 $  38,377     $     483         1.3 %   $  22,437     $     694         3.1 %   $  25,859     $     826         3.2 %
  Federal funds sold        15,904           185         1.2 %      29,145         1,043         3.6 %      21,398         1,157         5.4 %
  Investment
securities                  58,772         3,958         6.7 %       3,846           177         4.6 %       1,350            74         5.5 %
  Commercial loans          58,639         3,879         6.6 %       9,973           745         7.5 %           -             -           -
  Net investment in
leases,
   including
discounted
   lease rentals (1,2)     225,576        21,857         9.7 %     238,602        25,528        10.7 %     233,403        25,317        10.8 %
Total interest-earning
assets                     397,268        30,362         7.6 %     304,003        28,187         9.3 %     282,010        27,374         9.7 %
Other assets                30,196                                  39,658                                  38,267
                         $ 427,464                               $ 343,661                               $ 320,277

Liabilities and
Shareholders' Equity
Interest-bearing
liabilities
  Demand and savings
deposits                 $  52,735         1,349         2.6 %   $  11,091           436         3.9 %   $   7,041           318         4.5 %
  Time deposits            131,074         5,082         3.9 %     107,005         5,299         5.0 %      88,809         4,388         4.9 %
  Short and long term
borrowings                  23,658           186         0.8 %           -             -           -             -             -           -
  Non-recourse debt          8,951           500         5.6 %       5,808           346         6.0 %       7,365           471         6.4 %
Total interest-bearing
liabilities                216,418         7,117         3.3 %     123,904         6,081         4.9 %     103,215         5,177         5.0 %
Other liabilities           20,774                                  19,280                                  20,784
Shareholders' equity       190,272                                 200,477                                 196,278
                         $ 427,464                               $ 343,661                               $ 320,277
Net interest income                    $  23,245                               $  22,106                               $  22,197
Net direct finance and
interest
  income to average
  interest-earning
assets                                                   5.9 %                                   7.3 %                                   7.9 %
Average
interest-earning
assets
  over average
  interest-bearing
liabilities                                            183.6 %                                 245.4 %                                 273.2 %


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(2) Average balance is based on month-end balances, includes non-accrual leases, and is presented net of unearned income.

Provision for Credit Losses -- The Company recorded a provision for credit losses of $1.7 million for fiscal 2009, compared to a provision of $1.2 million recognized in fiscal 2008 and a net recovery of $120,000 in fiscal 2007. The 2009 provision related to substantial growth in and heightened credit risk within the commercial loan portfolio, as well as deterioration in the credit quality of certain customers. The Company recorded a provision for credit losses of $1.2 million in fiscal 2008 due to the deterioration in the credit quality of certain leases and the growth of the commercial loan portfolio. The net recovery of $120,000 recorded in fiscal 2007 reflected a $633,000 recovery on a previously charged off lease receivable, offset by a provision of $513,000 during the year.

Total Non-interest Income -- Total non-interest income accounted for 24% of the Company's gross profit during the year ended June 30, 2009, compared to 23% during 2008 and 29% during 2007. Total non-interest income of $6.8 million for the year ended June 30, 2009 increased $667,000, or 11%, from $6.1 million in 2008 but was 26% lower than the $9.2 million earned in fiscal 2007. The increase in non-interest income in fiscal 2009 compared to fiscal 2008 reflects an increase in the gain on sales of leases and leased property of $346,000, as higher income from sale of leases offset lower income from sale of leased property, as well as a $293,000 increase of in operating and sales-type income due to an increased volume of lease extensions and short-term lease renewals. Other income increased $212,000 on higher fees and charges collected. The Company recognized an impairment loss on investment securities of $869,000 in fiscal 2009 compared to an impairment loss of $685,000 in fiscal 2008. The Company continues to hold these investments.

The decrease in total non-interest income in fiscal 2008 compared to fiscal 2007 primarily reflects a decrease of $1.6 million in operating and sales-type income as the volume of lease extensions and short-term lease renewals declined. Gain on sales of leases and leased property declined $195,000, as higher income from sale of leases did not offset lower income from sale of leased property. Other income decreased $545,000, reflecting the $659,000 unrealized loss recorded on an equity investment.

Selling, General, and Administrative Expenses -- The Company's selling, general and administrative expenses ("SG&A") decreased $2.4 million, or 15%, to $13.5 million recognized for the year ended June 30, 2009. This compared to SG&A expenses in fiscal 2008 of $15.9 million, which had increased by $422,000, or 3%, from $15.5 million in fiscal 2007. The decrease in SG&A expenses during fiscal 2009 is due to lower fixed and variable office costs, including substantial savings from lower personnel costs.

For the year ended June 30, 2008 SG&A expenses increased $422,000, or 3%, to $15.9 million compared to SG&A expenses in fiscal 2007 of $15.5 million. The increase in SG&A expenses during fiscal 2008 is due to higher costs resulting from the growth in the sales organization and higher operating costs.

Included in SG&A expenses are FDIC insurance premiums of $228,427, $74,917 and $12,025, respectively, for the fiscal years ending June 30, 2009, 2008 and 2007. The Bank's FDIC insurance premium rates were not increased during 2009 and 2008, although amounts paid increased in connection with the growth in deposits. Included in the fiscal 2009 amount is a special FDIC assessment of $130,000 recorded in June 2009. Effective June 30, 2009, the FDIC increased the assessment rate for the Bank from 5 basis points annually to 12 basis points.

Income Taxes -- Income taxes were accrued at a tax rate of 37.50% for the fiscal year ended June 30, 2009 as well as 37.50% for fiscal year ended June 30, 2008, and 38.25% for fiscal year ended June 30, 2007, representing the Company's estimated annual tax rates for each respective year. The income tax rate remained the same in fiscal 2009 due to a similar amount of interest earned on leases where interest earned is exempt from certain taxes. Tax-exempt leases represented approximately 6.6% of new lease bookings in fiscal 2009, compared to 11.7% during fiscal 2008 and 8.1% in fiscal 2007.

Financial Condition Analysis

Lease Portfolio Analysis

The Company currently funds a high percentage of new lease transactions internally, while only a small portion of leases are assigned to unaffiliated financial institutions. During the fiscal year ended June 30, 2009, approximately 87% of the total dollar amount of new leases and loans booked by the Company were held in its own portfolio, compared to 92% during fiscal 2008 and 97% during fiscal 2007. For the fiscal year ended June 30, 2009, the Company's net investment in lease receivables decreased by $6.1 million and the investment in estimated residual values decreased by $919,000. The decrease in the investment in lease receivables is primarily due to a larger run-off from the lease portfolio than new lease transactions booked and retained by the Company, while the decrease in investment in residual values is due to a lower volume of new leases on which the Company records a residual compared to the volume of residual values recognized at end of term.

The Company often makes payments to purchase leased property prior to the commencement of the lease. The disbursements for these lease transactions-in-process are generally made to facilitate the lessees' property implementation schedule. The lessee generally is contractually obligated by the lease to make rental payments directly to the Company during the period that the transaction is in process, and obligated to reimburse the Company for all disbursements under certain circumstances. Income is not recognized while a transaction is in process and prior to the commencement of the lease. At June . . .