SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 Form
10-K
 
 þ
              ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 For
the Fiscal Year ended December 31,
2008
 OR
 o
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 Commission
file number 333-12892
 
 MISSION COMMUNITY
BANCORP
 (Exact
name of registrant as specified in its charter)
 
 California                                                                               77-0559736
 State or
other jurisdiction of incorporation or
organization                                                                                              I.R.S.
Employer Identification No.
 
 581 Higuera St., San
Luis Obispo,
California  93401                                                                                                        (805)
782-5000
 (Address of principal executive
offices)                                                                                   Issuer’s
telephone number
 
 Securities
registered pursuant to Section 12(b) of the Exchange Act: None
 Securities
registered pursuant to Section 12(g) of the Exchange Act:  None
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.oYes.þNo
 
 Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act.   þ
 
 Indicate
by check mark whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the preceding 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 þNo o
 
 Check if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not
contained in this form, and no disclosure will be contained, to the best of the
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K þ.
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 Large
      accelerated filer o
              Accelerated
      filer  oNon-accelerated
      filer o
      (Do not check if a smaller
      reporting company)
              Smaller
      reporting company þ
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes oNo þ
 
 The
aggregate market value of the voting and non-voting common equity held by
non-affiliates, computed by reference to the price at which the common equity
was last sold, or the average bid and asked prices of such common equity, as of
the last business day of the registrant’s most recently completed second fiscal
quarter, was $10,348,913.
 
 As of
March 1, 2009, the
Registrant had 1,345,602 shares of Common Stock outstanding.
 
 Documents Incorporated by
Reference:  Portions of the definitive proxy statement for the
2009 Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission pursuant to SEC regulation 14A are incorporated by reference in Part
III, Items 9-12 and 14.
  ~  ~
  Forward
Looking Statements
  This
Annual Report on Form 10-K includes forward-looking information, which is
subject to the “safe harbor” created by Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act and the Private
Securities Litigation Reform Act of 1995.  When the Company uses or
incorporates by reference in this Annual Report on Form 10-K the words
“anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and
similar expressions, the Company intends to identify forward-looking
statements.  Such statements are subject to certain risks,
uncertainties and assumptions, including those described in this Annual Report
on Form 10-K.  Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, estimated, expected, projected,
intended, committed or believed.  Such risks and uncertainties
include, but are not limited to, the following factors: (i) general economic
conditions, whether national or regional, that could affect the demand for loans
and other banking services or lead to increased loan losses; (ii) competitive
factors, including increased competition with community, regional and national
financial institutions that may lead to pricing pressures on rates the Bank
charges on loans and pays on deposits or reduce the value of real estate
collateral securing the Bank's loans; (iii) loss of customers of greatest value
to the Bank or other losses; (iv) increasing or decreasing interest rate
environments that could lead to decreased net interest margin and increased
volatility of rate sensitive loans and deposits; (v) changing business
conditions in the banking industry; (vi) changes in the regulatory environment
or new legislation; (vii) changes in technology or required investments in
technology; (viii) credit quality deterioration which could cause an increase in
the provision for loan losses; (ix) dividend restrictions; (x) continued
tensions in Iraq and elsewhere in the Middle East; and (xi) increased regulation
of the securities markets, whether pursuant to the Sarbanes-Oxley Act of 2002 or
otherwise.
 
 Investors
and other readers are cautioned not to place undue reliance on forward-looking
statements, which reflect management's analysis only as of the date of the
statement.
 
 The
Company undertakes no obligation to revise any forward-looking statement to
reflect later events or circumstances.
  ~  ~
   PART
I
  
 Item
      1.  Description of
Business
  Business
Development
 
 The
Company
 
 Mission
Community Bancorp (“Bancorp”) is a California corporation that was formed in
September 2000 and acquired all of the outstanding shares of Mission Community
Bank (the “Bank”) in a one-bank holding company reorganization effective
December 15, 2000.  It is registered as a bank holding company under
the Bank Holding Company Act of 1956, as amended, and is headquartered in San
Luis Obispo, California.  Bancorp’s principal business is to serve as
a bank holding company for the Bank.  Bancorp and the Bank are
collectively referred to herein as “the Company.”
  As of
December 31, 2008, the Company had approximately $215 million in total assets
and $21 million in shareholders’ equity.
  On
October 14, 2003, Bancorp formed Mission Community Capital Trust I in order to
complete a trust preferred security transaction and raised approximately
$3,000,000 in long-term borrowings that qualifies as regulatory
capital.
  On
February 15, 2008 the Bancorp closed a secondary public offering of its common
stock, which was sold on a best efforts basis.  Bancorp sold an
aggregate of 410,644 shares of common stock in the offering at a purchase price
of $18.00 per share, raising net proceeds of approximately $6.8 million after
deducting offering expenses.
  On
December 2, 2008 the Company sold an aggregate of 225,026 shares of its
authorized but unissued shares of common stock (the “Shares”) to the Carpenter
Community BancFund-A, L.P. at a price of $17.10 per share, for aggregate
gross proceeds to the Company of $3,847,944.   There were no
underwriting discounts or commissions paid by the Company with respect to the
sale of the Shares.  The sale was made pursuant to an exemption from
registration set forth in Section 4(2) of the Securities Act of 1933, as
amended, as a privately negotiated transaction not involving a public
offering.
  See Market for Common Equity and Related
Shareholder Matters under Item 5 of Part II of this report.
  The U.S.
Department of the Treasury, Community Development Financial Institutions Fund,
has certified Bancorp and the Bank as Community Development Financial
Institutions (“CDFI”).  This status also conveys possible Community
Reinvestment Act (“CRA”) credit to institutional depositors and investors in the
Bank and Bancorp.  It also opens to the Bank and Bancorp various
government sponsored programs, grants, and awards in which they may
participate.  The Bank and Bancorp are also certified by the CDFI Fund
as Community Development Entities (“CDE’s”).  As CDE’s, qualifying
investments made in the Bank or Bancorp provide the investor with a New Markets
Tax Credit equal to 39% of the investment, to be realized over a seven-year
period.
  With its
status as a CDFI, Bancorp completed the private placement of $500,000 in
preferred stock during December 2000 with the CDFI Fund.  Bancorp also
was awarded a second $500,000 Core Award in 2001 from the CDFI Fund, which was
funded in December 2002 in the form of preferred stock.  This was
matched with a combination of preferred and common shares through an investment
of $500,000 from the National Community Investment Fund (“NCIF”).  In
2007 the Bank received a $326,000 Bank Enterprise Award (“BEA”) from the CDFI
Fund.  The award was made under the Fiscal Year 2007 BEA Program, which
provides an incentive for any FDIC insured bank to annually increase the levels
of financial services provided to economically distressed communities.  The
Bank also received similar awards in 2004 and 2001 of $1,241,000 and $990,000,
respectively.
  In 2005
Bancorp received a $133,000 CDFI technical assistance grant to help offset any
costs associated with providing additional services to the un- and under-banked
in its target market area.  Through December 31, 2006, the Company had
incurred qualifying expenses totaling $100 thousand.  A portion of the
grant was recognized in non-interest income in 2006 and the balance was
recognized in 2007.
   ~  ~
  Mission
Community Bank
  The Bank
is a California state-chartered bank headquartered in San Luis Obispo,
California.  It is also a member of the Federal Reserve
System.  Its deposits are insured by the FDIC up to the applicable
limits of the law.  The Bank commenced operations at its main office
in San Luis Obispo on December 18, 1997 and opened its first branch office in
the city of Paso Robles in San Luis Obispo County in 1998 and a second branch
office in Arroyo Grande in San Luis Obispo County in 2002.  The Bank
also opened a loan production office, the Business Banking Center, in San Luis
Obispo in January 2005.  The Business Banking Center is primarily
engaged in originating and servicing SBA-guaranteed loans.  In
December 2008 the Bank opened a new branch office in Santa Maria, in northern
Santa Barbara county.
  The Bank
is a community bank engaged in the general commercial banking business in the
Central Coast of California.  It offers a variety of deposit and loan
products to individuals and small businesses and a specialization in community
development financial services and SBA loans.  Through its community
development activities, the Bank seeks to provide financial support and services
by promoting community development and economic vitality.
  At
December 31, 2008, the Bank had approximately $215.5 million in assets, $153.3
million in loans, $144.8 million in deposits, and $20.5 million in stockholders’
equity.
  The Bank
is also certified by the State of California Department of Insurance to accept
deposits or investments under the California Organized Investment
Network (the “COIN”).  The COIN program provides California tax
credits and/or CRA credit to individuals, corporations, or partnerships that
invest at below market rates for specified terms.  In addition, the
Bank has obtained preferred lender status with the Small Business Administration
which generally allows it to approve and fund SBA loans without the necessity of
having the loan approved in advance by the SBA.
  Mission
Community Development Corporation (“MCDC”)
  Mission
Community Development Corporation, a community development corporation which was
incorporated in August 1997, is a wholly-owned subsidiary of the
Bank.  MCDC is a “for-profit” Community Development Corporation
(“CDC”), which provides financing for small businesses and low- to
moderate-income area development and/or affordable housing
projects.  Its purpose is to benefit small business and low- to
moderate-income areas/residents.  The board of directors of MCDC
consists of the members of the Board of Directors of the Bank.
  At
December 31, 2008, MCDC had approximately $194,000 in net loans and $323,000 in
shareholder’s equity, and provides loan accounting services for a very small
pool of community development micro loans which have been funded by a group of
banks through the Economic Vitality Corporation, as well as management of an
emergency assistance loan pool created after the San Simeon earthquake of
December 2003.  MCDC also manages a loan pool for the San Luis Obispo
County Housing Trust Fund to assist in providing affordable housing within the
county.
  Mission
Community Services Corporation (“MCSC”)
  Bancorp
and the Bank have an affiliate relationship with, but no ownership of, MCSC,
which was incorporated in August 1997 and which was established in September
2003 as a “not-for-profit” public charitable corporation under Internal Revenue
Code Section 501(c)(3).  The accounts of MCSC are not included in the
Company’s consolidated financial statements or elsewhere in this Form
10-K.  MCSC’s primary focus is to provide technical assistance and
training services to the community, including small business, minority and
low-income entrepreneurs.  The Board of Directors of MCSC includes
representatives from the Company, together with members representing the
low-income and business community.  Over the five-year period ended
December 31, 2008, Bancorp has provided $450 thousand in cash contributions and
$68 thousand in in-kind (non-cash) contributions to MCSC.
  In 2006,
MCSC was awarded a five-year, $750,000 grant from the U.S. Small Business
Administration to fund one of 99 Women’s Business Centers
nationwide.  MCSC is also “COIN”-certified as a CDFI.  See
also Note L to the Consolidated Financial Statements for additional information
regarding MCSC.
   ~  ~
  The
“Mission” Group
  Bancorp,
the Bank and its subsidiary MCDC, and MCSC form an organizational structure
intended to provide traditional community bank financial services and to foster
economic revitalization and community development to its target market areas
through its CDFI enhancements.
  
  Business
of Issuer
  Principal
Products, Services, and Markets
 Other
than holding the shares of the Bank, Bancorp conducts no significant activities.
Bancorp is authorized with the prior approval of the Board of Governors of the
Federal Reserve System (the “Federal Reserve Board”), its principal regulator,
to engage in a variety of activities which are deemed closely related to the
business of banking.
  The Bank
offers checking and savings accounts, money market accounts and time
certificates of deposits; offers commercial, agribusiness, government
guaranteed, real estate, automobile and other installment and term loans and
leases; issues drafts, sells travelers’ checks and provides other customary
banking services. Although the Bank does not operate a trust department or
provide international services, it makes trust services or international
services available through correspondent institutions.
  The areas
in which the Bank has directed virtually all of its lending activities are
commercial loans (including government-guaranteed and agricultural loans), real
estate loans, construction loans, consumer loans and lease
financing  As of December 31, 2008, these five categories accounted
for approximately 17.7%, 64.0%, 14.9%, 2.4%, and 1.0% respectively, of the
Bank’s gross loan portfolio.  As of that date, $120.9 million, or
78.9%, of the Bank’s loans consisted of real estate loans, for single family
residences or for commercial development, and interim construction
loans.  This represents an increase in real estate and construction
loans from the prior year’s combined 74.8%.  Under the regulatory
definition of commercial real estate—which excludes owner-occupied
properties—the Bank’s commercial real estate concentration is reduced to $63.6
million, or 41.5% of total loans.  See Loan Concentrations in
Management’s Discussion and Analysis under Item 6 of Part II of this
report.
  As of
December 31, 2008, the Bank had 4,859 deposit accounts, including 2,687 demand
accounts (both interest-bearing and non-interest-bearing) totaling $37.9
million; 1,174 savings accounts with balances totaling $17.6 million; and 998
time certificates of deposit totaling $89.3 million.
  The
principal sources of the Bank’s revenues are interest and fees on loans,
interest on investments including federal funds sold and deposits in other
banks, gain on sale of loans, grants and awards, and service charges on deposit
accounts.  For the year ended December 31, 2008, these sources
comprised 81.4%, 12.5%, 1.6%, 0.0%, and 3.0%, respectively, of the Bank’s total
operating income.
  Distribution
Methods of the Products and Services
  The
Bank’s primary service area consists of San Luis Obispo county and northern
Santa Barbara county, which lie centrally within the State of California along
the Pacific Ocean.  Secondary market areas include cities and
unincorporated areas in the neighboring counties, including Monterey, Kern,
Kings, and Fresno.
  The Bank
operates out of four full service offices (in the cities of San Luis Obispo,
Paso Robles, Arroyo Grande and Santa Maria) plus a loan production office and an
administrative facility, which are both located in the city of San Luis
Obispo.  The Bank provides some financial services through direct
contact by calling officers who travel into the neighboring
counties.  Physical expansion into the neighboring counties would most
likely come from acquisitions or in the form of loan production offices although
there are no immediate plans for acquisitions or loan production
offices.
  The
Bank’s operating policy since its inception has emphasized community development
through small business, commercial and retail banking.  Most of the
Bank’s customers are retail customers, farmers and small to medium-sized
businesses and their owners.  As a CDFI, the Bank also emphasizes
loans and financial services to low- to moderate
   ~  ~
  income
communities within its target market area.  Most of the Bank’s
deposits are attracted by relationship banking, local activities, and
advertising.
  The
business plan of the Bank emphasizes providing highly specialized financial
services in a professional and personalized manner to individuals and businesses
in its service area.  Its key strengths are customer service and an
experienced management team familiar with the community through the Bank’s
involvement in various community lending and development projects.
  In 2007
and 2008, the Bank extended its use of Internet technology as a distribution
tool to improve its customer service by making available a “remote capture”
deposit product, as well as enhanced Internet Banking, electronic Bill-Pay and
ACH origination.
  During
2006 the Bank began to capitalize on its status as one of only two banks in San
Luis Obispo County participating in the Certificate of Deposit Account Registry
Service (“CDARS”) program.  This program permits the Bank’s customers
to place all of their certificates of deposit at the Bank and have those
deposits fully-insured by the FDIC, up to $50 million.  The CDARS
program acts as a clearinghouse, matching deposits from one institution in the
CDARS network of nearly 3,000 banks with other network banks (in increments of
less than the $250 thousand FDIC insurance limit), so funds that a customer
places with the Bank essentially remain on the Bank’s balance
sheet.  While the Bank continues to focus on its local market areas,
its participation in the CDARS program permits it to bid on additional
certificates of deposit through banks across the country to meet additional
funding needs.  These “One-Way Buy” CDARS deposits are considered to
be brokered deposits.  When the Bank has excess funds, the CDARS
program enables the Bank to place those funds in CD’s with CDARS network banks
(known as the “One-Way Sell” program), which generally results in a higher yield
than if those funds were invested in Federal Funds.  The Bank also
expects to continue to use its CDFI and COIN designations to attract lower cost
deposits.
  Status
of and Publicly Announced New Products or Services
  The Bank
participated in a 3-year project (2002-2005) sponsored by NCIF to explore and
develop a profitable range of retail financial products and services to low
income and unbanked customers (“low income customers”).  NCIF
underwrote a majority of the costs associated with this project.  The
project involved developing replicable and profitable business models for both
particular products and services targeted at low income customers, and
coordinated suites of products that can meet a range of
needs.  Product and service specifications, target market, cross
selling and profitability data were tracked over a two- to three-year time
horizon and suites of products were developed that meet household financial and
asset building needs while being profitable for financial
institutions.
  A
Financial Education team of bank employees has been formed, in an effort to
reach out to the community to share sound money management practices and habits
to the target market of low-income and under-banked individuals.  A series
of training workshops covering the fundamentals of banking and financial
services have been developed in English and Spanish.  The Bank expects
to increase its focus on profitable financial services for the un- and
under-banked customers in its market area, but does not expect these services
will be a material percentage of its deposit activities.
  The Bank
has created a new division at Mission Community Bank: the “Hispanic Banking
Division,” staffed with employees who are bilingual in English and
Spanish.  The new division is dedicated to working closely in the Hispanic
communities it serves, including Santa Maria.  The division will offer
specifically designed deposit and loan products and services benefiting the
Hispanic community.
  In 2007
the Bank received from the Bank Enterprise Award program of the Department of
the Treasury a $326 thousand grant based on lending activity the bank commenced
in 2006.  The award was recognized in non-interest income in
2007.
  The
Company applied to the CDFI in 2004 for a technical assistance grant to help
offset any costs associated with providing additional services to the un- and
under-banked in its market area, and received a grant of $134,935 in
2005.  During 2006 the Bank incurred approximately $100,000 in
qualifying expenses under this grant.  Accordingly, the Bank
recognized $100,000 of the grant as non-interest income in 2006.  An
additional $33 thousand of qualifying expenditures was incurred in
2007.  Therefore, the Bank recognized $33 thousand of non-interest
income related to this grant in 2007.
   ~  ~
  Competition
  The
banking and financial services business in the Bank’s market area is highly
competitive.  The increasingly competitive environment is a result
primarily of changes in regulation, and changes in technology and product
delivery systems.  The Bank emphasizes to its customers the advantages
of dealing with a locally owned and community development oriented institution.
Larger banks may have a competitive advantage because of higher lending limits
and major advertising and marketing campaigns in addition to expanded products
like trust services, international banking, discount brokerage and insurance
services that the Bank does not offer.  As a service to its customers,
the Bank has made arrangements with other financial service providers to extend
such services to its customers where possible.  For borrowers
requiring loans in excess of the Bank’s legal lending limits, the Bank makes use
of loan participations with its correspondent banks and with other independent
banks, retaining the portion of such loans which is within its legal lending
limits.  Commercial banks compete with savings and loan associations,
credit unions, other financial institutions, securities brokerage firms, and
other entities for funds.  For instance, yields on corporate and
government debt securities and other commercial paper affect the ability of
commercial banks to attract and hold deposits.
  The Bank
utilizes technology to improve its competitive advantages by use of ATMs,
Internet Banking, ACH origination, electronic bill pay, email, remote deposit
capture and credit card and merchant card relationships.
  In
addition, in order to compete effectively, the Bank has created a sales and
service culture that combines the experience of its senior officers with the
commitment to service and a focus on the individual needs of its customers that
is found at the best community banks.  The Bank also relies on local
advertising programs, direct personal contact by its officers, directors,
employees and shareholders and specialized services such as courier pick-up and
remote deposit capture.  The Bank believes it provides a level of
service and decision-making responsiveness not generally offered by larger
institutions.
  The
Bank’s primary service area consists of the county of San Luis Obispo and
northern Santa Barbara county.    As in most major U.S.
cities, large banks compete in our service area.  However, rather than
these large financial institutions, we believe our primary competitors for
individuals and small and medium-sized business customers are the community
banks that can provide the service and responsiveness attractive to this
customer base.
  Within
San Luis Obispo county and northern Santa Barbara county, based on data from the
FDIC as of June 30, 2008, there were 20 banks with 105 branches with aggregate
deposits of $6.2 billion.  The Bank’s deposits represent a 2.0% share
of this market.  Of the 20 banks, 10 were community banks (banks with
less than $1 billion in assets), with 7 of these banks headquartered in San Luis
Obispo county and 3 headquartered in Santa Barbara county.  There were
also 7 credit unions operating in San Luis Obispo and northern Santa Barbara
Counties.  Three of those credit unions are headquartered in the
Bank’s target market area.
  No
Dependence on One or a Few Major Customers
  The Bank
is limited, due to legal lending limits, in the size of loans it can make to any
one individual borrower (in the aggregate).  It has in its portfolio
approximately 600 loans to approximately 475 loan customers.  As of
December 31, 2008, the Bank’s legal lending limit to a single borrower, and such
borrower’s related parties, was approximately $6.4 million on a secured basis,
and was $3.8 million for unsecured loans, based on regulatory capital plus
reserves of approximately $25.5 million.
  A
material portion of the Bank’s deposits have not been obtained from a single
person or a few persons, the loss of any one or more of which would have a
materially adverse effect on the business of the Bank.  However, the
Bank does have a higher than average dependence (as measured by peer group
analysis) on larger deposit balances (deposits of $100,000 or more) with a total
of 295 deposit accounts holding $69.2 million in deposits as of December 31,
2008.  Included in those totals are 16 customers with deposits of $1
million or more totaling $39.7 million.  These deposit balances have
been reasonably stable during the past several years and are consistent with the
Bank’s deposit/funding strategy.
  The
Bank’s business does not appear to be seasonal.
   ~  ~
  Recent
Developments
  On
January 9, 2009, the Company issued to the United States Department of the
Treasury (“Treasury Department”) 5,116 shares of Mission Community Bancorp
Series D Fixed Rate Perpetual Preferred Stock, without par value (the “Series D
Preferred Stock”), having a liquidation amount per share equal to $1,000 for a
total price of $5,116,000.  The Preferred Stock was issued pursuant to
the Treasury Department’s Capital Purchase Program under the Troubled Asset
Relief Program (“TARP”).  The Series D Preferred Stock pays cumulative
dividends at a rate of 5% per year for the first five years and thereafter at a
rate of 9% per year.  The Company may not redeem the Series D
Preferred Stock during the first three years except with the proceeds from a
“qualified equity offering.” After three years, the Company may, at its option,
redeem the Series D Preferred Stock at par value plus accrued and unpaid
dividends.  The Series D Preferred Stock is generally
non-voting.  Prior to January 9, 2012, unless the Company has redeemed
the Series D Preferred Stock or the Treasury Department has transferred the
Series D Preferred Stock to a third party, the consent of the Treasury
Department will be required for the Company to issue a common stock dividend or
repurchase its common stock, or other equity or capital securities, other than
in connection with benefit plans consistent with past practice and certain other
circumstances.  See also Note T to Notes to Consolidated Financial
Statements.
  Effect
of Government Policies and Regulations
  Banking
is a business that depends on rate differentials.  In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowings and the interest rate received by the Bank on loans extended to
its customers and securities held in the Bank’s portfolio comprise the major
portion of the Bank’s earnings.  These rates are highly sensitive to
many factors that are beyond the control of the Bank. Accordingly, the earnings
and growth of the Bank are subject to the influence of domestic and foreign
economic conditions, including inflation, recession and
unemployment.
  The
commercial banking business is not only affected by general economic conditions
but is also influenced by the monetary and fiscal policies of the federal
government and the policies of regulatory agencies, particularly the Federal
Reserve Board.  The Federal Reserve Board implements national monetary
policies (with objectives such as curbing inflation and combating recession) by
its open-market operations in U.S. Government securities, by adjusting the
required level of reserves for financial institutions subject to its reserve
requirements and by varying the discount rates applicable to borrowings by
depository institutions. The actions of the Federal Reserve Board in these areas
influence the growth of bank loans, investments and deposits and also affect
interest rates charged on loans and paid on deposits.  The nature and
impact of any future changes in monetary policies cannot be
predicted.
  From time
to time, legislation is enacted which has the effect of increasing the cost of
doing business, limiting or expanding permissible activities or affecting the
competitive balance between banks and other financial
institutions.  Proposals to change the laws and regulations governing
the operations and taxation of banks, bank holding companies and other financial
institutions are frequently made in Congress, in the California legislature and
before various bank regulatory and other professional agencies.  For
example, the Bank’s ability to originate and sell SBA loans would be severely
impacted if federal appropriations for the SBA lending program were curtailed or
eliminated.
  Supervision
and Regulation
  Both
federal and state law extensively regulates banks and bank holding
companies.  This regulation is intended primarily for the protection
of depositors and the deposit insurance fund and not for the benefit of
shareholders of the Company.  The following is a summary of particular
statutes and regulations affecting the Company and the Bank.  This
summary is qualified in its entirety by the statutes and
regulations.  No assurance can be given that such statutes or
regulations will not change in the future.
  Regulation
of Mission Community Bancorp
  Mission
Community Bancorp is a registered bank holding company under the Bank Holding
Company Act of 1956, as amended, and is regulated by the Federal Reserve
Board.  The Company is required to file periodic reports with the
Federal Reserve Board and such additional information as the Federal Reserve
Board may require pursuant to the Bank Holding Company Act.  The
Federal Reserve Board may conduct examinations of the Company and its
subsidiaries, which includes the Bank.
   ~  ~
  The Bank
Holding Company Act requires every bank holding company to obtain the prior
approval of the Federal Reserve Board before acquiring substantially all the
assets of any bank or bank holding company or ownership or control of any voting
shares of any bank or bank holding company, if, after the acquisition, it would
own or control, directly or indirectly, more than 5% of the voting shares of the
bank or bank holding company.
  The
Company is prohibited by the Bank Holding Company Act, except in statutorily
prescribed instances, from acquiring direct or indirect ownership or control of
more than 5% of the outstanding voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks or furnishing
services to its subsidiaries.  However, the Company, subject to
notification or the prior approval of the Federal Reserve Board, as applicable
in each specific case, may engage in any, or acquire shares of companies engaged
in, activities that are deemed by the Federal Reserve Board to be “so closely
related to banking” or managing or controlling banks as to be a “proper incident
thereto.”
  In
approving acquisitions by bank holding companies of companies engaged in
banking-related activities, the Federal Reserve Board considers whether the
performance of any activity by a subsidiary of the holding company reasonably
can be expected to produce benefits to the public, including greater
convenience, increased competition, or gains in efficiency, which outweigh
possible adverse effects, including over-concentration of resources, decrease of
competition, conflicts of interest, or unsound banking practices.
  Regulations
and policies of the Federal Reserve Board require a bank holding company to
serve as a source of financial and managerial strength to its subsidiary
banks.  It is the Federal Reserve Board’s policy that a bank holding
company should stand ready to use available resources to provide adequate
capital funds to a subsidiary bank during periods of financial stress or
adversity and should maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting a subsidiary
bank.  Under certain conditions, the Federal Reserve Board may
conclude that certain actions of a bank holding company, such as a payment of a
cash dividend, would constitute an unsafe and unsound banking
practice.
  The
Company is required to give the Federal Reserve Board prior written notice of
any repurchase of its outstanding equity securities which (for a period of 12
months) is equal to 10% or more of the Company’s consolidated net worth, unless
certain conditions are met.
  Bank
holding company transactions with subsidiaries and other affiliates are
restricted, including qualitative and quantitative restrictions on extensions of
credit and similar transactions.
  The
Company and the Bank are deemed to be affiliates of one another within the
meaning set forth in the Federal Reserve Act and are subject to Sections 23A and
23B of the Federal Reserve Act.  This means, for example, that there
are limitations on loans by the Bank to affiliates, and that all affiliate
transactions must satisfy certain limitations and otherwise be on terms and
conditions at least as favorable to the Bank as would be available for
non-affiliates.
  The
securities of the Company are also subject to the requirements of the Securities
Act, and matters related thereto are regulated by the Securities and Exchange
Commission.  Certain issuances may also be subject to the California's
corporate securities law as administered by the California Commissioner of
Corporations.  The Company is subject to the public reporting
requirements of the Securities and Exchange Act of 1934, as amended, generally
applicable to publicly held companies, under Section 15(d) of the Exchange
Act.  Companies which file a registration statement under the
Securities Act are required under Section 15(d) of the Exchange Act for at least
a 12-month period after the effectiveness of such registration statement to file
periodic quarterly and annual reports under the Securities Act.  If
and when the Company has more than 500 shareholders of record, it will be
required to register its securities with the Securities and Exchange Commission
under Section 12(g) of the Exchange Act at which time its filing of periodic
reports, as well as certain other reporting obligations, will become
mandatory.
  Regulation
of Mission Community Bank
  As a
California state-chartered bank, the Bank is subject to regulation, supervision
and examination by the California Department of Financial
Institutions.  It is also a member of the Federal Reserve System and,
as such, is subject to applicable provisions of the Federal Reserve Act and the
related regulations promulgated by the Board of Governors of the Federal Reserve
System.  In addition, the deposits of the Bank are currently insured
by the Federal Deposit Insurance
   ~  ~
  Corporation
(“FDIC”) to a maximum of $250,000 per depositor, and potentially higher limits
with respect to certain retirement accounts, until December 31, 2009, and
therefore it is currently anticipated that limits will return to a maximum of
$100,000 per depositor, with higher limits with respect to certain retirement
accounts, if the provisions increasing deposit insurance coverage under the
Emergency Economic Stabilization Act of 2008 are not extended after that
date.  Beginning December 5, 2008, the Bank elected to participate in
the FDIC’s Transaction Account Guarantee Program (“TLGP”), which provides,
through December 31, 2009, an unlimited guarantee of funds in
noninterest-bearing transaction accounts (including NOW accounts restricted
during the guarantee period to interest rates of 0.50% or less).  For
deposit insurance protection, the Bank pays a quarterly assessment to the FDIC
and is subject to the rules and regulations of the FDIC pertaining to deposit
insurance and other matters.  The regulations of those agencies will
govern most aspects of the Bank’s business, including the making of periodic
reports by the Bank, and the Bank’s activities relating to dividends,
investments, loans, borrowings, capital requirements, certain check-clearing
activities, branching, mergers and acquisitions, reserves against deposits, the
issuance of securities and numerous other areas.
  The
earnings and growth of the Bank is largely dependent on its ability to maintain
a favorable differential or “spread” between the yield on its interest-earning
assets and the rate paid on its deposits and other interest-bearing
liabilities.  As a result, the Bank's performance is influenced by
general economic condi­tions, both domestic and foreign, the monetary and
fiscal policies of the federal government, and the policies of the regulatory
agencies, particularly the Federal Reserve Board.  The Federal Reserve
Board implements national monetary policies (such as seeking to curb inflation
and combat recession) by its open-market operations in United States Government
securities, by adjusting the required level of reserves for financial
institutions subject to its reserve requirements and by varying the discount
rate applicable to borrowings by banks which are members of the Federal Reserve
System.  The actions of the Federal Reserve Board in these areas
influence the growth of bank loans, investments and deposits and also affect
interest rates charged on loans and deposits.  The nature and impact
of any future changes in monetary policies cannot be predicted.
  Capital
Adequacy Requirements
  The
Company and the Bank are subject to the regulations of the Federal Reserve Board
governing capital adequacy.  Those regulations incorporate both
risk-based and leverage capital requirements.  Under existing
regulations, the capital requirements for a bank holding company whose
consolidated assets are less than $500 million, like the Company, are deemed to
be the same as that of its subsidiary bank.  The Federal Reserve Board
has established risk-based and leverage capital guidelines for the banks it
regulates, which set total capital requirements and define capital in terms of
“core capital elements,” or Tier 1 capital and “supplemental capital elements,”
or Tier 2 capital.  Tier 1 capital is generally defined as the sum of
the core capital elements less goodwill and certain intangibles.  The
following items are defined as core capital elements:  (i) common
stockholders' equity; (ii) qualifying non-cumulative perpetual preferred stock
and related surplus; and (iii) minority interests in the equity accounts of
consolidated subsidiaries.  Supplementary capital elements
include:  (i) allowance for loan and lease losses (but not more than
1.25% of an institution's risk-weighted assets); (ii) perpetual preferred stock
and related surplus not qualifying as core capital; (iii) hybrid capital
instruments, perpetual debt and mandatory convertible debt instruments; and (iv)
term subordinated debt and intermediate-term preferred stock and related
surplus.  The maximum amount of supplemental capital elements which
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill.
  The Bank
is required to maintain a minimum ratio of qualifying total capital to total
risk-weighted assets of 8.0% (“Total Risk-Based Capital Ratio”), at least
one-half of which must be in the form of Tier 1 capital (“Tier 1 Risk-Based
Capital Ratio”).  Risk-based capital ratios are calculated to provide
a measure of capital that reflects the degree of risk associated with a banking
organization's operations for both transactions reported on the balance sheet as
assets, and transactions, such as letters of credit and recourse arrangements,
which are recorded as off-balance sheet items.  Under the risk-based
capital guidelines, the nominal dollar amounts of assets and credit-equivalent
amounts of off-balance sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with very low credit
risk, such as certain U. S. Treasury securities, to 100% for assets with
relatively high credit risk, such as business loans.  As of December
31, 2008 and December 31, 2007, the Bank’s Total Risk-Based Capital Ratio was
13.3% and 11.7%, respectively, and its Tier 1 Risk-Based Capital Ratio was 12.0%
and 10.9%, respectively.
  The
risk-based capital standards also take into account concentrations of credit and
the risks of “non-traditional” activities (those that have not customarily been
part of the banking business). The regulations require institutions with high or
inordinate levels of risk to operate with higher minimum capital standards, and
authorize the regulators to review an institution's management of such risks in
assessing an institution’s capital adequacy.
   ~  ~
  Additionally,
the regulatory statements of policy on risk-based capital include exposure to
interest rate risk as a factor that the regulators will consider in evaluating a
bank’s capital adequacy, although interest rate risk does not impact the
calculation of a bank’s risk-based capital ratios.  Interest rate risk
is the exposure of a bank's current and future earnings and equity capital
arising from adverse movements in interest rates.  While interest risk
is inherent in a bank's role as financial intermediary, it introduces volatility
to bank earnings and to the economic value of the bank or bank holding
company.
  Banks are
also required to maintain a leverage capital ratio designed to supplement the
risk-based capital guidelines.  Banks that have received the highest
rating of the five categories used by regulators to rate banks and are not
anticipating or experiencing any significant growth must maintain a ratio of
Tier 1 capital (net of all intangibles) to adjusted total assets (“Leverage
Capital Ratio”) of at least 3%.  All other institutions are required
to maintain a leverage ratio of at least 100 to 200 basis points above the 3%
minimum, for a minimum of 4% to 5%.  Pursuant to federal regulations,
banks must maintain capital levels commensurate with the level of risk to which
they are exposed, including the volume and severity of problem loans, and
federal regulators may set higher capital requirements when a bank's particular
circumstances warrant.   The Bank’s Leverage Capital Ratio was
9.5% as of both December 31, 2008 and December 31, 2007.  See also
Notes O and T to the Consolidated Financial Statements for additional
information regarding regulatory capital.
  On March
1, 2005, the Federal Reserve Board adopted a final rule that allows the
continued inclusion of trust-preferred securities in the Tier I capital of bank
holding companies.  However, under the final rule, after a five-year
transition period, the aggregate amount of trust preferred securities and
certain other capital elements that could qualify as Tier I capital would be
limited to 25 percent of Tier I capital elements, net of goodwill
  Prompt
Corrective Action Provisions
  Federal
law requires each federal banking agency to take prompt corrective action to
resolve the problems of insured financial institutions, including but not
limited to those that fall below one or more prescribed minimum capital
ratios.  The federal banking agencies have by regulation defined the
following five capital categories: “well capitalized” (Total Risk-Based Capital
Ratio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Capital Ratio
of 5%); “adequately capitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1
Risk-Based Capital Ratio of 4%; and Leverage Capital Ratio of 4%) (or 3% if the
institution receives the highest rating from its primary regulator);
“undercapitalized” (Total Risk-Based Capital Ratio of less than 8%; Tier 1
Risk-Based Capital Ratio of less than 4%; or Leverage Capital Ratio of less than
4%) (or 3% if the institution receives the highest rating from its primary
regulator); “significantly undercapitalized” (Total Risk-Based Capital Ratio of
less than 6%; Tier 1 Risk-Based Capital Ratio of less than 3%; or Leverage
Capital Ratio less than 3%); and “critically undercapitalized” (tangible equity
to total assets less than 2%).  A bank may be treated as though it
were in the next lower capital category if after notice and the opportunity for
a hearing, the appropriate federal agency finds an unsafe or unsound condition
or practice so warrants, but no bank may be treated as “critically
undercapitalized” unless its actual capital ratio warrants such
treatment.
  At each
successively lower capital category, an insured bank is subject to increased
restrictions on its operations.  For example, a bank is generally
prohibited from paying management fees to any controlling persons or from making
capital distributions if to do so would make the bank
“undercapitalized.”  Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit written capital restoration
plans meeting specified requirements (including a guarantee by the parent
holding company, if any).  “Significantly undercapitalized” banks are
subject to broad regulatory authority, including among other things, capital
directives, forced mergers, restrictions on the rates of interest they may pay
on deposits, restrictions on asset growth and activities, and prohibitions on
paying bonuses or increasing compensation to senior executive officers without
regulatory approval.  Even more severe restrictions apply to
critically undercapitalized banks.  Most importantly, except under
limited circumstances, not later than 90 days after an insured bank becomes
critically undercapitalized, the appropriate federal banking agency is required
to appoint a conservator or receiver for the bank.
  In
addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential actions by the federal regulators for
unsafe or unsound practices in conducting their businesses or for violations of
any law, rule, regulation or any condition imposed in writing by the agency or
any written agreement with the agency.  Enforcement actions may
include the issuance of cease and desist orders, termination of insurance of
deposits (in the case
   ~  ~
  of a
bank), the imposition of civil money penalties, the issuance of directives to
increase capital, formal and informal agreements, or removal and prohibition
orders against “institution-affiliated” parties.
  Safety
and Soundness Standards
  The
federal banking agencies have also adopted guidelines establishing safety and
soundness standards for all insured depository institutions.  Those
guidelines relate to internal controls, information systems, internal audit
systems, loan underwriting and documentation, compensation and interest rate
exposure.  In general, the standards are designed to assist the
federal banking agencies in identifying and addressing problems at insured
depository institutions before capital becomes impaired.  If an
institution fails to meet these standards, the appropriate federal banking
agency may require the institution to submit a compliance plan and institute
enforcement proceedings if an acceptable compliance plan is not
submitted.
  The
Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief
Program
  In
response to unprecedented market turmoil and the financial crises affecting the
overall banking system and financial markets in the United States, the Emergency
Economic Stabilization Act of 2008 (“EESA”) was enacted in
October 2008.  On February 17, 2009, the American Recovery and
Reinvestment Act of 2009 (the “Stimulus Bill”) was enacted, which among other
things augmented certain provisions of the EESA.  Under the EESA, the
Treasury Department has authority, among other things, to purchase up to $700
billion in mortgage loans, mortgage-related securities and certain other
financial instruments, including debt and equity securities issued by financial
institutions in the Troubled Asset Relief Program (the “TARP”).  The
purpose of the TARP is to restore confidence and stability to the U.S. banking
system and to encourage financial institutions to increase their lending to
customers and to each other.
  Pursuant
to the EESA, the Treasury Department was initially authorized to use
$350 billion for the TARP. Of this amount, the Treasury Department
allocated $250 billion to the TARP Capital Purchase Program (see
description below). On January 15, 2009, the second $350 billion of
TARP monies was released to the Treasury Department.
  The TARP
Capital Purchase Program (“CPP) was developed to purchase $250 billion in senior
preferred stock from qualifying financial institutions, and was designed to
strengthen the capital and liquidity positions of viable institutions and to
encourage banks and thrifts to increase lending to creditworthy
borrowers.  The amount of the Treasury Department’s preferred stock a
particular qualifying financial institution could be approved to issue would be
not less than 1% of risk-weighted assets and not more than the lesser of
$25 billion or 3% of risk-weighted assets.
  The
general terms of the TARP CPP include:
  ·
              dividends
      on the Treasury Department’s preferred stock at a rate of five percent for
      the first five years and nine percent
  thereafter;
 ·
              common
      stock dividends cannot be increased for three years while the Treasury
      Department is an investor unless preferred stock is redeemed or consent
      from the Treasury is received;
 ·
              the
      Treasury Department must consent to any buyback of other stock (common or
      other preferred);
 ·
              the
      Treasury Department’s preferred stock will have the right to elect two
      directors if dividends have not been paid for six
  periods;
 ·
              the
      Treasury Department receives warrants equal to 15 percent of the Treasury
      Department’s total investment in the participating institution (provided,
      however, that the Company was not required to issue any warrants due to
      its status as a Community Development Financial Institutions);
      and
 ·
              the
      participating institution’s executives must agree to certain compensation
      restrictions, and restrictions on the amount of executive compensation
      that is tax deductible.
 ·
              The
      Company elected to participate in the TARP CPP and in January 2009 issued
      $5.1 million worth of preferred stock to the Treasury Department pursuant
      to this program.  See “Recent Developments”
    above.
 
 The EESA
also established a Temporary Liquidity Guarantee Program (“TLGP”) that gives the
FDIC the ability to provide a guarantee for newly-issued senior unsecured debt
and non-interest bearing transaction deposit accounts at eligible insured
institutions.  The Company has no current plans to participate in the
senior unsecured debt of the TLGP. The Company is currently participating in the
guarantee program for non-interest bearing transaction deposit accounts. For
non
   ~  ~
  interest
bearing transaction deposit accounts, a 10 basis point annual rate surcharge
will be applied to deposit amounts in excess of $250,000.
  Deposit
Insurance
  The
Bank’s deposits are insured under the Federal Deposit Insurance Act, up to the
maximum applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and
are subject to deposit insurance assessments to maintain the DIF. The Bank paid
no deposit insurance assessments on its deposits under the risk-based assessment
system utilized by the FDIC through December 31, 2006.
  Effective
January 1, 2007 the FDIC adopted a new risk-based insurance assessment
system designed to tie what banks pay for deposit insurance more closely to the
risks they pose. The FDIC also adopted a new base schedule of rates that the
FDIC could adjust up or down, depending on the needs of the DIF, and set initial
premiums for 2007 that ranged from 5 cents per $100 of domestic deposits in the
lowest risk category to 43 cents per $100 of domestic deposits for banks in
the highest risk category. The new assessment system resulted in annual
assessments on the Bank’s deposits of 7 cents per $100 of domestic deposits. The
Bank’s deposit insurance premiums for 2008 and 2007 were $96 thousand and $86
thousand, respectively.
  As
required by law, in October 2008, the FDIC adopted a restoration plan that
would increase the reserve ratio to the 1.15% threshold within five years. As
part of that plan, in December, 2008, the FDIC voted to increase risk-based
assessment rates uniformly by seven cents, on an annual basis, for the first
quarter of 2009 due to deteriorating financial conditions in the banking
industry.  The resulting new rates range from 12-14 basis points for
Risk Category I institutions to 50 basis points for Risk Category IV
institutions.  The FDIC has further proposed that beginning
April 1, 2009, the base assessment rates would range from 10-14 basis
points for Risk Category I institutions to 45 basis points for Risk
Category IV institutions, subject to adjustments as described in the next
sentence.  Changes to the risk-based assessment system would include
increasing premiums for institutions that rely on excessive amounts of brokered
deposits, including CDARS, increasing premiums for excessive use of secured
liabilities, including Federal Home Loan Bank advances, lowering premiums for
smaller institutions with very high capital levels, and adding financial ratios
and debt issuer ratings to the premium calculations for banks with over
$10 billion in assets, while providing a reduction for their unsecured
debt.  It is generally expected that rates will continue to increase
in the near future due to the significant cost of bank failures beginning in the
third quarter of 2008, and the increase in the number of troubled
banks.
  The FDIC
recently announced that, in view of the significant decrease in the deposit
insurance funds’ reserves, it will impose a special assessment in the second
quarter of 2009.  The FDIC also approved an increase in regular
premium rates, which banks must continue to pay on top of any special
assessment.  The regular premium rate for most banks in the second
quarter will now be between 12 and 16 basis points, compared to a range of
between 12 and 14 basis points which most banks currently pay.
  In
addition, banks must pay an amount which fluctuates but is currently 0.285 cents
per $100 of insured deposits per quarter, towards the retirement of the
Financing Corporation bonds issued in the 1980’s to assist in the recovery of
the savings and loan industry. These assessments will continue until the
Financing Corporation bonds mature in 2019.
  The
enactment of the EESA (discussed above) temporarily raised the basic limit on
federal deposit insurance coverage from $100,000 to $250,000 per depositor. The
temporary increase in deposit insurance coverage became effective on
October 3, 2008. EESA provides that the basic deposit insurance limit will
return to $100,000 after December 31, 2009.  In addition,
pursuant to the guarantee program for non-interest bearing transaction deposit
accounts under the TLGP in which the Bank has elected to participate, which
provides a temporary unlimited guarantee of funds in non-interest bearing
accounts, as defined, a 10 basis point annual rate surcharge will be applied to
deposit amounts in excess of $250,000.   As of December 31, 2008,
the Bank had approximately $2.7 million in non-interest bearing accounts
exceeding $250,000.
  Community
Reinvestment Act
  The Bank
is subject to certain requirements and reporting obligations involving Community
Reinvestment Act activities.  The Community Reinvestment Act generally
requires the federal banking agencies to evaluate the record of a financial
institution in meeting the credit needs of its local communities, including low
and moderate income neighborhoods. The Community Reinvestment Act further
requires the agencies to take a financial institution's record of
   ~  ~
  meeting
its community credit needs into account when evaluating applications for, among
other things, domestic branches, consummating mergers or acquisitions, or
holding company formations.  In measuring a bank's compliance with its
Community Reinvestment Act obligations, the regulators utilize a
performance-based evaluation system which bases Community Reinvestment Act
ratings on the bank's actual lending service and investment performance, rather
than on the extent to which the institution conducts needs assessments,
documents community outreach activities or complies with other procedural
requirements.  In connection with its assessment of Community
Reinvestment Act performance, the agencies assign a rating of “outstanding,”
“satisfactory,” “needs to improve” or “substantial
noncompliance.”  The Bank received an “outstanding” rating in its most
recent Community Reinvestment Act examination.
  Privacy
and Data Security
  The
Gramm-Leach-Bliley Act, also known as the “Financial Modernization Act”, which
became effective in 2000 imposed new requirements on financial institutions with
respect to consumer privacy.  The statute generally prohibits
disclosure of consumer information to non-affiliated third parties unless the
consumer has been given the opportunity to object and has not objected to such
disclosure.  Financial institutions are further required to disclose
their privacy policies to consumers annually.  Financial institutions,
however, will be required to comply with state law if it is more protective of
consumer privacy than the Gramm-Leach-Bliley Act.  The statute also
directed federal regulators, including the Federal Reserve and the FDIC, to
prescribe standards for the security of consumer information.  Bancorp
and Bank are subject to such standards, as well as standards for notifying
consumers in the event of a security breach.
  Other
Consumer Protection Laws and Regulations
  Activities
of all insured banks are subject to a variety of statutes and regulations
designed to protect consumers, such as the Fair Credit Reporting Act, Equal
Credit Opportunity Act, and Truth-in-Lending Act.  Interest and other
charges collected or contracted for by the Bank are also subject to state usury
laws and certain other federal laws concerning interest rates.  The
Bank’s loan operations are also subject to federal laws and regulations
applicable to credit transactions.  Together, these laws and
regulations include provisions that:
  ·
              govern
      disclosures of credit terms to consumer
  borrowers;
 ·
              require
      financial institutions to provide information to enable the public and
      public officials to determine whether a financial institution is
      fulfilling its obligation to help meet the housing needs of the community
      it serves;
 ·
              prohibit
      discrimination on the basis of race, creed, or other prohibited factors in
      extending credit;
 ·
              govern
      the use and provision of information to credit reporting agencies;
      and
 ·
              govern
      the manner in which consumer debts may be collected by collection
      agencies.
 
 Mission
Community Bank’s deposit operations are also subject to laws and regulations
that:
  ·
              impose
      a duty to maintain the confidentiality of consumer financial records and
      prescribe procedures for complying with administrative subpoenas of
      financial records; and
 ·
              govern
      automatic deposits to and withdrawals from deposit accounts and customers’
      rights and liabilities arising from the use of automated teller machines
      and other electronic banking
services.
 
 Interstate
Banking and Branching
  The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 regulates
the interstate activities of banks and bank holding companies and establishes a
framework for nationwide interstate banking and branching.  Since
June 1, 1997, a bank in one state has generally been permitted to merge
with a bank in another state without the need for explicit state law
authorization.  However, states were given the ability to prohibit
interstate mergers with banks in their own state by "opting-out" (enacting state
legislation applying equally to all out-of-state banks prohibiting such mergers)
prior to June 1, 1997.
  Since
1995, adequately capitalized and managed bank holding companies have been
permitted to acquire banks located in any state, subject to two exceptions:
first, any state may still prohibit bank holding companies from acquiring a bank
which is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquirer would control more then
10% of the deposits held by insured depository institutions nationwide
or
   ~  ~
  30%
percent or more of the deposits held by insured depository institutions in any
state in which the target bank has branches.
  In 1995
California enacted legislation to implement important provisions of the
Riegle-Neal Act discussed above and to repeal California’s previous interstate
banking laws, which were largely preempted by the Riegle-Neal Act.
  A bank
may establish and operate de novo branches in any state in which the bank does
not maintain a branch if that state has enacted legislation to expressly permit
all out-of-state banks to establish branches in that state.  However,
California law expressly prohibits an out-of-state bank which does not already
have a California branch office from (i) purchasing a branch office of a
California bank (as opposed to purchasing the entire bank) and thereby
establishing a California branch office or (ii) establishing a de novo branch in
California.
  The
changes effected by the Riegle-Neal Act and California laws have increased
competition in the environment in which the Bank operates to the extent that
out-of-state financial institutions may directly or indirectly enter the Bank's
market areas.  It appears that the Riegle-Neal Act has contributed to
the accelerated consolidation of the banking industry.  While many
large out-of-state banks have already entered the California market as a result
of this legislation, it is not possible to predict the precise impact of this
legislation on the Bank and the competitive environment in which it
operates.
  Financial
Modernization Act
  Effective
March 11, 2000, the Gramm-Leach-Bliley Financial Modernization Act enabled full
affiliations to occur between banks and securities firms, insurance companies
and other financial service providers.  This legislation permits bank
holding companies to become “financial holding companies” and thereby acquire
securities firms and insurance companies and engage in other activities that are
financial in nature.  A bank holding company may become a financial
holding company if each of its subsidiary banks is “well capitalized” and “well
managed” under applicable definitions, and has at least a satisfactory rating
under the CRA by filing a declaration that the bank holding company wishes to
become a financial holding company.
  The
Financial Modernization Act defines “financial in nature” to include securities
underwriting, dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agency; merchant banking activities; and
activities that the Federal Reserve Board has determined to be closely related
to banking.  A national bank also may engage, subject to limitations
on investment, in activities that are financial in nature, other than insurance
underwriting, insurance company portfolio investment, real estate development
and real estate investment, through a financial subsidiary of the bank, if the
bank is well capitalized, well managed and has at least a satisfactory CRA
rating.  Subsidiary banks of a financial holding company or national
banks with financial subsidiaries must continue to be well capitalized and well
managed in order to continue to engage in activities that are financial in
nature without regulatory actions or restrictions, which could include
divestiture of financial subsidiaries.  In addition, a financial
holding company or a bank may not acquire a company that is engaged in
activities that are financial in nature unless each of the subsidiary banks of
the financial holding company or the bank has a CRA rating of satisfactory or
better.
  USA
Patriot Act of 2001
  The USA
Patriot Act of 2001 was enacted in October 2001 in response to the terrorist
attacks on September 11, 2001.  The Patriot Act is intended to
strengthen United States law enforcement’s and the intelligence community’s
ability to work cohesively to combat terrorism on a variety of
fronts.  The impact of the Patriot Act on financial institutions of
all kinds has been significant and wide ranging.  The Patriot Act
substantially enhanced existing anti-money laundering and financial transparency
laws, and required appropriate regulatory authorities to adopt rules to promote
cooperation among financial institutions, regulators, and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering.  Under the Patriot Act, financial institutions are subject
to prohibitions regarding specified financial transactions and account
relationships, as well as enhanced due diligence and “know your customer”
standards in their dealings with foreign financial institutions and foreign
customers.  For example, the enhanced due diligence policies,
procedures, and controls generally require financial institutions to take
reasonable steps:
 
 ·
              to
      conduct enhanced scrutiny of account relationships to guard against money
      laundering and report any suspicious
  transactions;
  ~  ~
  ·
              to
      ascertain the identity of the nominal and beneficial owners of, and the
      source of funds deposited into, each account as needed to guard against
      money laundering and report any suspicious
  transactions;
 ·
              to
      ascertain for any foreign bank, the shares of which are not publicly
      traded, the identity of the owners of the foreign bank, and the nature and
      extent of the ownership interest of each such owner;
  and
 ·
              to
      ascertain whether any foreign bank provides correspondent accounts to
      other foreign banks and, if so, the identity of those foreign banks and
      related due diligence information.
 
 The
Patriot Act also requires all financial institutions to establish anti-money
laundering programs, which must include, at minimum:
 
 ·
              the
      development of internal policies, procedures, and
  controls;
 ·
              the
      designation of a compliance
officer;
 ·
              an
      ongoing employee training program;
and
 ·
              an
      independent audit function to test the
programs.
 
 The Bank
has adopted comprehensive policies and procedures, and has taken all necessary
actions, to ensure compliance with all financial transparency and anti-money
laundering laws, including the Patriot Act.
 
 Sarbanes-Oxley
Act of 2002
  As a
public company, the Company is subject to the Sarbanes-Oxley Act of 2002, which
implements a broad range of corporate governance and accounting measures for
public companies designed to promote honesty and transparency in corporate
America and better protect investors from corporate wrongdoing.  The
Sarbanes-Oxley Act’s principal legislation and the derivative regulation and
rule making promulgated by the Securities and Exchange Commission
includes:
 
 ·
              the
      creation of an independent accounting oversight
  board;
 ·
              auditor
      independence provisions that restrict non-audit services that accountants
      may provide to their audit clients;
 ·
              additional
      corporate governance and responsibility measures, including the
      requirement that the chief executive officer and chief financial officer
      certify financial statements;
 ·
              a
      requirement that companies establish and maintain a system of internal
      control over financial reporting and that a company’s management provide
      an annual report regarding its assessment of the effectiveness of such
      internal control over financial reporting to the company’s independent
      accountants;
 ·
              a
      requirement that the company’s independent accountants provide an
      attestation report with respect to management’s assessment of the
      effectiveness of the company’s internal control over financial reporting
      (this requirement is currently proposed to become effective for companies
      like the Company, which is not an accelerated SEC filer, for our first
      fiscal year ending on or after December 15,
  2009);
 ·
              the
      forfeiture of bonuses or other incentive-based compensation and profits
      from the sale of an issuer’s securities by directors and senior officers
      in the twelve month period following initial publication of any financial
      statements that later require
restatement;
 ·
              an
      increase in the oversight of, and enhancement of certain requirements
      relating to audit committees of public companies and how they interact
      with the company’s independent
auditors;
 ·
              the
      requirement that audit committee members must be independent and are
      absolutely barred from accepting consulting, advisory or other
      compensatory fees from the issuer;
 ·
              the
      requirement that companies disclose whether at least one member of the
      committee is a “financial expert” (as such term is defined by the SEC) and
      if not, why not;
 ·
              expanded
      disclosure requirements for corporate insiders, including accelerated
      reporting of stock transactions by insiders and a prohibition on insider
      trading during pension blackout
periods;
 ·
              a
      prohibition on personal loans to directors and officers, except certain
      loans made by insured financial
institutions;
 ·
              disclosure
      of a code of ethics and the requirement of filing of a Form 8-K for a
      change or waiver of such code;
 ·
              mandatory
      disclosure by analysts of potential conflicts of interest;
    and
 ·
              a
      range of enhanced penalties for fraud and other
  violations.
  ~  ~
  Commercial
Real Estate Lending and Concentrations
  On
December 2, 2006, the federal bank regulatory agencies released Guidance on
Concentrations in Commercial Real Estate Lending, Sound Risk Management
Practices (“the Guidance”).  The Guidance, which was issued in
response to the agencies’ concern that rising CRE concentrations might expose
institutions to unanticipated earnings and capital volatility in the event of
adverse changes in the commercial real estate market, reinforces existing
regulations and guidelines for real estate lending and loan portfolio
management.
  Highlights
of the Guidance include the following:
  ·
              The
      agencies have observed that CRE concentrations have been rising over the
      past several years with small to mid-size institutions showing the most
      significant increase in CRE concentrations over the last
      decade.  However, some institutions’ risk management practices
      are not evolving with their increasing CRE concentrations, and therefore,
      the Guidance reminds institutions that strong risk management practices
      and appropriate levels of capital are important elements of a sound CRE
      lending program.
 ·
              The
      Guidance applies to national banks and state chartered banks and is also
      broadly applicable to bank holding companies.  For purposes of
      the Guidance, CRE loans include loans for land development and
      construction, other land loans and loans secured by multifamily and
      nonfarm nonresidential properties.  The definition also extends
      to loans to real estate investment trusts and unsecured loans to
      developers if their performance is closely linked to the performance of
      the general CRE market.
 ·
              The
      agencies recognize that banks serve a vital role in their communities by
      supplying credit for business and real estate
      development.  Therefore, the Guidance is not intended to limit
      banks’ CRE lending.  Instead, the Guidance encourages
      institutions to identify and monitor credit concentrations, establish
      internal concentration limits, and report all concentrations to management
      and the board of directors on a periodic
basis.
 ·
              The
      agencies recognized that different types of CRE lending present different
      levels of risk, and therefore, institutions are encouraged to segment
      their CRE portfolios to acknowledge these
      distinctions.  However, the CRE portfolio should not be divided
      into multiple sections simply to avoid the appearance of risk
      concentration.
 ·
              Institutions
      should address the following key elements in establishing a risk
      management framework for identifying, monitoring, and controlling CRE
      risk: (1) board of directors and management oversight; (2) portfolio
      management; (3) management information systems; (4) market analysis; (5)
      credit underwriting standards; (6) portfolio stress testing and
      sensitivity analysis; and (7) credit review
  function.
 ·
              As
      part of the ongoing supervisory monitoring processes, the agencies will
      use certain criteria to identify institutions that are potentially exposed
      to significant CRE concentration risk.  An institution that has
      experienced rapid growth in CRE lending, has notable exposure to a
      specific type of CRE, or is approaching or exceeds specified supervisory
      criteria may be identified for further supervisory
    analysis.
 
 The
Company believes that the Guidance is applicable to it, as it has a
concentration in CRE loans.  The Company and its board of directors
have discussed the Guidance and believe that Mission Community Bank’s
underwriting policy, management information systems, independent credit
administration process and monthly monitoring of real estate loan concentrations
adequately address the Guidance. See Loan Concentrations in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations under Item 6 of Part II of this report.
  Allowance
for Loan and Lease Losses
  On
December 13, 2006, the federal bank regulatory agencies released
Interagency Policy Statement on the Allowance for Loan and Lease Losses
(“ALLL”), which revised and replaced the banking agencies’ 1993 policy statement
on the ALLL.  The revised statement was issued to ensure consistency
with generally accepted accounting principles (GAAP) and more recent supervisory
guidance.  The revised statement also extended the applicability of
the policy to credit unions.  Additionally, the agencies issued 16
FAQs to assist institutions in complying with both GAAP and ALLL supervisory
guidance.
   ~  ~
  Highlights
of the revised statement include the following:
  ·
              The
      revised statement emphasizes that the ALLL represents one of the most
      significant estimates in an institution’s financial statements and
      regulatory reports and that an assessment of the appropriateness of the
      ALLL is critical to an institution’s safety and
  soundness.
 ·
              Each
      institution has a responsibility to develop, maintain, and document a
      comprehensive, systematic, and consistently applied process for
      determining the amounts of the ALLL.  An institution must
      maintain an ALLL that is sufficient to cover estimated credit losses on
      individual impaired loans as well as estimated credit losses inherent in
      the remainder of the portfolio.
 ·
              The
      revised statement updated the previous guidance on the following issues
      regarding ALLL: (1) responsibilities of the board of directors,
      management, and bank examiners; (2) factors to be considered in the
      estimation of ALLL; and (3) objectives and elements of an effective loan
      review system.
 
 The
Company believes that its ALLL methodology is comprehensive, systematic, and
that it is consistently applied across the Company.  The Company also
believes its management information systems, independent credit administration
process, policies and procedures adequately address the supervisory
guidance.
  
 Transactions
Between Affiliates
  Transactions
between a bank and its “affiliates” are quantitatively and qualitatively
restricted under the Federal Reserve Act.  The FRB has also issued
Regulation W, which codifies prior regulations under Sections 23A and 23B of the
Federal Reserve Act and interpretative guidance with respect to affiliate
transactions.  Regulation W incorporates the exemption from the
affiliate transaction rules but expands the exemption to cover the purchase of
any type of loan or extension of credit from an affiliate.  Affiliates
of a bank include, among other entities, companies that are under common control
with the bank.  In general, subject to certain specified exemptions, a
bank or its subsidiaries are limited in their ability to engage in “covered
transactions” with affiliates:
  ·
              to
      an amount equal to 10% of the bank’s capital and surplus, in the case of
      covered transactions with any one affiliate;
and
 ·
              to
      an amount equal to 20% of the bank’s capital and surplus, in the case of
      covered transactions with all
affiliates.
 
 In
addition, a bank and its subsidiaries may engage in covered transactions and
other specified transactions only on terms and under circumstances that are
substantially the same, or at least as favorable to the bank or its subsidiary,
as those prevailing at the time for comparable transactions with nonaffiliated
companies. A “covered transaction” includes:
  ·
              a
      loan or extension of credit to an
affiliate;
 ·
              a
      purchase of, or an investment in, securities issued by an
      affiliate;
 ·
              a
      purchase of assets from an affiliate, with some
  exceptions;
 ·
              the
      acceptance of securities issued by an affiliate as collateral for a loan
      or extension of credit to any party;
and
 ·
              the
      issuance of a guarantee, acceptance or letter of credit on behalf of an
      affiliate.
  In
addition, under Regulation W:
  ·
              a
      bank and its subsidiaries may not purchase a low-quality asset from an
      affiliate;
 ·
              covered
      transactions and other specified transactions between a bank or its
      subsidiaries and an affiliate must be on terms and conditions that are
      consistent with safe and sound banking practices;
  and
 ·
              with
      some exceptions, each loan or extension of credit by a bank to an
      affiliate must be secured by collateral with a market value ranging from
      100% to 130%, depending on the type of collateral, of the amount of the
      loan or extension of credit.
 
 Regulation
W generally excludes all non-bank and non-savings association subsidiaries of
banks from treatment as affiliates, except to the extent that the FRB decides to
treat these subsidiaries as affiliates.
   ~  ~
  
  Employees
  As of
December 31, 2008 the Bank had a total of 60 employees.  Neither
Bancorp nor MCDC have salaried employees; Bancorp’s officers all hold similar
positions at the Bank.  The Bank, under inter-company arrangements,
may charge Bancorp and/or MCDC for management, staff, and
services.  For 2008, the Bank charged Bancorp a total of $111,000 for
services performed on its behalf by Bank employees.
  
  Reports
to Security Holders.
  Annual
Report
  An annual
report to security holders including audited financial statements is sent each
year by the Company.
  Certain
reports are filed by the Company with the Securities Exchange Commission
pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934.   The SEC maintains an Internet site that contains reports
and other information statements.  The Company files its reports
electronically and they may be viewed from the SEC’s Internet site
http://www.sec.gov.  The public may also read and copy any materials
filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE,
Washington, D.C.  20549.  Information regarding the
operation of the Public Reference Room is available by calling the SEC at
1-800-SEC-0300.
  The
Company’s Internet site is http://www.missioncommunitybank.com.
  
  Item
1A.  Risk Factors
  In
addition to other information contained in this Report, the following risks may
affect the Company.  If any of these risks occur, the Company’s
business, financial condition and operations results could be adversely
affected
  The
Company’s business has been and may continue to be adversely affected by
volatile conditions in the financial markets and deteriorating economic
conditions generally.
  Since
December 2007, the United States has been in a recession.  Negative
developments in the latter half of 2007 and in 2008 in the financial services
industry have resulted in uncertainty in the financial markets in general and a
related general economic downturn, which have continued into
2009.  Business activity across a wide range of industries and regions
is greatly reduced and local governments and many businesses are in serious
difficulty due to the lack of consumer spending and the lack of liquidity in the
credit markets. Unemployment has also increased significantly.
  Since
mid-2007, and particularly during the second half of 2008, the financial
services industry and the securities markets generally were materially and
adversely affected by significant declines in the values of nearly all asset
classes and by a serious lack of liquidity. This was initially triggered by
declines in home prices and the values of subprime mortgages, but spread to all
mortgage and real estate asset classes, to leveraged bank loans and to nearly
all asset classes, including equities. The global markets have been
characterized by substantially increased volatility and short-selling and an
overall loss of investor confidence, initially in financial institutions, but
more recently in companies in a number of other industries and in the broader
markets.
  Market
conditions have also led to the failure or merger of a number of prominent
financial institutions. Financial institution failures or near-failures have
resulted in further losses as a consequence of defaults on securities issued by
them and defaults under contracts entered into with such entities as
counterparties. Furthermore, declining asset values, defaults on mortgages and
consumer loans, and the lack of market and investor confidence, as well as other
factors, have all combined to increase credit default swap spreads, to cause
rating agencies to lower credit ratings, and to otherwise increase
   ~  ~
  the cost
and decrease the availability of liquidity, despite very significant declines in
Federal Reserve borrowing rates and other government actions. Some banks and
other lenders have suffered significant losses and have become reluctant to
lend, even on a secured basis, due to the increased risk of default and the
impact of declining asset values on the value of collateral. The foregoing has
significantly weakened the strength and liquidity of some financial institutions
worldwide. In 2008, the U.S. government, the Federal Reserve and other
regulators have taken numerous steps to increase liquidity and to restore
investor confidence, including investing approximately $250 billion in the
equity of banking organizations, but asset values have continued to decline and
access to liquidity continues to be very limited.
  As a
result of these financial and economic crises, many lending institutions,
including the Company, have experienced declines in the performance of their
loans.  Total nonperforming loans increased to $4.6 million as of
December 31, 2008 from $2.1 million as of December 31, 2007,
representing 2.93% and 1.63%, respectively, of total loans. Total nonperforming
loans, net of SBA guarantees, were $3.1 million as of December 31, 2008,
compared to $1.8 million as of December 31, 2007.
  Moreover,
competition among depository institutions for deposits and quality loans has
increased significantly. In addition, the values of real estate collateral
supporting many commercial loans and home mortgages have declined and may
continue to decline.  Bank and bank holding company stock prices have
been negatively affected, and the ability of banks and bank holding companies to
raise capital or borrow in the debt markets has become more difficult compared
to recent years. As a result, there is a potential for new federal or state laws
and regulations regarding lending and funding practices and liquidity standards,
and bank regulatory agencies are expected to be very aggressive in responding to
concerns and trends identified in examinations, including the expected issuance
of many formal or informal enforcement actions or orders. The impact of new
legislation in response to those developments may negatively impact the
Company’s operations by restricting its business operations, including the
ability to originate or sell loans, and may adversely impact the Company’s
financial performance or stock price.
  In
addition, further negative market developments may affect consumer confidence
levels and may cause adverse changes in payment patterns, causing increased
delinquencies and default rates, which may impact the Company’s charge-offs and
provision for loan losses. A worsening of these conditions would likely
exacerbate the adverse effects of these difficult market conditions on the
Company and others in the financial services industry.
  While the
Company’s market areas have not experienced the same degree of challenges as
other parts of the country or the state, no assurance can be given that this
will continue to be the case.  Overall, during the past year, the
general business environment has had an adverse effect on the Company’s
business, and there can be no assurance that the environment will improve in the
near term.  Until conditions improve, it is expected that the
Company’s business, financial condition and results of operations will be
adversely affected.
  Significant
reliance on loans secured by real estate may increase the Bank’s vulnerability
to the current downturn in the California real estate market and other variables
impacting the value of real estate
  A
substantial portion of the Bank’s assets consist of real estate loans (including
construction loans) which are generally secured by real estate in the Central
Coast of California.  At December 31, 2008, approximately $121 million
or 79% of the Bank’s loans were real estate and construction loans, and at
December 31, 2007, approximately $95 million or 75% of its loans were real
estate and construction loans. A prolonged and deepening of the current real
estate contraction in the Central Coast of California could increase the level
of non-performing assets and adversely affect results of operations. During
2008, the real estate market in the Central Coast of California deteriorated
significantly, as evidenced by declining prices, reduced transaction volume, and
increased foreclosure rates, and this deterioration resulted in an increase in
the level of the Company’s nonperforming loans, particularly commercial real
estate loans.  The Company had nonperforming commercial real estate
and construction loans of $1.6 million and $1.6 million, respectively, as of
December 31 2008, compared to $0.2 million and $1.5 million respectively, as of
December 31, 2007.  If this real estate trend in the Company’s market
areas continues or worsens, the result could be reduced income, increased
expenses, and less cash available for lending and other activities, which could
have a material impact on the Company’s financial condition and results of
operations.
   ~  ~
  If
a significant number of customers fail to perform under their loans, the
Company’s business, profitability, and financial condition would be adversely
affected
  As a
lender, the largest risk is the possibility that a significant number of client
borrowers will fail to pay their loans when due.  If borrower defaults
cause losses in excess of the allowance for loan losses, it could have an
adverse effect on the Bank’s business, profitability, and financial
condition.  A regular evaluation process designed to determine the
adequacy of the allowance for loan losses is in place.  Although this
evaluation process uses historical and other objective information, the
classification of loans and the establishment of loan losses are dependent to a
great extent upon experience and judgment.  Although management
believes that the allowance for loan losses is at a level adequate to absorb any
inherent losses in the loan portfolio, there is no assurance that there will not
be further increases to the allowance for loan losses or that the regulators
will not require an increase to this allowance.
  The
Bank’s earnings are subject to interest rate risks, especially if rates continue
to decline
  Traditionally,
the major portion of the Bank’s net income comes from the interest rate spread,
which is the difference between the interest rates paid on interest-bearing
liabilities, such as deposits and other borrowings, and the interest rates
received on interest-earning assets, such as loans extended to clients and
securities held in the investment portfolio.  Interest rates are
highly sensitive to many factors beyond our control, such as inflation,
recession, global economic disruptions, and
unemployment.  Fluctuations in interest rates affect the demand of
customers for products and services.  The Bank is subject to interest
rate risk to the degree that interest-bearing liabilities reprice or mature more
slowly or more rapidly or on a different basis from interest-earning
assets.  Given the current volume and mix of interest-bearing
liabilities and interest earning assets, the interest rate spread can be
expected to increase when market interest rates are rising, and to decline when
market interest rates are declining, i.e., the Bank is “asset
sensitive.”  Although management believes our current level of
interest rate sensitivity is reasonable, significant fluctuations in interest
rates may have an adverse impact on the interest rate spread.  Any
material decline in the interest rate spread would have a material adverse
effect on the Bank’s business and profitability.
  The
Bank has specific risks associated with Small Business Administration
Loans
  The Bank
originated $3.0 million and $7.1 million in SBA loans in 2008 and 2007,
respectively, and intends to increase its SBA loan origination in the
future.  The Bank recognized $187,000 and $308,000, respectively, in
2008 and 2007 in gains recognized on secondary market sales of SBA
loans.  The Bank has regularly sold the guaranteed portions of these
loans in the secondary market in previous years.  We can provide no
assurance that Mission Community Bank will be able to continue originating these
loans, or that a secondary market will exist for, or that it will continue to
realize premiums upon the sale of the SBA loans.  The federal
government presently guarantees 75% to 85% of the principal amount of each
qualifying SBA loan.  We can provide no assurance that the federal
government will maintain the SBA program, or if it does, that such guaranteed
portion will remain at its current funding level.  Furthermore, it is
possible that the Bank could lose its preferred lender status which, subject to
certain limitations, allows it to approve and fund SBA loans without the
necessity of having the loan approved in advance by the SBA.  It is
also possible that the federal government could reduce the amount of loans that
it guarantees.  We believe that the SBA loan portfolio does not
involve more than a normal risk of collectibility.  However, since the
Bank has sold some of the guaranteed portions of the SBA loan portfolio, it
incurs a pro rata credit risk on the non-guaranteed portion of the SBA loans
since the Bank shares pro rata with the SBA in any recoveries.
  In
addition, we are dependent on the expertise of the personnel in our SBA loan
department in order to originate and service SBA loans.  If we are
unable to retain qualified employees in our SBA Department in the future our
income from the origination, sale and servicing of SBA loans could be
substantially reduced.  Further, in 2006, as rates on SBA loans
climbed, a significant portion of SBA borrowers prepaid their loans,
substantially reducing the servicing income we receive on these
loans.  If there are similar increases in interest rates in the
future, our income from servicing of SBA loans could be substantially
reduced.
   ~  ~
  If
we are not successful in carrying out the new aspects of our business plan our
profitability will be adversely affected
  We have
recently implemented a strategy to grow our general commercial banking
activities and have implemented new initiatives in this regard, including
increased emphasis on our business banking and business development activities,
the creation of a new Hispanic Banking Division and the expansion of our
physical presence into northern Santa Barbara County through a new branch office
located in the city of Santa Maria.  If we are not successful in
implementing any or all of these new aspects of our business plan, this would
have a negative impact on our earnings.
  If
the Company or the Bank were to lose its status as a Community Development
Financial Institution, its ability to carry out a significant portion of its
business plan would be adversely affected
  A portion
of our business is augmented by our status as a Community Development Financial
Institution.  That status increases the potential for receiving grants
and awards that, in turn, enable us to increase the level of community
development financial services that we provide in the communities we serve and
to provide CRA credit for deposits and investments.  In order to
maintain our status as a certified Community Development Financial Institution
60% of our business must meet Community Development Financial Institutions Fund
requirements.  As our business has continued to expand, the proportion
of our business which meets Community Development Financial Institutions Fund
requirements has decreased, causing us to affirmatively expand our business into
areas which will afford us an opportunity to provide more community development
activities, such as our recent expansion to the city of Santa Maria in northern
Santa Barbara county, and our new Hispanic Banking Division.  In 2008,
64% of the number of loans we made, and 61% of the dollar amount of the loans
made, were in compliance with the Community Development Financial Institution
Fund requirements.  If we are unsuccessful in expanding our community
development activities, and if we are ultimately unable to maintain a sufficient
portion of our business in Community Development Financial Institutions Fund
qualifying business, we could lose our status as a Community Development
Financial Institution as well as the benefits that go with that
status.
  Mission
Community Bank is a community development bank which seeks to provide financial
support and services by promoting community development and economic
vitality.  Most community development banks are located in urban
areas, with very few exclusively community-development banks in rural
areas.  A significant portion of San Luis Obispo county is
rural.  Because of our market area, we may have difficulty locating
the types of community development projects that would likely attract awards and
grants that might be conferred to other financial institutions in urban
areas.  Although we intend to continue to apply for community
development related grants awards in the future, there can be no assurance that
we will receive any future grants or awards.  Further, funding for these
grant and award programs has diminished in the last several years making it less
likely that we will be the beneficiary of any grants and
awards.
  The
availability of government grants and awards to community development financial
institutions has declined in recent years, and there can be no assurance that
the Company and the Bank will receive any grants or awards in the
future
 Grants
and awards that we have received in the past with respect to our community
development activities have strengthened our capital position and increased our
profitability.  The Community Development Financial Institutions Fund
and other similar programs are an important source of capital for community
development banks such as us.  In 2007 the Bank received a $326,000
Bank Enterprise Award (“BEA”) from the CDFI Fund.  The award was made under
the Fiscal Year 2007 BEA Program, which provides an incentive for any FDIC
insured bank to annually increase the levels of financial services provided to
economically distressed communities.  In 2004 and 2001 the Bank received
similar BEA awards totaling $1,241,000 and $990,000,
respectively.  The Company received a technical assistance grant of
$134,935 in 2005 to help offset any costs associated with providing services to
the un- and under-banked in our market areas.  Although we intend to
continue to apply for community development related grants and awards in the
future, there can be no assurance that we will receive any future grants or
awards.
  Maintaining
or increasing the Bank’s market share depends on the introduction and market
acceptance of new products and services
  Our
success depends, in part, upon our ability to adapt our products and services to
evolving industry standards and consumer demand.  There is increasing
pressure on financial services companies to provide products and services at
lower prices.  In addition, the widespread adoption of new
technologies, including Internet-based services, could require us
   ~  ~
  to make
substantial expenditures to modify or adapt our existing products or
services.  A failure to achieve market acceptance of any new products
we introduce, or a failure to introduce products that the market may demand,
could have an adverse effect on our business, profitability, or growth
prospects.
  The
Bank faces substantial competition in its primary market area
  We
conduct our banking operations primarily in San Luis Obispo County and northern
Santa Barbara County in the Central Coast of California.  Increased
competition in our market may result in reduced loans and
deposits.  Ultimately, we may not be able to compete successfully
against current and future competitors.  Many competitors offer the
same banking services that we offer in our service area.  These
competitors include national banks, regional banks and other community
banks.  We also face competition from many other types of financial
institutions, including without limitation, savings and loan institutions,
finance companies, brokerage firms, insurance companies, credit unions, mortgage
banks and other financial intermediaries.  Additionally, banks and
other financial institutions with larger capitalization and financial
intermediaries not subject to bank regulatory restrictions have larger lending
limits and are thereby able to serve the credit needs of larger
customers.  Areas of competition include interest rates for loans and
deposits, efforts to obtain deposits, and range and quality of products and
services provided, including new technology-driven products and
services.
  Technology
and other changes are allowing parties to complete financial transactions that
historically have involved banks through alternative methods.  For
example, consumers can now maintain funds that would have historically been held
as bank deposits in brokerage accounts or mutual funds.  Consumers can
also complete transactions such as paying bills and/or transferring funds
directly without the assistance of banks.  The process of eliminating
banks as intermediaries, known as “disintermediation,” could result in the loss
of fee income, as well as the loss of customer deposits and the related income
generated from those deposits.  The loss of these revenue streams and
the lower cost deposits as a source of funds could have a material adverse
effect on the Company’s financial condition and results of
operations.
  In
addition, with recent increased concerns about bank failures, customers
increasingly are concerned about the extent to which their deposits are insured
by the FDIC.  Customers may withdraw deposits in an effort to ensure
that the amount they have on deposit with their bank is fully
insured.  Decreases in deposits may adversely affect the Company’s
funding costs and net income.
  If
the Bank fails to retain its key employees, its growth and profitability could
be adversely affected
  Our
future success depends in large part upon the continuing contributions of our
key management personnel.  If we lose the services of one or more key
employees within a short period of time, we could be adversely
affected.  Our future success is also dependent upon our continuing
ability to attract and retain highly qualified personnel.  Competition
for such employees among financial institutions in California is
intense.  Due to the lack of an experienced candidate pool in the San
Luis Obispo area for the types of personnel we need to operate the Bank, we may
be unable to quickly recruit new candidates to fill the positions of key
personnel which we are unable to retain.  Qualified employees demand
competitive salaries which we may not be able to offer.  Also, the
Company is a recipient of capital funding through the Treasury’s Troubled Asset
Relief Program (“TARP”), and the recently-enacted American Recovery and
Reinvestment Act of 2009 places significant constraints on executive
compensation paid by recipients of TARP funds.  Any inability to
attract and retain additional key personnel in the future could adversely affect
us.  We can provide no assurance that we will be able to retain any of
our key officers and employees or attract and retain qualified personnel in the
future.  However, we have entered into an employment agreement with
Anita Robinson, the Company’s President and Chief Executive Officer, which
continues until December 31, 2012, and an employment agreement with Brooks
W. Wise, the Bank’s President, which continues until December 31,
2009.
  The
Company may be unable to manage future growth
  We may
encounter problems in managing our future planned growth.  In December
2008 we opened an additional “de novo” branch in Santa Maria,
California.  We may open other branches and loan production offices in
the future.  In addition, we intend to investigate opportunities to
invest in other financial institutions that would complement our existing
business, as such opportunities may arise.  No assurance can be
provided, however, that we will be able to identify additional locations to open
additional branches or to identify a suitable acquisition target or consummate
any such acquisition.  Further, our ability to manage growth will
depend primarily on our ability to attract and retain qualified
   ~  ~
  personnel,
monitor operations, maintain earnings and control costs.  Any failure
by us to accomplish these goals could result in interruptions in our business
plans and could also adversely affect current operations.
  Increases
in the Bank’s allowance for loan losses could materially affect its earnings
adversely
  Like all
financial institutions, we maintain an allowance for loan losses to provide for
loan defaults and non-performance.  Our allowance for loan losses is
based on prior experience, as well as an evaluation of the risks in the current
portfolio.  However, actual loan losses could increase significantly
as the result of changes in economic, operating and other conditions, including
changes in interest rates, which are generally beyond our
control.  Thus, such losses could exceed our current allowance
estimates.  Although we believe that our allowance for loan losses is
at a level adequate to absorb any inherent losses in our loan portfolio, we
cannot assure you that we will not further increase the allowance for loan
losses.  Any increase in our allowance for loans losses could
materially affect our earnings adversely.
  In
addition, the Federal Reserve Board and the California Department of Financial
Institutions, as an integral part of their respective supervisory functions,
periodically review our allowance for loan losses.  Such regulatory
agencies may require us to increase our provision for loan losses or to
recognize further loan charge-offs, based upon judgments different from those of
management.  Any increase in our allowance required by the Federal
Reserve Board or the Department of Financial Institutions could adversely affect
us.
  The
Bank’s larger funding sources could strain the Bank’s liquidity resources if a
substantial amount is withdrawn in a short period of time
  The Bank
has a mix of deposits which includes 16 customers with deposits of $1 million or
more totaling $39.7 million, approximately $18.9 million of which has been
placed into the CDARS program.  In addition, $45.7 million of the
Bank’s funding sources is represented by borrowings from the Federal Home Loan
Bank of San Francisco (“FHLB”), with $39.7 million of that total maturing on
various dates in 2009.  If a substantial number of these large deposit
customers choose to withdraw their funds when they mature, or if the Bank’s
borrowing facility through the FHLB is reduced, and the Bank is unable to
develop alternate funding sources, the Bank may have difficulty funding loans or
meeting deposit withdrawal requirements.
  Recently
enacted legislation and the Company’s participation in the TARP Capital Purchase
Program may increase costs and limit the Company’s ability to pursue business
opportunities.
  The
Emergency Economic Stabilization Act of 2008 (the “EESA”), as augmented by the
American Recovery and Reinvestment Act of 2009 (the “Stimulus Bill”), was
intended to stabilize and provide liquidity to the U.S. financial markets. It is
impossible to predict, however, what actual impact the EESA and the Stimulus
Bill and their regulations and other governmental programs will have on such
markets.  The failure of the financial markets to stabilize and a
continuation or worsening of current financial market conditions could adversely
affect the Company’s business, financial condition and results of
operations.  The programs established or to be established under the
EESA and the Troubled Asset Relief Program (“TARP”) may result in increased
regulation of the industry in general and/or TARP Capital Purchase Program
participants in particular.  Compliance with such regulations may
increase the Company’s costs and limit its ability to pursue business
opportunities.
  The
Company’s participation in the TARP Capital Purchase Program may adversely
affect the value of the Company’s common stock and the rights of the Company’s
common shareholders.
  The terms
of the preferred stock the Company issued under the Treasury’s Capital Purchase
Program could reduce investment returns to the Company’s common shareholders by
restricting dividends, diluting existing shareholders’ ownership interests, and
restricting capital management practices. Without the prior consent of the
Treasury, the Company is prohibited from increasing the Company’s common stock
dividends for the first three years while the Treasury holds the preferred
stock.
  Also, the
preferred stock requires quarterly dividends to be paid at the rate of 5% per
annum for the first five years and 9% per annum thereafter until the stock is
redeemed by the Company. The payments of these dividends will decrease the
excess cash the Company otherwise has available to pay dividends on the
Company’s common stock and other series of preferred stock and to use for
general corporate purposes, including working capital.
   ~  ~
  Finally,
the Company will be prohibited from continuing to pay dividends on its common
stock and other series of preferred stock unless the Company has fully paid all
required dividends on the preferred stock issued to the Treasury.  The
Company fully expects to be able to pay all required dividends on the preferred
stock, but if for any reason the Company is unable to do so in the future, then
the Company would be precluded from paying dividends on its common stock and
other series of preferred stock.
  The
Company’s expenses will increase as a result of increases in FDIC insurance
premiums.
  Under the
Federal Deposit Insurance Act, the FDIC, absent extraordinary circumstances,
must establish and implement a plan to restore the deposit insurance reserve
ratio to 1.15% of insured deposits, over a five-year period, at any time that
the reserve ratio falls below 1.15%. Recent bank failures coupled with
deteriorating economic conditions have significantly reduced the deposit
insurance fund’s reserve ratio.  The FDIC expects a higher rate of
insured institution failures in the next few years, which may result in a
continued decline in the reserve ratio.
  As a
result of this reduced reserve ratio, on October 7, 2008, the FDIC released a
five-year recapitalization plan and a proposal to raise premiums to recapitalize
the fund. In order to implement the restoration plan, the FDIC proposed to
change both its risk-based assessment system and its base assessment rates.
Assessment rates would increase by seven basis points across the range of risk
weightings. In December 2008, the FDIC adopted its rule, uniformly increasing
the risk-based assessment rates by seven basis points, annually, resulting in a
range of risk-based assessments of 12 basis points to 50 basis points. Changes
to the risk-based assessment system would include increasing premiums for
institutions that rely on excessive amounts of brokered deposits, increasing
premiums for excessive use of secured liabilities, and lowering premiums for
smaller institutions with very high capital levels.
  As a
member institution of the FDIC, the Bank is required to pay
quarterly deposit insurance premium assessments to the FDIC. The Bank’s
deposit insurance premiums for 2008 and 2007 were $96 thousand and $86 thousand,
respectively.  Due to the continued failures of unaffiliated FDIC
insured depository institutions, it is expected that the Bank’s FDIC deposit
insurance premiums will continue to increase in the future, perhaps
significantly, thereby adversely impacting the Company’s future
earnings.
  If
the Company’s information systems were to experience a system failure or a
breach in its network security, the Company’s business and reputation could
suffer.
  The
Company relies heavily on communications and information systems to conduct its
business. The computer systems and network infrastructure we use could be
vulnerable to unforeseen problems.  The Company’s operations are
dependent upon its ability to protect its computer equipment against damage from
fire, power loss, telecommunications failure or a similar catastrophic
event.  In addition, the Company must be able to protect its computer
systems and network infrastructure against physical damage, security breaches
and service disruption caused by the Internet or other users.  Such
computer break-ins and other disruptions would jeopardize the security of
information stored in and transmitted through the Company’s computer systems and
network infrastructure.  The Company has policies and procedures
designed to prevent or limit the effect of the failure, interruption or security
breach of its information systems and will continue to implement security
technology and monitor and update operational procedures to prevent such
damage.  However, if such failures, interruptions or security breaches
were to occur, they could result in damage to the Company’s reputation, a loss
of customer business, increased regulatory scrutiny, or possible exposure to
financial liability, any of which could have a material adverse effect on the
Company’s financial condition and results of operations.
  The Company’s business may be
adversely affected by the highly regulated environment in which it
operates
  Our
operations are subject to extensive governmental supervision, regulation and
control and recent legislation has substantially affected the banking
business.  It cannot presently be predicted whether or in what form
any pending or future legislation may be adopted or the extent to which the
banking industry and our operations would be affected. Some of the legislative
and regulatory changes may benefit us.  However, other changes could
increase our costs of doing business or reduce our ability to compete in certain
markets.
   ~  ~
  
  Item
      2.  Properties
  The
Company occupies a property owned by the Bank at 581 Higuera Street, San Luis
Obispo, California, where the Bank’s main office is located.  For its
administration offices, the Bank has been leasing approximately 2,950 square
feet at 569 Higuera St. in San Luis Obispo at a cost of $6,143 per
month.  The lease expires on June 30, 2011.  The
administration office is located next to the Bank’s main office.
  The Bank
also leases a branch office at 1226 Park Street, Paso Robles, California, at a
cost of $4,995 per month.  The lease expires on July 31,
2013.
  The
Bank’s branch office at 154 West Branch Street, Arroyo Grande, California, is
leased at a cost of $3,063 per month, plus common area operating
expenses.  The lease expires in December 2010 and provides for one
five-year option period.
  The
Bank’s Business Banking Center at 3440 and 3480 S. Higuera Street, San Luis
Obispo, is leased for a five-year period expiring in 2009 at a cost of $6,925
per month.  One five-year option period is provided in the lease,
however, the lease has been extended for one year beyond its original 2009
expiration.
  During
2005, the Bank purchased a parcel located near the intersection of 6th and
Spring Streets in Paso Robles, where the Bank was planning to build a new branch
office to replace our existing branch office in Paso Robles.  An
adjacent parcel was purchased in 2006.  It is the Bank’s intention to
sell the property at this time.
  In
September 2006, the Bank entered into a 50-year ground lease for property at
South Higuera Street and Prado Road in San Luis Obispo, California, where the
Bank intended to build a full-service branch and administrative office. The
lease provided for rentals of $7,000 per month.  The terms of the
lease gave the Bank early termination rights through September 30, 2007, which
the Bank chose to exercise in July 2007.  In October 2007, the Bank
executed a 15-year build-to-suit lease for the South Higuera Street and Prado
Road property.  Currently the lease provides for tentative lease
payments of $36,708 per month, subject to the final size of the building (which
is currently under construction), and beginning on or about December 1,
2009.
  In March
2008, the Bank entered into a 5-year lease for an office building at 1670 South
Broadway in Santa Maria, California, where the Bank opened a full-service branch
office in December 2008.  The initial rental cost is $8,679 per
month.  The lease provides for two 5-year renewal options and an
option to purchase the property for a specified amount during the last two
months of 2010.
  For the
years ended December 31, 2008 and 2007, the Bank’s total occupancy costs were
approximately $586,000 and $546,000, respectively.  In the opinion of
management, the premises are adequate for the Bank’s purposes and the Bank has
sufficient insurance to cover its interest in the premises.  Note D to
the Consolidated Financial Statements contains additional information about
properties.
  Bancorp
is restricted by the bank holding company regulations in its power to hold real
estate property for investment.  The Company does not currently invest in
real estate, other than for purposes of operations and mortgage interests in
real estate securing loans made by the Bank in the ordinary course of business,
and has no plans to do so in the future.
  Item
3.  Legal Proceedings
  The
Company is, from time to time, subject to various pending and threatened legal
actions which arise out of the normal course of its business.  After
taking into consideration information furnished by counsel to the Company as to
the current status of these claims or proceedings to which the Bank is a party,
Management is of the opinion that the ultimate aggregate liability represented
by these claims, if any, will not have a material adverse affect on the
financial condition or results of operations of the Company.
   ~  ~
  There are
no material proceedings adverse to the Company to which any director, officer,
affiliate of the Company or 5% shareholder of the Company, or any associate of
any such director, officer, affiliate or 5% shareholder is a party, and none of
the above persons has a material interest adverse to the Company.
  
  Item
4.  Submission of Matters to a Vote of Security Holders
  No
matters were submitted to a vote of security holders during the fourth quarter
of 2008.
   ~  ~
   PART
II
  
 Item
      5.  Market  for Common Equity, Related Shareholder
      Matters and Issuer Purchases of Equity
  Securities
  Market
Information
 
 The
Company’s common stock has traded infrequently in the over-the-counter market
under the symbol “MISS.”  The Company’s Common Stock is not listed on
any exchange or market.  However, Howe Barnes Hoefer & Arnett,
Wedbush Morgan Securities, Stone & Youngberg LLC, and Monroe Securities make
a market in the Company’s Common Stock.  Certain information
concerning the Common Stock is reported on the Nasdaq OTC Bulletin Board
(www.otcbb.com).
  The
information in the following table indicates the daily high and low bid prices
of the Company’s Common Stock for each quarterly period during the last two
years based upon information provided by the OTC Bulletin Board. These prices do
not include retail mark-ups, mark-downs or commission.
  
 
 Holders
 
 As of
March 1, 2009, there were 325 holders of record of Bancorp’s Common
Stock.
  
 Dividends
 
 The
Company’s shareholders are entitled to receive dividends, when and as declared
by its Board of Directors, out of funds legally available therefor, subject to
the restrictions set forth in the California General Corporation Law (the
“Corporation Law”).  The Corporation Law provides that a corporation
may make a distribution to its shareholders if the corporation’s retained
earnings equal at least the amount of the proposed distribution.  The
Corporation Law also provides that, in the event that sufficient retained
earnings are not available for the proposed distribution, a corporation may
nevertheless make a distribution to its shareholders if it meets two conditions,
which generally stated are as follows: (i) the corporation’s assets equal at
least 1.25 times its liabilities, and (ii) the corporation’s current assets
equal at least its current liabilities or, if the average of the corporation’s
earnings before taxes on income and before interest expenses for the two
preceding fiscal years was less than the average of the corporation’s interest
expenses for such fiscal years, then the corporation’s current assets must equal
at least 1.25 times its current liabilities.  Under these conditions,
the Company was eligible to pay dividends at the end of 2007 and
2008.
  The
availability of operating funds for the Company and the ability of the Company
to pay a cash dividend depends largely on the Bank’s ability to pay a cash
dividend to Bancorp.  The payment of cash dividends by the Bank is
subject to restrictions.  In general, dividends may not be paid from
any of the Bank’s capital or surplus.  Dividends must be paid out of
available net profits, after deduction of all current operating expenses, actual
losses, accrued dividends on preferred stock, if any, and all federal and state
taxes.  Additionally, a bank is prohibited from declaring a dividend
on its shares of common stock until its surplus fund equals its common capital,
or, if its surplus fund does not equal its common capital, until at least
one-tenth of the bank’s net profits, for the preceding half year in the case of
quarterly or semi-annual dividends, or the preceding full year in the case of an
annual dividend, are transferred to its surplus fund each time dividends are
declared.  Regulatory approval is required if the total of all
dividends declared by a bank in any calendar year exceeds the total of its net
profits for that year combined with its retained net profits of the two
preceding years, less any required transfers to surplus or a fund for the
retirement of any preferred stock.  Furthermore, bank regulators also
have authority to prohibit the payment of dividends by a bank when it determines
such payment to be an unsafe and unsound banking practice.
  Additionally,
bank regulatory agencies have authority to prohibit banks from engaging in
activities that, in their opinion, constitute unsafe and unsound practices in
conducting its business.  It is possible, depending upon the financial
condition of the bank in question and other factors, that the bank regulatory
agencies could assert that the payment of dividends or other payments might,
under some circumstances, be an unsafe or unsound practice.  Further,
the bank
   ~  ~
  regulatory
agencies have established guidelines with respect to the maintenance of
appropriate levels of capital by banks or bank holding companies under their
jurisdiction.  Compliance with the standards set forth in such
guidelines and the restrictions that are or may be imposed under the prompt
corrective action provisions of federal law could limit the amount of dividends
which the Bank may pay.
  Under
these provisions and considering minimum regulatory capital requirements, the
Bank was eligible to pay dividends in 2007.  However, due to the
Bank’s net loss in 2008, regulatory approval would be required in 2009 for the
Bank to pay a dividend to Bancorp, even though it remains well
capitalized.
  On
November 26, 2007, the Company declared a $0.12 per share cash dividend for
holders of the Common Stock of record on December 7, 2007.  The
dividend was paid on December 17, 2007.  Series A Preferred Stock
received a $0.06 per share dividend and Series B and C Preferred Stock received
a $0.12 per share dividend. The total amount paid was $96,688.
  No
dividends were declared or paid on the Company’s common or preferred stock in
2008.
  Whether
or not stock or cash dividends will be paid in the future by the Company and/or
the Bank will be determined by the Board of Directors after consideration of
various factors including, but not limited to, profitability, regulatory capital
ratios, and financial condition. Additionally, certain provisions of the
preferred stock issuances restrict the ability of the Company to pay cash
dividends unless the required dividends on the preferred stock are also
paid.
  The
Company has issued and outstanding $3,093,000 of junior subordinated debt
securities due October 2033.  The indenture pursuant to which these
debt securities were issued provides that the Company must make interest
payments on the debentures before any dividends can be paid on its capital stock
and, in the event of the Company’s bankruptcy, dissolution or liquidation, the
holder of the debt securities must be paid in full before any distributions may
be made to the holders of our capital stock.  In addition, the Company
has the right to defer interest payments on the junior subordinated debt
securities for up to five years, during which time no dividends may be paid to
holders of the Company’s capital stock.
  On
January 9, 2009, in exchange for aggregate consideration of $5,116,000, Mission
Community Bancorp issued to the Treasury Department a total of 5,116 shares of a
new Series D Preferred Stock having a liquidation preference of $1,000 per
share.  This transaction is a part of the TARP Program.  The
Series D Preferred will pay cumulative dividends at a rate of 5% per annum for
the first five years and 9% per annum thereafter.  The Series D
Preferred may not be redeemed during the first three years after issuance except
from the proceeds of a “Qualified Equity Offering.”  Thereafter,
Mission Community Bancorp may elect to redeem the Series D Preferred at the
original purchase price plus accrued but unpaid dividends, if
any.  Until January 1, 2012, the consent of the Treasury Department
will be required for the Company to issue dividends other than consistent with
past practice and certain other circumstances.
   ~  ~
  Equity
Compensation Plans
 
 The
following table shows, as of December 31, 2008, each category of equity
compensation along with i) the number of securities to be issued upon the
exercise of outstanding options, warrants and rights, ii) the weighted-average
exercise price of the outstanding options, warrants and rights, and iii) the
remaining number of securities available for future issuance under the plans,
excluding stock options currently outstanding.
  
  Equity
      Compensation Plan InformationNumber
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
              
              Weighted
      average exercise price of outstanding options, warrants and
      rights
              
              Number
      of additional securities available for future grant under the
      planEquity
      compensation plans approved by security holders
              89,564
              
              $16.24
              
              160,776Equity
      compensation plans not approved by security holders
              -
              
              -
              
              -Total
              89,564
              
              $16.24
              
              160,776
 
  See Note
I to the consolidated financial statements for a discussion of the Company’s
Stock Option Plans.
  Purchases
of equity securities by Bancorp and affiliated purchasers
 
 On August
10, 2007, in a privately negotiated transaction, Mission Community Bancorp
(“Mission”) purchased 29,400 shares of its common stock held by Fannie Mae, at a
per share price of $15.62 for a total purchase price of
$459,228.  Other than this one transaction, neither Bancorp nor any
affiliate of Bancorp has repurchased any of its common or preferred stock during
the period covered by this report, and no stock repurchase plan has been
adopted.
  Report
of Offering of Securities and Use of Proceeds Therefrom
  A
registration statement with respect to a secondary public offering of securities
by Bancorp became effective on August 13, 2007.  The offering was a
best efforts offering to sell an aggregate of between 166,667 and 597,000 shares
of the Bancorp’s authorized but unissued common stock at a price of $18.00 per
share.   Seapower Carpenter Capital, Inc., dba Carpenter &
Company acted as Bancorp’s placement agent in the offering.  The
offering closed on February 15, 2008 with the sale of 410,644 shares for total
gross proceeds to the Company of approximately $7.4 million (net cash proceeds
of $6.8 million after offering expenses).  Bancorp invested $6.4
million of the net proceeds in the Bank as additional capital to support its
planned growth.
   ~  ~
  Item
6.  Selected Financial Data
 
 The
following is selected consolidated financial data with respect to the Company’s
consolidated financial statements for the three years ended December 31, 2008,
2007 and 2006. The information presented has been derived from the audited
consolidated financial statements included in Item 7 of Part II of this Form
10-K.  This information should be read in conjunction with such
consolidated financial statements and the notes thereto.
 
 
 Year Ended December 31,In
      thousands, except share and per share data
              
              2008
              
              
              2007
              
              
              2006Interest
      income
              
              $
              11,073
              
              
              $
              11,759
              
              
              $
              11,354Interest
      expense
              
              
              4,830
              
              
              
              5,129
              
              
              
              4,441Net
      interest income
              
              
              6,243
              
              
              
              6,630
              
              
              
              6,913Provision
      for loan losses
              
              
              4,245
              
              
              
              150
              
              
              
              -Non-interest
      income
              
              
              346
              
              
              
              1,257
              
              
              
              635Non-interest
      expense
              
              
              7,121
              
              
              
              6,594
              
              
              
              6,139Income
      (loss) before income taxes
              
              
              (4,777
              )
              
              
              1,143
              
              
              
              1,409Income
      tax expense (benefit)
              
              
              (929
              )
              
              
              378
              
              
              
              539Net
      income (loss)
              
              $
              (3,848
              )
              
              $
              765
              
              
              $
              870Net
      income (loss) allocable to preferred stock
              
              $
              (383
              )
              
              $
              115
              
              
              $
              133Balance
      Sheet Data at End of YearAssets
              
              $
              215,490
              
              
              $
              158,329
              
              
              $
              158,169Earning
      assets
              
              
              202,543
              
              
              
              149,439
              
              
              
              148,146Total
      loans
              
              
              153,311
              
              
              
              126,429
              
              
              
              122,799Deposits
              
              
              144,804
              
              
              
              112,433
              
              
              
              124,281Total
      shareholders' equity
              
              
              20,517
              
              
              
              13,138
              
              
              
              12,153Preferred
      equity
              
              
              1,686
              
              
              
              1,955
              
              
              
              1,845Common
      equity
              
              
              18,831
              
              
              
              11,183
              
              
              
              10,308Number
      of common shares outstanding
              
              
              1,345,602
              
              
              
              689,232
              
              
              
              673,399Average
      Balance Sheet DataAssets
              
              $
              190,792
              
              
              $
              157,869
              
              
              $
              150,899Earning
      assets
              
              
              181,232
              
              
              
              148,197
              
              
              
              140,894Loans
              
              
              142,342
              
              
              
              125,691
              
              
              
              118,303Deposits
              
              
              130,841
              
              
              
              121,480
              
              
              
              121,038Shareholders'
      equity
              
              
              18,451
              
              
              
              12,610
              
              
              
              11,555Per
      Share DataBasic
      earnings (loss) per share
              
              $
              (3.18
              )
              
              $
              0.96
              
              
              $
              1.10Diluted
      earnings (loss) per share
              
              
              (3.18
              )
              
              
              0.91
              
              
              
              1.02Average
      number of common shares outstanding - basic
              
              
              1,090,569
              
              
              
              679,144
              
              
              
              667,810Average
      number of common shares outstanding - diluted
              
              
              1,090,569
              
              
              
              713,152
              
              
              
              720,701Book
      value per common share
              
              $
              13.99
              
              
              $
              16.23
              
              
              $
              15.31Cash
      dividends declared
              
              
              -
              
              
              
              0.12
              
              
              
              0.12Performance
      RatiosReturn
      (loss) on average assets
              
              
              (2.02
              )%
              
              
              0.48
              %
              
              
              0.58
              %Return
      (loss) on average shareholders' equity
              
              
              (20.86
              )%
              
              
              6.07
              %
              
              
              7.53
              %Average
      equity to average assets
              
              
              9.67
              %
              
              
              7.99
              %
              
              
              7.66
              %Efficiency
      ratio
              
              
              108.07
              %
              
              
              83.61
              %
              
              
              81.33
              %Leverage
      ratio
              
              
              10.74
              %
              
              
              10.03
              %
              
              
              9.98
              %Net
      interest margin
              
              
              3.49
              %
              
              
              4.51
              %
              
              
              4.93
              %Non-interest
      revenue to total revenue
              
              
              5.25
              %
              
              
              15.94
              %
              
              
              8.41
              %Asset
      QualityNon-performing
      assets
              
              $
              4,580
              
              
              $
              2,056
              
              
              $
              2,169Allowance
      for loan losses
              
              
              3,942
              
              
              
              1,150
              
              
              
              1,026Net
      charge-offs (recoveries)
              
              
              1,453
              
              
              
              26
              
              
              
              115Non-performing
      assets to total assets
              
              
              2.13
              %
              
              
              1.30
              %
              
              
              1.37
              %Allowance
      for loan losses to loans
              
              
              2.57
              %
              
              
              0.91
              %
              
              
              0.84
              %Net
      charge-offs to average loans
              
              
              1.02
              %
              
              
              0.02
              %
              
              
              0.10
              %
 
  ~  ~
  Item
7.  Management’s Discussion and Analysis
 
 Executive
      Summary
 
 The
Company incurred a net loss of $(3.8) million for 2008, as compared to net
income of $765 thousand in 2007.  During 2007 the Company experienced
relatively flat balance sheet growth.  However, by December 31, 2008,
the Company had total consolidated assets of $215.5 million, a 36.1% increase
from December 31, 2007.  Total net loans increased 19.2%, to $149.4
million, over the past year.  Deposits increased 28.8%, to $144.8
million, while shareholders’ equity increased 56.2%, to $20.5
million.
 
 The
Company’s net loss was $(3,848,000), or $(3.18) per diluted share, for the year
ended December 31, 2008.  This compares with net income of $765
thousand, or $0.91 per diluted share, in 2007.
 
 The
following are the major factors impacting the Company’s results of operations
and financial condition in the past year.
 
 ·
              A
      $4.1 million increase in the provision for loan losses.  As real
      estate conditions continued to weaken in 2008 and the overall economy
      contracted—particularly in the fourth quarter—we charged off a few large
      credits.  Net charge-offs for the year totaled $1.5 million, up
      from $26 thousand in 2007.  In addition to replenishing the
      allowance for loan and lease losses following these charge-offs, we
      aggressively set aside additional reserves for other loans in the
      portfolio that have shown signs of weakness through our loan grading
      process or may come under stress if the economy continues to
      weaken.
 ·
              A
      decrease in the net interest margin.  The net interest margin
      for 2008 was 3.53%, down 1.04 percentage points from 2007.  As
      short-term interest rates began to decline in 2007 and dropped more
      precipitously in 2008, the Bank experienced increasing pressure on the
      margin, as competition for deposits in the local market would not permit
      decreases in deposit rates at the same speed or to the same degree as loan
      rates were falling.
 ·
              A
      decrease in the volume of SBA loans originated, sold, and
      brokered.  SBA loans originated for sale decreased 58% in 2008
      as compared to 2007, as the secondary market for SBA-guaranteed loans
      almost completely dried up in the second half of
      2008.  Non-interest income related to SBA loans sold and
      brokered decreased $268 thousand, or 59%, from 2007 to
    2008.
 ·
              A
      decrease in awards received for our community development
      activities.  In 2007 the Bank received a $326 thousand grant
      from the Bank Enterprise Award program of the Department of the
      Treasury.  The award was based on lending activity the Bank
      commenced in 2006.  No awards were received in 2008, as no
      application was submitted.
 ·
              The
      sale of $10.7 million of additional capital stock.  During 2008
      the Company issued 410,644 common shares in a secondary public offering
      for net cash proceeds of $6.8 million, and additional 225,026 shares of
      common stock were issued to the Carpenter Community BancFund-A,
      L.P. for net cash proceeds of $3.9
million.
 
 Critical
Accounting Policies
  A
critical accounting policy is defined as one that is both material to the
presentation of the Company’s financial statements and requires management to
make difficult, subjective or complex judgments that could have a material
effect on the Company’s financial condition and results of operations and may
change in future periods.  Note A to the Consolidated Financial
Statements describes the significant accounting policies used in the preparation
of the Consolidated Financial Statements.  Not all of these accounting
policies require management to make difficult, subjective or complex judgments
or estimates.  However, management believes that the following
policies could be considered critical within the SEC’s definition.
 
 Reserves
and Contingencies
 
 In the
normal course of business, the Company must manage and control certain risks
inherent to the business of banking.  These include credit risk,
interest rate risk, fraud risk, and operations and settlement
risk.  The Company has established reserves for risk of losses,
including loan losses.  The allowance for loan losses represents
management’s estimate of the probable losses that have occurred as of the date
of the financial statements, as further described in Note A in the Notes to the
Consolidated Financial Statements.  See also Allowance for Loan Losses
below.  These reserves or accruals are reviewed by management at least
quarterly.  If the latest estimate of loss (or the actual loss)
differs from the accrual or reserve recorded to date, the financial impact is
reflected in the period in which the estimate is revised (or the actual loss
is
  ~  ~
  determined).
 
 Revenue
recognition
 
 The
Company’s primary source of revenue is interest income from loans and investment
securities.  Interest income is recorded on an accrual
basis.  Note A in the Notes to the Consolidated Financial Statements
contains an explanation of the process for determining when the accrual of
interest income is discontinued on impaired loans and under what circumstances
loans are returned to an accruing status.
 
 The
Company also records gains in connection with the sale of the guaranteed portion
of certain SBA-guaranteed loans for which the Bank retains the right to service
the loans.  Recording of such gains involves the use of estimates and
assumptions related to the expected life of the loans and future cash
flows.  Notes A and C in the Notes to the Consolidated Financial
Statements contain additional information regarding the Company’s accounting
policy for revenue recorded in connection with the sale of loans.  SBA
loan servicing rights are based upon estimates and are subject to the risk of
prepayments and market value fluctuation.
 
 Basis
of Presentation
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the Company’s
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period.  Actual results could differ
from those estimates.
 
 The
following discussion and analysis is intended to assist in an understanding of
the significant factors that affected our consolidated financial condition and
results of operations for the years ended December 31, 2008 and
2007.  This discussion, which refers to the Company on a consolidated
basis, should be read in conjunction with the Company’s consolidated financial
statements and corresponding notes.
 
 Bancorp
is inactive except for interest expense associated with the junior subordinated
debentures (related to the trust preferred securities) and minimal other
expenses.  Therefore, the financial information is primarily
reflective of the Bank.
 
 The Bank
operates as a traditional community bank, but has also used management’s
expertise as a CDFI to provide a selection of financial services identified as
“community development” activities, with a focus on financial services to
under-served markets, small businesses and business
professionals.  Bancorp and the Bank have received and used both
grants and deposits under programs authorized by CDFI and continuously review
various options for both grants and deposit programs from various government and
public/private entities.  The CDFI status is dependent on management’s
specialized knowledge of working with various governmental programs and requires
a significant increase in reporting and documentation as compared with
traditional bank activities.
 
 MCDC
provides financing for small businesses and low- to moderate-income areas based
on direct loans or funding pools established in conjunction with
others.  MCDC currently has one small community development loan
outstanding and provides loan servicing for several small loans owned by the San
Luis Obispo County Economic Vitality Corporation.  MCDC also manages a
loan pool for the San Luis Obispo County Housing Trust Fund to assist in
providing affordable housing.  MCDC has also been servicing the San
Simeon Earthquake Recovery Loan Fund (the “Earthquake Fund”), a loan pool funded
by the Bank and other local banks.  The Earthquake Fund was structured
to provide low cost financing to individuals and businesses in San Luis Obispo
and northern Santa Barbara counties which experienced severe damage in the
December 22, 2003, San Simeon Earthquake.  During 2008, as the loans
made by the Earthquake Fund had been substantially paid off, the full amount of
the participating banks’ initial investments was returned.  As of
December 31, 2008, the Earthquake Fund had $18,000 in loans
outstanding.  The consortium is considering alternative community
development uses for the loan pool.
 
 MCSC
provides technical assistance services and training to the underserved segments
of the community including small businesses, minorities and low-income
entrepreneurs, and provides technical assistance to applicants for the
Earthquake Fund.  During 2006, MCSC was awarded a five-year, $750,000
grant from the U.S. Small Business Administration to fund one of 99 Women’s
Business Centers nationwide.  While MCSC has not engaged in any direct
lending, it intends to provide some
   ~  ~
  lending
in the near future.  As of December 31, 2008, the Bank has had limited
direct benefit from its association with MCSC.  See also Note L to the
Consolidated Financial Statements for additional information regarding
MCSC.
  Results
of Operations
 
 Average Balance Sheets and Analysis
of Net Interest Income
 
 The
principal component of earnings for most banks is net interest
income.  Net interest income is the difference between the interest
earned on loans and investments and the interest paid on deposits and other
interest-bearing liabilities.
 
 The
banking industry uses two key ratios to measure relative profitability of net
interest income.  The net interest rate spread measures the difference
between the average yield on earning assets and the average rate paid on
interest bearing liabilities.  The interest rate spread ignores the
beneficial impact of non-interest bearing deposits and capital, and provides a
direct perspective on the effect of market interest rate movements.  The
net interest margin is defined as net interest income as a percentage of average
interest-earning assets.  This ratio includes the positive impact of
obtaining a portion of the funding for earning assets with non-interest bearing
deposits and capital.
 
 The
following table presents, for the periods indicated, the total dollar amounts of
interest income from average interest-earning assets and the resultant yields.
Also presented are the dollar amounts of interest expense and average
interest-bearing liabilities, expressed both in dollars and in
rates.
 
 
 Net Interest Analysis(Dollars
      in thousands)For
      the Year EndedDecember
      31, 2008
              
              December
      31, 2007
              
              December
      31, 2006Average
              
              Average
              
              Average
              
              Average
              
              Average
              
              AverageBalance
              Interest
              Rate
              
              Balance
              Interest
              Rate
              
              Balance
              Interest
              RateASSETSInterest-earning
      assets:Loans,
      net of unearned income*
              
              $142,342
              $
      9,598
              6.80%
              *
              $125,691
              $
      10,764
              8.64%
              *
              $118,303
              $10,386
              8.81%
              *Investment
      securities*
              
              23,966
              1,122
              4.99%
              *
              16,071
              699
              4.64%
              *
              16,470
              685
              4.32%
              *Federal
      funds sold
              
              7,314
              122
              1.67%
              
              2,814
              140
              4.98%
              
              4,283
              211
              4.93%Other
      interest income
              
              7,610
              231
              3.03%
              
              3,621
              156
              4.32%
              
              1,838
              72
              3.91%Total
      interest-earning assets / interest income
              
              181,232
              11,073
              6.19%
              
              148,197
              11,759
              8.03%
              
              140,894
              11,354
              8.10%Non-interest-earning
      assets:Allowance
      for loan losses
              
              (2,118)
              
              
              
              (1,051)
              
              
              
              (1,181)Cash
      and due from banks
              
              2,987
              
              
              
              2,511
              
              
              
              2,930Premises
      and equipment
              
              3,529
              
              
              
              3,648
              
              
              
              3,639Other
      assets
              
              5,162
              
              
              
              4,564
              
              
              
              4,607Total
      assets
              
              $190,792
              
              
              
              $157,869
              
              
              
              $150,889LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-bearing
      deposits:Interest-bearing
      demand accounts
              
              $
      17,187
              361
              2.10%
              
              $
      13,611
              421
              3.09%
              
              $6,747
              121
              1.80%Savings
      deposits
              
              19,309
              327
              1.70%
              
              22,988
              575
              2.50%
              
              30,559
              899
              2.94%Certificates
      of deposit
              
              72,187
              2,471
              3.42%
              
              60,893
              2,931
              4.81%
              
              57,701
              2,541
              4.40%Total
      interest-bearing deposits
              
              108,683
              3,159
              2.91%
              
              97,492
              3,927
              4.03%
              
              95,007
              3,561
              3.75%Federal
      funds purchased
              
              34
              1
              2.81%
              
              4
              -
              6.34%
              
              -
              -
              -Federal
      Home Loan Bank advances
              
              37,232
              1,450
              3.89%
              
              19,383
              925
              4.77%
              
              13,904
              609
              4.38%Subordinated
      debt
              
              3,093
              220
              7.12%
              
              3,093
              277
              8.95%
              
              3,093
              271
              8.76%Total
      borrowed funds
              
              40,359
              1,671
              4.14%
              
              22,480
              1,202
              5.35%
              
              16,997
              880
              5.17%Total
      interest-bearing liabilities / interest expense
              
              149,042
              4,830
              3.24%
              
              119,972
              5,129
              4.28%
              
              112,004
              4,441
              3.97%Non-interest-bearing
      liabilities:Non-interest-bearing
      deposits
              
              22,158
              
              
              
              23,988
              
              
              
              26,031Other
      liabilities
              
              1,141
              
              
              
              1,299
              
              
              
              1,299Total
      liabilities
              
              172,341
              
              
              
              145,259
              
              
              
              139,334Shareholders'
      equity
              
              18,451
              
              
              
              12,610
              
              
              
              11,555Total
      liabilities and shareholders' equity
              
              $190,792
              
              
              
              $157,869
              
              
              
              $150,889Net
      interest-rate spread
              
              
              
              2.95%
              
              
              
              3.75%
              
              
              
              4.13%Impact
      of non-interest-bearingsources
      and other changes inbalance
      sheet composition
              
              
              
              0.58%
              
              
              
              0.82%
              
              
              
              0.82%Net
      interest income / margin on earning assets
              
              
              $ 6,243
              3.53%
              **
              
              $ 6,630
              4.57%
              **
              
              $ 6,913
              4.95%
              ***Yields
      on municipal securities and loans have been adjusted to their
      fully-taxable equivalents**
      Net interest income as a % of earning assets
 Non-accrual
loans are included in the calculation of the average balances of loans; interest
not accrued is excluded.
  ~  ~
  Net
interest income is affected by changes in the amount and mix of our
interest-earning assets and interest-bearing liabilities, referred to as the
change due to volume.  Average interest-earning assets grew by $33.0
million in 2008 over 2007.  All categories of interest-earning
assets—both long-term and liquid assets—grew substantially in
2008.  Interest-bearing liabilities increased $29.1 million over the
past year.  Net interest income is also affected by changes in the
yields we earn on interest-earning assets and the rates we pay on
interest-bearing deposits and borrowed funds, referred to as the change due to
rate.  The average yield on interest-earning assets decreased by 184
basis points (1.84%) in 2008, while the average rate paid on interest-bearing
liabilities decreased by only 104 basis points, causing pressure on the net
interest margin.  As a result, the net interest margin decreased 104
basis points in 2008, from 4.57% to 3.53%.
 
 The
following table sets forth changes in interest income and interest expense for
each major category of interest-earning assets and interest-bearing liabilities,
and the amount of those variances attributable to volume and rate changes for
the years indicated.
 
 
 Rate
      / Volume Variance Analysis(In
      thousands)
              
              Year
      Ended December 31, 2008
              
              
              Year
      Ended December 31, 2007Compared
      to 2007
              
              
              Compared
      to 2006Increase
      (Decrease)
              
              
              Increase
      (Decrease)in
      interest income and expense
              
              
              in
      interest income and expensedue
      to changes in:
              
              
              due
      to changes in:Volume
              
              
              Rate
              
              
              Total
              
              
              Volume
              
              
              Rate
              
              
              TotalInterest-earning
      assets:Loans,
      net of unearned income
              
              $
              1,310
              
              
              $
              (2,476
              )
              
              $
              (1,166
              )
              
              $
              637
              
              
              $
              (259
              )
              
              $
              378Investment
      securities
              
              
              366
              
              
              
              57
              
              
              
              423
              
              
              
              (16
              )
              
              
              30
              
              
              
              14Federal
      funds sold
              
              
              119
              
              
              
              (137
              )
              
              
              (18
              )
              
              
              (73
              )
              
              
              2
              
              
              
              (71
              )Other
      interest income
              
              
              132
              
              
              
              (57
              )
              
              
              75
              
              
              
              76
              
              
              
              8
              
              
              
              84Total
      increase (decrease) in interest income
              
              
              1,927
              
              
              
              (2,613
              )
              
              
              (686
              )
              
              
              624
              
              
              
              (219
              )
              
              
              405Interest-bearing
      liabilities:Transaction
      accounts
              
              
              95
              
              
              
              (155
              )
              
              
              (60
              )
              
              
              176
              
              
              
              124
              
              
              
              300Savings
      deposits
              
              
              (82
              )
              
              
              (166
              )
              
              
              (248
              )
              
              
              (202
              )
              
              
              (122
              )
              
              
              (324
              )Certificates
      of deposit
              
              
              482
              
              
              
              (942
              )
              
              
              (460
              )
              
              
              145
              
              
              
              245
              
              
              
              390Total
      interest-bearing deposits
              
              
              495
              
              
              
              (1,263
              )
              
              
              (768
              )
              
              
              119
              
              
              
              247
              
              
              
              366Federal
      funds purchased
              
              
              1
              
              
              
              -
              
              
              
              1
              
              
              
              -
              
              
              
              -
              
              
              
              -FHLB
      advances
              
              
              721
              
              
              
              (196
              )
              
              
              525
              
              
              
              257
              
              
              
              59
              
              
              
              316Subordinated
      debt
              
              
              -
              
              
              
              (57
              )
              
              
              (57
              )
              
              
              -
              
              
              
              6
              
              
              
              6Total
      borrowed funds
              
              
              722
              
              
              
              (253
              )
              
              
              469
              
              
              
              257
              
              
              
              65
              
              
              
              322Total
      increase (decrease) in interest expense
              
              
              1,217
              
              
              
              (1,516
              )
              
              
              (299
              )
              
              
              376
              
              
              
              312
              
              
              
              688Increase
      (decrease) in net interest income
              
              $
              710
              
              
              $
              (1,097
              )
              
              $
              (387
              )
              
              $
              248
              
              
              $
              (531
              )
              
              $
              (283
              )
 
 Changes
not solely attributable to rate or volume have been allocated to volume and rate
changes in proportion to the relationship of the absolute dollar amounts of the
changes in each.
 
 The Bank
is asset sensitive (see the Asset and Liability
Management section of this discussion) and benefited from the steady
increase in short-term interest rates in 2004 and 2005.  Short-term
rates leveled off in 2006, began to decline in 2007 and dropped precipitously in
early 2008.  During 2007 and 2008 the Bank also experienced increased
pressure on the margin due to competition for deposits in the local
market.  Overall, the Bank expects pressure on the margin to continue
in 2009.  However, as short-term rates stabilize at a very low level
we expect to see deposit and liability rates decline to a greater degree than
loan rates, relieving some pressure on the net interest margin.
 
 
 Provision
for Loan Losses
 
 Credit
risk is inherent in the business of making loans.  The Bank makes
provisions for loan losses when required to bring the total allowance for loan
losses to a level deemed appropriate. The determination of the appropriate level
for the allowance is based on such factors as historical experience, the volume
and type of lending conducted, the amount of nonperforming loans, regulatory
policies, general economic conditions, and other factors related to the
collectibility of loans in the portfolio.  The provision for loan
losses is charged to earnings and totaled $4,245,000 for 2008 and $150,000 for
2007.
  ~  ~
  
 See Allowance for Loan Losses
below for additional information on the procedures for monitoring the adequacy
of the allowance, as well as detailed information concerning the allowance for
loan losses.
 
 
 Non-interest
Income
 
 Non-interest
income decreased $911 thousand in 2008 as compared to 2007, due to decreased SBA
loan origination, sale, and broker activity, as well as the lack of grants and
awards related to the Bank’s community development activity in
2008.  Also contributing to the decrease in non-interest income were
$379 thousand in write-downs on fixed assets.  Property which had been
held for a future branch site was transferred to other real estate in 2008 and
written down to its current estimated fair value.  In addition,
equipment no longer used for information technology (“IT”) purposes after that
function was outsourced was written off in 2008.
 
 The Bank
derives a material portion of its non-interest income from the sale and
servicing of SBA guaranteed loans.  Gain on sale of SBA loans
decreased $121 thousand in 2008 as compared to 2007, after increasing $44
thousand in 2007.  In 2007 the Bank was able to broker certain SBA
loans to other banks, resulting in fee income even though the Bank did not
originate the loan.  Brokered loan fees totaled $112 thousand in 2007,
but no loans were brokered in 2008.  Loan servicing fees (net of
amortization) increased $6 thousand—to $72 thousand—in 2008.
 
 In 2007
the Bank received a $326 thousand grant from the Bank Enterprise Award program
of the Department of the Treasury, based on lending activity the bank commenced
in 2006.  The award was recognized in non-interest income in
2007.  No cash awards were received in 2008.  The Bank and
the Company expect to continue to apply for grants and awards, but no assurance
can be given that any future grants or awards will be received.
 
 Non-interest
Expense
 
 Non-interest
expense increased in 2008 by $527 thousand, or 8%.
 
 Non-interest
expenses that had material changes from 2007 to 2008 were:
 ·
              Salary
      and benefits increased by $102 thousand, or 3%.  Salaries
      increased $284 thousand, due to normal salary increases as well as new
      officers hired during the year.  Employee benefit costs for
      incentive plans and company contributions to the 401(k) plan decreased
      $186 thousand from 2007 to 2008.
 ·
              Occupancy
      expense increased by $39 thousand, or 7%, due primarily to the cost of the
      lease for the new branch in Santa Maria, California.  We entered
      into the lease in March 2008, although the branch did not open until
      December.
 ·
              Data
      processing expenses increased by $144 thousand, or 29%, due to a decision
      in the third quarter of 2008 to outsource the management of the Bank’s
      information technology (“IT”)
function.
 ·
              Professional
      fees were up $157 thousand, or 60%, in 2008, primarily due to legal and
      audit fees related to non-performing
assets.
 ·
              Marketing
      costs decreased $85 thousand, or 29% in 2008 as compared to 2007, as
      reductions were made in the Bank’s budget for advertising
      sponsorships.
 
 
 Income
Taxes
 
 The
Company’s combined federal and state effective income tax rate was 19.4% (tax
benefit) in 2008 and 33.1% (tax expense) in 2007.  The decrease in the
effective rate from 2007 to 2008 was primarily due to a $1.1 million deferred
tax valuation allowance that was established because the Bank’s loss in 2008
exceeded its ability to fully recognize deferred tax assets by carrying the loss
back to previous tax years.  As of December 31, 2008, the ability of
the Bank to reduce the deferred tax valuation allowance and recognize those
deferred tax assets was dependent on the Bank generating taxable income in
future years.  See Notes H and T to the consolidated financial
statements for more information on income taxes.
 
  ~  ~
  Financial
Condition
 
 Investment
Activities
 
 Banks
purchase and own investment securities for yield, to provide liquidity and to
balance the overall interest-rate sensitivity of its assets and liabilities. The
Bank does not maintain a trading account.
 
 Investment
goals are to obtain the highest yield consistent with maintaining a stable
overall asset and liability position while limiting economic
risks.  In accordance with this policy, management actively manages
its investment portfolio between available for sale and held to maturity
investments, the composition of which has shifted over time.  All
securities in the Bank’s portfolio are classified as available for
sale.
 
 Investment
policies and limits have been established by the board of
directors.  Investments can include federally-insured certificates of
deposit, obligations of the U.S. Treasury and U.S. agencies, mortgage-related
instruments issues or backed by U.S. agencies, municipal bonds rated Baa or
better (Moody’s), Aaa-rated private label mortgage-backed and asset-backed
securities, and corporate securities rated A or A-1.  Guidelines have
been established for diversification of the portfolio among these investment
categories and per-transaction limits have been established as
well.  The Bank’s chief financial officer reports investment purchase
and sale activity to the Board on a monthly basis and more detailed quarterly
reports are presented to the Investment Committee.
 
 The
following table presents the distribution of investments by sector, the maturity
dates of the investments, and the weighted average yields of the
investments:
 
 Investment
      securities compositionDecember
      31, 2008
              
              December
      31, 2007
              
              December
      31, 2006Approx.
              
              
              
              Approx.
              
              
              
              Approx.Amortized
              Market
              %
              
              Amortized
              Market
              %
              
              Amortized
              Market
              %Cost
              Value
              Yield
              
              Cost
              Value
              Yield
              
              Cost
              Value
              Yield(Dollars
      in thousands)U.S.
      Government agencies:Within
      one year
              $2,000
              $2,036
              3.38%
              
              $1,998
              $2,000
              4.43%
              
              $1,999
              $1,982
              3.51%One
      to five years
              500
              518
              4.00%
              
              1,995
              2,010
              4.24%
              
              3,494
              3,432
              4.16%Five
      to ten years
              1,000
              1,016
              5.18%
              
              1,000
              1,001
              4.97%
              
              1,000
              990
              4.73%After
      10 years
              -
              -
              0.00%
              
              1,000
              999
              4.31%
              
              999
              966
              4.31%Total
      U.S. Government agencies
              3,500
              3,570
              3.98%
              
              5,993
              6,010
              4.44%
              
              7,492
              7,370
              4.08%Mortgage-backedand
      asset-backed securities:Within
      one year
              334
              334
              4.07%
              
              130
              128
              3.88%
              
              3
              3One
      to five years
              577
              582
              4.66%
              
              1,003
              997
              4.61%
              
              855
              842
              4.10%Five
      to ten years
              1,810
              1,873
              4.83%
              
              1,105
              1,108
              4.87%
              
              236
              230
              4.09%After
      10 years
              14,689
              15,053
              4.94%
              
              5,738
              5,917
              4.82%
              
              5,989
              6,028
              4.30%Total
      mortgage-backedand
      asset-backed securities
              17,410
              17,842
              4.90%
              
              7,976
              8,150
              4.79%
              
              7,083
              7,103
              4.27%Municipal
      securities:Within
      one year
              -
              -
              
              
              -
              -
              
              
              -
              -One
      to five years
              -
              -
              
              
              -
              -
              
              
              -
              -Five
      to ten years
              -
              -
              
              
              -
              -
              
              
              -
              -After
      10 years
              3,581
              3,434
              5.95%
              
              2,972
              2,964
              6.00%
              
              1,941
              1,943
              6.01%Total
      municipal securities
              3,581
              3,434
              5.95%
              
              2,972
              2,964
              6.00%
              
              1,941
              1,943
              6.01%Total
      investment securities
              $24,491
              $24,846
              4.92%
              
              $16,941
              $17,124
              4.88%
              
              $16,516
              $16,416
              4.39%
 
 The
non-accrual security is included in the amortized cost and market value of
securities.  Yields reflect no interest income on the non-accrual
security.  Yields on tax-exempt municipal securities have been
adjusted to their fully-taxable equivalents.
 
 During
2008 and 2007, the Bank purchased $0.9 million and $1.0 million, respectively,
of municipal securities in order to take advantage of their higher yields on a
fully taxable equivalent basis.  All of the municipal securities
purchased to date are within California, bank qualified, insured and are rated
at least Baa1.  Except for one security carried at $290 thousand, all
municipal securities are insured by companies rated at least A by Standard &
Poor’s, with 74% of those companies rated AAA.
  ~  ~
  
 In 2004,
management established a loss reserve for one of the Bank’s asset-backed
securities after concluding it was “other than temporarily
impaired.”  The security is in non-accrual status, with any interest
payments received being credited to the reserve.  As of December 31,
2008, the gross book value of the security was $309,000 and the reserve was
$277,000, for a net book value of $32,000.
 
 See Note
B in the notes to the consolidated financial statements for additional
information on investment securities.
 
 
 Lending
Activities
 
 The Bank
originates loans, participates in loans from other banks and structures loans
for possible sale in the secondary market.
 
 The
following table sets forth the composition of our loan portfolio by type of loan
as of the dates indicated:
 
 
 Loan
      Portfolio Composition(Dollars
      in thousands)
              As
      of December 31,2008
              
              2007
              
              2006
              
              2005
              
              2004Type of LoanCommercial
              $24,454
              
              $25,653
              
              $18,000
              
              $14,190
              
              $15,298Agricultural
              -
              
              122
              
              123
              
              152
              
              774Leases,
      net of unearned income
              1,491
              
              839
              
              1,041
              
              815
              
              880Municipal
      loans
              2,729
              
              2,789
              
              2,903
              
              -
              
              -Real
      estate
              98,049
              
              72,009
              
              66,591
              
              71,878
              
              60,445Construction
              22,857
              
              22,513
              
              31,639
              
              29,921
              
              24,394Consumer
              3,731
              
              2,504
              
              2,502
              
              2,519
              
              1,585Total
      loans
              $153,311
              
              $126,429
              
              $122,799
              
              $119,475
              
              $103,376Off-balance-sheet
      commitments:Undisbursed
      loan commitments
              $28,427
              
              $28,608
              
              $35,375
              
              $37,379
              
              $29,793Standby
      letters of credit
              304
              
              693
              
              213
              
              203
              
              123
 
 
 The
following table sets forth as of December 31, 2008, the maturities and
sensitivities of loans to interest rate changes:
 
 
 Maturity
      and Rate Sensitivity of Loans(Dollars
      in thousands)Rate
      Structure for LoansMaturity
              
              
              Maturing
      Beyond One YearOne
      year
              
              
              One
      through
              
              
              Over
      five
              
              
              
              
              
              Fixed
              
              
              Floatingor
      less
              
              
              five
      years
              
              
              years
              
              
              Total
              
              
              Rate
              
              
              RateCommercial
              
              $
              15,696
              
              
              $
              5,836
              
              
              $
              2,922
              
              
              $
              24,454
              
              
              $
              8,758
              
              
              $
              -Agricultural
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Leases,
      net of unearned income
              
              
              121
              
              
              
              1,370
              
              
              
              -
              
              
              
              1,491
              
              
              
              1,370
              
              
              
              -Municipal
      loans
              
              
              233
              
              
              
              -
              
              
              
              2,496
              
              
              
              2,729
              
              
              
              773
              
              
              
              1,723Real
      estate
              
              
              17,967
              
              
              
              26,439
              
              
              
              53,643
              
              
              
              98,049
              
              
              
              64,917
              
              
              
              15,165Construction
              
              
              21,928
              
              
              
              929
              
              
              
              -
              
              
              
              22,857
              
              
              
              929
              
              
              
              -Consumer
      Loans
              
              
              1,970
              
              
              
              1,677
              
              
              
              84
              
              
              
              3,731
              
              
              
              1,761
              
              
              
              -Total
      Loans
              
              $
              57,915
              
              
              $
              36,251
              
              
              $
              59,145
              
              
              $
              153,311
              
              
              $
              78,508
              
              
              $
              16,888
 
 
 The Bank
funds commercial loans to provide working capital, to finance the purchase of
equipment and for other business purposes.  These loans can be short-term, with maturities
ranging from thirty days to one year, or term loans, with maturities
normally ranging from one to twenty-five years.  Short-term loans are
generally intended to finance current transactions and typically provide for
periodic principal payments, with interest payable monthly.
  ~  ~
  
 Included
in commercial loans are SBA loans.  The Bank originates and services
SBA loans and is active in specific SBA programs.  Further, the Bank
is designated as an SBA preferred lender which allows greater flexibility to
meet small business loan requests with a more timely credit approval
process.
 
 The Bank
makes adjustable rate SBA-guaranteed loans and generally sells the guaranteed
portion of the SBA loans in the secondary market while retaining the servicing
rights for those loans.  At December 31, 2008 and 2007, the Bank
serviced approximately $23.2 million and $24.7 million, respectively, in SBA
loans.
 
 Consumer
loans are used to finance automobiles, various types of consumer goods, and
other personal purposes.  Consumer loans generally provide for the
monthly payment of principal and interest.  Most consumer loans are
secured by the personal property being purchased.
 
 The Bank
has been active in construction lending for interim loans to finance the
construction of commercial and single family residential
property.  Construction loans totaled $22.9 million as of December 31,
2008, a $344 thousand increase from a year earlier.  These loans are
typically extended for terms of no more than 12 to 18
months.  Generally, the Bank does not provide loans for speculative
purposes except to known builders who have a track record of successful projects
and the expertise and financial strength for the particular type of
building.
 
 Residential
real estate loans are generally limited to home equity loans and home equity
lines of credit.  The Bank has not been active in other forms of
residential real estate lending.
 
 Other
real estate loans consist primarily of commercial and industrial real estate
loans.  These loans are made based on the income generating capacity
of the property or the cash flow of the borrower and are secured by the
property.  The Bank offers both fixed and variable rate loans with
maturities which generally do not exceed ten years.  Exceptions are
made for SBA-guaranteed loans secured by real estate, or for other commercial
real estate loans which can be readily sold in the secondary
market.
 
 
 Asset
Quality
 
 The risk
of nonpayment of loans is inherent in the banking business. That risk varies
with the type and purpose of the loan, the collateral which is utilized to
secure payment and, ultimately, the creditworthiness of the
borrower.  In order to minimize this credit risk, all loans exceeding
lending officers’ individual lending limits are reviewed and approved by a
Management Loan Committee.  Loans exceeding the Management Loan
Committee’s authorization are reviewed and approved by the Loan Committee of the
board of directors.  The Board Loan Committee is comprised of outside
directors as well as the Bank’s chief executive officer and its
president.
 
 Loan
grades are assigned based on a risk assessment of each loan.  Loans
with minimum risk are graded as “pass,” with other classifications of “special
mention,” “substandard,” “doubtful” and “loss,” depending on credit
quality.  Loans graded “substandard” or “doubtful” are considered
“classified” loans, and loans graded “loss” are charged off.  As these
loans are identified in our review process, they are added to the internal watch
list and a loss allowance is established for them.  See Allowance for Loan Losses
below for additional information on how the amount of allowance for loan losses
is determined.
 
  ~  ~
  The
following table provides year-end information with respect to the components of
our impaired or nonperforming assets at the dates indicated:
 
 
 Non-Performing
      Assets(Dollars
      in thousands)
              
              As
      of December 31,2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004Loans
      in nonaccrual status:Commecial
              
              $
              578
              
              
              $
              254
              
              
              $
              240
              
              
              $
              76
              
              
              $
              206Real
      estate
              
              
              1,427
              
              
              
              190
              
              
              
              -
              
              
              
              -
              
              
              
              -Construction
      & land development
              
              
              1,552
              
              
              
              1,544
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      nonaccrual loans
              
              
              3,557
              
              
              
              1,988
              
              
              
              240
              
              
              
              76
              
              
              
              206Loans
      past due 90 days or more and accruing:
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -
              
              
              
              -Commecial
              
              
              -
              
              
              
              54
              
              
              
              -
              
              
              
              -
              
              
              
              -Lease
      financing
              
              
              -
              
              
              
              14
              
              
              
              -
              
              
              
              -
              
              
              
              -Real
      estate
              
              
              265
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Construction
      & land development
              
              
              -
              
              
              
              -
              
              
              
              1,929
              
              
              
              -
              
              
              
              -Total
      loans 90 days past due and accruing
              
              
              265
              
              
              
              68
              
              
              
              1,929
              
              
              
              -
              
              
              
              -Restructured
      loans:Construction
      & land development
              
              
              675
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      restructured loans
              
              
              675
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      nonperforming loans
              
              
              4,497
              
              
              
              2,056
              
              
              
              2,169
              
              
              
              76
              
              
              
              206Foreclosed
      real estate
              
              
              83
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      nonperforming assets
              
              $
              4,580
              
              
              $
              2,056
              
              
              $
              2,169
              
              
              $
              76
              
              
              $
              206Allowance
      for loan losses
              
              $
              3,942
              
              
              $
              1,150
              
              
              $
              1,026
              
              
              $
              1,141
              
              
              $
              1,094Asset
      quality ratios:Non-performing
      assets to total assets
              
              
              2.13
              %
              
              
              1.30
              %
              
              
              1.37
              %
              
              
              0.05
              %
              
              
              0.15
              %Non-performing
      loans to total loans
              
              
              2.93
              %
              
              
              1.63
              %
              
              
              1.77
              %
              
              
              0.06
              %
              
              
              0.20
              %Allowance
      for loan losses to total loans
              
              
              2.57
              %
              
              
              0.91
              %
              
              
              0.84
              %
              
              
              0.96
              %
              
              
              1.06
              %Allowance
      for loan losses to totalnon-performing
      loans
              
              
              88
              %
              
              
              56
              %
              
              
              47
              %
              
              
              1501
              %
              
              
              531
              %
 
 
 Non-accrual
loans are loans which management believes may not be fully collectible as to
principal and interest.  Generally, loans are placed in non-accrual
status when they are 90 days or more past due unless they are well-secured and
in the process of collection.  Once placed in non-accrual status, a
loan is not returned to accrual status until it is brought current with respect
to both principal and interest payments, the loan is performing to current terms
and conditions, the interest rate is commensurate with market interest rates and
future principal and interest payments are no longer in doubt, at which time a
further review of the loan is conducted.
 
 The
increase in non-accrual loans from year-end 2007 to December 31, 2008 was due to
the significant downturn in the economy and reduction in real estate collateral
values in 2008.  A large portion of the increase was in our SBA loan
portfolio.  As of December 31, 2008, $1.640 million of the non-accrual
loans were SBA loans, with $1.361 million of the total guaranteed by the
SBA.  At December 31, 2007, $254 thousand of the Bank’s non-accrual
loans were SBA loans, and $241 thousand of the total was guaranteed by the
SBA.
 
 Restructured
loans are those loans with concessions in interest rates or repayment terms due
to a decline in the financial condition of the borrower.  Other real
estate owned is acquired in satisfaction of loans through foreclosure or other
means and is carried on an individual asset basis at the lower of the recorded
investment in the related loan or the estimated fair value of the property, less
selling expenses.
 
 The Bank
has no foreign loans.
  ~  ~
  Potential
Problem Loans
  At
December 31, 2008, the Company had approximately $17.6 million of loans that
were not categorized as non-performing, but for which known information about
the borrower’s financial condition caused management to have concern about the
ability of the borrowers to comply with the repayment terms of the
loans.  These loans were identified through the loan review process
described above.  The $17.6 million of potential problem loans are
supported by $249 thousand of SBA loan guarantees.  Potential problem
loans are subject to continuing management attention and management has provided
in the allowance for loan and lease losses for potential losses related to these
loans, based on an evaluation of current market conditions, loan collateral,
other secondary sources of repayment and cash flow generation.
  While
credit quality, as measured by loan delinquencies and by the Bank’s internal
risk grading system, appears to be manageable as of December 31, 2008, there can
be no assurances that new problem loans will not develop in future
periods.  A decline in economic conditions in the Bank’s market area
or other factors could adversely impact individual borrowers or the loan
portfolio in general.  The Bank has well defined underwriting
standards and expects to continue with prompt collection efforts, but economic
uncertainties or changes may cause one or more borrowers to experience problems
in the coming months.
 
 
 Loan
Concentrations
  The Board
of Directors has approved concentration levels (as a percentage of capital) for
various loan types based on the Bank’s business plan and historical loss
experience.  On a quarterly basis, management provides a loan
concentration report to the board with information relating to
concentrations.  Management’s review of possible concentrations
includes an assessment of loans to multiple borrowers engaged in similar
activities which would cause them to be similarly impacted by economic or other
conditions.  Management is not aware of any such concentrations in
similar activities.
 
 The
following table reflects the major concentrations in the loan portfolio, by type
of loan, as of December 31, 2008:
 
 
 Loan
      ConcentrationsDecember
      31, 2008(Dollars
      in thousands)Type
      of Loan
              
              Amount
              
              
              Percent
      of Total LoansConstruction
      and land development
              
              $
              22,857
              
              
              
              14.9
              %Other
      real estate loans (by type of collateral):Non-farm,
      non-residential property:Owner-occupied
              
              
              36,208
              
              
              
              23.6
              %Non-owner-occupied
              
              
              37,375
              
              
              
              24.4
              %1
      to 4 family residential:First
      liens
              
              
              5,464
              
              
              
              3.6
              %Junior
      liens
              
              
              11,840
              
              
              
              7.7
              %Multi-family
      residential
              
              
              3,340
              
              
              
              2.2
              %Farmland
              
              
              3,822
              
              
              
              2.5
              %Total
      real estate-secured loans
              
              
              120,906
              
              
              
              78.9
              %Commercial
      loans
              
              
              24,454
              
              
              
              16.0
              %Agricultural
      loans
              
              
              -
              
              
              
              0.0
              %Lease
      financing
              
              
              1,491
              
              
              
              1.0
              %Municipal
      loans
              
              
              2,729
              
              
              
              1.8
              %Consumer
      loans
              
              
              3,731
              
              
              
              2.3
              %Total
      loans, including loans held for sale
              
              $
              153,311
              
              
              
              100.0
              %
 
 
 The table
indicates a concentration in commercial real estate loans (loans secured by
non-farm, non-residential and multi
  ~  ~
  family
residential properties, including construction loans) totaling $99.8
million.  However, under the regulatory definition of commercial real
estate—which excludes owner-occupied properties—the Bank’s commercial real
estate concentration is reduced to $63.6 million, or 41.5% of total
loans.  To date, the Bank has had only two losses on construction and
land development loans (both occurring in 2008) and none with other types of
commercial real estate loans.
 
 The
Bank’s analysis of loan concentrations compared to a California peer group of 50
banks suggests that the Bank does not have an unusually high real estate
concentration compared to other similar sized banks in
California.  Banks in California typically are more prone than banks
in other states to use real estate collateral for many commercial loans for
business purposes where collateral is taken as an abundance of
caution.  In its analysis of real estate concentrations, the Bank
carefully considers economic trends and real estate values.  The
commercial real estate market in San Luis Obispo county has weakened in 2008 and
rents have decreased, but the market has not seen the weakness seen in many
other areas of California and the U.S.  Vacancies in San Luis Obispo
county are most notable where national retailers have ceased business, but are
not widespread.
 
 Allowance
for Loan Losses
 
 The
following table summarizes, for each reported period, changes in the allowance
for loan losses arising from loans charged off, recoveries on loans previously
charged off, additions to the allowance which have been charged to operating
expenses, and certain ratios relating to the allowance for loan
losses:
 
 
 Summary
      of Loan Loss Experience(Dollars
      in thousands)2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004Balance
      at beginning of year
              
              $
              1,150
              
              
              $
              1,026
              
              
              $
              1,141
              
              
              $
              1,094
              
              
              $
              812Loans
      charged off:Real
      estate and construction
              
              
              (547
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
              
              
              (880
              )
              
              
              (13
              )
              
              
              (102
              )
              
              
              (24
              )
              
              
              (1
              )Consumer
              
              
              (52
              )
              
              
              (4
              )
              
              
              (19
              )
              
              
              (7
              )
              
              
              -Other
              
              
              -
              
              
              
              (14
              )
              
              
              -
              
              
              
              -
              
              
              
              -Total
      loans charged off
              
              
              (1,479
              )
              
              
              (31
              )
              
              
              (121
              )
              
              
              (31
              )
              
              
              (1
              )Recoveries:Real
      estate and construction
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
              
              
              22
              
              
              
              4
              
              
              
              6
              
              
              
              1
              
              
              
              3Consumer
              
              
              3
              
              
              
              -
              
              
              
              -
              
              
              
              2
              
              
              
              -Other
              
              
              1
              
              
              
              1
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      recoveries
              
              
              26
              
              
              
              5
              
              
              
              6
              
              
              
              3
              
              
              
              3Net
      recoveries (charge-offs)
              
              
              (1,453
              )
              
              
              (26
              )
              
              
              (115
              )
              
              
              (28
              )
              
              
              2Provision
      charged to operations
              
              
              4,245
              
              
              
              150
              
              
              
              -
              
              
              
              75
              
              
              
              280Balance
      at end of year
              
              $
              3,942
              
              
              $
              1,150
              
              
              $
              1,026
              
              
              $
              1,141
              
              
              $
              1,094Ratio
      of net charge-offs to average loans
              
              
              1.02
              %
              
              
              0.02
              %
              
              
              0.10
              %
              
              
              0.03
              %
              
              
              0.00
              %Ratio
      of provision to average loans
              
              
              2.98
              %
              
              
              0.12
              %
              
              
              0.00
              %
              
              
              0.07
              %
              
              
              0.29
              %
 
 
 The Bank
performs a quarterly detailed review to identify the risks inherent in the loan
portfolio, to assess the overall quality of the loan portfolio and to determine
the adequacy of the allowance for loan losses and the related provision for loan
losses to be charged to expense.  Systematic reviews follow the
methodology set forth by various regulatory policy statements on the allowance
for loan losses.
 
 A key
element of the Bank’s methodology is the previously discussed credit
classification process.  The amount determined by management to be an
appropriate level for the allowance is based on the Bank’s historical loss rate
for each type of loan and risk grade, with adjustments made for certain
qualitative factors such as current and expected economic conditions, trends in
collateral values, the quality of the Bank’s loan review process,
etc.  For loans identified as impaired
under
  ~  ~
  Statement
of Financial Accounting Standards No. 114, the allowance allocated to the loan
is the deficiency, if any, in either the present value of expected cash flows
from the loan or the fair value of the collateral, as compared to the Bank’s
investment in the loan.  The Bank engages an outside firm to perform,
at least quarterly, a review of the loan portfolio, and to test the adequacy of
the allowance for loan losses.  In addition, loans are examined
periodically by the Bank’s federal and state regulators.
 
 Management
and the board consider the allowance for loan losses to be adequate to provide
for losses inherent in the loan portfolio. Although management uses available
information to recognize losses on loans and leases, future additions to the
allowance may be necessary based on changes in economic
conditions.  In addition, federal regulators periodically review our
allowance for loan losses and may recommend additions based upon their
evaluation of the portfolio at the time of their
examination.  Accordingly, there can be no assurance that our
allowance for loan losses will be adequate to cover future loan losses or that
significant additions to the allowance for loan losses will not be required in
the future.  Material additions to the allowance for loan losses would
decrease earnings and capital and would thereby reduce the Bank’s ability to pay
dividends, among other adverse consequences.
 
 The ratio
of allowance for loan losses to total loans as of December 31, 2008 was
2.57%.  Management and the board consider this to be adequate based on
their analysis and reviews of the portfolio.
 
 As part
of the analysis of the allowance, the Bank assigns certain risk factors to
unclassified loans in addition to the specific percentages used for classified
loans.  The following table summarizes the allocation of the allowance
for loan losses by general loan types based on collateral or security type as
used internally by the Bank as of the end of each of the past five
years.
 
 
 December
      31, 2008
              December
      31, 2007
              December
      31, 2006
              December
      31, 2005
              December
      31, 2004Percent
      of Total
              Allowance
              Percent
      of Total
              
              Percent
      of Total
              Allowance
              Percent
      of Total
              
              Percent
      of Total
              Allowance
              Percent
      of Total
              
              Percent
      of Total
              Allowance
              Percent
      of Total
              
              Percent
      of Total
              Allowance
              Percent
      of Total(dollars
      in thousands)
              Loans
              Loans
              Allocation
              Allowance
              Loans
              Loans
              Allocation
              Allowance
              Loans
              Loans
              Allocation
              Allowance
              Loans
              Loans
              Allocation
              Allowance
              Loans
              Loans
              Allocation
              AllowanceUnclassified
      loans:Commercial
              $22,252
              14.5%
              $  860
              21.8%
              $
      25,238
              20.0%
              $  390
              33.9%
              $  17,855
              14.5%
              $234
              22.8%
              $
      11,890
              10.0%
              $   287
              25.2%
              $  14,565
              14.1%
              $ 
      367
              33.5%Agricultural
              -
              0.0%
              -
              0.0%
              122
              0.1%
              1
              0.1%
              123
              0.1%
              1
              0.1%
              152
              0.1%
              1
              0.1%
              774
              0.7%
              4
              0.4%Leases
              1,491
              1.0%
              14
              0.4%
              811
              0.6%
              7
              0.6%
              1,041
              0.8%
              5
              0.5%
              814
              0.7%
              7
              0.6%
              880
              0.9%
              8
              0.7%Municipal
      loans
              2,729
              1.8%
              16
              0.4%
              2,789
              2.2%
              14
              1.2%
              2,903
              2.4%
              15
              1.5%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%Real
      estate
              88,735
              57.9%
              719
              18.2%
              72,009
              57.0%
              261
              22.7%
              66,591
              54.3%
              313
              30.5%
              71,878
              60.2%
              308
              27.0%
              60,316
              58.4%
              241
              22.0%Construction
              15,430
              10.1%
              200
              5.1%
              18,433
              14.6%
              192
              16.7%
              29,710
              24.2%
              135
              13.2%
              27,992
              23.4%
              123
              10.8%
              24,394
              23.6%
              109
              10.0%Consumer
              3,723
              2.4%
              91
              2.3%
              2,491
              2.0%
              22
              1.9%
              2,502
              2.0%
              20
              1.9%
              2,517
              2.1%
              21
              1.8%
              1,585
              1.5%
              13
              1.2%Total
      unclassified loans
              134,360
              87.7%
              1,900
              48.2%
              121,893
              96.5%
              887
              77.1%
              120,725
              98.3%
              723
              70.5%
              115,243
              96.5%
              747
              65.5%
              102,514
              99.2%
              742
              67.8%Classified
      loans:Commercial
              2,202
              1.4%
              454
              11.5%
              415
              0.3%
              76
              6.6%
              145
              0.1%
              30
              2.9%
              2,300
              1.9%
              87
              7.6%
              733
              0.7%
              120
              11.0%Agricultural
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%Leases
              -
              0.0%
              -
              0.0%
              28
              0.0%
              2
              0.2%
              -
              0.0%
              -
              0.0%
              1
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%Municipal
      loans
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%Real
      estate
              9,314
              6.1%
              337
              8.5%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%
              129
              0.1%
              19
              1.7%Construction
              7,427
              4.8%
              1,057
              26.9%
              4,080
              3.2%
              30
              2.6%
              1,929
              1.6%
              -
              0.0%
              1,929
              1.6%
              -
              0.0%
              -
              0.0%
              -
              0.0%Consumer
              8
              0.0%
              -
              0.0%
              13
              0.0%
              1
              0.1%
              -
              0.0%
              -
              0.0%
              2
              0.0%
              -
              0.0%
              -
              0.0%
              -
              0.0%Total
      classified loans
              18,951
              12.3%
              1,848
              46.9%
              4,536
              3.5%
              109
              9.5%
              2,074
              1.7%
              30
              2.9%
              4,232
              3.5%
              87
              7.6%
              862
              0.8%
              139
              12.7%Other
      economic factors
              
              
              
              194
              4.9%
              
              
              154
              13.4%
              
              
              273
              26.6%
              
              
              307
              26.9%
              
              
              213
              19.5%Total
      loans and allowance
              $153,311
              100.0%
              $3,942
              100.0%
              $126,429
              100.0%
              $1,150
              100.0%
              $122,799
              100.0%
              $1,026
              100.0%
              $119,475
              100.0%
              $1,141
              100.0%
              $103,376
              100.0%
              $1,094
              100.0%
 
 
 
 Deposits
 
 Deposits
are the primary source of funding for lending and investing
needs.  Total deposits were $144.8 million as of December 31, 2008,
and $112.4 million at December 31, 2007.  Deposits increased by $32.4
million, or 29%, following an $11.8 million, or 10%, decrease in
2007.  Increasing competition for deposits in the local market and
from other non-local financial institutions made deposit growth a formidable
challenge in 2007.  Much of the Bank’s deposit growth in 2008 was from
the Bank’s CDARS product, as discussed below.
 
 The Bank
generally prices deposits at or above the median rate by classification based on
periodic interest rate surveys in the local market.  Deposit rates are
then adjusted to balance the cost of funds versus funding needs and asset and
liability considerations.  The Net Interest Analysis and
Rate/Volume Analysis
earlier in this Discussion contain information regarding the average rates paid
on deposits for 2008 and 2007.
 
 The Bank
is one of only two banks in San Luis Obispo county participating in the
Certificate of Deposit Account Registry Service (“CDARS”)
program.  This program permits the Bank’s customers to place their
certificates of deposit at one
  ~  ~
  institution—Mission
Community Bank—and have those deposits fully-insured by the FDIC, up to $50
million.  The CDARS program acts as a clearinghouse, matching deposits
from one institution in the CDARS network of nearly 3,000 banks with other
network banks (in increments of less than the $250 thousand FDIC insurance
limit), so funds that a customer places with the Bank essentially remain on the
Bank’s balance sheet.  The CDARS program became very attractive in the
second half of 2008 as local depositors sought out both safety and
yield.  As of December 31, 2008, the Bank had issued $30.2 million of
certificates of deposit to local customers through the CDARS program, up from
$3.9 million as of December 31, 2007.
 
 The
following table reflects the maturity distribution of certificates of deposit in
the amounts of $100,000 or more as of December 31, 2008:
 
 
 Maturities
      of Time Deposits of $100,000 or More(Dollars
      in thousands)Three
      months or less
              
              $
              21,159Three
      months to six months
              
              
              4,396Six
      months to one year
              
              
              10,806Over
      one year
              
              
              1,422Total
      time deposits of $100,000 or more
              
              $
              37,783
 
 
 Short
Term and Other Borrowings
 
 As of
December 31, 2008, the Bank had $45.7 million in outstanding borrowings from the
Federal Home Loan Bank of San Francisco, $39.7 million of which matures during
2009, and the balance matures on various dates from May 2010 through December
2013.  Note F to the consolidated financial statements contains
additional information regarding these borrowings.
 
 
 Off-Balance-Sheet
Financial Instruments
 
 In the
normal course of business, the Bank enters into financial commitments to
customers, primarily to extend credit.  Those instruments involve, to
varying degrees, elements of credit and interest rate risk not recognized in the
consolidated balance sheets.  As of December 31, 2008, the Bank had
outstanding commitments to extend credit totaling $28.4 million and standby
letters of credit totaling approximately $300 thousand.  See Note M to
the consolidated financial statements for additional information on
off-balance-sheet commitments and contingencies.
 
 The Bank
has not entered into any off-balance-sheet derivative financial instruments as
of December 31, 2008.
 
 Liquidity
Management
 
 The
objective of our asset/liability strategy is to manage liquidity and interest
rate risks to ensure the safety and soundness of the Bank and its capital base,
while maintaining an adequate net interest margin in order to provide an
appropriate return to shareholders.
 
 The
Bank’s liquidity, which primarily represents the ability to meet fluctuations in
deposit levels and provide for customers’ credit needs, is managed through
various funding strategies that reflect the maturity structures of the sources
of funds and the assets being funded.  The Bank’s liquidity is further
augmented by payments of principal and interest on loans and securities, as well
as increases in short-term liabilities such as demand deposits and short-term
certificates of deposit.  Short-term investments, primarily federal
funds sold, is the primary means for providing immediate
liquidity.  The Bank had $9.9 million in federal funds sold on
December 31, 2008, and $3.3 million on December 31, 2007.
 
 In order
to meet the Bank’s liquidity requirements, the Bank endeavors to maintain an
appropriate liquidity ratio.  The liquidity ratio is the total of
liquid assets (the sum of cash and deposits at other banks, federal funds sold,
and unpledged available-for-sale securities) divided by total deposits and
borrowed funds maturing within one year.  As of December 31, 2008 and
2007, the Bank’s liquidity ratios were 26.6% and 10.9%,
respectively.
  ~  ~
  While the
Bank uses federal funds sold as the primary immediate source of cash liquidity,
it also has established short-term borrowing lines (federal funds purchased) for
a total of $6.5 million from its correspondent banks.  These lines are
for short-term needs and are rarely used.
 
 The Bank
also has a secured borrowing facility through the FHLB.  FHLB
borrowings can be structured over various terms ranging from overnight to ten
years.  As of December 31, 2008, the Bank had outstanding borrowings
from the FHLB totaling $45.7 million.  Interest rates and terms for
FHLB borrowings are generally more favorable than the rates for similar term
brokered certificates of deposit or for federal funds purchased.  The
Bank has the potential (on a secured basis) to borrow up to approximately 40
percent of its total assets or an additional $3.1 million from the
FHLB.  The Bank expects to substantially reduce its FHLB borrowings as
they mature in 2009.  However, FHLB borrowings may be used from time
to time when needed as part of the Bank’s normal liquidity management to fund
asset growth on a cost-effective basis.  The Bank has adequate loans
to pledge as collateral should it need additional liquidity that cannot be
funded by deposits.
 
 Subsequent
to December 31, 2008, the Bank received conditional approval from the Federal
Reserve Board to access its “Discount Window” for additional secured borrowing
should the need arise.
 
 Following
is a summary of the Company’s contractual obligations extending beyond one year
from December 31, 2008:
 
 
 Long-Term
      Contractual ObligationsLess
      than
              
              
              1
      thru 3
              
              
              3
      thru 5
              
              
              More
      than1 year
              
              
              years
              
              
              years
              
              
              5 years
              
              
              Total(Dollars
      in thousands)Borrowed
      funds
              
              $
              39,700
              
              
              $
              3,000
              
              
              $
              3,000
              
              
              $
              -
              
              
              $
              45,700Junior
      subordinated debentures
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,093
              
              
              
              3,093Operating
      leases
              
              
              447
              
              
              
              1,429
              
              
              
              1,212
              
              
              
              6,230
              
              
              
              9,318Capital
      leases
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Purchase
      obligations
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Other
      long-term liabilities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      contractual obligations
              
              $
              40,147
              
              
              $
              4,429
              
              
              $
              4,212
              
              
              $
              9,323
              
              
              $
              58,111
 
 
 While
local deposits remain the primary source of deposits, the Bank also has
alternate sources for competitive rate deposits.  Through the CDARS
program (see Deposits
earlier in this analysis), the Bank is able to bid on additional certificates of
deposit through banks across the country to meet additional funding
needs.  These “One-Way Buy” CDARS deposits are typically priced
comparable to FHLB secured borrowing rates, but with no collateral
required.  As of December 31, 2008, the Bank had approximately $10.6
million of “One-Way Buy” CDARS deposits, which are considered to be brokered
deposits.  The Bank also expects to continue to use its CDFI and COIN
designations to attract lower cost deposits.
 
 The Bank
has a mix of deposits which includes some large deposit relationships, including
16 customers with deposits of $1 million or more totaling $39.7 million,
approximately $18.9 million of which has been placed into the CDARS
program.  In addition, $45.7 million of the Bank’s funding sources is
represented by borrowings from the Federal Home Loan Bank of San Francisco
(“FHLB”), with $39.7 million maturing on various dates in
2009.  Although these sources have been relatively stable in the past,
should a substantial number of these large deposit customers choose to withdraw
their funds when they mature, or if the Bank’s borrowing facility through the
FHLB is reduced, and the Bank is unable to develop alternate funding sources,
the Bank may have difficulty funding loans or meeting deposit withdrawal
requirements.
 
 Bancorp
is a company separate and apart from the Bank and must provide for its own
liquidity.  As of December 31, 2008, Bancorp had no borrowings other
than the junior subordinated debentures reflected in the above table, and had
approximately $1,469,000 in unrestricted cash.  See Note Q to the
consolidated financial statements for additional financial information regarding
Bancorp.
 
 Substantially
all of Bancorp’s revenues are obtained from dividends declared and paid by the
Bank.  There are statutory and
  ~  ~
  regulatory
provisions that limit the ability of the Bank to pay dividends to
Bancorp.  Management believes that these provisions will not have an
impact on the ability of Bancorp to meet its ongoing cash
obligations.  See Note O to the consolidated financial statements for
additional information regarding regulatory dividend and capital
restrictions.
 
 
 Asset
and Liability Management
 
 The
objectives of interest rate risk management are 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.  Even with perfectly matched repricing of assets
and liabilities, risks remain in the form of prepayment of assets, and timing
lags in adjusting certain assets and liabilities that have varying sensitivities
to market interest rates.
 
 Interest
rate sensitivity gap analysis attempts to capture interest rate risk, which is
attributable to the mismatching of interest rate sensitive assets and
liabilities.  A positive cumulative gap would mean that over the
indicated period our assets would be expected to reprice faster than our
liabilities (an asset-sensitive structure), and a negative gap would mean that
our liabilities would likely reprice faster than our assets
(liability-sensitive).
 
 The
Interest Rate Sensitivity table below sets forth a “static” gap analysis of the
interest rate sensitivity of interest-earning assets and interest-bearing
liabilities as of December 31, 2008.  For purposes of the table, an
asset or liability is considered rate-sensitive in the first period when it can
be repriced, matures within its contractual terms, or is expected to be
prepaid.  For example, based on their contractual terms, loans may
reprice or mature beyond one year, but our prepayment assumptions would indicate
that a certain percentage of them would likely be paid off
earlier.  That portion estimated to be paid off early would be shown
in one of the columns to the left of its actual maturity.
 
 One
should use caution if attempting to predict future levels of net interest income
through the use this type of static gap analysis, however.  The actual
impact of interest rate movements on net interest income may differ
significantly from that implied by any gap measurement, depending on the
direction and magnitude of the interest rate movements, the repricing
characteristics of various on- and off-balance sheet instruments, as well as
competitive pressures.  Many of the Bank’s loans are tied to the prime
rate, which declined in the second half of 2007 and throughout
2008.  However, competitive pressures often keep deposit rates from
dropping to the same degree and as quickly as loan rates, causing a reduction in
the net interest margin even though the gap analysis may show the Bank in a more
balanced posture.
 
 Also,
changes in the mix of earning assets or supporting liabilities can either
increase or decrease the net interest margin without affecting this particular
measure of interest rate sensitivity.  In addition, varying interest
rate environments can create unexpected changes in prepayment activity as
compared to prepayments assumed in the interest rate sensitivity
analysis.  Prepayments may have significant impact on our net interest
margin.  These factors are not fully reflected in the following gap
analysis and, as a result, the gap report may not provide a complete assessment
of our interest rate risk.
  ~  ~
  
 
 Interest
      Sensitivity - Static Gap AnalysisDecember
      31, 2008
              
              Sensitive
      to Rate Changes Within3
              
              
              4
      to 12
              
              
              1
      to 5
              
              
              Over
      5
              
              
              Non-Rate-Months
              
              
              Months
              
              
              Years
              
              
              Years
              
              
              Sensitive
              
              
              Total(Dollars
      in thousands)Earning
      Assets:Loans,
      net of unearned income
              
              $
              52,575
              
              
              $
              24,995
              
              
              $
              53,346
              
              
              $
              22,395
              
              
              $
              -
              
              
              $
              153,311Investment
      securities
              
              
              1,416
              
              
              
              6,650
              
              
              
              9,995
              
              
              
              6,753
              
              
              
              32
              
              
              
              24,846Other
      earning assets
              
              
              12,811
              
              
              
              11,575
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              24,386Non-interest-earning
      assets
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              12,947
              
              
              
              12,947Total
      assets
              
              
              66,802
              
              
              
              43,220
              
              
              
              63,341
              
              
              
              29,148
              
              
              
              12,979
              
              
              
              215,490Interest-Bearing
      Liabilities:Non-maturity
      interest-bearing deposits
              
              
              8,903
              
              
              
              2,564
              
              
              
              13,670
              
              
              
              7,531
              
              
              
              -
              
              
              
              32,668Certificates
      of deposit
              
              
              43,747
              
              
              
              43,380
              
              
              
              2,207
              
              
              
              -
              
              
              
              -
              
              
              
              89,334Borrowed
      funds
              
              
              10,402
              
              
              
              29,303
              
              
              
              5,995
              
              
              
              -
              
              
              
              -
              
              
              
              45,700Junior
      subordinated debentures
              
              
              3,093
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,093Non-interest-bearing
      liabilities and equity
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              44,695
              
              
              
              44,695Total
      liabilities and equity
              
              
              66,145
              
              
              
              75,247
              
              
              
              21,872
              
              
              
              7,531
              
              
              
              44,695
              
              
              
              215,490Interest
      rate sensitivity gap
              
              $
              657
              
              
              $
              (32,027
              )
              
              $
              41,469
              
              
              $
              21,617
              
              
              $
              (31,716
              )
              
              $
              -Cumulative
      interest rate sensitivity gap
              
              $
              657
              
              
              $
              (31,370
              )
              
              $
              10,099
              
              
              $
              31,716
              
              
              $
              -Cumulative
      gap to total earning assets
              
              
              0
              %
              
              
              -15
              %
              
              
              5
              %
              
              
              15
              %
 
 
 The table
shows that during the first year $110 million of the interest earning assets are
expected to reprice, as well as $141 million of interest bearing liabilities,
which would indicate a liability-sensitive structure over that time
period.  In general, this means that in a rising interest rate
environment, with all other conditions remaining constant, net interest income
would be expected to decrease, and in a declining interest rate environment net
interest income would be expected to increase.  However, the table
reflects a balanced rate sensitivity structure over the first three months after
the balance sheet date.  Significant adjustments can be, and often
are, made to the balance sheet in the short-term.  Thus, although the
Bank is in a liability-sensitive posture on a static gap basis, in a practical
sense management views the Bank as slightly asset-sensitive.
 
 Based on
current economic forecasts, the Bank anticipates that short-term interest rates
will stabilize at a very low level in 2009 and, if so, we expect to see
certificate of deposit rates decline to a greater degree than loan rates,
relieving some pressure on the net interest margin.
 
 
 
 Effects
of Inflation and Economic Issues
 
 A
financial institution’s asset and liability structure is substantially different
from that of an industrial firm in that primarily all assets and liabilities of
a bank are monetary in nature, with relatively little investments in fixed
assets or inventories.  Inflation has an important impact on the
growth of total assets and the resulting need to increase equity capital at
higher than normal rates in order to maintain an appropriate equity to assets
ratio.  Management believes that the impact of inflation on financial
results depends on the Company’s ability to react to changes in interest rates
and, by such reaction, reduce the inflationary impact on
performance.  Management has attempted to structure the mix of
financial instruments and manage interest rate sensitivity in order to minimize
the potential adverse effects of inflation or other market forces on net
interest income and, therefore, earnings and capital.
 
 San Luis
Obispo County continues to have a lower than average unemployment rate (7.1% as
of December 2008 vs. a California statewide seasonally-adjusted rate of 8.7% and
a nationwide seasonally-adjusted rate of 7.2%).  Local unemployment
has increased in 2008—up from 4.7% in December 2007—and real estate values
declined significantly in
  ~  ~
  2007 and
2008.  After several years of strong appreciation, residential and
commercial sale activity—and especially construction activity—has slowed
dramatically.  There can be no assurance that the local economy will
rebound quickly or that real estate values will return to pre-2006 levels in the
short term.  As such, the Bank closely monitors credit quality,
interest rate risk and operational expenses.
 
 
 Return
on Equity and Assets
 
 The
following table shows the Company’s return on average assets and return on
average equity for past five years:
 
 
 2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004Return
      (Loss) on Average Assets
              
              
              (2.02
              )%
              
              
              0.48
              %
              
              
              0.58
              %
              
              
              0.68
              %
              
              
              1.16
              %Return
      (Loss) on Average Equity
              
              
              (20.86
              )%
              
              
              6.07
              %
              
              
              7.53
              %
              
              
              9.16
              %
              
              
              16.15
              %
 
 
  ~  ~
  Item
      8.  Financial Statements
  
 
 
 
 MISSION
COMMUNITY BANCORPAND
SUBSIDIARY
 
 CONSOLIDATED
FINANCIAL STATEMENTS
 WITH
 INDEPENDENT
AUDITORS’ REPORT
 
 December
31, 2008 and 2007
 
  ~  ~
  
 
 
 
 
 
 
 
 
 
 
 
 CONTENTS
 
 
 
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
 ON THE CONSOLIDATED FINANCIAL
STATEMENTS   51
 
 
 
 CONSOLIDATED FINANCIAL STATEMENTS
 
 Consolidated Balance Sheets  52 and
53
 Consolidated Statements of Income  54
 Consolidated Statement of Changes in Shareholders'
Equity  55
 Consolidated Statements of Cash Flows  56
 Notes to Consolidated Financial
Statements  57 through
82
 
 
 
  ~  ~
  
 
 
   REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
  
 Board of
Directors and Shareholders of
 Mission
Community Bancorp and Subsidiary
 
 We have
audited the accompanying consolidated balance sheets of Mission Community
Bancorp and Subsidiary as of December 31, 2008 and 2007 and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows of the years then ended.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the public company
accounting oversight board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Mission Community Bancorp
and Subsidiary as of December 31, 2008 and December 31, 2007, and the results of
its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of
America.
  Laguna
Hills, California
 March 12,
2009
 
 
 
 
 
 
  ~  ~
  
  MISSION COMMUNITY BANCORP AND SUBSIDIARY
  CONSOLIDATED
BALANCE SHEETS
 December
31, 2008 and 2007
 
 
 
 2008
              
              
              2007ASSETSCash
      and Due from Banks
              
              $
              7,804,306
              
              
              $
              2,211,704Federal
      Funds Sold
              
              
              9,920,000
              
              
              
              3,315,000TOTAL
      CASH AND CASH EQUIVALENTS
              
              
              17,724,306
              
              
              
              5,526,704Certificates
      of Deposit in Other Banks
              
              
              11,710,000
              
              
              
              550,000Investment
      Securities Available for Sale
              
              
              24,845,839
              
              
              
              17,124,144Loans
      held for sale
              
              
              1,264,251
              
              
              
              3,012,226Loans:Commercial
              
              
              25,918,262
              
              
              
              25,429,647Agricultural
              
              
              -
              
              
              
              121,450Leases,
      Net of Unearned Income
              
              
              1,490,668
              
              
              
              839,189Construction
              
              
              22,857,024
              
              
              
              22,512,642Real
      Estate
              
              
              98,049,035
              
              
              
              72,009,406Consumer
              
              
              3,731,566
              
              
              
              2,504,099TOTAL
      LOANS
              
              
              152,046,555
              
              
              
              123,416,433Allowance
      for Loan and Lease Losses
              
              
              (3,942,220
              )
              
              
              (1,149,874
              )NET
      LOANS
              
              
              148,104,335
              
              
              
              122,266,559Federal
      Home Loan Bank Stock and Other Stock, at Cost
              
              
              2,756,525
              
              
              
              2,021,175Premises
      and Equipment
              
              
              2,598,697
              
              
              
              3,537,201Other
      Real Estate Owned
              
              
              983,100
              
              
              
              -Company
      Owned Life Insurance
              
              
              2,789,366
              
              
              
              2,289,407Accrued
      Interest and Other Assets
              
              
              2,713,426
              
              
              
              2,001,960$
              215,489,845
              
              
              $
              158,329,376
 
  The
accompanying notes are an integral part of these consolidated financial
statements.
 
 ~  ~
  MISSION
COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2008 and 2007
 
 
 
 
 2008
              
              
              2007LIABILITIES
      AND SHAREHOLDERS' EQUITYDeposits:Noninterest-Bearing
      Demand
              
              $
              22,802,269
              
              
              $
              23,164,629Money
      Market, NOW and Savings
              
              
              32,668,070
              
              
              
              32,630,126Time
      Deposits Under $100,000
              
              
              51,550,524
              
              
              
              18,803,034Time
      Deposits $100,000 and Over
              
              
              37,783,195
              
              
              
              37,835,667TOTAL
      DEPOSITS
              
              
              144,804,058
              
              
              
              112,433,456Other
      Borrowings
              
              
              45,700,000
              
              
              
              28,200,000Junior
      Subordinated Debt Securities
              
              
              3,093,000
              
              
              
              3,093,000Accrued
      Interest and Other Liabilities
              
              
              1,375,964
              
              
              
              1,464,616TOTAL
      LIABILITIES
              
              
              194,973,022
              
              
              
              145,191,072Commitments
      and Contingencies - Notes D and  M
              
              
              -
              
              
              
              -Shareholders'
      Equity:Preferred
      Stock - Authorized 10,000,000 Shares:Series
      A - $5 Stated Value; 100,000 Issued and OutstandingLiquidation
      Value of $500,000
              
              
              392,194
              
              
              
              392,194Series
      B - $10 Stated Value; 20,500 Issued and OutstandingLiquidation
      Value of $205,000
              
              
              191,606
              
              
              
              191,606Series
      C - $10 Stated Value; 50,000 Issued and OutstandingLiquidation
      Value of $500,000
              
              
              500,000
              
              
              
              500,000Common
      Stock - Authorized 10,000,000 Shares;Issued
      and Outstanding: 1,345,602 in 2008 and 689,232 in 2007
              
              
              18,041,851
              
              
              
              7,125,819Additional
      Paid-In Capital
              
              
              172,285
              
              
              
              108,340Retained
      Earnings
              
              
              863,750
              
              
              
              4,712,120Accumulated
      Other Comprehensive Income - UnrealizedAppreciation
      on Available-for-Sale Securities,Net
      of Tax
              
              
              355,137
              
              
              
              108,225TOTAL
      SHAREHOLDERS' EQUITY
              
              
              20,516,823
              
              
              
              13,138,304$
              215,489,845
              
              
              $
              158,329,376
 
  The
accompanying notes are an integral part of these consolidated financial
statements.
 
 ~  ~
  MISSION COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF INCOME
 Years
Ended December 31, 2008 and 2007
 
 2008
              
              
              2007INTEREST
      INCOMEInterest
      and Fees on Loans
              
              $
              9,598,625
              
              
              $
              10,763,845Interest
      on Investment Securities
              
              
              1,122,021
              
              
              
              698,751Other
      Interest Income
              
              
              352,752
              
              
              
              296,413TOTAL
      INTEREST INCOME
              
              
              11,073,398
              
              
              
              11,759,009INTEREST
      EXPENSEInterest
      on Money Market, NOW and Savings Deposits
              
              
              688,256
              
              
              
              995,785Interest
      on Time Deposits
              
              
              2,470,919
              
              
              
              2,931,209Other
      Interest Expense
              
              
              1,671,320
              
              
              
              1,202,013TOTAL
      INTEREST EXPENSE
              
              
              4,830,495
              
              
              
              5,129,007NET
      INTEREST INCOME
              
              
              6,242,903
              
              
              
              6,630,002Provision
      for Loan and Lease Losses
              
              
              4,245,000
              
              
              
              150,000NET
      INTEREST INCOME AFTERPROVISION
      FOR LOAN LOSSES
              
              
              1,997,903
              
              
              
              6,480,002NON-INTEREST
      INCOMEService
      Charges on Deposit Accounts
              
              
              350,763
              
              
              
              291,500Gain
      on Sale of Loans
              
              
              186,816
              
              
              
              307,914Brokered
      Loan Fees
              
              
              -
              
              
              
              147,183Loan
      Servicing Fees, Net of Amortization
              
              
              72,519
              
              
              
              65,561Grants
      and Awards
              
              
              -
              
              
              
              359,480Loss
      on Writedown of Fixed Assets
              
              
              (378,585
              )
              
              
              -Other
      Income and Fees
              
              
              114,575
              
              
              
              85,265TOTAL
      NON-INTEREST INCOME
              
              
              346,088
              
              
              
              1,256,903NON-INTEREST
      EXPENSESalaries
      and Employee Benefits
              
              
              3,698,559
              
              
              
              3,597,155Occupancy
      Expenses
              
              
              586,435
              
              
              
              546,329Furniture
      and Equipment
              
              
              440,329
              
              
              
              442,020Data
      Processing
              
              
              634,508
              
              
              
              490,629Professional
      Fees
              
              
              420,379
              
              
              
              263,192Marketing
      and Business Development
              
              
              208,621
              
              
              
              293,992Office
      Supplies and Expenses
              
              
              234,266
              
              
              
              219,291Insurance
      and Regulatory Assessments
              
              
              211,000
              
              
              
              206,210Loan
      and Lease Expenses
              
              
              106,115
              
              
              
              90,077Other
      Expenses
              
              
              580,805
              
              
              
              444,873TOTAL
      NON-INTEREST EXPENSE
              
              
              7,121,017
              
              
              
              6,593,768INCOME  (LOSS)
      BEFORE INCOME TAXES
              
              
              (4,777,026
              )
              
              
              1,143,137Income
      Tax Expense (Benefit)
              
              
              (928,656
              )
              
              
              377,843NET
      INCOME (LOSS)
              
              $
              (3,848,370
              )
              
              $
              765,294Per
      Share Data (Notes A and N):Net
      Income (Loss)  - Basic
              
              $
              (3.18
              )
              
              $
              0.96Net
      Income  (Loss) - Diluted
              
              $
              (3.18
              )
              
              $
              0.91
  The
accompanying notes are an integral part of these consolidated financial
statements.
 
 ~  ~
  MISSION COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
 Years
Ended December 31, 2008 and 2007
 
 AccumulatedAdditional
              
              
              
              
              
              
              
              
              OtherPreferred
              
              
              Common
      Stock
              
              
              Paid-In
              
              
              Comprehensive
              
              
              Retained
              
              
              ComprehensiveStock
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Income
      (Loss)
              
              
              Earnings
              
              
              Income
              
              
              TotalBalance
      atJanuary
      1, 2007
              
              $
              1,083,800
              
              
              
              673,399
              
              
              $
              6,858,648
              
              
              $
              60,798
              
              
              
              
              
              $
              4,208,742
              
              
              $
              (58,887
              )
              
              $
              12,153,101Dividends
      paid
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (96,688
              )
              
              
              
              
              
              
              (96,688
              )Exercise
      of stock options,and
      related tax benefitof
      $108,841
              
              
              
              
              
              
              45,233
              
              
              
              561,171
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              561,171Repurchase
      of common stock
              
              
              
              
              
              
              (29,400
              )
              
              
              (294,000
              )
              
              
              
              
              
              
              
              
              
              (165,228
              )
              
              
              
              
              
              
              (459,228
              )Stock-based
      compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              47,542
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              47,542Comprehensive
      Income:Net
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              765,294
              
              
              
              765,294
              
              
              
              
              
              
              
              765,294Net
      unrealized gain onavailable-for-sale
      securities,net
      of taxes of $116,128
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              167,112
              
              
              
              
              
              
              
              167,112
              
              
              
              167,112Total
      Comprehensive Income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              932,406Balance
      atDecember
      31, 2007
              
              $
              1,083,800
              
              
              
              689,232
              
              
              $
              7,125,819
              
              
              $
              108,340
              
              
              
              
              
              
              $
              4,712,120
              
              
              $
              108,225
              
              
              $
              13,138,304Dividends
      paid
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -
              
              
              
              
              
              
              
              -Exercise
      of stock options,and
      related tax benefitof
      $28,772
              
              
              
              
              
              
              20,700
              
              
              
              235,772
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              235,772Issuance
      of common stockin
      public offering, netof
      offering expenses of $556,413
              
              
              
              
              
              
              410,644
              
              
              
              6,835,179
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              6,835,179Issuance
      of common stockin
      private placement, netof
      offering expenses
              
              
              
              
              
              
              225,026
              
              
              
              3,845,081
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,845,081Stock-based
      compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              63,945
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              63,945Comprehensive
      Income (Loss):Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (3,848,370
              )
              
              
              (3,848,370
              )
              
              
              
              
              
              
              (3,848,370
              )Net
      unrealized gain onavailable-for-sale
      securities,net
      of taxes of $75,207
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              246,912
              
              
              
              
              
              
              
              246,912
              
              
              
              246,912Total
      Comprehensive Loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (3,601,458
              )Balance
      atDecember
      31, 2008
              
              $
              1,083,800
              
              
              
              1,345,602
              
              
              $
              18,041,851
              
              
              $
              172,285
              
              
              
              
              
              
              $
              863,750
              
              
              $
              355,137
              
              
              $
              20,516,823
 
 
  The
accompanying notes are an integral part of these consolidated financial
statements.
 
 ~  ~
  MISSION COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
Ended December 31, 2008 and 2007
 
 
 2008
              
              
              2007OPERATING
      ACTIVITIESNet
      income (loss)
              
              $
              (3,848,370
              )
              
              $
              765,294Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Provision
      (credit) for deferred income taxes
              
              
              (494,803
              )
              
              
              (54,774
              )Depreciation
              
              
              347,294
              
              
              
              358,959Accretion
      of discount on securities and loans, net
              
              
              (177,922
              )
              
              
              (123,748
              )Provision
      for loan losses
              
              
              4,245,000
              
              
              
              150,000Provision
      for losses on unfunded loan commitments
              
              
              15,000
              
              
              
              -Stock-based
      compensation
              
              
              63,945
              
              
              
              47,542Loss
      on disposal of fixed assets
              
              
              378,584
              
              
              
              -Gain
      on loan sales
              
              
              (186,816
              )
              
              
              (307,914
              )Proceeds
      from loan sales
              
              
              6,038,681
              
              
              
              5,061,817Loans
      originated for sale
              
              
              (4,026,298
              )
              
              
              (7,127,310
              )Increase
      in company owned life insurance
              
              
              (94,998
              )
              
              
              (81,773
              )Decrease
      (increase) in accrued taxes receivable
              
              
              (497,625
              )
              
              
              79,579Other,
      net
              
              
              342,721
              
              
              
              4,918NET
      CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
              
              
              2,104,393
              
              
              
              (1,227,410
              )INVESTING
      ACTIVITIESNet
      increase in Federal Home Loan Bank and other stock
              
              
              (651,150
              )
              
              
              (660,850
              )Deposits
      placed in other banks
              
              
              (11,160,000
              )
              
              
              -Purchase
      of available-for-sale securities
              
              
              (14,880,260
              )
              
              
              (3,988,477
              )Proceeds
      from maturities, calls and paydowns of available-for-sale
      securities
              
              
              7,388,852
              
              
              
              3,548,050Net
      increase in loans
              
              
              (30,298,532
              )
              
              
              (1,045,241
              )Purchase
      of company-owned life insurance
              
              
              (404,961
              )
              
              
              -Proceeds
      from sale of fixed assets
              
              
              4,708
              
              
              
              -Purchases
      of premises and equipment
              
              
              (692,082
              )
              
              
              (172,352
              )NET
      CASH USED IN INVESTING ACTIVITIES
              
              
              (50,693,425
              )
              
              
              (2,318,870
              )FINANCING
      ACTIVITIESNet
      decrease in demand deposits and savings accounts
              
              
              (324,416
              )
              
              
              (7,129,228
              )Net
      increase (decrease) in time deposits
              
              
              32,695,018
              
              
              
              (4,717,995
              )Net
      increase in other borrowings
              
              
              17,500,000
              
              
              
              10,800,000Common
      stock repurchased
              
              
              -
              
              
              
              (459,228
              )Proceeds
      from issuance of common stock
              
              
              10,916,032
              
              
              
              561,171Payment
      of dividends
              
              
              -
              
              
              
              (96,688
              )NET
      CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
              
              
              60,786,634
              
              
              
              (1,041,968
              )NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              
              12,197,602
              
              
              
              (4,588,248
              )Cash
      and cash equivalents at beginning of year
              
              
              5,526,704
              
              
              
              10,114,952CASH
      AND CASH EQUIVALENTS AT END OF YEAR
              
              $
              17,724,306
              
              
              $
              5,526,704Supplemental
      disclosures of cash flow information:Interest
      paid
              
              $
              4,708,982
              
              
              $
              5,179,256Taxes
      paid
              
              
              35,000
              
              
              
              210,000Supplemental
      schedule of non-cash investing activities:Real
      estate acquired by foreclosure
              
              $
              83,100
              
              
              $
              -Portfolio
      loans reclassified to loans held for sale
              
              
              -
              
              
              
              1,172,869
 
  The
accompanying notes are an integral part of these consolidated financial
statements.
 
 ~  ~
  NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 Principles of
Consolidation
 
 The
financial statements include the accounts of Mission Community Bancorp
(“Bancorp”) and its subsidiary, Mission Community Bank (“the Bank”), and the
Bank’s subsidiary, Mission Community Development Corporation, collectively
referred to herein as “the Company.”  All significant intercompany
transactions have been eliminated.
 
 Nature of
Operations
 
 The Bank
has been organized as a single reporting segment and operates four branches in
the Central Coast area of California (in the cities of San Luis Obispo, Paso
Robles, Arroyo Grande and Santa Maria).
 
 The
Bank’s primary source of revenue is providing real estate, commercial (including
Small Business Administration (“SBA”) guaranteed loans) and consumer loans to
customers, who are predominately small and middle-market businesses and
individuals.  The Company and the Bank are certified by the Department
of Treasury as Community Development Financial Institution(s) (“CDFI”) with a
commitment to focus on providing financial services to low- and moderate-income
communities.
 
 Mission Community
Development Corporation
 
 Mission
Community Development Corporation (“MCDC”) is a community development
corporation which provides financing for small businesses and projects in low-
to moderate-income areas.  The Board of Directors of Mission Community
Development Corporation consists of four members of the Board of Directors of
the Company and three outside members who are actively involved in supporting
community affairs and activities. Community development investment is limited to
5% of the Bank’s capital and up to 10% with prior approval by the Federal
Reserve Board.  Operations of MCDC were not material for the years
ended December 31, 2008 or 2007.
 
 Mission Community Services
Corporation
 
 Mission
Community Services Corporation (“MCSC”), an affiliate organization, was
organized in 1998 and the corporation was established as a not-for-profit
company with Section 501(c)(3) status.  This company’s primary focus
is to provide technical support and training services to the underserved
segments of the community including small businesses, minorities and low-income
entrepreneurs.  The Board of Directors of Mission Community Services
Corporation includes representatives from the Company, together with members
representing the communities represented.  The accounts of MCSC are
not included in the Company’s consolidated financial statements.  See
Note L for additional information regarding MCSC.
 
 Use of Estimates in the
Preparation of Financial Statements
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ from those
estimates.
  ~  ~
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Reclassifications
 
 Certain
reclassifications were made to prior years’ presentations to conform to the
current year.  These reclassifications had no effect on net income or
earnings per share.
 
 Cash and Cash
Equivalents
 
 For
purposes of reporting cash flows, cash and cash equivalents include cash,
amounts due from other banks and federal funds sold.  Generally,
federal funds are sold for one-day periods.
 
 Cash and Due From
Banks
 
 Banking
regulations require that all banks maintain a percentage of their deposits as
reserves in cash or on deposit with the Federal Reserve Bank
(“FRB”).  The Bank was in compliance with this requirement, which was
$503,000 as of December 31, 2008.
 
 The
Company maintains amounts due from other banks which exceed federally insured
limits.  The Company has not experienced any losses in such
accounts.
 
 Investment
Securities
 
 Bonds,
notes, and debentures for which the Company has the positive intent and ability
to hold to maturity are reported at cost, adjusted for premiums and discounts
that are recognized in interest income using the interest method over the period
to maturity.
 
 Investments
not classified as trading securities nor as held-to-maturity securities are
classified as available-for-sale securities and recorded at fair
value.  Unrealized gains or losses on available-for-sale securities
are excluded from net income and reported net of taxes as a separate component
of comprehensive income, which is included in shareholders’
equity.  Premiums or discounts are amortized or accreted into income
using the interest method.  Realized gains or losses on sales of
securities are recorded using the specific identification method.
 
 Other-than-temporary
declines in the fair value of individual held-to-maturity and available-for-sale
securities below their cost result in write-downs of the individual securities
to their fair value.  The related write-downs are included in earnings
as realized losses.  In estimating other-than-temporary impairment
losses, management considers the length of time and the extent to which the fair
value has been less than cost, the financial condition and near-term prospects
of the issuer, and the intent and ability of the Bank to retain its investment
in the issuer for a period of time sufficient to allow for any anticipated
recovery in fair value.
 
  ~  ~
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Loans
 
 Loans are
reported at the principal amount outstanding, net of any deferred loan
origination fee income and deferred direct loan origination costs, and net of
any unearned interest on discounted loans.  Deferred loan origination
fee income and direct loan origination costs are amortized to interest income
over the life of the loan using the interest method.  Interest on
loans is accrued to income daily based upon the outstanding principal
balances.
 
 Loans for
which the accrual of interest has been discontinued are designated as
non-accrual loans.  Loans are classified as non-accrual when principal
or interest is past due 90 days or more based on the contractual terms of the
loan or when, in the opinion of management, there exists a reasonable doubt as
to the full and timely collection of either principal or interest, unless the
loan is well secured and in the process of collection.  Income on such
loans is then only recognized to the extent that cash is received and where the
future collection of principal is probable.  Accrual of interest is
resumed only when principal and interest are brought fully current and when such
loans are considered to be collectible as to both principal and
interest.
 
 For
impairment recognized in accordance with Financial Accounting Standards Board
(“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for
Impairment of a Loan,” as amended by SFAS No. 118, the entire change in
either the present value of expected cash flows or the fair value of the
collateral is reported as either provision for credit losses in the same manner
in which impairment initially was recognized, or as a reduction in the amount of
provision for credit losses that otherwise would be reported.
 
 Loans Held for
Sale
 
 SBA loans
originated and intended for sale in the secondary market are carried at the
lower of cost or estimated market value in the aggregate.  Net
unrealized losses are recognized through a valuation allowance by charges to
income.  Gains or losses realized on the sales of loans are recognized
at the time of sale and are determined by the difference between the net sales
proceeds and the carrying value of the loans sold, adjusted for any servicing
asset or liability.  Gains and losses on sales of loans are included
in non-interest income.
 
 The Bank
has adopted SFAS No. 140, “Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities,” and
SFAS No. 156, “Accounting for
Servicing of Financial Assets—an amendment of FASB Statement No. 140.”SFAS No. 140 provides accounting and reporting standards for transfers
and servicing of financial assets and extinguishments of
liabilities.  Under this Statement, after a transfer of financial
assets, an entity recognizes the financial and servicing assets it controls and
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished.  SFAS No.
156 permitted the Bank to choose between two different methods of measuring
ongoing changes in the value of its SBA loan servicing asset: the amortization
method or the fair value measurement method.  The Bank adopted the
amortization method in 2007.
 
  ~  ~
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Allowance for Loan
Losses
 
 The
allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries).  Charge-offs are loans and leases
deemed uncollect­ible, which are charged to the
allowance.  Management performs, at least quarterly, an analysis of
the allowance for loan losses to determine its adequacy.  In this
analysis, all non-classified loans are segmented into components by loan type
and internal risk rating.  Estimated loss factors are applied to each
loan pool based on historical losses as well as management’s assessment of
current factors that may impact these historical factors, such as changes in the
local economy, changes in underwriting standards, changes in loans
concentrations and trends in past due and non-performing
loans.  Significant loans considered impaired by management, the
Bank’s regulators or external credit review consultants are evaluated separately
in the process.  In this evaluation, management reviews the borrower’s
ability to repay as well as the estimated value of any underlying
collateral.
 
 Federal Home Loan Bank
(FHLB) Stock
 
 The Bank
is a member of the Federal Home Loan Bank system.  Members are
required to own a certain amount of FHLB stock based on the level of borrowings
and other factors, and may invest additional amounts.  FHLB stock is
carried at cost, classified as a restricted security, and periodically evaluated
for impairment based on the ultimate recovery of par value. Both cash and stock
dividends are reported as income.
 
 Premises and
Equipment
 
 Land is
carried at cost.  Premises and equipment are carried at cost less
accumulated depreciation and amortization.  Depreciation is computed
using the straight-line method over the estimated useful lives, which range from
three to ten years for furniture and fixtures and forty years for
buildings.  Leasehold improvements are amortized using the
straight-line method over the estimated useful lives of the improvements or the
remaining lease term, whichever is shorter.  Expenditures for
betterments or major repairs are capitalized and those for ordinary repairs and
maintenance are charged to operations as incurred.
 
 Other Real Estate
Owned
 
 Real
estate acquired by foreclosure or deed in lieu of foreclosure is recorded at
fair value at the date of foreclosure, establishing a new cost basis by a charge
to the allowance for loan loss, if necessary.  Other real estate owned
is carried at the lower of the Bank’s cost basis or fair value, less estimated
carrying costs and costs of disposition.  Fair value is based on
current appraisals less estimated selling costs.  Any subsequent
write-downs are charged against operating expenses and recognized as a valuation
allowance.  Operating expenses of such properties, net of related
income, and gains and losses on their disposition are included in other
operating expenses.
 
 Company Owned Life
Insurance
 
 Company
owned life insurance is recorded at the amount that can be realized under the
insurance contract at the balance sheet date, which is the cash surrender value
adjusted for other charges or amounts due that are probable at
settlement.
  ~  ~
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 Advertising
Costs
 
 The Bank
expenses the costs of advertising in the period incurred.
 
 Income
Taxes
 
 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.  The Company classifies any interest or
penalties related to income taxes as a part of income tax expense when
incurred.  No such interest or penalties were incurred for in 2007 or
2008.
 
 FASB
Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income
Taxes, clarifies the accounting for uncertainty in tax positions taken or
expected to be taken on a tax return.  FIN 48 provides that the tax
effects from an uncertain tax position can be recognized in our financial
statements only if, based on its technical merits, the position is more likely
than not to be sustained on audit.  Management believes that all tax
positions taken to date meet the “more likely than not” standard and, therefore,
no accounting adjustment has been made to our financial statements as a result
of adopting FIN 48.
 
 Comprehensive
Income
 
 SFAS No.
130, “Reporting Comprehensive
Income,”
requires the disclosure of comprehensive income and its
components.  Changes in unrealized gain or loss on available-for-sale
securities net of income taxes is the only component of accumulated other
comprehensive income for the Company.
 
 
 Financial
Instruments
 
 In the
ordinary course of business, the Company has entered into off-balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit and standby letters of credit.  Such financial
instruments are recorded in the financial statements when they are funded or
related fees are incurred or received.
 
 Earnings Per Share
(“EPS”)
 
 EPS is
computed under the provisions of Statement of Accounting Standards No. 128,
Earnings per Share,
(“SFAS No. 128”) and the Emerging Issues Task Force (“EITF”) Consensus on Issue
No. 03-6, Participating
Securities and the Two-Class Method under FASB Statement No.
128.  EITF 03-6 requires that income per share for the
Company’s common stock be calculated assuming 100% of the Company’s earnings are
distributed as dividends to its common and preferred shareholders based on their
respective dividend rights, even though the Company does not anticipate
distributing 100% of its earnings as dividends.   Basic EPS is
computed by dividing income available to common shareholders, using the method
prescribed above under EITF 03-6, by the weighted-average number of common
shares outstanding for the period.  Diluted EPS reflects the potential
dilution that could occur if options or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the Company.
  ~  ~
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 Stock-Based
Compensation
 
 Equity-based
compensation arrangements, including employee stock options, are accounted for
in accordance with Statement of Financial Accounting Standards No. 123 (Revised
2004), Share-Based
Payment (“SFAS No. 123R”).  SFAS No. 123R generally requires
entities to recognize the cost of employee services received in exchange for
awards of stock options or other equity instruments based on the grant-date fair
value of those awards.  This cost is recognized over the period which
an employee is required to provide services in exchange for the award, generally
the vesting period.  The Company adopted SFAS No. 123R using the
“modified prospective method.”  Under this method, compensation
expense is recognized using the fair-value method for all new stock option
awards as well as any existing awards that are modified, repurchased or
cancelled.  Compensation expense for unvested options that were
outstanding on January 1, 2006, the date SFAS 123R was adopted, is recognized
over the requisite service period based on the fair value of those options as
previously calculated under the pro forma disclosures of SFAS No.
123.  The fair value of each grant is estimated using the
Black-Scholes option pricing model.
 
 Fair Value
Measurement
 
 Effective
January 1, 2008, the Bank adopted SFAS No. 157, Fair Value
Measurements.  This Statement defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements.  This Statement establishes a fair value hierarchy about
the assumptions used to measure fair value and clarifies assumptions about risk
and the effect of a restriction on the sale or use of an asset.  The
impact of adoption of SFAS No. 157 is not material.  Applicable
disclosures are presented in these consolidated financial
statements.
 
 In
February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of
FASB Statement No. 157.  This FSP delays the effective date of SFAS
157 for all non-financial assets and non-financial liabilities, except those
that are recognized or disclosed at fair value on a recurring basis (at least
annually) for fiscal years beginning after November 15, 2008.  Major
categories of assets that are recognized or disclosed at fair value for which
the Bank has not applied the provisions of SFAS 157 include Other Real Estate
Owned and Company Owned Life Insurance.
 
 In
February 2007, the FASB issued Statement 159, The Fair Value Option for
Financial Assets and Financial Liabilities.  The standard provides
companies with an option to report selected financial assets and liabilities at
fair value and establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities.  The new
standard was effective for the Bank on January 1, 2008.  The Bank did
not elect the fair value option for any financial assets or financial
liabilities as of January 1, 2008.
 
  ~  ~
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Statement
157 defines fair value as the exchange price that would be received for an asset
or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. Statement 157 also establishes a
fair value hierarchy, which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The standard describes three levels of inputs that may be used to measure fair
value:
 
 Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement
date.
 
 Level 2:
Significant other observable inputs other than Level 1 prices such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable
market data.
 
 Level 3:
Significant unobservable inputs that reflect a Bank’s own assumptions about the
assumptions that market participants would use in pricing an asset or
liability.
 
 See Note
R for more information and disclosures relating to the Bank’s fair value
measurements.
 
 
 NOTE
B - INVESTMENT SECURITIES
 
 Investment
securities have been classified in the consolidated balance sheets according to
management's intent.  The amortized cost of securities and their
approximate fair values at December 31 were as follows:
 
 
 Gross
              
              
              Gross
              
              
              EstimatedAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              MarketCost
              
              
              Gains
              
              
              Losses
              
              
              ValueSecurities
      Available for Sale:December
      31, 2008:U.S.
      Government agencies
              
              $
              3,500,000
              
              
              $
              70,155
              
              
              $
              -
              
              
              $
              3,570,155Mortgage-backed
      securities
              
              
              15,972,382
              
              
              
              459,930
              
              
              
              (24,700
              )
              
              
              16,407,612Municipal
      securities
              
              
              3,581,152
              
              
              
              -
              
              
              
              (146,784
              )
              
              
              3,434,368Asset-backed
      securities
              
              
              1,437,168
              
              
              
              14,372
              
              
              
              (17,836
              )
              
              
              1,433,704$
              24,490,702
              
              
              $
              544,457
              
              
              $
              (189,320
              )
              
              $
              24,845,839December
      31, 2007:U.S.
      Government agencies
              
              $
              5,992,575
              
              
              $
              26,962
              
              
              $
              (9,377
              )
              
              $
              6,010,160Mortgage-backed
      securities
              
              
              7,327,838
              
              
              
              36,520
              
              
              
              (35,465
              )
              
              
              7,328,893Municipal
      securities
              
              
              2,971,893
              
              
              
              15,549
              
              
              
              (23,272
              )
              
              
              2,964,170Asset-backed
      securities
              
              
              648,406
              
              
              
              173,014
              
              
              
              (499
              )
              
              
              820,921$
              16,940,712
              
              
              $
              252,045
              
              
              $
              (68,613
              )
              
              $
              17,124,144
 
  ~  ~
  NOTE
B - INVESTMENT SECURITIES - Continued
  During
2004, one of the Bank’s asset-backed securities was identified as “other than
temporarily impaired,” and a loss reserve was established for this
security.  The security is in non-accrual status, with any interest
payments received being credited to the reserve.  As of December 31,
2008, the gross book value of the security was $309,000 and the reserve was
$277,000, for a net book value of $32,000.  Management estimates that
the fair value of this security is approximately equal to the $32,000 net book
value.
   The
scheduled maturities of investment securities at December 31, 2008, were as
follows.  Actual maturities may differ from contractual maturities
because some investment securities may allow the right to call or prepay the
obligation with or without call or prepayment penalties.
  
 Available-for-Sale
      SecuritiesAmortized
              
              
              FairCost
              
              
              ValueWithin
      one year
              
              $
              2,333,543
              
              
              $
              2,369,920Due
      in one year to five years
              
              
              1,076,622
              
              
              
              1,100,293Due
      in five years to ten years
              
              
              2,810,152
              
              
              
              2,889,249Due
      in greater than ten years
              
              
              18,270,385
              
              
              
              18,486,377$
              24,490,702
              
              
              $
              24,845,839
 
 Included
in accumulated other comprehensive income at December 31, 2008 were net
unrealized gains on investment securities available for sale of
$355,137.  No deduction was made for income taxes on as of December
31, 2008 (see Note H).  At December 31, 2007, accumulated other
comprehensive income included net unrealized gains on available-for-sale
securities of $183,432 less applicable income taxes of $75,207.  No
securities were sold in 2008 or 2007.
 
 Investment
securities in a temporary unrealized loss position as of December 31, 2008 and
2007 are shown in the following table, based on the length of time they have
been continuously in an unrealized loss position:
 
 
 Less
      than 12 Months
              
              
              12
      Months or Longer
              
              
              TotalFair
              
              
              Unrealized
              
              
              Fair
              
              
              Unrealized
              
              
              Fair
              
              
              UnrealizedValue
              
              
              Losses
              
              
              Value
              
              
              Losses
              
              
              Value
              
              
              LossesDecember
      31, 2008:U.S.
      Government agencies
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -Mortgage-backed
      securities
              
              
              1,720,805
              
              
              
              24,700
              
              
              
              -
              
              
              
              -
              
              
              
              1,720,805
              
              
              
              24,700Municipal
      securities
              
              
              3,434,368
              
              
              
              146,784
              
              
              
              -
              
              
              
              -
              
              
              
              3,434,368
              
              
              
              146,784Asset-backed
      securities
              
              
              440,060
              
              
              
              6,439
              
              
              
              80,110
              
              
              
              11,397
              
              
              
              520,170
              
              
              
              17,836$
              5,595,233
              
              
              $
              177,923
              
              
              $
              80,110
              
              
              $
              11,397
              
              
              $
              5,675,343
              
              
              $
              189,320December
      31, 2007:U.S.
      Government agencies
              
              $
              -
              
              
              $
              -
              
              
              $
              2,490,320
              
              
              $
              9,377
              
              
              $
              2,490,320
              
              
              $
              9,377Mortgage-backed
      securities
              
              
              611,527
              
              
              
              2,965
              
              
              
              3,507,599
              
              
              
              32,500
              
              
              
              4,119,126
              
              
              
              35,465Municipal
      securities
              
              
              360,412
              
              
              
              2,725
              
              
              
              1,211,867
              
              
              
              20,547
              
              
              
              1,572,279
              
              
              
              23,272Asset-backed
      securities
              
              
              -
              
              
              
              -
              
              
              
              107,314
              
              
              
              499
              
              
              
              107,314
              
              
              
              499$
              971,939
              
              
              $
              5,690
              
              
              $
              7,317,100
              
              
              $
              62,923
              
              
              $
              8,289,039
              
              
              $
              68,613
 
  ~  ~
  NOTE
B - INVESTMENT SECURITIES – Continued
 
 As of
December 31, 2008, 24 securities have been in an unrealized loss position for
less than one year.  The unrealized loss on investments in
asset-backed securities which have been in an unrealized loss position for one
year or longer as of December 31, 2008, represents one
security.  Because the Bank has the ability to hold all investments in
an unrealized loss position until a recovery in fair value, which may be
maturity, the unrealized loss on these investments are not considered to be
other-than-temporarily impaired as of December 31, 2008.  Other than
the one impaired asset-backed security footnoted above, none of the Bank’s
securities has exhibited a decline in value as a result of changes in credit
risk.
 
 Investments
securities carried at $5,121,000 and $10,631,000 as of December 31, 2008 and
2007, respectively, were pledged to secure public deposits as required by
law.  As of December 31, 2008, securities carried at $8,794,000 were
pledged to secure borrowings from the Federal Home Loan Bank of San
Francisco, as described in Note F.
 
  
  NOTE
C - LOANS
  
 The
Bank’s loan portfolio consists primarily of loans to borrowers within the
Central Coast area of 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 area and, as a result, the Bank’s loan
and collateral portfolios are concentrated in those industries and in that
geographic area.  As of December 31, 2008, 65% of the loan portfolio
was secured by commercial real estate (including construction and land
development loans as well as loans secured by non-farm, non-residential and
multi-family residential properties).  Under guidelines for commercial
real estate (“CRE”) lending issued by the bank regulatory agencies in 2006,
which generally excludes owner-occupied properties from the definition of
commercial real estate, CRE loans represented 42% of the loan portfolio as of
December 31, 2008.
 
 Included
in total loans are net deferred loan fees of $67,000 and $22,000 at December 31,
2008 and 2007, respectively.
 
 The
following is a summary of the investment in impaired loans as of December 31,
including the related allowance for loan losses and cash-basis income
recognized.  Also shown are loans on non-accrual and those that are
past due and still accruing interest:
 
 2008
              
              
              2007Impaired
      Loans:Impaired
      loans with a related allowance for loan losses
              
              $
              4,513,760
              
              
              $
              273,348Impaired
      loans with no related allowance for loan losses
              
              
              3,970,355
              
              
              
              1,714,658Total
      impaired loans
              
              
              8,484,115
              
              
              
              1,988,006Related
      Allowance for Loan Losses
              
              
              1,342,312
              
              
              
              20,172Average
      Recorded Investment in Impaired Loans
              
              
              4,948,951
              
              
              
              980,401Interest
      Income Recognized for Cash Payments While Impaired
              
              
              243,479
              
              
              
              105,977Total
      Loans on Non-accrual
              
              
              3,556,660
              
              
              
              1,988,006Total
      Loans Past Due 90 Days or More and Still Accruing
              
              
              265,174
              
              
              
              68,263
 
  ~  ~
  NOTE
C - LOANS - Continued
 
 Following
is a summary of the changes in the allowance for possible loan and lease losses
for the years ended December 31:
 
 2008
              
              
              2007Balance
      at Beginning of Year
              
              $
              1,149,874
              
              
              $
              1,025,939Additions
      to the Allowance Charged to Expense
              
              
              4,245,000
              
              
              
              150,000Less
      Loans Charged Off
              
              
              (1,478,652
              )
              
              
              (31,425
              )Plus
      Recoveries on Loans Previously Charged Off
              
              
              25,998
              
              
              
              5,360Balance
      at End of Year
              
              $
              3,942,220
              
              
              $
              1,149,874
 
 
 The Bank
also originates SBA-guaranteed loans for sale to institutional
investors.  At December 31, 2008 and 2007 the Bank was servicing
$23,229,000 and $24,722,000, respectively, in loans previously sold or
participated.  The Bank has recorded servicing assets related to these
sold loans of approximately $187,000 and $253,000 at December 31, 2008 and 2007,
respectively.  In calculating the gain on sale of SBA loans and the
related servicing asset, the Bank used the following assumptions for sales
recorded in 2008:
 
 Range                                      Weighted
Average
 Discount
rate                                                   7.50%
to
9.00%                                                        7.97%
 Estimated
life                                                    40-48
months                                                  47.8
months
 
 Management
performs an analysis each quarter to reassess these assumptions, which are
significant determinants on the value ascribed to the servicing
asset.  Following is a summary of the changes in the balances of the
SBA loan servicing asset for 2008 and 2007:
 
 2008
              
              
              2007Balance
      at Beginning of Year
              
              $
              252,572
              
              
              $
              282,696Additions
      to the Asset
              
              
              71,425
              
              
              
              96,127Less
      amortization
              
              
              (136,609
              )
              
              
              (126,251
              )Balance
      at End of Year
              
              $
              187,388
              
              
              $
              252,572
 
 The
estimated fair value of the servicing assets approximated the carrying amount at
December 31, 2008 and 2007.  These assets are included in accrued
interest and other assets in the consolidated balance
sheets.  Amortization of these assets is netted against loan servicing
fees in the consolidated statements of income.
 
  ~  ~
  NOTE
D - PREMISES AND EQUIPMENT
 
 A summary
of premises and equipment as of December 31 follows:
 
 2008
              
              
              2007Land
              
              $
              976,498
              
              
              $
              2,171,007Buildings
              
              
              796,633
              
              
              
              823,227Leasehold
      improvements
              
              
              671,142
              
              
              
              339,319Furniture,
      fixtures, and equipment
              
              
              2,482,904
              
              
              
              2,309,5144,927,177
              
              
              
              5,643,067Accumulated
      depreciation and amortization
              
              
              (2,328,480
              )
              
              
              (2,105,866
              )Net
      premises and equipment
              
              $
              2,598,697
              
              
              $
              3,537,201
 
 The Bank
has entered into operating leases for its branches and operating facilities,
which expire at various dates through 2024.  These leases include
provisions for periodic rent increases as well as payment by the lessee of
certain operating expenses.  Rental expense relating to these leases
was $357,000 in 2008 and $324,000 in 2007.
 
 At
December 31, 2008, the approximate future minimum annual payments under these
leases for the next five years are as follows:
 
 2009
              
              $
              446,9572010
              
              
              745,9452011
              
              
              683,1052012
              
              
              662,5832013
              
              
              549,176Later
      years
              
              
              6,229,679$
              9,317,445
 
 The
minimum rental payments shown above are given for the existing lease obligations
and do not reflect any increases in rent unless the increases are scheduled and
currently determinable.  It does not represent a forecast of future
rental expenses.  Included in the above table are obligations under a
15-year build-to-suit lease for property in San Luis Obispo, California, upon
which the Bank intends to lease a full-service branch and administrative
office.  Currently the lease provides for tentative rentals of $36,708
per month, subject to the final size of the yet-to-be-constructed building, and
beginning on or about October 1, 2009.  As of December 31, 2006, the
Bank was obligated under a 50-year land lease for property on this
site.  The terms of that lease gave the Bank early termination rights
through September 30, 2007, which the Bank chose to exercise in July
2007.
 
 In March
2008, the Bank entered into a 5-year lease for an office building in Santa
Maria, California, where the Bank opened a full-service branch office in
December 2008.  The current rental cost is $8,679 per
month.  The lease provides for two 5-year renewal options and an
option to purchase the property for a specified amount during the last two
months of 2010.
 
  ~  ~
  NOTE
E - DEPOSITS
 
 At
December 31, 2008, the scheduled maturities of time deposits are as
follows:
 
 
 Due in one year
              
              $
              87,032,013Due
      in one to five years
              
              
              2,301,706$
              89,333,719
 
 Sixteen
deposit customers comprised $39.7 million, or 27.4%, of the Bank’s total
deposits as of December 31, 2008.
 
 
 NOTE
F - OTHER BORROWINGS
 
 Other
borrowings at December 31, 2008, comprised of fixed rate advances from the
Federal Home Loan Bank of San Francisco, are scheduled to mature as
follows:
 
 
 Maturity
                Date
              
              Interest
                Rate
              
              
              Amount2009
              
              
              3.31
              %
              
              $
              39,700,0002010
              
              
              5.13
              %
              
              
              3,000,0002013
              
              
              4.89
              %
              
              
              3,000,000Total
      / Weighted Average
              
              
              3.54
              %
              
              $
              45,700,000
 
 These
advances are secured by loans of approximately $97.5 million and securities of
approximately $9 million.  As of December 31, 2008, the Bank had a
borrowing capacity of approximately $3.1 million with the Federal Home Loan Bank
of San Francisco in addition to the borrowings listed above.
 
 The Bank
also has unsecured borrowing lines with correspondent banks totaling $6.5
million.  As of December 31, 2008, there were no balances outstanding
on these lines.
 
 
 NOTE
G - JUNIOR SUBORDINATED DEBT SECURITIES
 
 On
October 14, 2003, the Company issued $3,093,000 of junior subordinated debt
securities (the “debt securities”) to Mission Community Capital Trust, a
statutory trust created under the laws of the State of
Delaware.  These debt securities are subordinated to effectively all
borrowings of the Company and are due and payable on October 7,
2033.  Interest is payable quarterly on these debt securities at 3-mo.
LIBOR plus 2.95% for an effective rate of 7.77% as of December 31,
2008.  The debt securities can be redeemed at par.
 
 The
Company also purchased a 3% minority interest in Mission Community Capital
Trust. The balance of the equity of Mission Community Capital Trust is comprised
of mandatorilyredeemable preferred securities.UnderFASB Interpretation No.
46 (FIN 46), “Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51,”Mission
Community Capital Trust is not consolidated into the Company’s financial
statements.  The Federal Reserve Board has ruled that subordinated
notes payable to unconsolidated special purpose entities (“SPE’s”) such as
Mission Community Capital Trust, net of the bank holding company’s investment in
the SPE, qualify as Tier 1 Capital, subject to certain limits.
 
  ~  ~
  NOTE
H - INCOME TAXES
 
 The
income tax expense (benefit) for the years ended December 31, 2008 and 2007 is
comprised of the following:
 
 
 2008
              
              
              2007Current
      Taxes:Federal
              
              $
              (436,253
              )
              
              $
              309,294State
              
              
              2,400
              
              
              
              123,323(433,853
              )
              
              
              432,617Deferred
              
              
              (494,803
              )
              
              
              (54,774
              )$
              (928,656
              )
              
              $
              377,843
 
 
 A
comparison of the federal statutory income tax rates to the Company’s effective
income tax (benefit) follows:
 
 2008
              
              
              2007Amount
              
              
              Rate
              
              
              Amount
              
              
              RateFederal
      tax rate
              
              $
              (1,624,189
              )
              
              
              34.0
              %
              
              $
              388,667
              
              
              
              34.0
              %California
      franchise taxes, net of federaltax
      benefit
              
              
              (344,040
              )
              
              
              7.2
              %
              
              
              79,987
              
              
              
              7.0
              %Allowance
      for deferred tax assets
              
              
              1,125,885
              
              
              
              (23.6
              )%
              
              
              -
              
              
              
              -Interest
      on municipal securities and loans
              
              
              (90,220
              )
              
              
              1.9
              %
              
              
              (79,623
              )
              
              
              (7.0
              )%Increase
      in cash surrender valueof
      bank-owned life insurance
              
              
              (32,299
              )
              
              
              0.7
              %
              
              
              (27,803
              )
              
              
              (2.4
              )%Other
      items - net
              
              
              36,207
              
              
              
              (0.8
              )%
              
              
              16,615
              
              
              
              1.5
              %$
              (928,656
              )
              
              
              19.4
              %
              
              $
              377,843
              
              
              
              33.1
              %
 
 Deferred
taxes are a result of differences between income tax accounting and generally
accepted accounting principles with respect to income and expense
recognition.  The Company’s principal timing differences are from the
cash basis of tax reporting and the allowance for loan and lease
losses.
  ~  ~
  
 NOTE
H - INCOME TAXES - Continued
 
 The
following is a summary of the components of the net deferred tax asset accounts
recognized in the accompanying consolidated balance sheets:
 
 2008
              
              
              2007Deferred
      Tax Assets:Allowance
      for Loan Losses Due to Tax Limitations
              
              $
              1,476,622
              
              
              $
              474,813Reserve
      for Impaired Security
              
              
              113,815
              
              
              
              110,994Net
      Operating Loss Carryforwards
              
              
              525,724
              
              
              
              -Other
              
              
              307,569
              
              
              
              203,5312,423,730
              
              
              
              789,338Valuation
      Allowance
              
              
              (1,125,885
              )
              
              
              -Deferred
      Tax Liabilities:Deferred
      Loan Costs
              
              
              (215,485
              )
              
              
              (188,336
              )Depreciation
      Differences
              
              
              (167,282
              )
              
              
              (81,221
              )Unrealized
      Gain on Available-for-Sale Securities
              
              
              -
              
              
              
              (75,207
              )BEA
      Award Deferred for Tax Purposes
              
              
              -
              
              
              
              (134,157
              )Other
              
              
              (83,117
              )
              
              
              (48,466
              )(465,884
              )
              
              
              (527,387
              )Net
      Deferred Tax Assets
              
              $
              831,961
              
              
              $
              261,951
 
 
 The
valuation allowance was established because the Bank’s loss in 2008 exceeded its
ability to fully recognize deferred tax assets by carrying the loss back to
previous tax years.  The Bank has net operating loss carry forwards of
approximately $1,118,000 for federal income and $2,037,000 for California
franchise tax purposes.  The federal and California net operating loss
carry forwards, to the extent not used, will expire in 2028.  See also
Note T regarding a change to the federal carryback period enacted subsequent to
December 31, 2008.
 
 As of
December 31, 2008, tax years for 2005 through 2008 remain open to audit by the
Internal Revenue Service and 2004 through 2008 remain open by the California
Franchise Tax Board.  In the opinion of management, all significant
tax positions taken, or expected to be taken, by the Company in any open tax
year would more likely than not be sustained upon examination by the tax
authorities.
 
  ~  ~
  NOTE
I - STOCK OPTION PLANS
  The
Company adopted in 1998 a stock option plan under which 180,000 shares of the
Company’s common stock may be issued.  The 1998 Plan has been
terminated with respect to the granting of future options under the
Plan.  In 2008 the Company adopted and received shareholder approval
for the Mission Community Bancorp 2008 Stock Incentive Plan.  The 2008
Plan provides for the grant of various equity awards, including stock
options.  A total of 201,840 common shares may be issued under the
2008 Plan.  Options are granted at a price not less than 100% of the
fair value of the stock on the date of grant, generally for a term of ten years,
with vesting occurring ratably over five years.  The Plans provide for
acceleration of vesting of all options upon change in control of the
Bank.  The Bank recognized in 2008 and 2007 stock-based compensation
of $64 thousand and $48 thousand, respectively.  Income tax benefits
related to that stock-based compensation was $-0-and $1 thousand for 2008 and
2007, respectively.
   On May
27, 2008, the Company granted to the Bank’s two most senior officers options to
purchase a total of 41,064 shares of common stock at an exercise price of $18.00
per share.  These non-qualified stock options were granted under the
2008 Plan, vest over five years, and expire ten years after the date of
grant.  The fair value ascribed to those options, using the
Black-Scholes option pricing model, was $4.58 per share, or a total of
$188,073.  No options were granted in 2007.
  A summary
of the status of the Company’s fixed stock option plans as of December 31, 2008
and changes during the year is presented below:
 
 Weighted-
              
              AggregateWeighted-
              
              Average
              
              IntrinsicAverage
              
              Remaining
              
              Value
      ofExercise
              
              Contractual
              
              In-the-MoneyShares
              
              Price
              
              Term
              
              OptionsOutstanding
      at Beginning of Year
              
              80,900
              
              $13.42Granted
              
              41,064
              
              18.00Exercised
              
              (20,700)
              
              10.00Forfeited/Expired
              
              (11,700)
              
              13.97Outstanding
      at End of Year
              
              89,564
              
              $16.24
              
              6.5
              Years
              
              $42,755Options
      Exercisable at Year-End
              
              41,900
              
              $13.05
              
              3.7
              Years
              
              $42,755
 
  The total
intrinsic value of options exercised during the years ended December 31, 2008
and 2007 were $110,000 and $362,000, respectively.
   As of
December 31, 2008, the Company has unvested options outstanding with
unrecognized compensation expense totaling $208 thousand, which is scheduled to
be recognized as follows (in thousands):
  2009     $  80
 2010    38
 2011        37
 2012        38
 2013        15
 Total
unrecognized compensation cost $208
 
 
  ~  ~
  NOTE
J – DEFINED CONTRIBUTION PLAN
 
 The
Company has adopted a defined contribution plan, the Mission Community Bank 401k
Profit Sharing Plan (“the 401k Plan”), covering substantially all employees
fulfilling minimum age and service requirements.  Matching and
discretionary employer contributions to the 401k Plan are determined annually by
the Board of Directors.  The expense for the 401k Plan was
approximately $90,000 in 2008 and $165,000 in 2007.
 
 NOTE
K - PREFERRED STOCK
 
 Series A
– the Series A Preferred Stock has a $5.00 stated value and is non-voting,
convertible and redeemable.  Each share is convertible into one-half
share of voting common stock of the Company.  Series A shares are not
entitled to any fixed rate of return, but do participate on the same basis (as
if converted on a two-for-one exchange) in any dividends declared on the
Company’s common stock.  Series A shares may be redeemed upon request
of the holder at their stated value if the Bank is found to be in default under
any Community Development Financial Institutions Program Assistance Agreement
for Equity Investments in Regulated Institutions, or any successor
agreement.  In the event of liquidation, the holders of Series A
shares will be entitled to a liquidation preference of $5.00 per share before
the holders of common stock receive any distributions and after the holders of
common stock receive distributions of $10.00 per share, all distributions will
be on the same basis (as if converted on a one-for-two
exchange).  These shares were issued for $392,194 (net of issuance
costs of $107,806) pursuant to an award from the Community Development Financial
Institutions Fund of the Department of the Treasury.
 
 Series B
– the Series B Preferred Stock has a $10.00 stated value and is non-voting,
non-convertible and non-redeemable.  Series B shares are not entitled
to any fixed rate of return but do participate on the same basis in any
dividends declared on the Company’s common stock. In the event of liquidation,
the holders of Series B shares will be entitled to a liquidation preference of
$10.00 per share before the holders of common stock receive any
distributions.  Additionally, in the event of a specified “change in
control event” (including certain mergers or sales of assets), holders of the
Series B Preferred Stock shall be entitled to receive payment on the same basis
as the holders of the common stock of the Company.  These shares were
issued for $191,606 (net of issuance costs of $13,394) pursuant to an investment
from the National Community Investment Fund (“NCIF”).  In connection
with this investment, NCIF also purchased 29,500 shares of the Company’s common
stock for $10.00 per share.  As part of the investment agreement, the
Company by covenant agreed that so long as NCIF or any successor owns and holds
any of the Shares to remain a CDFI and to meet certain reporting
requirements.
 
 Series C
– the Series C Preferred Stock has $10.00 stated value and is non-voting,
convertible and redeemable.  Each share is convertible into one share
of voting common stock of the Company.  Series C shares are not
entitled to any fixed rate of return, but do participate on the same basis (as
if converted on a one-to-one exchange) in any dividends declared on the
Company’s common stock.  Series C shares may be redeemed upon request
of the holder at their stated value if the Bank is found to be in default under
any Community Development Financial Institutions Program Assistance Agreement
for Equity Investments in Regulated Institutions, or any successor
agreement.  In the event of liquidation, the holders of Series C
shares will be entitled to a liquidation preference of $10.00 per share (as
adjusted for any stock dividends, combinations or splits with respect to such
shares) before the holders of common stock receive any
distributions.  These shares were issued for $500,000 pursuant to an
award from the Community Development Financial Institutions Fund of the
Department of the Treasury.
 
  ~  ~
  NOTE
L - RELATED PARTY TRANSACTIONS
 
 In the
ordinary course of business, the Bank has granted loans to certain directors and
the companies with which they are associated.  In the Bank’s opinion,
all loans and loan commitments to such parties are made on substantially the
same terms, including interest rate and collateral, as those prevailing at the
time for comparable transactions with other persons.
 
 The
following is a summary of the activity in these loans:
 
 2008
              
              
              2007Balance
      at the beginning of the year
              
              $
              2,498,900
              
              
              $
              2,730,982New
      loans and advances
              
              
              3,187,523
              
              
              
              1,227,114Repayments
              
              
              (700,128
              )
              
              
              (1,459,196
              )Balance
      at the end of the year
              
              $
              4,986,295
              
              
              $
              2,498,900
 
 Deposits
from related parties held by the Bank totaled approximately $4,761,000 at
December 31, 2008, and $4,609,000 at December 31, 2007.
 
 During
2003, Bancorp pledged a $250,000 certificate of deposit in an unaffiliated bank
as collateral for borrowings of MCSC under a line of credit.  The
certificate matured in 2008 and was replaced by a certificate for $75,000, which
has been pledged as collateral for the line of credit.  As of December
31, 2008, MCSC had borrowed $35,500 on the line.  No potential
liability was recognized by Bancorp as of December 31, 2008, because the
outstanding balance on the line is expected to be repaid with funds to be
received from other sources, including a grant program through the U.S. Small
Business Administration.  During 2007 Bancorp made cash contributions
to MCSC totaling $36,013.  No cash contributions were made to MCSC
during 2008.
 
  ~  ~
  NOTE
M - COMMITMENTS AND CONTINGENCIES
 
 In the
normal course of business, the Bank enters into financial commitments to meet
the financing needs of its customers.  These financial commitments
include commitments to extend credit and standby letters of
credit.  Those instruments involve to varying degrees, elements of
credit and interest rate risk not recognized in the statement of financial
position.
 
 The
Bank's exposure to credit loss in the event of nonperformance on commitments to
extend credit and standby letters of credit is represented by the contractual
amount of those instruments.  The Bank uses the same credit policies
in making commitments as it does for loans reflected in the financial
statements.
 
 As of
December 31, the Bank had the following outstanding financial commitments whose
contractual amount represents credit risk:
 
 2008
              
              
              2007Commitments
      to Extend Credit
              
              $
              28,427,000
              
              
              $
              28,608,000Standby
      Letters of Credit
              
              
              304,000
              
              
              
              693,000$
              28,731,000
              
              
              $
              29,301,000
 
 Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Standby
letters of credit are conditional commitments to guarantee the performance of a
Bank customer to a third party.  Since many of the commitments and
standby letters of credit are expected to expire without being drawn upon, the
total amounts do not necessarily represent future cash
requirements.  The Bank evaluates each customer's creditworthiness on
a case-by-case basis.  The amount of collateral obtained if deemed
necessary by the Bank is based on management's credit evaluation of the
customer.
 
 The Bank
has established an allowance for possible losses on unfunded loan commitments in
the amount of $70,000, which is included in other liabilities in the
consolidated statements of condition.  To date, no losses have been
charged against this allowance.
 
 In the
ordinary course of business, various claims and lawsuits are brought by and
against the Company and the Bank.  In the opinion of management, there
is no pending or threatened proceeding in which an adverse decision could result
in a material adverse change in the consolidated financial condition or results
of operations of the Company.
 
   ~  ~
  NOTE
N - EARNINGS (LOSS) PER SHARE
 
 The
following is a reconciliation of net income (loss) and shares outstanding to the
income (loss) and number of shares used in the computation of earnings (loss)
per share:
 
 
 2008
              
              
              2007Average
      common shares outstandingduring
      the year (used for basic EPS)
              
              
              1,090,569
              
              
              
              679,144Dilutive
      effect of outstanding stock options
              
              
              -
              
              
              
              34,008Average
      common shares used for diluted EPS
              
              
              1,090,569
              
              
              
              713,152Net
      income (loss)
              
              $
              (3,848,370
              )
              
              $
              765,294Less
      income or loss allocated to preferred stock
              
              
              (382,908
              )
              
              
              115,214Income
      allocated to common stock
              
              $
              (3,465,462
              )
              
              $
              650,080Basic
      earnings (loss) per common share
              
              $
              (3.18
              )
              
              $
              0.96Diluted
      earnings (loss) per common share
              
              
              (3.18
              )
              
              
              0.91
 
 
  Excluded
from the diluted EPS computation for 2007 were options for 19,500 shares because
the effect would be anti-dilutive.  Those options have an exercise
price of $25.50 per share and will expire on March 28, 2015.  All
options were excluded from the diluted EPS computation in 2008 because any stock
options would have an anti-dilutive effect on the net loss.
 
   ~  ~
  NOTE
O - REGULATORY MATTERS
 
 The Bank
is subject to various regulatory capital requirements administered by the
federal bank regulatory agencies.  Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Bank’s financial statements.  Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices.  The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
 
 Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of Total
and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as
defined).  Management believes, as of December 31, 2008, that the Bank
meets all capital adequacy requirements to which it is subject.
 
 As of
December 31, 2008, the most recent notification from the Federal Reserve Board
categorized the Bank as well-capitalized under the regulatory framework for
prompt corrective action.  There are no conditions or events since
that notification that management believes have changed the Bank’s
category.  To be categorized as well-capitalized, the Bank must
maintain minimum ratios as set forth in the table below.  The
following table also sets forth the Bank's actual capital amounts and ratios
(dollar amounts in thousands):
 
 Amount
      of Capital RequiredTo
      Be
              
              
              To
      Be AdequatelyActual
              
              
              Well-Capitalized
              
              
              CapitalizedAmount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              RatioAs
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
              
              $
              22,467
              
              
              
              13.27
              %
              
              $
              16,937
              
              
              
              10.0
              %
              
              $
              13,550
              
              
              
              8.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              20,326
              
              
              
              12.00
              %
              
              $
              10,162
              
              
              
              6.0
              %
              
              $
              6,775
              
              
              
              4.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              20,326
              
              
              
              9.47
              %
              
              $
              10,729
              
              
              
              5.0
              %
              
              $
              8,583
              
              
              
              4.0
              %As
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
              
              $
              16,324
              
              
              
              11.74
              %
              
              $
              13,899
              
              
              
              10.0
              %
              
              $
              11,119
              
              
              
              8.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              15,119
              
              
              
              10.88
              %
              
              $
              8,340
              
              
              
              6.0
              %
              
              $
              5,560
              
              
              
              4.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              15,119
              
              
              
              9.47
              %
              
              $
              7,979
              
              
              
              5.0
              %
              
              $
              6,383
              
              
              
              4.0
              %
 
 
 The
Company is not subject to similar regulatory capital requirements because its
consolidated assets do not exceed $500 million, the minimum asset size criteria
for bank holding companies subject to those requirements.
 
 Banking
regulations limit the amount of cash dividends that may be paid without prior
approval of the Bank’s primary regulatory agency.  Cash dividends are
limited by the California Financial Code to the lesser of the Bank’s retained
earnings or its net income for the last three fiscal years, net of the amount of
any dividends or other capital distributions made during those
periods.  Under this rule, due to the Bank’s 2008 net loss, regulatory
approval is required as of December 31, 2008, for any dividend distributions
from the Bank to Bancorp.  However, dividend distributions from the
Bank would not downgrade the Bank’s prompt corrective action status from
well-capitalized to adequately-capitalized unless they exceeded
$5,557,000.
  ~  ~
  NOTE
P - GRANTS AND AWARDS
 
 In 2007
the Bank received a $326 thousand grant from the Bank Enterprise Award program
of the Department of the Treasury, based on lending activity the bank commenced
in 2006.  That grant was recognized in non-interest income in
2007.
 
 Although
the Bank is a certified CDFI bank and expects to continue to apply for various
grants and awards, there can be no assurance that it will receive similar future
grants or awards.
 
  NOTE
Q - MISSION COMMUNITY BANCORP (Parent Company Only)
 
 On
December 15, 2000, Mission Community Bancorp acquired Mission Community Bank by
issuing 600,566 shares of common stock in exchange for all outstanding shares of
the Bank’s common stock.  There was no cash involved in this
transaction.
 
 Following
are the separate financial statements for Mission Community Bancorp (parent
company only):
 
 
 Mission
      Community Bancorp (Parent Company Only)CONDENSED
      BALANCE SHEETS2008
              
              
              2007ASSETSCash
              
              $
              1,468,589
              
              
              $
              59,065Deposits
      in other banks
              
              
              75,000
              
              
              
              250,000Investment
      in subsidiary bank
              
              
              21,531,964
              
              
              
              15,252,121Other
      assets
              
              
              645,066
              
              
              
              866,559TOTAL
      ASSETS
              
              $
              23,720,619
              
              
              $
              16,427,745LIABILITIES
      AND SHAREHOLDERS' EQUITYJunior
      subordinated debentures
              
              $
              3,093,000
              
              
              $
              3,093,000Due
      to Mission Community Bank
              
              
              26,889
              
              
              
              131,685Other
      liabilities
              
              
              83,907
              
              
              
              64,756TOTAL
      LIABILITIES
              
              
              3,203,796
              
              
              
              3,289,441TOTAL
      SHAREHOLDERS' EQUITY
              
              
              20,516,823
              
              
              
              13,138,304$
              23,720,619
              
              
              $
              16,427,745
 
  ~  ~
  NOTE Q - MISSION COMMUNITY BANCORP
(Parent Company Only) – Continued
 
 
 CONDENSED
      STATEMENTS OF INCOME2008
              
              
              2007Interest
      income
              
              $
              26,668
              
              
              $
              11,750Interest
      expense
              
              
              220,335
              
              
              
              276,864Net
      interest (expense)
              
              
              (193,667
              )
              
              
              (265,114
              )Dividends
      received from subsidiary
              
              
              -
              
              
              
              300,283Less
      contributions to Mission Community Services Corp.
              
              
              -
              
              
              
              36,013Less
      other expenses
              
              
              286,998
              
              
              
              210,756Loss
      before taxes
              
              
              (480,665
              )
              
              
              (211,600
              )Income
      taxes expense (benefit)
              
              
              (92,080
              )
              
              
              (209,872
              )Income
      (loss) before equity in undistributed income of subsidiary
              
              
              (388,585
              )
              
              
              (1,728
              )Equity
      in undistributed income of subsidiary
              
              
              (3,459,785
              )
              
              
              767,022Net
      income (loss)
              
              $
              (3,848,370
              )
              
              $
              765,294
 
 
  
  
  CONDENSED
      STATEMENTS CASH FLOWS2008
              
              
              2007Operating
      activities:Net
      income (loss)
              
              $
              (3,848,370
              )
              
              $
              765,294Adjustments
      to reconcile net income (loss)to
      net cash used by operating activities:Income
      of subsidiary
              
              
              3,459,785
              
              
              
              (1,067,305
              )Amortization
      expense
              
              
              12,925
              
              
              
              17,232Other,
      net
              
              
              122,923
              
              
              
              (344,829
              )Net
      cash used by operating activities
              
              
              (252,737
              )
              
              
              (629,608
              )Investing
      activities:Investment
      in certificate of deposit
              
              
              (75,000
              )
              
              
              -Maturity
      of certificate of deposit
              
              
              250,000
              
              
              
              -Dividends
      received from subsidiary
              
              
              -
              
              
              
              300,283Investment
      in subsidiary
              
              
              (9,428,771
              )
              
              
              -Net
      cash provided by (used in) investing activities
              
              
              (9,253,771
              )
              
              
              300,283Financing
      activities:Proceeds
      from issuance of common stock
              
              
              10,916,032
              
              
              
              561,171Common
      stock repurchased
              
              
              -
              
              
              
              (459,228
              )Cash
      dividends paid
              
              
              -
              
              
              
              (96,688
              )Net
      cash provided by financing activities
              
              
              10,916,032
              
              
              
              5,255Net
      increase (decrease) in cash
              
              
              1,409,524
              
              
              
              (324,070
              )Cash
      at beginning of year
              
              
              59,065
              
              
              
              383,135Cash
      at end of year
              
              $
              1,468,589
              
              
              $
              59,065
 
  
   ~  ~
  
 NOTE
R - FAIR VALUE MEASUREMENT
  
 The
following is a description of valuation methodologies used for assets and
liabilities recorded at fair value:
 
 Securities: The fair
values of securities available for sale are determined by obtaining quoted
prices on nationally recognized securities exchanges (Level 1) or matrix
pricing, which is a mathematical technique used widely in the industry to value
debt securities without relying exclusively on quoted prices for specific
securities but rather by relying on the securities’ relationship to other
benchmark quoted securities (Level 2).
 
 In
certain cases where there is limited activity or less transparency for inputs to
the valuation, securities are classified in Level 3 of the valuation hierarchy.
For instance, the Bank has one security in its available-for-sale portfolio that
has been assessed as “impaired” since 2004.  Prior to January 1, 2008,
the Bank has used a pricing method for this security that would be considered
Level 2 pricing.  Upon adoption of SFAS No. 157 in 2008, the Bank
concluded that Level 3 pricing was more appropriate for this security, given the
lack of observable inputs to the estimation process.  Due to the
illiquidity in the secondary market for this security, this fair value estimate
cannot be corroborated by observable market data.  This change in
estimate resulted in a reduction in the fair value of this security by $168
thousand as of January 1, 2008.  Because this security remains in the
available-for-sale portfolio, this change in estimate was included in other
comprehensive income (loss) but had no effect on reported net income
(loss).  With the exception of this one security, all of the Bank's
securities were classified in Level 2.
 
 Loans Held for Sale:Loans held for sale are carried at the lower of cost or market
value.  The fair value of loans held for sale is determined using
quoted market prices for similar assets (Level 2).
 
 SBA Loan Servicing
Rights: SBA loan servicing rights are initially recorded at fair value in
accordance with SFAS No. 156, Accounting for Servicing of
Financial Assets, an amendment of SFAS No. 140and are subsequently
measured using the amortization method which requires servicing rights to be
amortized into non-interest income in proportion to, and over the period of, the
estimated future net servicing income of the underlying loans.  Loan
servicing rights are evaluated for impairment subsequent to initial
recording.  Impairment is determined by stratifying rights into
groupings based on predominant risk characteristics, such as interest rate, risk
grade and loan type.  Impairment is recognized through a valuation
allowance for an individual grouping, to the extent that fair value is less than
the carrying amount.  SBA loan servicing rights do not trade in an
active market with readily observable prices. Accordingly, the Bank determines
the fair value of loan servicing rights by estimating the present value of the
future cash flows associated with the loans being serviced. Key economic
assumptions used in measuring the fair value of loan servicing rights include
prepayment speeds and discount rates. While market-based data is used to
determine the input assumptions, the Bank incorporates its own estimates of
assumptions market participants would use in determining the fair value of loan
servicing rights (Level 3).
 
 Collateral-Dependent
Impaired Loans:  The Bank does not record loans at fair value
on a recurring basis. However, from time to time, fair value adjustments are
recorded on these loans to reflect (1) partial write-downs, through charge-offs
or specific reserve allowances, that are based on the current appraised or
market-quoted value of the underlying collateral or (2) the full charge-off of
the loan carrying value. In some cases, the properties for which market quotes
or appraised values have been obtained are located in areas where comparable
sales data is limited, outdated, or unavailable. Fair value estimates for
collateral-dependent impaired loans are obtained from real estate brokers or
other third-party consultants (Level 3).
  ~  ~
  NOTE
R - FAIR VALUE MEASUREMENT – Continued
  
 The
following table provides the hierarchy and fair value for each major category of
assets and liabilities measured at fair value at December 31, 2008:
 
 Fair
      Value Measurements UsingLevel 1
              
              
              Level 2
              
              
              Level 3
              
              
              TotalAssets
      measured at fair value on a recurring basis:Securities
      Available for Sale
              
              $
              -
              
              
              $
              24,813,494
              
              
              $
              32,345
              
              
              $
              24,845,839Assets
      measured at fair value on a non-recurring basis:Collateral-Dependent
      Impaired Loans, Net of Specific Reserves
              
              $
              -
              
              
              $
              -
              
              
              $
              4,723,314
              
              
              $
              4,723,314
 
 
 SBA loan
servicing rights, which are carried at the lower of cost or fair value, have
resulted in no write-down or valuation allowance as of December 31,
2008.
 
 Collateral-dependent
impaired loans, which are measured for impairment using the fair value of the
collateral, had a carrying value of $6,065,619, with a specific reserve of
$1,342,305, as of December 31, 2008.
 
 The
following table presents a reconciliation of assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) during
2008:
 
 SecuritiesBeginning
      balance 12/31/07
              
              $
              -Transfers
      into Level 3
              
              
              226,899Total
      Gains (Losses):Included
      in Income (Loss)
              
              
              -Unrealized
      Gains (Losses) Included in Other Comprehensive Income
    (Loss)
              
              
              (168,493
              )Purchases
              
              
              -Settlements
              
              
              -Paydowns
      and maturities
              
              
              (26,061
              )Ending
      Balance 12/31/08
              
              $
              32,345Total
      unrealized gains (losses) for the period relating to assets still held at
      the reporting date
              
              $
              (168,493
              )
 
  ~  ~
  NOTE
S - FAIR VALUE OF FINANCIAL INSTRUMENTS
  
 The fair
value of a financial instrument is the amount at which the asset or obligation
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale.  Fair value estimates are made at a
specific point in time based on relevant market information and information
about the financial instrument.  These estimates do not reflect any
premium or discount that could result from offering for sale at one time the
entire holdings of a particular financial instrument.  Because no
market value exists for a significant portion of the financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors.  These estimates are
subjective in nature, involve uncertainties and matters of judgment and,
therefore, cannot be determined with precision.  Changes in
assumptions could significantly affect the estimates.
 
 Fair
value estimates are based on financial instruments both on and off the balance
sheet without attempting to estimate the value of anticipated future business
and the value of assets and liabilities that are not considered financial
instruments.  Additionally, tax consequences related to the
realization of the unrealized gains and losses can have a potential effect on
fair value estimates and have not been considered in many of the
estimates.
 
 The
following methods and assumptions were used to estimate the fair value of
significant financial instruments:
 
 Financial
      Assets
  The
carrying amounts of cash and short-term investments are considered to
approximate fair value.  Short-term investments include federal funds
sold and interest bearing deposits with Banks.  The fair values of
investment securities, including available-for-sale, are generally based on
matrix pricing.  The fair value of loans are estimated using a
combination of techniques, including discounting estimated future cash flows and
quoted market prices of similar instruments, where available.
 
 Financial
      Liabilities
  The
carrying amounts of deposit liabilities payable on demand and short-term
borrowed funds are considered to approximate fair value.  For fixed
maturity deposits, fair value is estimated by discounting estimated future cash
flows using currently offered rates for deposits of similar remaining
maturities.  The fair value of long-term debt is based on rates
currently available to the Bank for debt with similar terms and remaining
maturities.
 
 Off-Balance Sheet
      Financial Instruments
  The fair
value of commitments to extend credit and standby letters of credit is estimated
using the fees currently charged to enter into similar
agreements.  The fair value of these financial instruments is not
material.
 
  ~  ~
  NOTE
S - FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued
  
 The
estimated fair value of financial instruments is summarized as
follows:
 
  December
      31,2008
              
              
              2007Carrying
              
              
              Fair
              
              
              Carrying
              
              
              FairValue
              
              
              Value
              
              
              Value
              
              
              ValueFinancial
      Assets:Cash
      and due from banks
              
              $
              7,804,000
              
              
              $
              7,804,000
              
              
              $
              2,212,000
              
              
              $
              2,212,000Federal
      funds sold
              
              
              9,920,000
              
              
              
              9,920,000
              
              
              
              3,315,000
              
              
              
              3,315,000Interest-bearing
      deposits in other banks
              
              
              11,710,000
              
              
              
              11,710,000
              
              
              
              550,000
              
              
              
              550,000Investment
      securities
              
              
              24,846,000
              
              
              
              24,846,000
              
              
              
              17,124,000
              
              
              
              17,124,000Loans,
      net
              
              
              149,369,000
              
              
              
              150,476,000
              
              
              
              125,279,000
              
              
              
              128,412,000Federal
      Home Loan Bank and other stocks
              
              
              2,757,000
              
              
              
              2,757,000
              
              
              
              2,021,000
              
              
              
              2,021,000Company
      owned life insurance
              
              
              2,713,000
              
              
              
              2,713,000
              
              
              
              2,289,000
              
              
              
              2,289,000Accrued
      interest receivable
              
              
              824,000
              
              
              
              824,000
              
              
              
              747,000
              
              
              
              747,000Financial
      Liabilities:Deposits
              
              
              144,804,000
              
              
              
              145,206,000
              
              
              
              112,433,000
              
              
              
              112,448,000Other
      borrowings
              
              
              45,700,000
              
              
              
              46,484,000
              
              
              
              28,200,000
              
              
              
              28,514,000Junior
      subordinated debt securities
              
              
              3,093,000
              
              
              
              3,211,000
              
              
              
              3,093,000
              
              
              
              3,212,000Accrued
      interest and other liabilities
              
              
              1,376,000
              
              
              
              1,376,000
              
              
              
              1,465,000
              
              
              
              1,465,000
 
  
  NOTE
T – SUBSEQUENT EVENTS
  
 On
January 9, 2009, in exchange for aggregate consideration of $5,116,000, Mission
Community Bancorp issued to the United States Department of the Treasury (“the
Treasury”) a total of 5,116 shares of a new Series D Fixed Rate Cumulative
Perpetual Preferred Stock (the “Series D Preferred”) having a liquidation
preference of $1,000 per share.  This transaction is a part of the
Capital Purchase Program of the Treasury’s Troubled Asset Relief Program
(TARP).  The $5.1 million in new capital was subsequently invested in
Mission Community Bank as Tier 1 capital.  After giving effect to this
additional capital investment, the Bank’s pro forma capital ratios as of
December 31, 2008, would increase from the amounts shown in Note O to the
following:
 Total
risk-based capital
ratio                                                                     15.81%
 Tier 1
risk-based capital
ratio                                                                     14.58%
 Tier 1
leverage
ratio                                                                                  
 11.58%
 
 The
Series D Preferred will pay cumulative dividends at a rate of 5% per annum for
the first five years and 9% per annum thereafter. The Series D Preferred may not
be redeemed during the first three years after issuance except from the proceeds
of a “Qualified Equity Offering.”  Thereafter, Mission Community
Bancorp may elect to redeem the Series D Preferred at the original purchase
price plus accrued but unpaid dividends, if any.
 
 On
February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“the
Act”) was signed into law, which provides for an increased carryback period for
2008 net operating losses of eligible small businesses.  Management
believes the Company qualifies as an eligible small business under the
Act.  This provision under the Act will permit the Company to carry
back up to three additional years the $1,118,000 federal net operating loss
carry forward reported in Note H, resulting in a tax refund and the recognition
of approximately $380 thousand of tax benefits in 2009.
  ~  ~
  
 
  Item
9.  Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
 
 There
have been no changes in or disagreements with the Company’s
accountants.
 
 
 Item
9AT.  Controls and Procedures
 
 Our Chief
Executive Officer and our Chief Financial Officer carried out an evaluation as
of December 31, 2008, of the effectiveness of the design and operation of our
disclosure controls and procedures as defined in Exchange Act Rule
15a-15.  Based upon that evaluation, the Chief Executive Officer and
the Chief Financial Officer concluded that current disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company and/or Bank that is required to be included in our
periodic filings with the Securities and Exchange Commission and also with bank
or bank holding company regulatory agencies.
  
 There
were no significant changes in the Company’s internal controls or in other
factors that could significantly affect the Company’s internal controls over
financial reporting in the fourth quarter of 2008.
 
 Management’s Annual Report on
Internal Control Over Financial Reporting
  
 The
following section of this Annual Report on Form 10-K will not be deemed
incorporated by reference by any general statement incorporating by reference
this Annual Report on Form 10-K into any filing under the Securities Act of 1933
or under the Securities Exchange Act of 1934, except to the extent that we
specifically incorporate this information by reference, and will not otherwise
be deemed filed under these Acts.
  Management
is responsible for establishing and maintaining adequate internal control over
financial reporting for the Company and the Bank, including periodic filings
with the Securities Exchange Commission, the Federal Deposit Insurance
Corporation (“FDIC”), the Federal Reserve Bank of San Francisco (“FRBSF”) and
the California Department of Financial Institutions (“DFI”).  Such
periodic financial reports are prepared internally and reviewed by management
prior to filing.  These financial reports are also reviewed for timely
filing, completeness and accuracy with possible civil monetary penalties for
late filing and intentional inaccurate reporting by the various agencies where
the reports are filed.
 
 The
Company’s internal control over financial reporting is a process designed under
the supervision of the Company’s management, including its Chief Executive
Officer and its Chief Financial Officer, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the
Company’s financial statements for external reporting purposes in accordance
with accounting principles that are generally accepted in the United States of
America.
 
 The
Company’s internal control over financial reporting includes policies and
procedures that pertain to the maintenance of records which, in reasonable
detail, accurately and fairly reflect transactions and dispositions of assets;
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures are being made only in
accordance with authorizations of management and the directors of the Company;
and provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company’s assets that could
have a material effect on the Company’s financial statements.
 
 Management
recognizes that there are inherent limitations in the effectiveness of any
system of internal control and, accordingly, even effective internal control can
provide only reasonable assurance with respect to financial statement
preparation and fair presentation. Further, because of changes in conditions,
the effectiveness of internal control may vary over time.
 
 Under the
supervision and with the participation of the Company’s management, including
the Company’s Chief Executive Officer and Chief Financial Officer, the Company
conducted an assessment of the effectiveness of the Company’s internal control
over financial reporting based on the framework established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission and interpretive guidance provided by the Securities
and Exchange Commission.  Based on this assessment, management has
determined that the Company’s internal control over financial reporting as of
December 31, 2008 is effective.
  ~  ~
  
 Internal
controls over the Bank’s operational, lending procedures and underwriting,
financial systems and other systems are reviewed by internal auditors, holding
company and/or bank examiners, and by registered public
accountants.  At present, Bancorp, based on its asset size and lack of
activity other than banking, is not independently examined by the
FRB.
 
 Bancorp
and the Bank have elected to outsource the internal audit function to firms who
specialize in performing such auditing functions for community
banks.  Internal audit engagements are in writing, including the
anticipated scope, and are generally for 18 to 24 months with interim auditing
during the term of the engagement.  Engagements are presented to and
approved by the Board’s Audit Committee.  Each of the internal audits,
along with management’s response to any observations, is completed in writing
and presented to the Audit Committee.  Management is then responsible
to take any corrective action required to modify procedures or policies to
improve internal controls and procedures. Based on internal audits performed in
2007 and 2008, neither management nor the Audit Committee has been informed of
any material weaknesses in internal controls over financial
reporting.
 
 Internal
controls, lending, and financial reporting are also periodically reviewed by
bank and bank holding company examiners.  As a state charted bank, the
Bank is examined by the FRBSF and the DFI.  Written reports of
examination by state or federal regulators are provided to the Bank, reviewed by
management and by the Board’s Audit Committee.  If an examination
revealed material issues, the Bank could be subject to regulatory action
including formal or informal agreements to take corrective
action.  Bank examination reports are confidential, and the results
are not disclosed unless there are material exceptions noted.  In the
event of material exceptions, a bank could be required to enter into a formal
agreement (such as a Memorandum of Understanding or Cease and Desist Order)
which would document the specific weaknesses and corrective action that must be
taken.  These formal agreements are generally required to be disclosed
to the public.  As of December 2008, the Bank is not operating under
any formal or informal agreement with the FRB or DFI.
 
 Finally,
internal controls and financial reporting is reviewed by independent registered
public accountants on an annual basis.  These audited reports,
including any recommendations for improvements in accounting or internal
controls, are presented to management and the Board’s Audit
Committee.  As of December 31, 2008, the Company’s independent
registered public accountants have certified the audited financial statements of
the Company, with no material weaknesses identified in internal controls or
financial reporting.  This Annual Report on Form 10-K does not include
an attestation report of our registered public accounting firm regarding
internal control over financial reporting.  Management’s report was
not subject to attestation by our registered pubic accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit us to
provide only management’s report in this Annual Report on Form
10-K.
 
 
 
 Item
8B.  Other Information
 
 None.
 
 
  ~  ~
  
  PART
III
  
 Item
      10.  Directors, Executive Officers, Promoters, Control Persons
      and Corporate Governance; Compliance With Section 16(a) of the Exchange
      Act.
 
 Information
for this item is incorporated by reference to the Company’s proxy statement for
the annual meeting of shareholders to be held May 27, 2009.
 
 Section 16(a) Beneficial
Ownership Reporting Compliance
 The
Company does not have a class of equity securities registered pursuant to
Section 12 of the Securities Exchange Act of 1934 (the “Exchange
Act”).  Therefore, the Company’s officers and directors, and persons
who own more than 10% of the Company’s Common Stock, are not subject to the
reporting requirements under Section 16(a) of the Exchange Act.
 
 Item
11.  Executive Compensation
 
 The
information for this item is incorporated by reference to the Company’s proxy
statement for the annual meeting of shareholders to be held May 27,
2009.
 
 Item
      12.
              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Shareholder Matters
  The
information required by Item 11 with respect to securities authorized for
issuance under equity compensation plans is set forth under “Item 5—Market for
Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
Securities,” above.  The other information for this item is
incorporated by reference to the Company’s proxy statement for the annual
meeting of shareholders to be held May 27, 2009.
 
 Item
      13.  Certain Relationships and Related Transactions, and
      Director Independence
  The
information for this item is incorporated by reference to the Company’s proxy
statement for the annual meeting of shareholders to be held May 27,
2009.
 
 Item
14.  Principal Accountant Fees and Services
 
 The
information for this item is incorporated by reference to the Company’s proxy
statement for the annual meeting of shareholders to be held May 27,
2009.
 
 
  ~  ~
  
 Item
      15.  Exhibits
  Exhibit
Index:
 Exhibit #2.1
              Plan
      of Reorganization and Agreement of Merger dated as of October 4, 2000
      (A)3.1
              Restated
      Articles of Incorporation (I)3.2
              Certificate
      of Amendment to Articles of Incorporation (L)3.3
              Bylaws
      (B)4.1
              Certificate
      of Determination for Series A Non-Voting Preferred Stock
    (B)4.2
              Certificate
      of Determination for Series B Non-Voting Preferred Stock
    (B)4.3
              Certificate
      of Determination for Series C Non-Voting Preferred Stock
    (D)4.4
              Purchase
      Agreement dated October 10, 2003, by and among Registrant, Mission
      Community Capital Trust I, and Bear Stearns & Co., Inc.
      (E)4.5
              Indenture
      dated as of October 14, 2003 by and between Registrant and Wells Fargo
      Bank, National Association, as trustee (E)4.6
              Declaration
      of Trust Mission Community Capital Trust I dated  October 10,
      2003 (E)4.7
              Amended
      and Restated Declaration of Trust of Mission Community Capital Trust I
      dated October 14, 2003 by and among the Registrant, Wells Fargo Delaware
      Trust Company, as Trustee, and Anita M. Robinson and William C. Demmin, as
      Administrators (E)4.8
              Guarantee
      Agreement dated October 14, 2003 between Registrant, as Guarantor, and
      Wells Fargo Bank, National Association, as Guarantee Trustee
      (E)4.9
              Fee
      Agreement dated October 14, 2003 by and among the Registrant, Wells Fargo
      Delaware Trust Co., Bear Stearns & Co., Inc. and Mission Community
      Capital Trust I (E)4.10
              Certificate
      of Determination for Series D Preferred Stock (Q)10.1
              Purchase
      and Sale Agreement and Lease dated January, 1997, as amended
      (B)10.2
              Intentionally
      omitted10.3
              Lease
      Agreement – Paso Robles (B)10.4
              Lease
      Agreement – San Luis Obispo (B)10.5
              Lease
      Agreement – Arroyo Grande (B)10.6
              1998
      Stock Option Plan, as amended (B)10.7
              Lease
      Agreement – 569 Higuera, San Luis Obispo (D)10.8
              Lease
      Agreement – 671 Tefft Street, Nipomo (C)10.9
              Intentionally
      omitted10.10
              Lease
      Agreement – 3480  S. Higuera, San Luis Obispo
(F)10.11
              Salary
      Protection Agreement — Mr. Pigeon (G)10.12
              Salary
      Protection Agreement — Mr. Judge (H)10.13
              Second
      Amended and Restated Employment Agreement dated August 28, 2006 between
      Anita M. Robinson and Mission Community Bank (J)10.14
              Employment
      Agreement dated June 3, 2007 between Brooks Wise and Mission Community
      Bank(J)10.15
              Financial
      Advisory Services Agreement dated January 4, 2007 between the Company and
      Seapower Carpenter Capital, Inc. (K)10.16
              Common
      Stock Repurchase Agreement dated August 10, 2007 between Fannie Mae and
      the Company (M)10.17
              Build-to-Suit
      Lease Agreement between Walter Bros. Construction Co., Inc. and Mission
      Community Bank for property at South Higuera Street and Prado Road in San
      Luis Obispo, California (N)10.18
              Lease
      Agreement – 1670 South Broadway, Santa Maria (O)10.19
              Mission
      Community Bancorp 2008 Stock Incentive Plan (P)10.20
              Amendment
      No. 1 to Second Amended and Restated Employment Agreement dated December
      29, 2008 by and among Mission Community Bancorp, Mission Community Bank,
      and Anita M. Robinson (R)10.21
              Amendment
      No. 1 to Employment Agreement dated December 29, 2008 by and among Mission
      Community Bancorp, Mission Community Bank, and Brooks W. Wise
      (R)10.22
              Amended
      and Restated Salary Protection Agreement dated December 29, 2008 by and
      between Mission Community Bank and Ronald B. Pigeon (R)10.23
              Letter
      Agreement dated January 9, 2009 between Mission Community Bancorp and the
      United States Department of Treasury, which include the Securities
      Purchase Agreement—Standard Term attached thereto, with respect to the
      issuance and sale of the Series D. Preferred Stock (Q)10.24
              Side
      Letter Agreement dated January 9, 2009 amendment the Stock Purchase
      Agreement between Mission Community Bancorp and the Department of the
      Treasury (Q)10.25
              Side
      Letter Agreement dated January 9, 2009 between Mission Community Bancorp
      and The Department of the Treasury regarding maintenance of two open seats
      on the Board of Directors (Q)10.26
              Side
      Letter Agreement dated January 9, 2009 between Mission Community Bancorp
      ad The Department of the Treasury regarding CDFI status
(Q)14
              Code of Ethics21
              Subsidiaries of the registrant23.1
              Consent of Independent Registered Public Accounting
      Firm31.1
              Certification of CEO pursuant to Section 302 of
      Sarbanes Oxley Act31.2
              Certification of CFO pursuant to Section 302 of
      Sarbanes Oxley Act32.1
              Certification of CEO pursuant to Section 906 of
      Sarbanes Oxley Act32.2
              Certification of CFO pursuant to Section 906 of
      Sarbanes Oxley Act(A)Included
      in the Company’s Form 8-K filed on December 18, 2000
                (B)Included
      in the Company’s Form 10-KSB filed on April 2, 2001
                (C)Included
      in the Company’s Form 10-QSB filed August 12, 2002
                (D)Included
      in the Company’s Form 10-QSB filed on November 12, 2002
                (E)Included
      in the Company’s Form 8-K filed on October 21, 2003
                (F)Included
      in the Company’s Form 10-QSB filed on August 10, 2004
                (G)Included
      in the Company’s Form 8-K filed on January 19, 2005
                (H)Included
      in the Company’s Form 8-K filed on February 17, 2005
                (I)Included
      in the Company’s Form 10-QSB filed on August 14, 2006
                (J)Included
      in the Company’s Form 8-K filed on June 13, 2007
                (K)Included
      in the Company’s Form SB-2 Registration Statement filed on June 13,
      2007
                (L)Included
      in the Company’s Pre-Effective Amendment No. 1 to the Form SB-2
      Registration Statement filed on July 24, 2007
                (M)Included
      in the Company’s Form 8-K filed on August 14, 2007
                (N)Included
      in the Company’s Form 8-K filed on October 23, 2007
                (O)Included
      in the Company’s Form 10-KSB filed on March 28, 2008
                (P)Included
      in the Company’s Form 10-Q filed on May 15, 2008
                (Q)Included
      in the Company’s Form 8-K filed on January 14, 2009
                (R)Included
      in the Company’s Form 8-K filed on December 30, 2008
 
 
 
 SUPPLEMENTAL
INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE
ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12
OF THE ACT
  As of the
date of the filing of this report, neither the Company’s proxy materials nor
annual report to shareholders has been sent to the Company’s
shareholders.  The Company will furnish copies of the Company’s proxy
materials and annual report to shareholders to the Commission on or prior to the
time it is sent to the Company’s shareholders.
  ~  ~
  Signatures
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
 
 MISSION
COMMUNITY BANCORP
 
 
 
 By: /s/ Anita M.
Robinson
 ANITA M.
ROBINSON
 President
and Chief Executive Officer
 Dated:       March
13, 2009
 
 
 
 By: /s/ Ronald B.
Pigeon
 RONALD B.
PIGEON
 Executive
Vice President and Chief Financial Officer
 Dated:       March
13, 2009
 
 [Signatures
continue on next page]
  ~  ~
  Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
 
 /s/
      Bruce M. Breault
              Director
              March
      14, 2009BRUCE
      M. BREAULT/s/
      Roxanne M. Carr
              Vice
      Chairman of the Board
              March
      13, 20099ROXANNE
      M. CARR/s/
      William B. Coy
              Chairman
      of the Board
              March
      14, 2009WILLIAM
      B. COYDirectorHOWARD
      N. GOULD/s/
      Richard Korsgaard
              Director
              March
      14, 2009RICHARD
      KORSGAARD/s/
      Ronald B. Pigeon
              Executive
      Vice President and Chief Financial Officer
                (Principal
      Accounting and Financial Officer)
              March
      13, 2009RONALD
      B. PIGEON/s/
      Anita M. Robinson
              Director,
      President and Chief Executive Officer (Principal Executive
      Officer)
              March
      13, 2009ANITA
      M. ROBINSONDirectorROBIN
      L. ROSSIDirectorGARY
      E. STEMPER/s/
      Brooks W. Wise
              Director
              March
      14, 2009BROOKS
      W. WISEDirectorKARL
      F. WITTSTROM
 
 
  ~  ~