**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**Form 10-KSB**

**o**                                 ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe Fiscal Year ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Commissionfile number 333-12892**

**MISSION COMMUNITY BANCORP**

(Exact name of registrantas specified in its charter)

| **California**                  |   | **77-0559736**      |
|---------------------------------|--------|---------------------|
| State or other  jurisdiction of |   | I.R.S. Employer     |
| incorporation or  organization  |   | Identification  No. |

 
| **581 Higuera St., San Luis Obispo, California 93401** | **(805)  782-5000**             |
|--------------------------------------------------------|---------------------------------|
| (Address of  principal executive offices)              | Issuer’s  telephone number |

 

Securitiesregistered pursuant to Section 12(b) of the Exchange Act: **None**

Securitiesregistered pursuant to Section 12(g) of the Exchange Act:  **None**

Check whether theissuer is not required to file reports pursuant to Section 13 or 15(d) of theExchange Act.   x

Check whether theissuer (1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Exchange Act during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes  x** **No  **o**

Check ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-B is notcontained in this form, and no disclosure will be contained, to the best of theregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB   x**.**

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).Yes  **o**** **No  x

Registrant’s revenue for this year ended **December 31, 2006** was **$11,988,986.**

State the aggregate market value of the voting stockand non-voting common equity held by non-affiliates computed by reference tothe price at which the common equity was sold, or the average bid and askedprices of such common equity; as of **March 1, 2007**suchaggregate market value was **$12,958,959.**

As of **March 1, 2007**,the Registrant had 673,399 shares of Common Stock outstanding.

Transitional SmallBusiness Disclosure Format (check one)  Yes  **o**  No  x

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**Documents Incorporated byReference:**  Portions ofthe definitive proxy statement for the 2007 Annual Meeting of Shareholders tobe filed with the Securities and Exchange Commission pursuant to SEC regulation14A are incorporated by reference in Part III, Items 9-12 and 14.

 

 

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**ForwardLooking Statements**

This Annual Report onForm 10-KSB includes forward-looking information, which is subject to the “safeharbor” created by Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act ant the Private SecuritiesLitigation Reform Act of 1995.  When theCompany uses or incorporates by reference in this Annual Report on Form 10-KSBthe words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe”and similar expressions, the Company intends to identify forward-lookingstatements.  Such statements are subjectto certain risks, uncertainties and assumptions, including those described inthis Annual Report on Form 10-KSB. Should one or more of these risks or uncertainties materialize, orshould underlying assumptions prove incorrect, actual results may varymaterially from those anticipated, estimated, expected, projected, intended,committed or believed.  Such risks anduncertainties include, but are not limited to, the following factors: (i)general economic conditions, whether national or regional, that could affectthe demand for loans and other banking services or lead to increased loanlosses; (ii) competitive factors, including increased competition withcommunity, regional and national financial institutions that may lead topricing pressures on rates the Bank charges on loans and pays on deposits orreduce 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 todecreased net interest margin and increased volatility of rate sensitive loansand deposits; (v) changing business conditions in the banking industry; (vi)changes in the regulatory environment or new legislation; (vii) changes intechnology or required investments in technology; (viii) credit qualitydeterioration which could cause an increase in the provision for loan losses;(ix) dividend restrictions; (x) the effects of the September 11, 2001 terroristattacks and their aftermath; (xi) continued tensions in Iraq and elsewhere inthe Middle East; and (xii) increased regulation of the securities markets,whether pursuant to the Sarbanes-Oxley Act of 2002 or otherwise.

Investors and otherreaders are cautioned not to place undue reliance on forward-lookingstatements, which reflect management’s analysis only as of the date of thestatement.

The Company undertakes noobligation to revise any forward-looking statement to reflect later events orcircumstances.

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# **PART I**

## **Item 1. Description of Business**

**BUSINESS DEVELOPMENT**

**TheCompany**

Mission Community Bancorp(“Bancorp”) is a California corporation that was formed in September 2000.Bancorp’s principal business is to serve as a bank holding company for MissionCommunity Bank (the “Bank”).  Bancorp andthe Bank are collectively referred to herein as “the Company.”

As of December 31, 2006,the Company had approximately $158 million in total assets and $12 million inshareholders’ equity.

On October 14, 2003,Bancorp formed Mission Community Capital Trust I in order to complete a trustpreferred security transaction and raised approximately $3,000,000 in long-termborrowings that qualifies as regulatory capital.  See *Market for Common Equityand Related Shareholder Matters*under Item 5 of Part II of thisreport.

The U.S. Department ofthe Treasury, Community Development Financial Institutions Fund, has certifiedBancorp and the Bank as Community Development Financial Institutions (“CDFI”).  This status also conveys possible CommunityReinvestment Act (“CRA”) credit to institutional depositors and investors inthe Bank and Bancorp.  It also opens tothe Bank and Bancorp various government sponsored programs, grants, and awardsin which they may participate.  The Bankand Bancorp are also certified by the CDFI Fund as Community DevelopmentEntities (“CDE’s”).  As CDE’s, qualifyinginvestments made in the Bank or Bancorp provide the investor with a New MarketsTax Credit equal to 39% of the investment, to be realized over a seven-yearperiod.

With its status as a CDFI, Bancorp completed theprivate placement of $500,000 in preferred stock during December 2000 with theCDFI Fund.  Bancorp also was awarded asecond $500,000 Core Award in 2001 from the CDFI Fund, which was funded inDecember 2002 in the form of preferred stock. This was matched with a combination of preferred and common sharesthrough an investment of $500,000 from the National Community Investment Fund (“NCIF”).  In 2004 the Bank received a $1,240,929 BankEnterprise Award (“BEA”) from the CDFI Fund.  The award was made under theFiscal Year 2004 BEA Program, which provides an incentive for any FDIC insuredbank to annually increase the levels of financial services provided toeconomically distressed communities.  The Bank also received a similaraward in 2001 of $990,000.

In 2005 Bancorp received a $135,000 CDFI technicalassistance grant to help offset any costs associated with providing additionalservices to the un- and under-banked in its target market area.  Through December 31, 2006, the Company hadincurred qualifying expenses totaling $100 thousand.  That portion of the grant was recognized innon-interest income in 2006.  To theextent that future qualifying expenses or purchases are not incurred theremaining grant funds may have to be returned.

**MissionCommunity Bank**

The Bank opened onDecember 18, 1997, in San Luis Obispo, California, as a national bank charteredby the Comptroller of the Currency and opened additional offices in San LuisObispo County in the city of Paso Robles in 1998, and in Arroyo Grande andNipomo in 2002.  In July of 2005, theNipomo office was closed.  The Bank alsoopened a loan production office, the Business Banking Center, in San LuisObispo in January 2005.  The BusinessBanking Center is primarily engaged in originating and servicing SBA-guaranteedloans.  The Bank is authorized to engagein the general commercial banking business, and its deposits are insured by theFederal Deposit Insurance Corporation up to the applicable limits of thelaw.  At December 31, 2006, the Bank hadapproximately $157.7 million in assets, $122.8 million in loans, $124.7 millionin deposits, and $13.3 million in stockholders’ equity. The Bank does not offertrust services or international banking services and does not plan to do so inthe near future.

The Bank is alsocertified by the State of California Department of Insurance to accept depositsor investments under the California Organized Investment Network (the “COIN”).  The COIN program provides California taxcredits and/or CRA credit to individuals, corporations, or partnerships thatinvest at below market rates for specified terms.

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On December 29, 2003, theCalifornia Department of Financial Institutions (the “DFI”) approved the Bank’sconversion application to be chartered in the State of California as a FederalReserve Member Bank and effective on this date, the Bank returned its nationalcharter from the Comptroller of the Currency. The change in charter was completed primarily to allow the Bank tobenefit from the larger secured legal lending limit for banks chartered inCalifornia, specifically, increasing its legal lending limit from 15% to 25%for certain real estate secured loans. The Bank is now supervised by the Federal Reserve and the DFI.  Other than the change in legal lending limit,no material changes have occurred or are anticipated to occur in the futurefrom the charter change.

**Mission Community Development Corporation (“MCDC”)**

Mission Community Development Corporation, a communitydevelopment corporation which was incorporated in August 1997, is awholly-owned subsidiary of the Bank. MCDC is a “for-profit” Community Development Corporation (“CDC”), whichprovides financing for small businesses and low- to moderate-income areadevelopment and/or affordable housing projects. Its purpose is to benefit small business and low- to moderate-incomeareas/residents.  The board of directorsof MCDC consists of four members of the Board of Directors of the Bank andthree outside members who are actively involved in representing and supportingthe low income community.

At December 31, 2006,MCDC had approximately $200,000 in net loans and $313,000 in shareholder’sequity, and provided loan accounting services for a very small pool ofcommunity development micro loans which were funded by a group of banks throughthe Economic Vitality Corporation, as well as management of an emergencyassistance loan pool created after the San Simeon earthquake of December2003.  MCDC also manages a loan pool forthe San Luis Obispo County Housing Trust Fund to assist in providing affordablehousing within the county.

**Mission Community Services Corporation (“MCSC”)**

Bancorp and the Bank have an affiliate relationshipwith, but no ownership of, MCSC, which was incorporated in August 1997 andwhich was established in September 2003 as a “not-for-profit” public charitablecorporation under Internal Revenue Code Section 501(c)(3).  The accounts of MCSC are not included in theCompany’s consolidated financial statements or elsewhere in this Form10-KSB.  MCSC’s primary focus is toprovide technical assistance and training services to the community, includingsmall business, minority and low-income entrepreneurs.  The Board of Directors of MCSC includesrepresentatives from the Company, together with members representing thelow-income and business community.  Overthe three-year period ended December 31, 2006, Bancorp has provided approximately$414 thousand in cash contributions to MCSC.

During 2006, MCSC was awarded a five-year, $750,000grant from the U.S. Small Business Administration to fund one of 99 Women’sBusiness Centers nationwide.  While MCSChas not engaged in any direct lending, it intends to provide some lending inthe near future.  See also Note L to theConsolidated Financial Statements for additional information regarding MCSC.

**The “Mission” Group**

Bancorp, the Bank and its subsidiary MCDC, and MCSCform an organizational structure intended to provide traditional community bankfinancial services and to foster economic revitalization and communitydevelopment to its target market areas.

**Bankruptcy or Similar Proceedings**

There are no bankruptcy, receivership, or similarproceedings applicable to the Company, the Bank, MCDC, nor MCSC.

**Material Reclassifications or Other Changes**

There have been no material reclassifications,mergers, consolidations, or purchase or sale of a significant amount of assetsnot in the ordinary course of business.

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**BUSINESS OF ISSUER**

**Principal Products, Services, and Markets**

Other than holding the shares of the Bank, Bancorpconducts no significant activities. Bancorp is authorized with the priorapproval of the Board of Governors of the Federal Reserve System (the “FederalReserve Board”), its principal regulator, to engage in a variety of activitieswhich are deemed closely related to the business of banking.

The Bank offers checkingand savings accounts, money market accounts and time certificates of deposits;offers commercial, agribusiness, government guaranteed, real estate, automobileand other installment and term loans and leases; issues drafts, sells travelers’checks and provides other customary banking services. Although the Bank doesnot operate a trust department or provide international services, it makestrust services or international services available through correspondentinstitutions.

The areas in which theBank has directed virtually all of its lending activities are commercial loans(including government-guaranteed loans), agricultural loans, constructionloans, real estate loans, and consumer loans. As of December 31, 2006, these five categories accounted forapproximately 17.9%, 0.1%, 25.8%, 54.2%, and 2.0% respectively, of the Bank’sgross loan portfolio.  As of that date,$98.2 million, or 80.0%, of the Bank’s loans consisted of interim constructionand real estate loans, for single family residences or for commercialdevelopment.  This represents a decreasein construction and real estate loans from the prior year’s combined85.2%.  Under the regulatory definitionof commercial real estate—which excludes owner-occupied properties—the Bank’scommercial real estate concentration is reduced to $69.4 million, or 56.5% oftotal loans.  See *Concentrations*in Management’s Discussion and Analysis under Item 6 of Part II of this report.

As of December 31, 2006,the Bank had 3,948 deposit accounts, including 2,221 demand accounts totaling$36.7 million; 1,133 savings accounts with balances totaling $26.3 million; and594 time certificates of deposit totaling $61.3 million.

The principal sources of the Bank’s revenues areinterest and fees on loans, interest on investments including federal fundssold, gain on sale of loans, service charges on deposit accounts, and othercharges and fees.  For the year endedDecember 31, 2006, these sources comprised 86.6%, 8.0%, 2.5%, 2.2%,and 0.7%,respectively, of the Bank’s total operating income.

**Distribution Methods of theProducts and Services**

The Bank’s primaryservice area consists of San Luis Obispo County and Northern Santa BarbaraCounty, which lie centrally within the State of California along the PacificOcean.  Secondary market areas includecities and unincorporated areas in the neighboring counties, includingMonterey, Kern, Kings, and Fresno.

The Bank operates out ofthree full service offices (in the cities of San Luis Obispo, Paso Robles andArroyo Grande) 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 servicesthrough direct contact by calling officers who travel into the neighboringcounties.  Physical expansion into theneighboring counties would most likely come from acquisitions or in the form ofloan production offices although there are no immediate plans for acquisitionsor loan production offices.

The Bank’s operating policy since its inception hasemphasized community development through small business, commercial and retailbanking.  Most of the Bank’s customers areretail customers, farmers and small to medium-sized businesses.  As a CDFI, the Bank also emphasizes loans andfinancial services to low- to moderate-income communities within its targetmarket area.  Most of the Bank’s depositsare attracted by relationship banking, local activities, and advertising.

The business plan of theBank emphasizes providing highly specialized financial services in aprofessional and personalized manner to individuals and businesses in itsservice area.  Its key strengths are customerservice and an experienced management team familiar with the community throughthe Bank’s involvement in various community lending and development projects.

In 2005 and 2006, the Bank extended its use ofInternet technology as a distribution tool to improve its customer service bymaking available an enhanced Internet Banking and bill-pay product, as well asACH origination.

During 2006 the Bank began to capitalize on its statusas the only bank in San Luis Obispo County participating in the Certificate ofDeposit Account Registry Service (“CDARS”) program.  This program permits the Bank’s customers toplace all

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of their deposits at the Bank and have those depositsfully-insured by the FDIC, up to $30 million. The CDARS program acts as a clearinghouse, matching deposits from oneinstitution in the CDARS network of over 1,500 banks with other network banks(in increments of less than the $100 thousand FDIC insurance limit), so fundsthat a customer places with the Bank essentially remain on the Bank’s balancesheet.  While the Bank continues to focuson its local market areas, its participation in the CDARS program permits it tobid on additional certificates of deposit through banks across the country tomeet additional funding needs.  These “One-WayBuy” CDARS deposits are considered to be brokered deposits.  Management expects that brokered depositswill be used from time to time in the future as an alternative source offunding loan growth.  The Bank alsoexpects to continue to use its CDFI and COIN designations to attract lower costdeposits.

**Status of and Publicly Announced New Products orServices**

There has been no significant change in the types ofservices offered by the Bank since its inception. The Company has no presentplans to enter any material new line of business that would require theinvestment of a material amount of total assets.

The Bank participated in a 3-year project (2002-2005)sponsored by NCIF to explore and develop a profitable range of retail financialproducts and services to low income and unbanked customers (“low incomecustomers”).  NCIF is underwriting amajority of the costs associated with this project.  The project involved developing replicableand profitable business models for both particular products and services targetedat low income customers, and coordinated suites of products that can meet arange of needs.  Product and servicespecifications, target market, cross selling and profitability data has beentracked over a two- to three-year time horizon and suites of products are beingdeveloped that meet household financial and asset building needs while beingprofitable for financial institutions.

A Financial Education team of bank employees has beenformed, in an effort to reach out to the community to share sound moneymanagement practices and habits to the target market of low-income andunder-banked individuals.  A series of training workshops covering thefundamentals of banking and financial services have been developed in Englishand Spanish.  In conjunction with thesefinancial education programs, the Bank expects to offer Individual DevelopmentAccounts and access to debit cards and other electronic services.  The Bank expects to increase its focus onprofitable financial services for the un- and under-banked customers in itsmarket area, but does not expect these services will be a material percentageof its deposit activities.

The Company applied to the CDFI in 2004 for atechnical assistance grant to help offset any costs associated with providingadditional services to the un- and under-banked in its market area, andreceived a grant of $134,935 in 2005. During 2006 the Bank incurred approximately $100,000 in qualifyingexpenses under this grant.  Accordingly,the Bank recognized $100,000 of the grant as non-interest income in 2006.

**Competition**

The banking and financial services business in theBank’s market area is highly competitive. The increasingly competitive environment is a result primarily ofchanges in regulation, and changes in technology and product deliverysystems.  In order to compete with otherfinancial institutions in its service area, the Bank relies upon localadvertising programs; direct personal contact by officers, directors,employees, and shareholders; and specialized services such as courierpick-up.  The Bank emphasizes to itscustomers the advantages of dealing with a locally owned and communitydevelopment oriented institution. Larger banks may have a competitive advantagebecause of higher lending limits and major advertising and marketing campaignsin 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 hasmade arrangements with other financial service providers to extend suchservices to its customers where possible. For borrowers requiring loans in excess of the Bank’s legal lendinglimits, the Bank makes use of loan participations with its correspondent banksand with other independent banks, retaining the portion of such loans which iswithin its legal lending limits. Commercial banks compete with savings and loan associations, creditunions, other financial institutions, securities brokerage firms, and otherentities for funds.  For instance, yieldson corporate and government debt securities and other commercial paper affectthe ability of commercial banks to attract and hold deposits.

The Bank utilizes technology to improve itscompetitive advantages by use of ATMs, Internet Banking, ACH origination,electronic bill pay, email, and credit card and merchant card relationships.

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In addition, in order tocompete effectively, the Bank has created a sales and service culture thatcombines the experience of its senior officers with the commitment to serviceand a focus on the individual needs of its customers that is found at the bestcommunity banks.  The Bank also relies onlocal advertising programs, direct personal contact by its officers, directors,employees and shareholders and specialized services such as courierpick-up.  The Bank believes it provides alevel of service and decision-making responsiveness not generally offered bylarger institutions.

The Bank’s primary servicearea consists of the County of San Luis Obispo and Northern Santa BarbaraCounty.    As in most major U.S. cities,large banks compete in our service area. However, rather than these large financial institutions, we believe ourprimary competitors for individuals and small and medium-sized businesscustomers are the community banks that can provide the service andresponsiveness attractive to this customer base.

Within San Luis ObispoCounty, based on data from the FDIC as of June 30, 2006, there were 15 bankswith 74 branches with aggregate assets of $4.5 billion.  Of the 15 banks, 10 were community banks(banks with less than $1 billion in assets), with 8 of these banksheadquartered in San Luis Obispo County. There were also four credit unions in San Luis Obispo County.  In Northern Santa Barbara County there were 16banks with 37 branch offices having an aggregate of $2.1 billion indeposits.  Eight of those banks arecommunity banks with only 1 headquartered in Northern Santa Barbara County.

**Sources and availability of Raw Materials andPrincipal Suppliers**

As a service organization, the Company is notdependent on raw materials.

**No Dependence on One or a Few Major Customers**

The Bank is limited, due to legal lending limits, inthe size of loans it can make to any one individual borrower (in theaggregate).  It has in its portfolioapproximately 600 loans to nearly 400 loan customers.  As of December 31, 2006, the Bank’s legallending limit to a single borrower, and such borrower’s related parties, wasapproximately $3.8 million on a secured basis (first trust deed), and was $2.2million for unsecured loans, based on regulatory capital plus reserves ofapproximately $14.3 million.

A material portion of the Bank’s deposits have notbeen obtained from a single person or a few persons, the loss of any one ormore of which would have a materially adverse effect on the business of theBank.  The Bank has a higher than averagedependence (as measured by peer group analysis) on larger deposit balances(deposits of $100,000 or more) with a total of 308 deposit accounts holding$74.8 million in deposits as of December 31, 2006.  Included in those totals are ten customerswith deposits of $1 million or more totaling $26.6 million.  These deposit balances have been reasonablystable during the past several years and are consistent with the Bank’sdeposit/funding strategy.

The Bank’s business does not appear to be seasonal.

**Patents, trademarks, licenses, franchisees,concessions, royalties, etc.**

The Bank holds no special patents, licenses (otherthan licenses obtained from bank regulatory authorities), franchises orconcessions.

**Effect ofGovernment Policies and Regulations**

Banking is a business that depends on ratedifferentials.  In general, the differencebetween the interest rate paid by the Bank on its deposits and its other borrowingsand the interest rate received by the Bank on loans extended to its customersand securities held in the Bank’s portfolio comprise the major portion of theBank’s earnings.  These rates are highlysensitive 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 domesticand foreign economic conditions, including inflation, recession and unemployment.

The commercial bankingbusiness is not only affected by general economic conditions but is alsoinfluenced by the monetary and fiscal policies of the federal government andthe policies of regulatory agencies, particularly the Federal ReserveBoard.  The Federal Reserve Boardimplements national monetary policies (with objectives such as curbing inflationand combating recession) by its open-market operations in U.S. Governmentsecurities, by adjusting the required level of reserves for financialinstitutions subject to its reserve requirements and by varying the discountrates applicable to borrowings by

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depository institutions.The actions of the Federal Reserve Board in these areas influence the growth ofbank loans, investments and deposits and also affect interest rates charged onloans and paid on deposits.  The natureand 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 doingbusiness, limiting or expanding permissible activities or affecting the competitivebalance between banks and other financial institutions.  Proposals to change the laws and regulationsgoverning the operations and taxation of banks, bank holding companies andother financial institutions are frequently made in Congress, in the Californialegislature and before various bank regulatory and other professionalagencies.  For example, the Bank’sability to originate and sell SBA loans would be severely impacted if federalappropriations for the SBA lending program were curtailed or eliminated.

**Supervision and Regulation**

Both federal and statelaw extensively regulates banks and bank holding companies.  This regulation is intended primarily for theprotection of depositors and the deposit insurance fund and not for the benefitof shareholders of the Company.  Thefollowing is a summary of particular statutes and regulations affecting theCompany and the Bank.  This summary isqualified in its entirety by the statutes and regulations.  No assurance can be given that such statutesor regulations will not change in the future.

**Regulation of MissionCommunity Bancorp**

Mission Community Bancorpis a registered bank holding company under the Bank Holding Company Act of1956, as amended, and is regulated by the Federal Reserve Board.  The Company is required to file periodicreports with the Federal Reserve Board and such additional information as theFederal Reserve Board may require pursuant to the Bank Holding CompanyAct.  The Federal Reserve Board may conductexaminations of the Company and its subsidiaries, which includes the Bank.

The Bank Holding CompanyAct requires every bank holding company to obtain the prior approval of theFederal Reserve Board before acquiring substantially all the assets of any bankor bank holding company or ownership or control of any voting shares of anybank or bank holding company, if, after the acquisition, it would own orcontrol, directly or indirectly, more than 5% of the voting shares of the bankor bank holding company.

The Company is prohibitedby the Bank Holding Company Act, except in statutorily prescribed instances,from acquiring direct or indirect ownership or control of more than 5% of theoutstanding voting shares of any company that is not a bank or bank holdingcompany and from engaging directly or indirectly in activities other than thoseof banking, managing or controlling banks or furnishing services to itssubsidiaries.  However, the Company,subject to notification or the prior approval of the Federal Reserve Board, asapplicable in each specific case, may engage in any, or acquire shares ofcompanies engaged in, activities that are deemed by the Federal Reserve Boardto be “so closely related to banking” or managing or controlling banks as to bea “proper incident thereto.”

In approving acquisitionsby bank holding companies of companies engaged in banking-related activities,the Federal Reserve Board considers whether the performance of any activity bya subsidiary of the holding company reasonably can be expected to producebenefits to the public, including greater convenience, increased competition,or gains in efficiency, which outweigh possible adverse effects, includingover-concentration of resources, decrease of competition, conflicts ofinterest, or unsound banking practices.

Regulations and policiesof the Federal Reserve Board require a bank holding company to serve as asource of financial and managerial strength to its subsidiary banks.  It is the Federal Reserve Board’s policy thata bank holding company should stand ready to use available resources to provideadequate capital funds to a subsidiary bank during periods of financial stressor adversity and should maintain the financial flexibility and capital-raisingcapacity to obtain additional resources for assisting a subsidiary bank.  Under certain conditions, the Federal ReserveBoard may conclude that certain actions of a bank holding company, such as apayment of a cash dividend, would constitute an unsafe and unsound bankingpractice.

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The Company is requiredto give the Federal Reserve Board prior written notice of any repurchase of itsoutstanding 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 aremet.

Bank holding companytransactions with subsidiaries and other affiliates are restricted, includingqualitative and quantitative restrictions on extensions of credit and similartransactions.

The Company and the Bankare deemed to be affiliates of one another within the meaning set forth in theFederal Reserve Act and are subject to Sections 23A and 23B of the FederalReserve Act.  This means, for example,that there are limitations on loans by the Bank to affiliates, and that allaffiliate transactions must satisfy certain limitations and otherwise be onterms and conditions at least as favorable to the Bank as would be availablefor non-affiliates.

The securities of theCompany are also subject to the requirements of the Securities Act, and mattersrelated thereto are regulated by the Securities and Exchange Commission.  Certain issuances may also be subject to theCalifornia’s corporate securities law as administered by the CaliforniaCommissioner of Corporations.  TheCompany is subject to the public reporting requirements of the Securities andExchange Act of 1934, as amended, generally applicable to publicly heldcompanies, under Section 15(d) of the Exchange Act.  Companies which file a registration statementunder the Securities Act are required under Section 15(d) of the Exchange Actfor at least a 12-month period after the effectiveness of such registrationstatement to file periodic quarterly and annual reports under the SecuritiesAct.  If and when the Company has morethan 500 shareholders of record, it will be required to register its securitieswith the Securities and Exchange Commission under Section 12(g) of the ExchangeAct at which time its filing of periodic reports, as well as certain otherreporting obligations, will become mandatory.

**Regulation of MissionCommunity Bank**

As a Californiastate-chartered bank, the Bank is subject to regulation, supervision andexamination by the California Department of Financial Institutions.  It is also a member of the Federal ReserveSystem and, as such, is subject to applicable provisions of the Federal ReserveAct and the regulations promulgated thereunder by the Board of Governors of theFederal Reserve System.  In addition, thedeposits of the Bank are insured by the Federal Deposit Insurance Corporationto a maximum of $100,000 per depositor, and up to a maximum of $250,000 withrespect to certain retirement accounts. For this protection, the Bank pays a quarterly assessment to the FDICand is subject to the rules and regulations of the FDIC pertaining to depositinsurance and other matters.  Theregulations of those agencies will govern most aspects of  the Bank’s business, including the making ofperiodic reports by the Bank, and the Bank’s activities relating to dividends,investments, loans, borrowings, capital requirements, certain check-clearingactivities, branching, mergers and acquisitions, reserves against deposits, theissuance of securities and numerous other areas.

The earnings and growthof the Bank is largely dependent on its ability to maintain a favorabledifferential or “spread” between the yield on its interest-earning assets andthe rate paid on its deposits and other interest-bearing liabilities.  As a result, the Bank’s performance isinfluenced by general economic condi­tions, both domestic and foreign, themonetary and fiscal policies of the federal government, and the policies of theregulatory agencies, particularly the Federal Reserve Board.  The Federal Reserve Board implements nationalmonetary policies (such as seeking to curb inflation and combat recession) byits open-market operations in United States Government securities, by adjustingthe required level of reserves for financial institutions subject to itsreserve requirements and by varying the discount rate applicable to borrowingsby banks which are members of the Federal Reserve System.  The actions of the Federal Reserve Board inthese areas influence the growth of bank loans, investments and deposits andalso affect interest rates charged on loans and deposits.  The nature and impact of any future changesin monetary policies cannot be predicted.

**Capital AdequacyRequirements**

The Company and the Bankare subject to the regulations of the Federal Reserve Board governing capitaladequacy.  Those regulations incorporateboth risk-based and leverage capital requirements.  Under existing regulations, the capitalrequirements 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 subsidiarybank.  The Federal Reserve Board hasestablished risk-based and leverage capital guidelines for the banks itregulates, which set total capital requirements and define capital in terms of “corecapital elements,” or Tier 1 capital and “supplemental capital elements,” orTier 2 capital.  Tier 1 capital isgenerally defined as the sum of the core capital elements less goodwill andcertain intangibles.  The following itemsare defined as

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core capitalelements:  (i) common stockholders’equity; (ii) qualifying non-cumulative perpetual preferred stock and relatedsurplus; and (iii) minority interests in the equity accounts of consolidatedsubsidiaries.  Supplementary capitalelements include:  (i) allowance for loanand lease losses (but not more than 1.25% of an institution’s risk-weightedassets); (ii) perpetual preferred stock and related surplus not qualifying ascore capital; (iii) hybrid capital instruments, perpetual debt and mandatoryconvertible debt instruments; and (iv) term subordinated debt and intermediate-termpreferred stock and related surplus.  Themaximum amount of supplemental capital elements which qualifies as Tier 2capital is limited to 100% of Tier 1 capital, net of goodwill.

The Bank is required tomaintain a minimum ratio of qualifying total capital to total risk-weightedassets of 8.0% (“Total Risk-Based Capital Ratio”), at least one-half ofwhich must be in the form of Tier 1 capital (“Tier 1 Risk-Based Capital Ratio”).  Risk-based capital ratios arecalculated to provide a measure of capital that reflects the degree of riskassociated with a banking organization’s operations for both transactionsreported on the balance sheet as assets, and transactions, such as letters ofcredit and recourse arrangements, which are recorded as off-balance sheetitems.  Under the risk-basedcapital guidelines, the nominal dollar amounts of assets and credit-equivalentamounts of off-balance sheet items are multiplied by one of several riskadjustment percentages, which range from 0% for assets with low credit risk,such as certain U. S. Treasury securities, to 100% for assets withrelatively high credit risk, such as business loans.  As of December 31, 2006 and December 31,2005, the Bank’s Total Risk-Based Capital Ratio was 11.3% and 10.7%,respectively, and its Tier 1 Risk-Based Capital Ratio was 10.5% and 9.8%,respectively.

The risk-basedcapital standards also take into account concentrations of credit and the risksof “non-traditional” activities (those that have not customarily beenpart of the banking business). The regulations require institutions with highor inordinate levels of risk to operate with higher minimum capital standards,and authorize the regulators to review an institution’s management of suchrisks in assessing an institution’s capital adequacy.

Additionally, the regulatorystatements of policy on risk-based capital include exposure to interestrate risk as a factor that the regulators will consider in evaluating a bank’scapital adequacy, although interest rate risk does not impact the calculationof a bank’s risk-based capital ratios. Interest rate risk is the exposure of a bank’s current and futureearnings and equity capital arising from adverse movements in interestrates.  While interest risk is inherentin a bank’s role as financial intermediary, it introduces volatility to bankearnings and to the economic value of the bank or bank holding company.

The Federal Reserve Boardrisk-based capital guidelines are based upon the 1988 capital accord of theBasel Committee on Banking Supervision (the “BIS”).  The BIS is a committee of central banks andbank supervisors/regulators from the major industrialized countries thatdevelops broad policy guidelines that each country’s supervisors can use todetermine the supervisory policies they apply. The BIS has been working for a number of years on revisions to the 1988capital accord and in June 2004 released the final version of its proposed newcapital framework, with an update in November 2005 (“BIS II”).  BIS II provides two approaches for settingcapital standards for credit risk — an internal ratings-based approach tailoredto individual institutions’ circumstances (which for many asset classes isitself broken into a “foundation” approach and an “advanced” or “A-IRB”approach, the availability of which is subject to additional restrictions) anda standardized approach that bases risk weightings on external creditassessments to a much greater extent than permitted in existing risk-basedcapital guidelines. BIS II also would set capital requirements for operationalrisk and refine the existing capital requirements for market risk exposures.

The U.S. banking andthrift agencies are developing proposed revisions to their existing capitaladequacy regulations and standards based on BIS II. In September 2006, theagencies issued a notice of proposed rulemaking setting forth a definitiveproposal for implementing BIS II in the United States that would apply only tointernationally active banking organizations — defined as those withconsolidated total assets of $250 billion or more or consolidated on-balancesheet foreign exposures of $10 billion or more — but that other U.S. bankingorganizations could elect but would not be required to apply.  In December 2006 the agencies issued a noticeof proposed rulemaking describing proposed amendments to their existingrisk-based capital guidelines to make them more risk-sensitive, generallyfollowing aspects of the standardized approach of BIS II.  These latter proposed amendments, oftenreferred to as “BIS I-A”, would apply to banking organizations that are notinternationally active banking organizations subject to the A-IRB approach forinternationally active banking organizations and do not “opt in” to thatapproach.  The comment periods for bothof the agencies’ notice of proposed rulemakings expire on March 26, 2007.  The agencies have indicated their intent tohave the A-IRB provisions for internationally active U.S. banking organizationsfirst become effective in March 2009 and that those provisions and the BIS I-Aprovisions for others will be implemented on similar timeframes.

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The Company is not aninternationally active banking organization and has not made a determination asto whether, as a stand-alone institution, it would opt to apply the A-IRBprovisions applicable to internationally active U.S. banking organizations oncethey become effective.

Banks are also requiredto maintain a leverage capital ratio designed to supplement the risk-basedcapital guidelines.  Banks that havereceived the highest rating of the five categories used by regulators to ratebanks and are not anticipating or experiencing any significant growth mustmaintain a ratio of Tier 1 capital (net of all intangibles) to adjusted totalassets (“Leverage Capital Ratio”) of at least 3%.  All other institutions are required tomaintain 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 levelscommensurate with the level of risk to which they are exposed, including thevolume and severity of problem loans, and federal regulators may set highercapital requirements when a bank’s particular circumstances warrant.  As of December 31, 2006 and December 31,2005, the Bank’s Leverage Capital Ratio was 9.3% and  9.2%, respectively.

On March 1, 2005, theFederal Reserve Board adopted a final rule that allows the continued inclusionof trust-preferred securities in the Tier I capital of bank holdingcompanies.  However, under the finalrule, after a five-year transition period, the aggregate amount of trustpreferred securities and certain other capital elements that could qualify asTier I capital would be limited to 25 percent of Tier I capital elements, netof goodwill

**Prompt Corrective ActionProvisions**

Federal law requires eachfederal banking agency to take prompt corrective action to resolve the problemsof insured financial institutions, including but not limited to those that fallbelow one or more prescribed minimum capital ratios.  The federal banking agencies have byregulation 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-BasedCapital Ratio of 8%; Tier 1 Risk-Based Capital Ratio of 4%; and LeverageCapital Ratio of 4%) (or 3% if the institution receives the highest rating fromits primary regulator); “undercapitalized” (Total Risk-Based Capital Ratio ofless than 8%; Tier 1 Risk-Based Capital Ratio of less than 4%; or LeverageCapital Ratio of less than 4%) (or 3% if the institution receives the highestrating from its primary regulator); “significantly undercapitalized” (TotalRisk-Based Capital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio ofless than 3%; or Leverage Capital Ratio less than 3%); and “criticallyundercapitalized” (tangible equity to total assets less than 2%).  A bank may be treated as though it were inthe next lower capital category if after notice and the opportunity for ahearing, the appropriate federal agency finds an unsafe or unsound condition orpractice so warrants, but no bank may be treated as “criticallyundercapitalized” unless its actual capital ratio warrants such treatment.

At each successivelylower capital category, an insured bank is subject to increased restrictions onits operations.  For example, a bank isgenerally prohibited from paying management fees to any controlling persons orfrom making capital distributions if to do so would make the bank “undercapitalized.”  Asset growth and branching restrictions applyto undercapitalized banks, which are required to submit written capitalrestoration plans meeting specified requirements (including a guarantee by theparent holding company, if any).  “Significantlyundercapitalized” banks are subject to broad regulatory authority, includingamong other things, capital directives, forced mergers, restrictions on therates of interest they may pay on deposits, restrictions on asset growth andactivities, and prohibitions on paying bonuses or increasing compensation tosenior executive officers without regulatory approval.  Even more severe restrictions apply tocritically undercapitalized banks.  Mostimportantly, except under limited circumstances, not later than 90 days afteran insured bank becomes critically undercapitalized, the appropriate federalbanking agency is required to appoint a conservator or receiver for the bank.

In addition to measurestaken under the prompt corrective action provisions, insured banks may besubject to potential actions by the federal regulators for unsafe or unsoundpractices in conducting their businesses or for violations of any law, rule,regulation or any condition imposed in writing by the agency or any writtenagreement with the agency.  Enforcementactions may include the issuance of cease and desist orders, termination ofinsurance of deposits (in the case of a bank), the imposition of civil moneypenalties, the issuance of directives to increase capital, formal and informalagreements, or removal and prohibition orders against “institution-affiliated”parties.

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**Safety and SoundnessStandards**

The federal banking agencies have also adoptedguidelines establishing safety and soundness standards for all insureddepository institutions.  Thoseguidelines relate to internal controls, information systems, internal auditsystems, loan underwriting and documentation, compensation and interest rateexposure.  In general, the standards aredesigned to assist the federal banking agencies in identifying and addressingproblems at insured depository institutions before capital becomesimpaired.  If an institution fails tomeet these standards, the appropriate federal banking agency may require theinstitution to submit a compliance plan and institute enforcement proceedingsif an acceptable compliance plan is not submitted.

**Premiums for DepositInsurance**

The Bank is a member of the Deposit Insurance Fund,maintained by the FDIC, and pays deposit insurance assessments to the DepositInsurance Fund.  The Deposit InsuranceFund was formed on March 31, 2006 following the merger of the Bank InsuranceFund and the Savings Association Insurance Fund in accordance with the FederalDeposit Insurance Reform Act of 2005.

We were not assessed any Deposit Insurance Fund orBank Insurance Fund premiums in 2005 or 2006. In November 2006 the FDIC adopted a new risk-based insurance assessmentsystem effective January 1, 2007 designed to tie what banks pay fordeposit insurance more closely to the risks they pose.  The FDIC also adopted a new base schedule ofrates that the FDIC can adjust up or down, depending on the needs of theDeposit Insurance Fund and set initial premiums beginning January 1, 2007, thatrange from 5 cents per $100 of domestic deposits in the lowest risk category to43 cents per $100 of domestic deposits for banks in the highest riskcategory.  Because the new rates arecalculated quarterly in arrears, we have not yet been notified of our newassessment rate as of January 1, 2007, but we expect it to be in the range of 5cents to 7 cents per $100 of domestic deposits.

In addition, all Federal Deposit InsuranceCorporation-insured institutions are required to pay assessments to the FederalDeposit Insurance Corporation at an annual rate of approximately 0.0122% ofinsured deposits to fund interest payments on bonds issued by the FinancingCorporation to fund the closing and disposal of failed thrift institutions bythe Resolution Trust Corporation.  Theseassessments will continue until the Financing Corporation bonds mature in 2017.

**Community ReinvestmentAct**

The Bank is subject to certain requirements andreporting obligations involving Community Reinvestment Act activities.  The Community Reinvestment Act generallyrequires the federal banking agencies to evaluate the record of a financial institutionin meeting the credit needs of its local communities, including low andmoderate income neighborhoods. The Community Reinvestment Act further requiresthe agencies to take a financial institution’s record of meeting its communitycredit needs into account when evaluating applications for, among other things,domestic branches, consummating mergers or acquisitions, or holding companyformations.  In measuring a bank’scompliance with its Community Reinvestment Act obligations, the regulatorsutilize a performance-based evaluation system which bases CommunityReinvestment Act ratings on the bank’s actual lending service and investmentperformance, rather than on the extent to which the institution conducts needsassessments, documents community outreach activities or complies with other proceduralrequirements.  In connection with itsassessment of Community Reinvestment Act performance, the agencies assign arating of “outstanding,” “satisfactory,” “needs to improve” or “substantialnoncompliance.”  The Bank received an “outstanding”rating in its most recent Community Reinvestment Act examination.

**Other Consumer ProtectionLaws and Regulations**

The banking regulatory agencies have been increasinglyfocusing attention on compliance with consumer protection laws andregulations.  Examination and enforcementhas become intense, and banks have been advised to carefully monitor compliancewith various consumer protection laws and their implementing regulations. Thefederal Interagency Task Force on Fair Lending issued a policy statement on discriminationin home mortgage lending describing three methods that federal agencies willuse to prove discrimination: overt evidence of discrimination, evidence ofdisparate treatment, and evidence of disparate impact.  In addition to Community Reinvestment Act andfair lending requirements, the Bank is subject to numerous other federalconsumer protection statutes and regulations. Due to heightened regulatory 

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concern related tocompliance with consumer protection laws and regulations generally, the Bank mayincur substantial compliance costs or be required to expend additional fundsfor investments in the local communities it serves.

**Interstate Banking andBranching**

The Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994 regulates the interstate activities of banks and bankholding companies and establishes a framework for nationwide interstate bankingand branching.  Since June 1, 1997,a bank in one state has generally been permitted to merge with a bank inanother state without the need for explicit state law authorization.  However, states were given the ability toprohibit interstate mergers with banks in their own state by “opting-out”(enacting state legislation applying equally to all out-of-state banksprohibiting such mergers) prior to June 1, 1997.

Since 1995, adequately capitalized and managed bankholding companies have been permitted to acquire banks located in any state,subject to two exceptions: first, any state may still prohibit bank holdingcompanies 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 theacquiror would control more then 10% of the deposits held by insured depositoryinstitutions nationwide or 30% percent or more of the deposits held by insureddepository institutions in any state in which the target bank has branches.

In 1995 California enacted legislation to implementimportant provisions of the Riegle-Neal Act discussed above and to repealCalifornia’s previous interstate banking laws, which were largely preempted bythe Riegle-Neal Act.

A bank may establish and operate de novo branches inany state in which the bank does not maintain a branch if that state hasenacted legislation to expressly permit all out-of-state banks toestablish branches in that state. However, California law expressly prohibits an out-of-statebank which does not already have a California branch office from (i) purchasinga branch office of a California bank (as opposed to purchasing the entire bank)and thereby establishing a California branch office or (ii) establishing a denovo branch in California.

The changes effected by the Riegle-Neal Act andCalifornia laws have increased competition in the environment in which the Bankoperates to the extent that out-of-state financial institutions maydirectly or indirectly enter the Bank’s market areas.  It appears that the Riegle-Neal Act hascontributed to the accelerated consolidation of the banking industry.  While many large out-of-state banks havealready entered the California market as a result of this legislation, it isnot possible to predict the precise impact of this legislation on the Bank andthe competitive environment in which it operates.

**Financial ModernizationAct**

Effective March 11, 2000, the Gramm-Leach-Bliley Act,also known as the “Financial Modernization Act”, enabled full affiliations tooccur between banks and securities firms, insurance companies and otherfinancial service providers.  Thislegislation permits bank holding companies to become “financial holdingcompanies” and thereby acquire securities firms and insurance companies andengage in other activities that are financial in nature.  A bank holding company may become a financialholding company if each of its subsidiary banks is “well capitalized” and “wellmanaged” under applicable definitions, and has at least a satisfactory ratingunder the CRA by filing a declaration that the bank holding company wishes tobecome a financial holding company.

The Financial Modernization Act defines “financial innature” to include securities underwriting, dealing and market making;sponsoring mutual funds and investment companies; insurance underwriting andagency; merchant banking activities; and activities that the Federal ReserveBoard has determined to be closely related to banking.  A national bank also may engage, subject tolimitations on investment, in activities that are financial in nature, otherthan insurance underwriting, insurance company portfolio investment, real estatedevelopment and real estate investment, through a financial subsidiary of thebank, if the bank is well capitalized, well managed and has at least asatisfactory CRA rating.  Subsidiarybanks of a financial holding company or national banks with financialsubsidiaries must continue to be well capitalized and well managed in order tocontinue to engage in activities that are financial in nature withoutregulatory actions or restrictions, which could include divestiture offinancial subsidiaries.  In addition, afinancial holding company or a bank may not acquire a company that is engagedin activities that are financial in nature unless each of the subsidiary banksof the financial holding company or the bank has a CRA rating of satisfactoryor better. The Gramm-Leach-Bliley 

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Act also imposessignificant requirements on financial institutions with respect to the privacyof customer information, and modifies other existing laws, including thoserelated to community reinvestment.

**USA Patriot Act of 2001**

The USAPatriot Act of 2001 was enacted in October 2001 in response to the terroristattacks on September 11, 2001.  ThePatriot Act is intended to strengthen United States law enforcement’s and theintelligence communities’ ability to work cohesively to combat terrorism on avariety of fronts.  The impact of thePatriot Act on financial institutions of all kinds has been significant andwide ranging.  The Patriot Actsubstantially enhanced existing anti-money laundering and financialtransparency laws, and required appropriate regulatory authorities to adoptrules to promote cooperation among financial institutions, regulators, and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering.  Under the PatriotAct, financial institutions are subject to prohibitions regarding specifiedfinancial transactions and account relationships, as well as enhanced duediligence and “know your customer” standards in their dealings with foreignfinancial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, andcontrols generally require financial institutions to take reasonable steps:

·                                          to conduct enhanced scrutiny of accountrelationships to guard against money laundering and report any suspicioustransactions;

·                                          to ascertain the identity of the nominaland beneficial owners of, and the source of funds deposited into, each accountas needed to guard against money laundering and report any suspicioustransactions;

·                                          to ascertain for any foreign bank, theshares of which are not publicly traded, the identity of the owners of theforeign bank, and the nature and extent of the ownership interest of each suchowner; and

·                                          to ascertain whether any foreign bankprovides correspondent accounts to other foreign banks and, if so, the identityof those foreign banks and related due diligence information.

The Patriot Act alsorequires all financial institutions to establish anti-money launderingprograms, 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 theprograms.

The Bank hasadopted comprehensive policies and procedures, and has taken all necessaryactions, to ensure compliance with all financial transparency and anti-moneylaundering laws, including the Patriot Act.

**Sarbanes-OxleyAct of 2002**

As apublic company, the Company is subject to the Sarbanes-Oxley Act of 2002, whichimplements a broad range of corporate governance and accounting measures forpublic companies designed to promote honesty and transparency in corporateAmerica and better protect investors from corporate wrongdoing.  The Sarbanes-Oxley Act’s principal legislationand the derivative regulation and rule making promulgated by the Securities andExchange Commission includes:

·                                          the creation of an independent accounting oversightboard;

·                                          auditor independence provisions that restrictnon-audit services that accountants may provide to their audit clients;

·                                          additional corporate governance and responsibilitymeasures, including the requirement that the chief executive officer and chieffinancial officer certify financial statements;

·                                          a requirement that companies establish and maintain asystem of internal control over financial reporting and that a company’smanagement provide an annual report regarding its assessment of theeffectiveness of such internal control over financial reporting to the company’sindependent accountants;

·                                          a requirement that the company’s independentaccountants provide an attestation report with respect to management’sassessment of the effectiveness of the company’s internal control overfinancial reporting (this requirement is currently proposed to become effectivefor companies like the Company which is not an accelerated SEC filer for ourfirst fiscal year ending on or after December 15, 2008);

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·                                          the forfeiture of bonuses or other incentive-basedcompensation and profits from the sale of an issuer’s securities by directorsand senior officers in the twelve month period following initial publication ofany financial statements that later require restatement;

·                                          an increase in the oversight of, and enhancement ofcertain requirements relating to audit committees of public companies and howthey interact with the company’s independent auditors;

·                                          the requirement that audit committee members must beindependent and are absolutely barred from accepting consulting, advisory orother compensatory fees from the issuer;

·                                          the requirement that companies disclose whether atleast one member of the committee is a “financial expert” (as such term isdefined by the SEC) and if not, why not;

·                                          expanded disclosure requirements for corporateinsiders, including accelerated reporting of stock transactions by insiders anda prohibition on insider trading during pension blackout periods;

·                                          a prohibition on personal loans to directors andofficers, except certain loans made by insured financial institutions;

·                                          disclosure of a code of ethics and the requirement offiling of a Form 8-K for a change or waiver of such code;

·                                          mandatory disclosure by analysts of potentialconflicts of interest; and

·                                          a range of enhanced penalties for fraud and otherviolations.

**Transactions Between Affiliates**

Transactions between a bank and its “affiliates” arequantitatively and qualitatively restricted under the Federal Reserve Act.  The FRB has also issued Regulation W, whichcodifies prior regulations under Sections 23A and 23B of the Federal ReserveAct and interpretative guidance with respect to affiliate transactions.  Regulation W incorporates the exemption fromthe affiliate transaction rules but expands the exemption to cover the purchaseof any type of loan or extension of credit from an affiliate.  Affiliates of a bank include, among otherentities, companies that are under common control with the bank.  In general, subject to certain specifiedexemptions, a bank or its subsidiaries are limited in their ability to engagein “covered transactions” with affiliates:

·                  toan amount equal to 10% of the bank’s capital and surplus, in the case ofcovered transactions with any one affiliate; and

·                  toan amount equal to 20% of the bank’s capital and surplus, in the case ofcovered transactions with all affiliates.

Inaddition, a bank and its subsidiaries may engage in covered transactions andother specified transactions only on terms and under circumstances that aresubstantially the same, or at least as favorable to the bank or its subsidiary,as those prevailing at the time for comparable transactions with nonaffiliatedcompanies. A “covered transaction” includes:

·                  aloan or extension of credit to an affiliate;

·                  apurchase of, or an investment in, securities issued by an affiliate;

·                  apurchase of assets from an affiliate, with some exceptions;

·                  theacceptance of securities issued by an affiliate as collateral for a loan orextension of credit to any party; and

·                  theissuance of a guarantee, acceptance or letter of credit on behalf of anaffiliate.

Inaddition, under Regulation W:

·                  abank and its subsidiaries may not purchase a low-quality asset from anaffiliate;

·                  coveredtransactions and other specified transactions between a bank or itssubsidiaries and an affiliate must be on terms and conditions that areconsistent with safe and sound banking practices; and

·                  withsome exceptions, each loan or extension of credit by a bank to an affiliatemust 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 ofcredit.

Regulation W generallyexcludes all non-bank and non-savings association subsidiaries of banks fromtreatment as affiliates, except to the extent that the FRB decides to treatthese subsidiaries as affiliates.

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**Environmental Regulations**

Management of the Bank is unaware of any materialeffect upon the Bank’s capital expenditures, earnings or competitive positionas a result of federal, state or local environmental regulation.

**Employees**

As of March 1, 2007 the Bank had a total of 53employees. The management of the Bank believes that its employee relations aresatisfactory.  Neither Bancorp nor MCDChave salaried employees; Bancorp’s officers all hold similar positions at theBank.  The Bank, under inter-companyarrangements, may charge Bancorp and/or MCDC for management, staff, andservices; however, the time and services are not material at this time.

**Certain Business Risks**

In addition to other information contained in thisReport, the following risks may affect the Company.  If any of these risks occur, the Company’sbusiness, financial condition and operations results could be adverselyaffected

**Significant reliance on loans secured by realestate may increase the Bank’s vulnerability to downturns in the Californiareal estate market and other variables impacting the value of real estate**

A substantial portion of our assets consist ofconstruction and real estate loans which are generally secured by real estatein the Central Coast of California.  AtDecember 31, 2006, approximately $98.0 million or 80% of our loans wereconstruction and real estate loans, and at December 31, 2005, approximately$102 million or  85% of our loans wereconstruction and real estate loans. A real estate recession in the CentralCoast of California could increase the level of our non-performing assets andadversely affect our results of operations. In recent years, real estate pricesin the Central Coast of California rose precipitously; however, this real estatemarket ended in 2006 with declining prices and a slower sales pace.  If real estate prices were to fallsignificantly in the Central Coast of California, the security for many of ourreal estate secured loans could be reduced and we could incur significantlosses if borrowers of real estate secured loans default, and the value of ourcollateral is insufficient to cover our losses.   In addition, California has experienced, onoccasion, significant natural disasters, including earthquakes, brush fires and,during early 1998, flooding attributed to the weather phenomenon known as “ElNino.”  The availability of insurance forlosses from such catastrophes is limited. The occurrence of one or more of such catastrophes could impair thevalue of the collateral for our real estate secured loans and adversely affectus.

**If a significant number of customers fail toperform under their loans, the Company’s business, profitability, and financialcondition would be adversely affected**

As a lender, the largest risk we face is thepossibility that a significant number of our client borrowers will fail to paytheir loans when due.  If borrowerdefaults cause losses in excess of our allowance for loan losses, it could havean adverse effect on our business, profitability, and financial condition.  We have established an evaluation processdesigned to determine the adequacy of the allowance for loan losses.  Although this evaluation process uses historicaland other objective information, the classification of loans and the establishmentof loan losses are dependent to a great extent on our experience andjudgment.  Although we believe that ourallowance for loan losses is at a level adequate to absorb any inherent lossesin our loan portfolio, we cannot assure you that we will not further increasethe allowance for loan losses or that our regulators will not require us toincrease this allowance.

**The Bank’s earnings are subject to interest raterisks, especially if rates fall**

A major portion of our net income comes from our interestrate spread, which is the difference between the interest rates paid by us oninterest-bearing liabilities, such as deposits and other borrowings, and theinterest rates we receive on interest-earning assets, such as loans we extendto our clients and securities held in our investment portfolio.  Interest rates are highly sensitive to manyfactors beyond our control, such as inflation, recession, global economicdisruptions, and unemployment. Fluctuations in interest rates affect the demand of customers forproducts and services.  We are subject tointerest rate risk to the degree that interest-bearing liabilities reprice ormature more slowly or more rapidly or on a different basis frominterest-earning assets.  Given ourcurrent volume and mix of interest-bearing liabilities and interest earningassets, our interest rate spread can be expected to increase when marketinterest rates are rising, and to decline when market 

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interest rates aredeclining, *i.e.*, we are “asset sensitive.”  Although we believe our current level ofinterest rate sensitivity is reasonable, significant fluctuations in interestrates may have an adverse impact on our interest rate spread.  Any material decline in our interest ratespread would have a material adverse effect on our business and profitability.

**If the Company or the Bank wereto lose its status as a Community Development Financial Institution, theCompany would not be able to carry out a significant portion of its businessplan**

A significant portion of our business is dependent onmaintaining our status as a Community Development Financial Institution,including our ability to apply for grants and awards to enable us to increasethe level of community development financial services that we provide in thecommunities we serve and to provide CRA credit for deposits andinvestments.  In order for the Companyand the Bank to maintain their  status ascertified Community Development Financial Institution 60% of our business mustmeet Community Development Financial Institutions Fund requirements.  As our business has continued to expand, theproportion of our business which meets Community Development FinancialInstitutions Fund requirements has decreased, causing us to affirmativelyexpand our business into areas which will afford us an opportunity to providemore community development activities.  If we are unsuccessful in expanding our community developmentactivities, and if we are ultimately unable to maintain 60% of our business inCommunity Development Financial Institutions Fund approved business, we couldlose our status as a Community Development Financial Institution as well as thebenefits that go with that status.

**Because the Company and the Bankare  community development financialinstitutions in a non-urban area, they may have difficulty fulfilling theircommunity development goals and be less likely to receive community developmentgrants and awards**

Mission Community Bank is a community development bankwhich seeks to provide financial support and services by promoting communitydevelopment and economic vitality.  Mostcommunity development banks are located in urban areas, with very fewexclusively community-development banks in rural areas.  A significant portion of San Luis ObispoCounty is rural.  Because of our marketarea, we may have difficulty locating the types of community developmentprojects that would likely attract awards and grants that might be conferred toother financial institutions in urban areas. We will seek to achieve our community development objectives, and toattract awards and grants for these activities, by focusing on the economic vitality of areas that are underserved byfinancial institutions and individuals that have been unable to take full advantage of the financial servicesindustry.  Management believes that theabsence of affordable housing, limited business and employment opportunitiesand diminished infrastructure that impacts families in San Luis Obispo Countyand Northern Santa Barbara County affords us an opportunity to carry out ourbusiness plan and to compete with other community development banks in urbanareas for grants and awards.

**The availability of governmentgrants and awards to community development financial institutions has declinedin recent years, and there can be no assurance that the Company and the Bankwill receive any grants or awards in the future**

Grants and awards that wehave received in the past with respect to our community development activitieshave strengthened our capital position and increased our profitability.  The Community Development FinancialInstitutions Fund, and other similar programs, are an important source ofcapital for community development banks such as us.    In 2004 the Bank received a $1,240,929 BankEnterprise Award from the Community Development Financial Institutions Fund toserve as an incentive to the Bank to annually increase the levels of financialservices provided to economically distressed communities.  The Bank received a similar Bank EnterpriseAward in 2001 of $990,000.  The Companyreceived a technical assistance grant of $134,935 in 2005 to help offset anycosts associated with providing services to the un- and under-banked in ourmarket areas.  Although we intend tocontinue to apply for community development related grants awards in thefuture, there can be no assurance that we will receive any future grants orawards.  Further, funding for these grantand award programs has diminished in the last several years making it lesslikely that we will be the beneficiary of any grants and awards.  For example, the Community DevelopmentFinancial Institutions Fund of the U.S. Department of the Treasury, which,among other things, operates the Bank Enterprise Awards Program and the NewMarkets Tax Credit Program, has seen a significant reduction in funding from$118 million in 2001 to $55 million in 2006.

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**The Bank has specific risks association with SmallBusiness Administration Loans**

The Bank originated $3.5 million and $4.1 million inSBA loans in 2006 and 2005, respectively, and intends to increase its SBA loanorigination in the future.  The Bankrecognized $299,000 and $344,000, respectively, in 2006 and 2005 in gainsrecognized on secondary market sales of SBA loans.  The Bank has regularly sold the guaranteedportions of these loans in the secondary market in previous years.  We can provide no assurance that MissionCommunity Bank will be able to continue originating these loans, or that asecondary market will exist for, or that it will continue to realize premiumsupon the sale of the SBA loans.  Thefederal government presently guarantees 75% to 80% of the principal amount ofeach qualifying SBA loan.  We can provideno assurance that the federal government will maintain the SBA program, or ifit does, that such guaranteed portion will remain at its current fundinglevel.  Furthermore, we can provide noassurance that the Bank will retain the preferred lender status which, subjectto certain limitations, allows it to approve and fund SBA loans without thenecessity of having the loan approved in advance by the SBA, or that if itdoes, the federal government will not reduce the amount of such guaranteedloans.  We believe that the SBA loanportfolio does not involve more than a normal risk of collectibility.  However, since the Bank has sold some of theguaranteed portions of the SBA loan portfolio, it incurs a pro rata credit riskon the non-guaranteed portion of the SBA loans since the Bank shares pro ratawith the SBA in any recoveries.

In addition, we aredependent on the expertise of the personnel in our SBA loan department in orderto originate and service SBA loans.  Wewere without a head of our government guaranteed lending department for a largeportion of 2006 and our originations of SBA loans were substantially reduced asa result, impacting the profitability of this product.  Further, in 2006, as rates on SBA loanscontinued to climb, a significant portion of SBA borrowers prepaid their loanssubstantially reducing the servicing income we receive on these loans.  Although our SBA loan department is now fullystaffed and we do not anticipate similar climbs in interest rates, if either ofthese circumstances should occur again, our income from the origination, saleand servicing of SBA loans could be substantially reduced.

**Adverse changes in domestic or global economicconditions, especially in California, could have a material adverse effect onthe Company’s business, growth, and profitability**

If conditions worsen in the domestic or globaleconomy, especially in California, our business, growth and profitability arelikely to be materially adversely affected. Almost all of our customers are geographically concentrated inCalifornia, and adverse economic conditions in California, or natural disastersin California, particularly in the Central Coast of California, could harm thebusinesses of a disproportionate number of our customers.  To the extent that our customers’ underlyingbusinesses are harmed, they are more likely to default on their loans.  We can provide no assurance that conditionsin the California economy will not deteriorate in the future and that suchdeterioration will not adversely affect us.

**Increased construction costs or constructiondelays on two new proposed facilities could hurt our profitability**

We are currently engaged in the design phase of aproject with respect to new branch office premises which will replace ourexisting branch in Paso Robles and in the planning stage with respect to aproposed construction project regarding a new main office and administrativeheadquarters in San Luis Obispo. Although we will budget for the costs of these two projects, haveretained a project manager to oversee the design phase of these two projects,and intend to obtain responsible contractors to construct these two newpremises should each of these projects proceed to fruition, there can be noassurance that these construction projects will be completed for their budgetedamounts or in any anticipated time frame. We are also in the planning stage for a new branch office in Santa Mariain Santa Barbara County.  Constructionprojects often substantially exceed initial estimates of costs, and extend wellpast estimated completion dates.  Anysignificant increase in construction costs or any extensive delay in theestimated completion dates of these projects would cause us to incur additionalexpenses for which we have not budgeted, and would decrease our profitability.

**Maintaining or increasing the Bank’s market sharedepends on the introduction and market acceptance of new products and services**

Our success depends, in part, upon our ability toadapt our products and services to evolving industry standards and consumerdemand.  There is increasing pressure onfinancial services companies to provide products and services at lowerprices.  In addition, the widespreadadoption of new technologies, including Internet-based services, could requireus to make substantial expenditures to modify or adapt our existing products orservices.  A failure to achieve marketacceptance of any new products we introduce, or a failure to introduce productsthat the market may demand, could have an adverse effect on our business,profitability, or growth prospects.

18

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**The Bank faces substantial competition in itsprimary market area**

We conduct our banking operations primarily in SanLuis Obispo County and Northern Santa Barbara County in the Central Coast ofCalifornia.  Increased competition in ourmarket may result in reduced loans and deposits.  Ultimately, we may not be able to competesuccessfully against current and future competitors.  Many competitors offer the same bankingservices that we offer in our service area. These competitors include national banks, regional banks and othercommunity banks.  We also facecompetition from many other types of financial institutions, including withoutlimitation, savings and loan institutions, finance companies, brokerage firms,insurance companies, credit unions, mortgage banks and other financialintermediaries.  In particular, ourcompetitors include several major financial companies whose greater resourcesmay afford them a marketplace advantage by enabling them to maintain numerousbanking locations and mount extensive promotional and advertising campaigns.  Additionally, banks and other financialinstitutions with larger capitalization and financial intermediaries notsubject to bank regulatory restrictions have larger lending limits and arethereby able to serve the credit needs of larger customers.  Areas of competition include interest ratesfor loans and deposits, efforts to obtain deposits, and range and quality ofproducts and services provided, including new technology-driven products andservices.   If we are unable to attractand retain banking customers, we may be unable to continue our loan growth andlevel of deposits and our results of operations and financial condition may beadversely affected.

**If the Bank fails to retain its key employees,its  growth and profitability could beadversely affected**

Our future success depends in large part upon thecontinuing contributions of our key management personnel.  If we lose the services of one or more keyemployees within a short period of time, we could be adversely affected.  Our future success is also dependent upon ourcontinuing ability to attract and retain highly qualified personnel.  Competition for such employees amongfinancial institutions in California is intense.  Due to the lack of an experienced candidatepool in the San Luis Obispo area for the types of personnel we need to operatethe Bank, we may be unable to quickly recruit new candidates to fill thepositions of key personnel which we are unable to retain.  Qualified employees demand competitive salarieswhich we may not be able to offer.  Priorto the retention of our current Chief Financial Officer in January 2005, ittook us approximately six months to fill the position of Chief FinancialOfficer when our previous Chief Financial Officer left to pursue otheremployment.  In addition, in 2006 we hadto go several months before filling the key position of Senior Vice Presidentin our Government Lending Department. Any inability to attract and retain additional key personnel in thefuture could adversely affect us.  We canprovide no assurance that we will be able to retain any of our key officers andemployees or attract and retain qualified personnel in the future.  However, we have entered into an employmentagreement with Anita Robinson, our President and Chief Executive Officer, whichcontinues until December 31, 2007.

**The Company may be unable to manage future growth**

We may encounter problems in managing our futureplanned growth.  We currently intend toopen an additional “de novo” branch in Santa Maria, California, although wehave not as yet identified a location for this new facility, and may open otherbranches and loan production offices in the future.  In addition, we intend to investigateopportunities to invest in other financial institutions that would complementour existing business, as such opportunities may arise.  No assurance can be provided, however, thatwe will be able to identify additional locations to open additional branches orto identify a suitable acquisition target or consummate any suchacquisition.  Further, our ability tomanage growth will depend primarily on our ability to attract and retainqualified personnel, monitor operations, maintain earnings and controlcosts.  Any failure by us to accomplishthese goals could result in interruptions in our business plans and could alsoadversely affect current operations.

**Increases in the Bank’s allowance for loan lossescould materially affect its earnings adversely**

Like all financial institutions, we maintain anallowance for loan losses to provide for loan defaults andnon-performance.  Our allowance for loanlosses is based on prior experience, as well as an evaluation of the risks inthe current portfolio.  However, actualloan losses could increase significantly as the result of changes in economic,operating and other conditions, including changes in interest rates, which aregenerally beyond our control.  Thus, suchlosses could exceed our current allowance estimates.  Although we believe that our allowance forloan losses is at a level adequate to absorb any inherent losses in our loanportfolio, we cannot assure you that we will not further increase the allowancefor loan losses.  Any increase in ourallowance for loans losses could materially affect our earnings adversely.

19

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In addition, the Federal Reserve Board and theCalifornia Department of Financial Institutions, as an integral part of theirrespective supervisory functions, periodically review our allowance for loanlosses.  Such regulatory agencies mayrequire us to increase our provision for loan losses or to recognize furtherloan charge-offs, based upon judgments different from those of management.  Any increase in our allowance required by theFederal Reserve Board or the Department of Financial Institutions couldadversely affect us.

**The Company’s business may beadversely affected by the highly regulated environment in which it operates**

Our operations are subject to extensive governmentalsupervision, regulation and control and recent legislation has substantiallyaffected the banking business.  It cannotpresently be predicted whether or in what form any pending or futurelegislation may be adopted or the extent to which the banking industry and ouroperations would be affected. Some of the legislative and regulatory changesmay benefit us.  However, other changescould increase our costs of doing business or reduce our ability to compete incertain markets.

**REPORTS TO SECURITY HOLDERS.**

**Annual Report**

An annual report to security holders including auditedfinancial statements is sent each year by the Company.

Certain reports are filed by the Company with theSecurities Exchange Commission pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934.   TheSEC maintains an Internet site that contains reports and other informationstatements.  The Company files itsreports electronically and they may be viewed from the SEC’s Internet sitehttp://www.sec.gov.  The public may alsoread and copy any materials filed with the SEC at the SEC’s Public ReferenceRoom at 100 F Street, NE, Washington, D.C.  20549. Information regarding the operation of the Public Reference Room isavailable by calling the SEC at 1-800-SEC-0300.

The Company’s Internet site ishttp://www.missioncommunitybank.com.

## **Item 2. Description of Property**

The Company occupies a property owned by the Bank at581 Higuera Street, San Luis Obispo, California, where the Bank’s main officeis located.  For its administrationoffices, the Bank has been leasing approximately 2,950 square feet at 569Higuera St. in San Luis Obispo at a cost of approximately $5,800 permonth.  The lease expires on June 30,2011.  The administration office islocated next to the Bank’s main office.

The Bank also leases abranch office at 1226 Park Street, Paso Robles, California, at a cost of $5,125per month.  The lease expires on July 31,2008 and provides for one five-year option.

The Bank’s branch officeat 154 West Branch Street, Arroyo Grande, California, is leased at a cost of$3,425 per month, plus common area operating expenses.  The lease expires in December 2010 andprovides for one five-year option period.

The Bank’s BusinessBanking Center at 3440 and 3480 S. Higuera Street, San Luis Obispo, is leasedfor a five-year period expiring in 2009 at a cost of $6,490 per month.  One five-year option period is provided inthe lease.

During 2005 the Bankclosed its branch office in Nipomo, California, which had been leased.  Although the lease had nearly two years leftat the time the office was closed, the Bank was able to negotiate a buyout of thelease in exchange for five months’ rent, which is included in occupancy expensefor 2005.

20

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During 2005, the Bank purchased a parcel located nearthe intersection of 6th and Spring Streets in Paso Robles, where the Bank plansbuild a branch office.  An adjacentparcel was purchased in 2006.  Theseproperties will assist in the facilitation of that development.  Noagreement to build has been entered into to date.

In September 2006 the Bank entered into a 50-yearground lease for property at South Higuera Street and Prado Road in San LuisObispo, California, where the Bank intends to build a full-service branch andadministrative office. Currently the lease provides for rentals of $7,000 permonth, but this rate could be reduced in the future under certain conditions.  The terms of the lease give the Bank earlytermination rights through September 30, 2007.

For the years endedDecember 31, 2006 and 2005, the Bank’s total occupancy costs were approximately$584,000 and $569,000, respectively.  Inthe opinion of management, the premises are adequate for the Bank’s purposesand the Bank has sufficient insurance to cover its interest in thepremises.  Note D to the ConsolidatedFinancial Statements contains additional information about properties.

Bancorp is restricted bythe bank holding company regulations in its power to hold real estate propertyfor investment.  The Company does not currently invest in real estate,other than for purposes of operations and mortgage interests in real estatesecuring loans made by the Bank in the ordinary course of business, and has noplans to do so in the future.

## **Item 3. Legal Proceedings**

The Company is, from time to time, subject to variouspending and threatened legal actions which arise out of the normal course ofits business.  The Company is not a partyto any pending legal or administrative proceedings (other than ordinary routinelitigation incidental to the Company’s business) and no such proceedings areknown to be contemplated.

There are no materialproceedings adverse to the Company to which any director, officer, affiliate ofthe Company or 5% shareholder of the Company, or any associate of any suchdirector, officer, affiliate or 5% shareholder is a party, and none of theabove persons has a material interest adverse to the Company.

## **Item 4. Submission of Matters to a Vote of Security Holders**

No matters were submittedto a vote of security holders during the fourth quarter of 2006.

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# **PART II**

## **Item 5. Market  for Common Equity, RelatedShareholder Matters and Issuer Purchases of Equity Securities**

**MarketInformation**

The Company’s commonstock has traded infrequently in the over-the-counter market under the symbol “MISS.”  The Company’s Common Stock is not listed onany exchange or market.  However, theSeidler Companies, Monroe Securities, Wedbush Morgan Securities, Hill ThompsonMagid & Co, and Howe Barnes Hoefer & Arnett make a market in theCompany’s Common Stock.  Certaininformation concerning the Common Stock is reported on the Nasdaq OTC BulletinBoard (www.otcbb.com).

The information in thefollowing table indicates the daily high and low bid prices of the Company’sCommon Stock for each quarterly period during the last two years based uponinformation provided by the OTC Bulletin Board. These prices do not includeretail mark-ups, mark-downs or commission. 

|            | ** ** | ** **   | ** ** | **Bid Prices** | ** ** |
|------------|------------|--------------|------------|---------------------|------------|
| ** ** | ** ** | ** **   | ** ** | **Low**             | ** ** | **High** | ** ** |
| 2005       |       | 1st  Quarter |       | $                   | 20.55      |   | $ | 24.75 |   |
|       |       | 2nd  Quarter |       | 22.00               |       | 24.00 |   |
|       |       | 3rd  Quarter |       | 22.50               |       | 26.00 |   |
|       |       | 4th  Quarter |       | 24.00               |       | 27.00 |   |
| 2006       |       | 1st  Quarter |       | 23.50               |       | 28.25 |   |
|       |       | 2nd  Quarter |       | 25.00               |       | 27.05 |   |
|       |       | 3rd  Quarter |       | 24.50               |       | 26.75 |   |
|       |       | 4th Quarter  |       | 22.50               |       | 26.75 |   |
|            |            |              |            |                     |            |  |  |  |  |

**Holders**

As of March 5, 2007,there were 283 holders of record of Bancorp’s Common Stock.

**Dividends**

The Company’s shareholders are entitled to receivedividends, when and as declared by its Board of Directors, out of funds legallyavailable therefore, subject to the restrictions set forth in the in the CaliforniaGeneral Corporation Law (the “Corporation Law”).  The Corporation Law provides that acorporation may make a distribution to its shareholders if the corporation’sretained earnings equal at least the amount of the proposed distribution.  The Corporation Law also provides that, inthe event that sufficient retained earnings are not available for the proposeddistribution, a corporation may nevertheless make a distribution to itsshareholders 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 liabilitiesor, if the average of the corporation’s earnings before taxes on income andbefore interest expenses for the two preceding fiscal years was less than theaverage of the corporation’s interest expenses for such fiscal years, then thecorporation’s current assets  must equalat least 1.25 times its current liabilities. The Company was eligible to pay dividends at the end of 2005 and 2006.

The availability of operating funds for the Companyand the ability of the Company to pay a cash dividend depends largely on theBank’s ability to pay a cash dividend to Bancorp.  The payment of cash dividends by the Bank issubject to restrictions.  In general,dividends may not be paid from any of the Bank’s capital.  Dividends must be paid out of available netprofits, after deduction of all current operating expenses, actual losses,accrued dividends on preferred stock, if any, and all federal and statetaxes.  Additionally, a bank isprohibited from declaring a dividend on its shares of common stock until itssurplus fund equals its common capital, or, if its surplus fund does not equalits common capital, until at least one-tenth of the bank’s net profits, for thepreceding half year in the case of quarterly or semi-annual dividends, or thepreceding full year in the case of an annual dividend, are transferred to itssurplus fund each time dividends are declared.  Regulatory approval is required if the totalof all dividends declared by a bank in any calendar year exceeds the total ofits net profits for that year combined with its retained 

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net profits of the two preceding years, less anyrequired transfers to surplus or a fund for the retirement of any preferredstock.  Furthermore, bank regulators alsohave authority to prohibit the payment of dividends by a bank when itdetermines such payment to be an unsafe and unsound banking practice.

Additionally, bank regulatory agencies have authorityto prohibit banks from engaging in activities that, in their respectiveopinions, constitute unsafe and unsound practices in conducting itsbusiness.  It is possible, depending uponthe financial condition of the bank in question and other factors, that thebank regulatory agencies could assert that the payment of dividends or otherpayments might, under some circumstances, be an unsafe or unsoundpractice.  Further, the bank regulatoryagencies have established guidelines with respect to the maintenance ofappropriate levels of capital by banks or bank holding companies under theirjurisdiction.  Compliance with thestandards set forth in such guidelines and the restrictions that are or may beimposed under the prompt corrective action provisions of federal law couldlimit the amount of dividends which the Bank may pay.

Under these provisions and considering minimumregulatory capital requirements, the Bank was eligible to pay dividends in 2005and 2006.

On November 28, 2005, theCompany declared a $0.12 per share cash dividend for holders of the CommonStock of record on December 9, 2005.  Thedividend was paid on December 19, 2005. Series A Preferred Stock received a $0.06 per share dividend and SeriesB and C Preferred Stock received a $0.12 per share dividend. The total amountpaid was $93,144.

On November 28, 2006, theCompany declared a $0.12 per share cash dividend for holders of the CommonStock of record on December 8, 2006.  Thedividend was paid on December 18, 2006. Series A Preferred Stock received a $0.06 per share dividend and SeriesB and C Preferred Stock received a $0.12 per share dividend. The total amountpaid was $94,908.

In December 2005 the Bankpaid a $90,085 dividend to Bancorp, and in December 2006 the Bank paid a$300,283 dividend to Bancorp.

Whether or not stock orcash dividends will be paid in the future by the Company and/or the Bank willbe determined by the Board of Directors after consideration of various factorsincluding, but not limited to, profitability, regulatory capital ratios, andfinancial condition. Additionally, certain provisions of the preferred stockissuances restrict the ability of the Company to pay cash dividends unless therequired dividends on the preferred stock are also paid.

The Company has issuedand outstanding $3,093,000 of junior subordinated debt securities due October2033.  The indenture pursuant to whichthese debt securities were issued provides that the Company must make interestpayments on the debentures before any dividends can be paid on its capitalstock 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 distributionsmay be made to the holders of our capital stock.  In addition, the Company has the right todefer interest payments on the junior subordinated debt securities for up tofive years, during which time no dividends may be paid to holders of theCompany’s capital stock.

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**EquityCompensation Plans**

The following table shows, as of December 31, 2006, 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 plan, excluding stock options currently outstanding.

Equity Compensation Plan Information

 
|                                                        |       |                                                                                                     |       |                                                                                    |       |                                                                                  |       |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Number 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 plan** | ** ** |
| Equity  compensation plans approved by security holders     |       | 126,133                                                                                                  |       | $                                                                                       | 12.19      |                                                                                  | 10,634     |   |
|                                                        |       |                                                                                                     |       |                                                                                    |       |                                                                                  |       |
| Equity  compensation plans not approved by security holders |       | —                                                                                                   |       | —                                                                                  |       | —                                                                                |       |
|                                                        |       |                                                                                                     |       |                                                                                    |       |                                                                                  |       |
| Total                                                       |       | 126,133                                                                                                  |       | $                                                                                       | 12.19      |                                                                                  | 10,634     |   |

See Note I to the consolidated financial statements for a discussion of the Company’s Stock Option Plan.

**Purchasesof equity securities by Bancorp and affiliated purchasers**

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.

**Item 6.  Management’s Discussion and Analysis**

**Executive Summary**

During 2006, the Companyexperienced a relatively flat year in both growth and earnings.  At December 31, 2006, the Company had totalconsolidated assets of $158.2 million, a 1% increase from December 31,2005.  Total net loans increased 3%, to$121.8 million, over that same period. Deposits decreased 3%, to $124.3 million, while shareholders’ equityincreased 11%, to $12.2 million, over the past year.

The Company’s net incomewas $870 thousand, or $1.02 per diluted share, for the year ended December 31,2006.  This compares with $957 thousand,or $1.14 per diluted share, in 2005.

The following are themajor factors impacting our results of operations and financial condition inthe past year.

·                  We experienced adecrease in our net interest margin.  Thenet interest margin for 2006 was 4.93%, down 9 basis points from 2005.  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 and2005.  Short-term rates leveled off in2006 and, at the same time, the Bank experienced increasing pressure on themargin due to competition for deposits in the local market.  Overall, the Bank expects that pressure tocontinue in 2007, but does not expect the margin to fall in 2007 significantlybelow its 2006 level.

·                  We experienced adecline in SBA loans originated, sold and serviced.  SBA loans originated and sold were significantlylower in 2005 as compared to previous years, and recovery from that low levelof SBA loan 

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production was further challenged in 2006 as the Bankwas without a manager of its Business Banking Center for most of the year.  Gains on loan sales declined 50% in 2005, to$344 thousand, and another 13% in 2006. That situation was exacerbated in 2006, as rates on SBA loans continuedto climb, prompting numerous SBA borrowers to prepay their loans.   When these loans were paid off the Bank hadto accelerate the amortization of the portion of the loan servicing assetrelated to those loans, reducing servicing fee income.  Loan servicing fees decreased $150 thousandin 2005, as compared to 2004, and decreased another $134 thousand in 2006.

·                  Our credit qualityremained high.  Credit quality remainedhigh in 2006, although non-performing loans increased $2.1 million fromyear-end 2005, and net charge-offs totaled $115 thousand (0.10% of averageloans) for the year.

**Critical Accounting Policies**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires the Company’s management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, disclosure of contingent assetsand liabilities at the date of the financial statements, and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

A critical accountingpolicy is defined as one that is both material to the presentation of theCompany’s financial statements and requires management to make difficult,subjective or complex judgments that could have a material effect on theCompany’s financial condition and results of operations and may change infuture periods.  Note A to theConsolidated Financial Statements describes the significant accounting policiesused in the preparation of the Consolidated Financial Statements.  Not all of these accounting policies requiremanagement to make difficult, subjective or complex judgments orestimates.  However, management believesthat the following policies could be considered critical within the SEC’sdefinition.

*Reserves and Contingencies*

In the normal course ofbusiness, the Company must manage and control certain risks inherent to thebusiness of banking.  These includecredit risk, interest rate risk, fraud risk, and operations and settlementrisk.  The Company has establishedreserves for risk of losses, including loan losses.  The allowance for loan losses representsmanagement’s estimate of the probable losses that have occurred as of the dateof the financial statements, as further described in Note A in the Notes to theConsolidated Financial Statements.  Seealso *Allowance for Loan Losses* below.  These reserves or accruals are reviewed bymanagement at least quarterly.  If thelatest estimate of loss (or the actual loss) differs from the accrual orreserve recorded to date, the financial impact is reflected in the period inwhich the estimate is revised (or the actual loss is determined).

*Revenue recognition*

The Company’s primary source of revenue is interestincome from loans and investment securities. Interest income is recorded on an accrual basis.  Note A in the Notes to the ConsolidatedFinancial Statements contains an explanation of the process for determiningwhen the accrual of interest income is discontinued on impaired loans and underwhat circumstances loans are returned to an accruing status.

The Company also recordsgains in connection with the sale of the guaranteed portion of certainSBA-guaranteed loans for which the Bank retains the right to service theloans.  Recording of such gains involvesthe use of estimates and assumptions related to the expected life of the loansand future cash flows.  Notes A and C inthe Notes to the Consolidated Financial Statements contain additionalinformation regarding the Company’s accounting policy for revenue recorded inconnection with the sale of loans.  SBAloan servicing rights are based upon estimates and are subject to the risk ofprepayments and market value fluctuation.

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**Selected Financial Data**

The following is selected consolidated financial datawith respect to the Company’s consolidated financial statements for the twoyears ended December 31, 2006 and 2005. The information presented has beenderived from the audited consolidated financial statements included in Item 7of Part II of this Form 10-KSB.  Thisinformation should be read in conjunction with such consolidated financial statementsand the notes thereto.

|                                                                                      | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **In thousands, except share and per share data** | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Interest income                                                                      |       | $                                          | 11,354     |   | $ | 9,435 |   |
| Interest expense                                                                     |       | 4,441                                      |       | 2,879 |   |
| Net interest  income                                                                 |       | 6,913                                      |       | 6,556 |   |
| Provision for loan  losses                                                           |       | —                                     |       | 75 |   |
| Non-interest income                                                                  |       | 635                                        |       | 805 |   |
| Non-interest expense                                                                 |       | 6,139                                      |       | 5,714 |   |
| Income before  income taxes                                                          |       | 1,409                                      |       | 1,572 |   |
| Income taxes                                                                         |       | 539                                        |       | 615 |   |
| Net income                                                                           |       | $                                          | 870        |   | $ | 957 |   |
| Net income  allocable to preferred stock                                             |       | $                                          | 133        |   | $ | 150 |   |
|                                                                                 |       |                                       |       |   |   |
| **Balance Sheet Data at End of  Year**                                               | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Assets                                                                               |       | $                                          | 158,169    |   | $ | 156,288 |   |
| Earning assets                                                                       |       | 148,146                                    |       | 145,290 |   |
| Total loans                                                                          |       | 122,799                                    |       | 119,475 |   |
| Deposits                                                                             |       | 124,281                                    |       | 127,588 |   |
| Total  shareholders’ equity                                                     |       | 12,153                                     |       | 10,981 |   |
| Preferred equity                                                                     |       | 1,084                                      |       | 1,084 |   |
| Common equity                                                                        |       | 11,069                                     |       | 9,897 |   |
| Number of common  shares outstanding                                                 |       | 673,399                                    |       | 659,799 |   |
| **Average Balance Sheet Data**                                                       | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Assets                                                                               |       | $                                          | 150,899    |   | $ | 140,344 |   |
| Earning assets                                                                       |       | 140,894                                    |       | 130,695 |   |
| Loans                                                                                |       | 118,303                                    |       | 108,289 |   |
| Deposits                                                                             |       | 121,038                                    |       | 115,016 |   |
| Shareholders’  equity                                                           |       | 11,555                                     |       | 10,451 |   |
| **Per Share Data**                                                                   | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Basic earnings  per share                                                            |       | $                                          | 1.10       |   | $ | 1.25 |   |
| Diluted earnings  per share                                                          |       | 1.02                                       |       | 1.14 |   |
| Average number  of common shares outstanding - basic                                 |       | 667,810                                    |       | 646,617 |   |
| Average number  of common shares outstanding - diluted                               |       | 720,701                                    |       | 708,076 |   |
| Book value per  common share                                                         |       | $                                          | 16.44      |   | $ | 15.00 |   |
| Cash dividends  declared                                                             |       | 0.12                                       |       | 0.12 |   |
| **Performance Ratios**                                                               | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Return on  average assets                                                            |       | 0.58                                       | %          | 0.68 | % |
| Return on  average shareholders’ equity                                         |       | 7.53                                       | %          | 9.16 | % |
| Average equity  to average assets                                                    |       | 7.66                                       | %          | 7.45 | % |
| Efficiency ratio                                                                     |       | 81.33                                      | %          | 77.63 | % |
| Leverage ratio                                                                       |       | 9.98                                       | %          | 9.75 | % |
| Net interest  margin                                                                 |       | 4.93                                       | %          | 5.02 | % |
| Non-interest  revenue to total revenue                                               |       | 8.41                                       | %          | 10.94 | % |
| **Asset Quality**                                                                    | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Non-performing  assets                                                               |       | $                                          | 2,169      |   | $ | 76 |   |
| Allowance for  loan losses                                                           |       | 1,026                                      |       | 1,141 |   |
| Net charge-offs  (recoveries)                                                        |       | 115                                        |       | 28 |   |
| Non-performing  assets to total assets                                               |       | 1.37                                       | %          | 0.05 | % |
| Allowance for  loan losses to loans                                                  |       | 0.84                                       | %          | 0.96 | % |
| Net charge-offs to  average loans                                                    |       | 0.10                                       | %          | 0.03 | % |

 

26

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#### **Basis of Presentation**

The following discussion and analysis is intended toassist in an understanding of the significant factors that affected ourconsolidated financial condition and results of operations for the years endedDecember 31, 2006 and 2005.  Thisdiscussion, which refers to the Company on a consolidated basis, should be readin conjunction with the Company’s consolidated financial statements andcorresponding notes.

Bancorp is inactiveexcept for interest expense associated with the junior subordinated debentures(related to the trust preferred securities) and minimal other expenses.  Therefore, the financial information isprimarily reflective of the Bank.

The Bank operates as atraditional community bank, but has also used management’s expertise as a CDFIto provide a selection of financial services identified as “communitydevelopment” activities, with a focus on financial services to under-servedmarkets, small businesses and business professionals.  Bancorp and the Bank have received and usedboth grants and deposits under programs authorized by CDFI and continuouslyreview various options for both grants and deposit programs from variousgovernment and public/private entities. The CDFI status is dependent on management’s specialized knowledge ofworking with various governmental programs and requires a significant increasein reporting and documentation as compared with traditional bank activities.

MCDC provides financingfor small businesses and low- to moderate-income areas based on direct loans orfunding pools established in conjunction with others.  MCDC currently has one small communitydevelopment loan outstanding and provides loan servicing for the San LuisObispo County Economic Vitality Corporation. MCDC also services the San Simeon Earthquake Recovery Loan Fund (the “EarthquakeFund”), a loan pool funded by the Bank and other local banks.  The Earthquake Fund is structured to providelow cost financing to individuals and businesses in San Luis Obispo andNorthern Santa Barbara counties which experienced severe damage in the December22, 2003, San Simeon Earthquake.  As ofDecember 31, 2006, the Earthquake Fund had $54,000 in loans outstanding and$366,000 available to lend.  Unless thestated purpose of the Earthquake Fund is changed in the future, it is unlikelythat the remainder of the Earthquake Fund will be used; no loans have beenfunded since October 2004. The consortium is looking at alternative communitydevelopment uses for the loan pool.  MCDCalso manages a loan pool for the San Luis Obispo County Housing Trust Fund toassist in providing affordable housing. As of December 31, 2006, the Housing Trust Fund had $1,219,000 in loansoutstanding.

MCSC provides technical assistance services andtraining to the underserved segments of the community including smallbusinesses, minorities and low-income entrepreneurs, and provides technicalassistance 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 99Women’s Business Centers nationwide. While MCSC has not engaged in any direct lending, it intends to providesome lending in the near future.  As ofDecember 31, 2006, the Bank has had limited direct benefit from its associationwith MCSC.  See also Note L to theConsolidated Financial Statements for additional information regarding MCSC.

**Results of Operations**

 **Average Balance Sheets andAnalysis of Net Interest Income**

The principal componentof earnings for most banks is net interest income.  Net interest income is the difference betweenthe interest earned on loans and investments and the interest paid on depositsand other interest-bearing liabilities.

The banking industry usestwo key ratios to measure relative profitability of net interest income. The net interest rate spread measures the difference between the average yieldon earning assets and the average rate paid on interest bearingliabilities.  The interest rate spread ignores the beneficial impact ofnon-interest bearing deposits and capital, and provides a direct perspective onthe effect of market interest rate movements.  The net interest margin isdefined as net interest income as a percentage of average interest-earningassets, which includes the positive impact of obtaining a portion of thefunding for earning assets with non-interest bearing deposits and capital.

27

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The following tablepresents, for the periods indicated, the total dollar amounts of interestincome from average interest-earning assets and the resultant yields. Alsopresented are the dollar amounts of interest expense and averageinterest-bearing liabilities, expressed both in dollars and in rates.

***Net Interest Analysis***

*(Dollars in thousands)*

 
| ** **                                                                             | ** ** | **For the Years Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                             | ** ** | **December 31, 2006**        | ** ** | **December 31, 2005** | ** ** |
| ** **                                                                             | ** ** | **Average  Balance**                   | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** |
| **ASSETS**                                                                             |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-earning  assets:**                                                          |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income                                                          |       | $                                      | 118,303    |   | $ | 10,386 |   | 8.78 | % | $ | 108,289 |   | $ | 8,625 |   | 7.96 | % |
| Investment securities                                                                  |       | 16,470                                 |       | 685 |   | 4.32 | % | 16,278 |   | 625 |   | 3.84 | % |
| Federal funds sold                                                                     |       | 4,283                                  |       | 211 |   | 4.93 | % | 4,429 |   | 137 |   | 3.09 | % |
| Other interest income                                                                  |       | 1,838                                  |       | 72 |   | 3.91 | % | 1,699 |   | 48 |   | 2.86 | % |
| **Total  interest-earning assets / interest income**                                   |       | 140,894                                |       | 11,354 |   | 8.08 | % | 130,695 |   | 9,435 |   | 7.22 | % |
| **Non-interest-earning  assets:**                                                      |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan losses                                                              |       | (1,181                                 | )          |   |   |   |   | (1,109 | ) |   |   |   |   |
| Cash and due from banks                                                                |       | 2,930                                  |       |   |   |   |   | 3,320 |   |   |   |   |   |
| Premises and equipment                                                                 |       | 3,639                                  |       |   |   |   |   | 2,921 |   |   |   |   |   |
| Other assets                                                                           |       | 4,607                                  |       |   |   |   |   | 4,517 |   |   |   |   |   |
| **Total  assets**                                                                      |       | $                                      | 150,889    |   |   |   |   |   | $ | 140,344 |   |   |   |   |   |
| ** **                                                                             |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                                     |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits:                                                             |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing demand accounts                                                       |       | $                                      | 6,747      |   | 121 |   | 1.80 | % | $ | 4,851 |   | 57 |   | 1.17 | % |
| Savings deposits                                                                       |       | 30,559                                 |       | 899 |   | 2.94 | % | 39,771 |   | 816 |   | 2.05 | % |
| Certificates of deposit                                                                |       | 57,701                                 |       | 2,541 |   | 4.40 | % | 47,001 |   | 1,365 |   | 2.90 | % |
| Total interest-bearing deposits                                                        |       | 95,007                                 |       | 3,561 |   | 3.75 | % | 91,623 |   | 2,238 |   | 2.44 | % |
| Federal funds purchased                                                                |       | —                                 |       | — |   | — |   | 65 |   | 3 |   | 4.74 | % |
| Federal Home Loan Bank advances                                                        |       | 13,904                                 |       | 609 |   | 4.38 | % | 10,615 |   | 422 |   | 3.97 | % |
| Subordinated debt                                                                      |       | 3,093                                  |       | 271 |   | 8.76 | % | 3,093 |   | 216 |   | 6.99 | % |
| Total borrowed funds                                                                   |       | 16,997                                 |       | 880 |   | 5.17 | % | 13,773 |   | 641 |   | 4.65 | % |
| **Total  interest-bearing liabilities / interest expense**                             |       | 112,004                                |       | 4,441 |   | 3.97 | % | 105,396 |   | 2,879 |   | 2.73 | % |
| **Non-interest-bearing  liabilities:**                                                 |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing deposits                                                          |       | 26,031                                 |       |   |   |   |   | 23,393 |   |   |   |   |   |
| Other liabilities                                                                      |       | 1,299                                  |       |   |   |   |   | 1,104 |   |   |   |   |   |
| Total liabilities                                                                      |       | 139,334                                |       |   |   |   |   | 129,893 |   |   |   |   |   |
| Shareholders’  equity                                                             |       | 11,555                                 |       |   |   |   |   | 10,451 |   |   |   |   |   |
| **Total  liabilities and shareholders’ equity**                                   |       | $                                      | 150,889    |   |   |   |   |   | $ | 140,344 |   |   |   |   |   |
| **Net  interest-rate spread**                                                          |       |                                   |       |   |   | 4.11 | % |   |   |   |   | 4.49 | % |
| Impact of  non-interest-bearing sources and other changes in balance sheet composition |       |                                   |       |   |   | 0.82 | % |   |   |   |   | 0.53 | % |
| **Net  interest income / margin on earning assets**                                    |       |                                   |       | $ | 6,913 |   | 4.93 | % |   |   | $ | 6,556 |   | 5.02 | % |

 

Non-accrual loans areincluded in the calculation of the average balances of loans; interest notaccrued is excluded.  Yields ontax-exempt municipal securities (included with investment securities) have beenadjusted to their fully-taxable equivalents in 2006.  The Bank had no tax-exempt securities in2005.

Net interest income isaffected by changes in the amount and mix of our interest-earning assets andinterest-bearing liabilities, referred to as the change due to *volume*.  Averageinterest-earning assets grew by $10.2 million in 2006 over 2005, primarilydriven by loan volume—the most profitable component of interest-earningassets.  Interest-bearing liabilitiesincreased $6.6 million over the past year. Net interest income is also affected by changes in the yields we earn oninterest-earning assets and the rates we pay on interest-bearing deposits andborrowed funds, referred to as the change due to *rate.*  The average yield on interest-earning assetsincreased by 86 basis points (0.86%) in 2006, while the average rate

28

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paid on interest-bearingliabilities increased by 124 basis points, causing pressure on the net interestmargin.  As a result, the net interestmargin decreased 9 basis points in 2006, from 5.02% to 4.93%.

The Bank is assetsensitive (see the *Asset and LiabilityManagement* section of this discussion) and benefited from the steadyincrease in short-term interest rates in 2004 and 2005.  As short-term rates leveled off in 2006, theBank experienced increasing pressure on the margin due to competition fordeposits in the local market and from other non-local financialinstitutions.  Overall, the Bank expectsthat pressure to continue in 2007, but does not expect the margin to fall in2007 significantly below its 2006 level.

The following table sets forth changes in interestincome and interest expense for each major category of interest-earning assetsand interest-bearing liabilities, and the amount of those variancesattributable to volume and rate changes for the years indicated.

***Rate / VolumeVariance Analysis***

*(Inthousands)*
| ** **                         | ** ** | **Year Ended December 31, 2006  Compared to 2005**                                    | ** ** | **Year Ended December 31, 2005  Compared to 2004**                                    | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **Increase (Decrease)  in interest income and expense  due to changes in:** | ** ** | **Increase (Decrease)  in interest income and expense  due to changes in:** | ** ** |
| ** **                         | ** ** | **Volume**                                                                                                          | ** ** | **Rate**                                                                                                            | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Interest-earning  assets:          |       |                                                                                                                |       |                                                                                                                |       |   |   |   |   |   |   |   |   |
| Loans, net of unearned income      |       | $                                                                                                                   | 836        |                                                                                                                | $          | 925 |   | $ | 1,761 |   | $ | 981 |   | $ | 959 |   | $ | 1,940 |   |
| Investment securities              |       | 7                                                                                                                   |       | 53                                                                                                                  |       | 60 |   | (10 | ) | 58 |   | 48 |   |
| Federal funds sold                 |       | (5                                                                                                                  | )          | 79                                                                                                                  |       | 74 |   | (10 | ) | 76 |   | 66 |   |
| Other interest income              |       | 4                                                                                                                   |       | 20                                                                                                                  |       | 24 |   | (33 | ) | (11 | ) | (44 | ) |
| Total increase in interest income  |       | 842                                                                                                                 |       | 1,077                                                                                                               |       | 1,919 |   | 928 |   | 1,082 |   | 2,010 |   |
|                               |       |                                                                                                                |       |                                                                                                                |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:     |       |                                                                                                                |       |                                                                                                                |       |   |   |   |   |   |   |   |   |
| Transaction accounts               |       | 27                                                                                                                  |       | 37                                                                                                                  |       | 64 |   | 10 |   | 22 |   | 32 |   |
| Savings deposits                   |       | (218                                                                                                                | )          | 301                                                                                                                 |       | 83 |   | (31 | ) | 320 |   | 289 |   |
| Certificates of deposit            |       | 360                                                                                                                 |       | 816                                                                                                                 |       | 1,176 |   | 119 |   | 501 |   | 620 |   |
| Total interest-bearing deposits    |       | 169                                                                                                                 |       | 1,154                                                                                                               |       | 1,323 |   | 98 |   | 843 |   | 941 |   |
| Federal funds purchased            |       | (3                                                                                                                  | )          | —                                                                                                              |       | (3 | ) | 3 |   | — |   | 3 |   |
| FHLB advances                      |       | 141                                                                                                                 |       | 46                                                                                                                  |       | 187 |   | 124 |   | 40 |   | 164 |   |
| Subordinated debt                  |       | —                                                                                                              |       | 55                                                                                                                  |       | 55 |   | — |   | 63 |   | 63 |   |
| Total borrowed funds               |       | 138                                                                                                                 |       | 101                                                                                                                 |       | 239 |   | 127 |   | 103 |   | 230 |   |
| Total increase in interest expense |       | 307                                                                                                                 |       | 1,255                                                                                                               |       | 1,562 |   | 225 |   | 946 |   | 1,171 |   |
| Increase in net  interest income   |       | $                                                                                                                   | 535        |                                                                                                                | $          | (178 | ) | $ | 357 |   | $ | 703 |   | $ | 136 |   | $ | 839 |   |

 

Changes not solelyattributable to rate or volume have been allocated to volume and rate changesin proportion to the relationship of the absolute dollar amounts of the changesin each.

**Provision for Loan Losses**

Credit risk is inherentin the business of making loans.  TheBank makes provisions for loan losses when required to bring the totalallowance for loan losses to a level deemed appropriate. The determination ofthe appropriate level for the allowance is based on such factors as historicalexperience, the volume and type of lending conducted, the amount ofnonperforming loans, regulatory policies, general economic conditions, andother factors related to the collectibility of loans in the portfolio.  The provision for loan losses is charged toearnings and totaled $75,000 for 2005. Based on management’s analysis of the allowance for loan losses as ofDecember 31, 2006, no additional provision was required in 2006, as managementjudged the allowance to be adequate to absorb currently identified potentiallosses as well as any likely future losses.

See *Allowancefor Loan Losses* below for additional information on the proceduresfor monitoring the adequacy of the allowance, as well as detailed informationconcerning the allowance for loan losses.

29

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**Non-interest Income**

Non-interest income decreased $170 thousand in 2006 ascompared to 2005, due to decreased SBA loan origination and sale activity, aswell as increased amortization of SBA servicing assets on loans previously soldwith servicing retained.

The Bank derives amaterial portion of its non-interest income from the sale of SBA guaranteedloans.  Gain on sale of SBA loansdecreased by $46,000 in 2006 as compared to 2005, after decreasing $321,000 in2005 as compared to 2004.  Due to anumber of factors, including competition in the local market, SBA loansoriginated and sold were at a reduced level in 2005.  Recovery from that low level of SBA loanproduction was further challenged in 2006 as the Bank was without a manager ofits Business Banking Center for most of the year.  Gains on loan sales declined 50% in 2005, to$344 thousand, and declined another 13% in 2006.

The increased amortization of the SBA servicing assetswas the result of loan payoffs earlier than originally projected, primarilybecause of the higher interest rate environment.  When these loans were paid off the Bank hadto accelerate the amortization of the portion of the loan servicing asset relatedto those loans, reducing servicing fee income in 2006.  Loan servicing fees (net of amortization)decreased $150 thousand in 2005, as compared to 2004, and decreased another$134 thousand in 2006.

In 2005 the Companyreceived a $135,000 CDFI technical assistance grant to help offset any costsassociated with providing additional services to the un- and under-banked inits target market area.  Until the fourthquarter of 2006 this grant had been reflected in other liabilities in theconsolidated balance sheet pending concurrence from the CDFI Fund regarding theproposed spending plan.  By December 31,2006, the Company had incurred qualifying expenses totaling $100 thousand.  That portion of the grant was recognized innon-interest income in 2006.  All or aportion of the remaining $35 thousand could be recognized in income in 2007 ifadditional qualifying expenses or purchases are incurred, and the Bank expectsto incur at least $13 thousand of qualifying purchases in 2007.  To the extent that qualifying expenses orpurchases are not incurred, however, the grant funds may be returned.

The Bank and the Companyexpect to continue to apply for grants and awards, but no assurance can begiven that any future BEA grants or awards will be received.

#### **Non-interest Expense**

Non-interest expense increased in 2006 by $425thousand, or 7%.

Non-interest expensesthat had material changes from 2005 to 2006 were:

·                  Salary andbenefits increased by $273 thousand, or 9%. Salaries increased $112 thousand, due to normal salary increases duringthe year.  Employee benefit costincreases included company contributions to 401(k), profit sharing andincentive plans ($71 thousand), group health insurance ($28 thousand) and stockcompensation expense for officers ($55 thousand).

·                  Furniture andequipment expense increased by $49 thousand, or 19%, due primarily todepreciation on computer hardware and software (up $43 thousand for the year).

·                  Data processingexpenses increased by $57 thousand, or 14%, due to growth, the Bank’s expandeduse of functions available in its core processing system, as well as the costsof converting to a new internet banking system in 2006.

·                  Marketing andbusiness development increased by $40 thousand, or 15%.  Advertising costs accounted for $29 thousandof the increase, as the Bank increased its promotion of deposit and loanproducts in the local print media.  Alsoincluded in marketing and business development for 2006 is $89 thousand ofcontributions to the non-profit affiliate MCSC, to further MCSC’s mission ofproviding Central Coast and Central California small businesses with technicalassistance, counseling and training in finance, management, marketingprocurement and access to the U. S. Small Business Administration’s programsand services. Also in 2006, The Mission Community Club program generated $25thousand in grants to local non-profit organizations.  In 2005 the Company recognized $75 thousandin contributions expense related to its guarantee of MCSC’s borrowings (seeNotes L and Q to the consolidated financial statements).

·                  Insurance andregulatory assessments increased $60 thousand, or 64%.  Liability insurance costs increased $32thousand, property/casualty insurance increased $20 thousand and regulatoryassessments were up $8 thousand.

·                  Loanand lease expenses decreased $22 thousand, or 22%, as the Bank’s loanoriginations were down in 2006 as compared to 2005.  These expenses are largely related to newloans originated and draws on construction loans.

30

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#### **Income Taxes**

The Company’s combined federaland state effective income tax rate was 38.3% in 2006 and 39.1% in 2005.  The decrease in the effective rate from 2005to 2006 was primarily due to increased tax-free income from municipalsecurities and loans.  See Note H to theconsolidated financial statements for more information on income taxes.

**Financial Condition**

**Investment Activities**

Banks purchase and own investment securities foryield, to provide liquidity and to balance the overall interest-ratesensitivity of its assets and liabilities. The Bank does not maintain a tradingaccount.

Investment goals are toobtain the highest yield consistent with maintaining a stable overall asset andliability position while limiting economic risks.  In accordance with this policy, managementactively manages its investment portfolio between available for sale and heldto maturity investments, the composition of which has shifted over time.  Due to a change in investment strategy in2005, all securities in the held-to-maturity category were reclassified toavailable-for-sale.  This change ininvestment strategy was intended to improve the Bank’s financial flexibility.

Investment policies andlimits have been established by the board of directors.  Investments can include federally-insuredcertificates of deposit, obligations of the U.S. Treasury and U.S. agencies,mortgage-related instruments issues or backed by U.S. agencies, municipal bondsrated Baa or better (Moody’s), Aaa-rated private label mortgage-backed andasset-backed securities, and corporate securities rated A or A-1.  Guidelines have been established fordiversification of the portfolio among these investment categories andper-transaction limits have been established as well.  The Bank’s chief financial officer reportsinvestment purchase and sale activity to the Board on a monthly basis and moredetailed quarterly reports are presented to the Investment Committee.

The following tablepresents the distribution of investments by sector, the maturity dates of theinvestments, and the weighted average yields of the investments:

31

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**Investmentsecurities composition**
| ** **                                        | ** ** | **December 31, 2006**      | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **Approx.**                          | ** ** | **Approx.**                     | ** ** |
| ** **                                        | ** ** | **Amortized**                        | ** ** | **Market**                      | ** ** | **%** | ** ** | **Amortized** | ** ** | **Market** | ** ** | **%** | ** ** |
| ** **                                        | ** ** | **Cost**                             | ** ** | **Value**                       | ** ** | **Yield** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Yield** | ** ** |
| ** **                                        | ** ** | **(Dollars in thousands)** | ** ** |
| U.S. Government  agencies:                        |       |                                 |       |                            |       |   |   |   |   |   |   |   |   |
| Within one year                                   |       | $                                    | 1,999      |                            | $          | 1,982 |   | 3.51 | % | $ | — |   | $ | — |   |   |   |
| One to five years                                 |       | 3,494                                |       | 3,432                           |       | 4.16 | % | 4,499 |   | 4,377 |   | 3.63 | % |
| Five to ten years                                 |       | 1,000                                |       | 990                             |       | 4.73 | % | 1,500 |   | 1,480 |   | 4.32 | % |
| After 10 years                                    |       | 999                                  |       | 966                             |       | 4.31 | % | 999 |   | 951 |   | 4.31 | % |
| Total U.S. Government agencies                    |       | 7,492                                |       | 7,370                           |       | 4.08 | % | 6,998 |   | 6,808 |   | 3.87 | % |
| Mortgage-backed and  asset-backed securities:     |       |                                 |       |                            |       |   |   |   |   |   |   |   |   |
| Within one year                                   |       | 3                                    |       | 3                               |       | — |   | — |   |   |   |   |   |
| One to five years                                 |       | 855                                  |       | 842                             |       | 4.10 | % | 962 |   | 934 |   | 3.72 | % |
| Five to ten years                                 |       | 236                                  |       | 230                             |       | 4.09 | % | 426 |   | 419 |   | 4.70 | % |
| After 10 years                                    |       | 5,989                                |       | 6,028                           |       | 4.30 | % | 7,756 |   | 7,655 |   | 4.20 | % |
| Total mortgage-backed and asset-backed securities |       | 7,083                                |       | 7,103                           |       | 4.27 | % | 9,144 |   | 9,008 |   | 4.17 | % |
| Municipal  securities:                            |       |                                 |       |                            |       |   |   |   |   |   |   |   |   |
| After 10 years                                    |       | 1,941                                |       | 1,943                           |       | 6.01 | % | — |   | — |   |   |   |
| Total municipal securities                        |       | 1,941                                |       | 1,943                           |       | 6.01 | % | — |   | — |   |   |   |
| Total investment securities                       |       | $                                    | 16,516     |                            | $          | 16,416 |   | 4.39 | % | $ | 16,142 |   | $ | 15,816 |   | 4.04 | % |

 

The non-accrual security isincluded in the amortized cost and market value of securities.  Yields reflect no interest income on thenon-accrual security.  Yields ontax-exempt municipal securities have been adjusted to their fully-taxableequivalents in 2006.  The Bank had notax-exempt securities in 2005.

During 2006, the Bankpurchased $1.9 million of municipal securities to take advantage of theirhigher yields on a fully taxable equivalent basis.  All of the municipal securities purchased todate are within California, bank qualified, and are rated at least Aaa.

In 2004, managementestablished a loss reserve for one of the Bank’s asset-backed securities afterconcluding it was “other than temporarily impaired.”  The security is in non-accrual status, withany interest payments received being credited to the reserve.  As of December 31, 2006, the gross book valueof the security was $330,613 and the reserve was $246,405, for a net book valueof $84,208.

See Note B in the notesto the consolidated financial statements for additional information oninvestment securities.

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#### **Lending Activities**

The Bank originates loans, participates in loans fromother banks and structures loans for possible sale in the secondary market.

The following table sets forth the composition of ourloan portfolio by type of loan at the periods indicated:

**Loan Portfolio Composition***(Dollars in thousands)*
| ** **                      | ** ** | **As of December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|
| ** **                      | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| **Type of Loan**      | ** ** | **Amount**                            | ** ** | **Percentage** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Commercial                      |       | $                                     | 21,944     |   | 17.87 | % | $ | 15,005 |   | 12.56 | % |
| Agricultural                    |       | 123                                   |       | 0.10 | % | 152 |   | 0.13 | % |
| Real estate                     |       | 66,591                                |       | 54.23 | % | 71,878 |   | 60.16 | % |
| Construction                    |       | 31,639                                |       | 25.76 | % | 29,921 |   | 25.04 | % |
| Consumer                        |       | 2,502                                 |       | 2.04 | % | 2,519 |   | 2.11 | % |
| Total loans                     |       | $                                     | 122,799    |   | 100.00 | % | $ | 119,475 |   | 100.00 | % |
|                            |       |                                  |       |   |   |   |   |   |   |
| Off-balance-sheet  commitments: |       |                                  |       |   |   |   |   |   |   |
| Undisbursed loan  commitments   |       | $                                     | 35,375     |   |   |   | $ | 37,379 |   |   |   |
| Standby letters  of credit      |       | 213                                   |       |   |   | 203 |   |   |   |

 

The following table setsforth as of December 31, 2006, the maturities and sensitivities of loans tointerest rate changes:

**Maturity and Rate Sensitivity of Loans***(Dollars in thousands)*
| ** **     | ** ** | ** **        | ** ** | ** **                                  | ** ** | ** **         | ** ** | ** ** | ** ** | **Rate Structure for Loans** | ** ** |
|----------------|------------|-------------------|------------|---------------------------------------------|------------|--------------------|------------|------------|------------|---------------------------------------------|------------|
| ** **     | ** ** | **Maturity**      | ** ** | **Maturing Beyond One Year** | ** ** |
| ** **     | ** ** | **One year** | ** ** | **One through**                        | ** ** | **Over five** | ** ** | ** ** | ** ** | **Fixed**                                   | ** ** | **Floating** | ** ** |
| ** **     | ** ** | **or less**  | ** ** | **five years**                         | ** ** | **years**          | ** ** | **Total**  | ** ** | **Rate**                                    | ** ** | **Rate** | ** ** |
| Commercial     |       | $                 | 14,000     |                                        | $          | 5,011              |       | $          | 2,933      |                                        | $          | 21,944 |   | $ | 7,711 |   | $ | 233 |   |
| Agricultural   |       | 123               |       | —                                      |       | —             |       | 123        |       | —                                      |       | — |   |
| Real estate    |       | 22,347            |       | 9,435                                       |       | 34,809             |       | 66,591     |       | 38,883                                      |       | 5,361 |   |
| Construction   |       | 29,649            |       | 203                                         |       | 1,787              |       | 31,639     |       | 248                                         |       | 1,742 |   |
| Consumer Loans |       | 468               |       | 698                                         |       | 1,336              |       | 2,502      |       | 2,034                                       |       | — |   |
| Total Loans    |       | $                 | 66,587     |                                        | $          | 15,347             |       | $          | 40,865     |                                        | $          | 122,799 |   | $ | 48,876 |   | $ | 7,336 |   |

 

The Bank funds commercialloans to provide working capital, to finance the purchase of equipment and forother business purposes.  These loans canbe *short-term,* with maturities ranging fromthirty days to one year, or *term loans,*with maturities normally ranging from one to twenty-five years.  Short-term loans are generally intended tofinance current transactions and typically provide for periodic principalpayments, with interest payable monthly. In years prior to 2006, term loans have normally provided for floatinginterest rates, with monthly payments of both principal and interest.  However, in 2006, with the increased interestrate environment, the Bank saw a marked increase in demand for fixed rateloans.  To retain valued borrowerrelationships the Bank converted approximately $5.8 million of floating rateloans to fixed rates in 2006.  Most ofthese loans are secured by real estate. The Bank’s Asset and Liability Committee (“ALCO”) approved this fixedrate loan program in light if the Bank’s asset-sensitive structure.

Included in commercialloans are SBA loans.  The Bank originatesand services SBA loans and is active in specific SBA programs.  Further, the Bank is designated as an SBA preferredlender which allows greater flexibility to meet small business loan requestswith a more timely credit approval process.

The Bank makes adjustablerate SBA-guaranteed loans and generally sells the guaranteed portion of the SBAloans in the secondary market while retaining the servicing rights for thoseloans.  At December 31, 2006 and 2005,the Bank serviced approximately $23.3 million and $32.2 million, respectively,in SBA loans.  During 2006, due to theabove-mentioned demand for fixed rate loans, approximately $4.4 million ofpreviously sold adjustable rate SBA loans were repurchased and converted tofixed rate SBA-guaranteed loans.  (Theserepurchased SBA loans are included in the $5.8 million total loans 

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converted from floatingto fixed rates mentioned above.)  Thesecondary market for fixed rate SBA loans is very limited, so none of thesefixed rate loans had been sold as of December 31, 2006, and the Bank intends toretain these loans for its own portfolio.

Consumer loans are usedto finance automobiles, various types of consumer goods, and other personalpurposes.  Consumer loans generallyprovide for the monthly payment of principal and interest.  Most consumer loans are secured by thepersonal property being purchased.

The Bank is active inconstruction lending for interim loans to finance the construction ofcommercial and single family residential property.  Construction loans totaled $31.6 million asof December 31, 2006, a $1.7 million increase from a year earlier.  These loans are typically extended for termsof no more than 12 to 18 months. Generally, the Bank does not provide loans for speculative purposesexcept to known builders who have a track record of successful projects and theexpertise and financial strength for the particular type of building.

Residential real estateloans are generally limited to home equity loans and home equity lines ofcredit.  The Bank has not been active inresidential real estate lending.

Other real estate loansconsist primarily of commercial and industrial real estate loans.  These loans are made based on the incomegenerating capacity of the property or the cash flow of the borrower and aresecured by the property.  The Bank offersboth fixed and variable rate loans with maturities which generally do notexceed 25 years.  Exceptions are made forSBA-guaranteed loans secured by real estate, or for other commercial realestate loans which can be readily sold in the secondary market.

#### **AssetQuality**

The risk of nonpayment of loans is inherent in the bankingbusiness. That risk varies with the type and purpose of the loan, thecollateral which is utilized to secure payment and, ultimately, thecreditworthiness of the borrower.  Inorder to minimize this credit risk, all loans exceeding lending officers’ individuallending limits are reviewed and approved by a Management Loan Committee.  Loans exceeding the Management Loan Committee’sauthorization are reviewed and approved by the Loan Committee of the board ofdirectors.  The Board Loan Committee iscomprised of outside directors and the Bank’s chief executive officer.

Loan grades are assignedbased on a risk assessment of each loan. Loans with minimum risk are graded as “pass,” with other classificationsof “special mention,” “substandard,” “doubtful” and “loss,” depending on creditquality.  Loans graded “substandard” or “doubtful”are considered “classified” loans, and loans graded “loss” are chargedoff.  As these loans are identified inour review process, they are added to the internal watch list and a lossallowance is established for them of at least the following amounts:  special mention — 5%, substandard — 15%,doubtful — 50%, and loss — 100%.  Theseamounts are reduced only if circumstances for a particular loan are such thatthe Bank is clearly insulated from loss. The Bank engages an outside firm to perform, at least quarterly, areview of the loan portfolio, and to test the adequacy of the allowance forloan losses.  In addition, loans areexamined periodically by the Bank’s federal and state regulators.

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The following table provides year-end information withrespect to the components of our impaired or nonperforming assets at the datesindicated:

**Non-Performing Assets***(Dollars in thousands)*

|                                              | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| Loans on nonaccrual  status                  |       | $                                     | 240        |   | $ | 76 | ** ** |
| Loans past due 90 days  or more and accruing |       | 1,929                                 |       | — |   |
| Restructured loans                           |       | —                                |       | — |   |
| Total  nonperforming loans                   |       | 2,169                                 |       | 76 |   |
| Other real estate owned                      |       | —                                |       | — |   |
| Total  nonperforming assets                  |       | $                                     | 2,169      |   | $ | 76 |   |
|                                         |       |                                  |       |   |   |
| Allowance for loan  losses                   |       | $                                     | 1,026      |   | $ | 1,141 |   |
|                                         |       |                                  |       |   |   |
| Asset quality ratios:                        |       |                                  |       |   |   |
| Non-performing  assets to total assets       |       | 1.37                                  | %          | 0.05 | % |
| Non-performing  loans to total loans         |       | 1.77                                  | %          | 0.06 | % |
| Allowance for  loan losses to total loans    |       | 0.84                                  | %          | 0.96 | % |
| Allowance for  loan losses to total          |       |                                  |       |   |   |
| non-performing loans                         |       | 47                                    | %          | 1501 | % |

 

Non-accrual loans areloans which management believes may not be fully collectible as to principaland interest.  Generally, loans areplaced in non-accrual status when they are 90 days or more past due unless theyare well-secured and in the process of collection.  Once placed in non-accrual status, a loan isnot returned to accrual status until it is brought current with respect to bothprincipal and interest payments, the loan is performing to current terms andconditions, the interest rate is commensurate with market interest rates andfuture principal and interest payments are no longer in doubt, at which time afurther review of the loan is conducted.

The $1.9 million of loanspast due 90 or more days and accruing represents one construction loan that waspast due as of December 31, 2006, but which was brought current in mid-January2007.  The loan is well-secured by realestate collateral and is expected to be paid off in mid-2007.  Management’s analysis of this loan as ofDecember 31, 2006, indicates that the Bank has no loss exposure.

Restructured loans arethose loans with concessions in interest rates or repayment terms due to adecline in the financial condition of the borrower.  Other real estate owned is acquired insatisfaction of loans through foreclosure or other means and is carried on anindividual asset basis at the lower of the recorded investment in the relatedloan or the estimated fair value of the property, less selling expenses.  The Bank had no restructured loans or otherreal estate at any time during 2005 or 2006.

As of December 31, 2006,all of the non-accrual loans were SBA loans, with $216 thousand of the totalguaranteed by the SBA.  At December 31,2005, 89% of the Bank’s non-accrual loans were SBA loans, and $58 thousand ofthe total was guaranteed by the SBA.

The Bank has no foreignloans.

**Potential Problem Loans**

At December 31, 2006, theCompany had approximately $121 thousand of loans that were not categorized asnon-performing, but for which known information about the borrower’s financialcondition caused management to have concern about the ability of the borrowersto comply with the repayment terms of the loans.  These loans were identified through the loanreview process described above.  Based onthe evaluation of current market conditions, loan collateral, other secondarysources of repayment and cash flow generation, management does not anticipateany significant losses related to these loans. These loans are subject to continuing management attention and areconsidered in the determination of the allowance for loan losses.

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While credit quality, asmeasured by loan delinquencies and by the Bank’s internal risk grading system,appears to be satisfactory as of December 31, 2006, there can be no assurancesthat new problem loans will not develop in future periods.  A decline in economic conditions in the Bank’smarket area or other factors could adversely impact individual borrowers or theloan portfolio in general.  The Bank haswell defined underwriting standards and expects to continue with promptcollection efforts, but economic uncertainties or changes may cause one or moreborrowers to experience problems in the coming months.

**Loan Concentrations**

The Board of Directorshas approved concentration levels (as a percentage of capital) for various loantypes based on the Bank’s business plan and historical loss experience.  On a quarterly basis, management provides aloan concentration report to the board with information relating toconcentrations.  Management’s review ofpossible concentrations includes an assessment of loans to multiple borrowersengaged in similar activities which would cause them to be similarly impactedby economic or other conditions.  Management is not aware of any suchconcentrations in similar activities.

The following table reflects the major concentrationsin the loan portfolio, by type of loan, as of December 31, 2006:

**Loan Concentrations**December 31, 2006*(Dollars in thousands)*
| **Type of Loan**                        | ** ** | **Amount** | ** ** | **Percent of   Total Loans** | ** ** |
|---------------------------------------------------|------------|------------|------------|---------------------------------------------|------------|
| Construction and land  development                |       | $          | 31,639     |                                        | 25.8       | % |
| Other real estate loans  (by type of collateral): |       |       |       |                                        |       |
| Non-farm,  non-residential property               |       | 49,224     |       | 40.1                                        | %          |
| 1 to 4 family  residential—1st liens         |       | 3,737      |       | 3.0                                         | %          |
| 1 to 4 family  residential—Jr. liens         |       | 6,249      |       | 5.1                                         | %          |
| Multi-family  residential                         |       | 4,972      |       | 4.0                                         | %          |
| Farmland                                          |       | 2,409      |       | 2.0                                         | %          |
| Total real  estate-secured loans                  |       | 98,230     |       | 80.0                                        | %          |
| Commercial loans  and leases                      |       | 21,944     |       | 17.9                                        | %          |
| Agricultural  loans                               |       | 123        |       | 0.1                                         | %          |
| Consumer loans                                    |       | 2,502      |       | 2.0                                         | %          |
| Total loans, including  loans held for sale       |       | $          | 122,799    |                                        | 100.0      | % |

 

The table indicates aconcentration in commercial real estate loans (construction loans and loanssecured by non-farm, non-residential and multi-family residential properties)totaling $85.8 million.  However, underthe regulatory definition of commercial real estate—which excludesowner-occupied properties—the Bank’s commercial real estate concentration isreduced to $69.4 million, or 56.5% of total loans.  The Bank has had no loss experience withthese types of loans, all are well secured and, except for the one loanreported above as past due more than 90 days and accruing, none are classified.

The Bank’s analysis ofloan concentrations compared to a California peer group of 50 banks suggeststhat the Bank does not have an unusually high real estate concentrationcompared to other similar sized banks in California.  Banks in California typically are more prone thanbanks in other states to use real estate collateral for many commercial loansfor business purposes where collateral is taken as an abundance ofcaution.  In its analysis of real estateconcentrations, the Bank carefully considers economic trends and real estatevalues.  The commercial real estatemarket in San Luis Obispo County remains strong, with good demand, limitedvacancies and rising rents.

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#### **Allowance for Loan Losses**

The following table summarizes, for each reportedperiod, changes in the allowance for loan losses arising from loans chargedoff, recoveries on loans previously charged off, additions to the allowancewhich have been charged to operating expenses, and certain ratios relating tothe allowance for loan losses:

**Summary of Loan Loss Experience***(Dollars in thousands)*

|                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** |
| Balance at  beginning of year              |       | $          | 1,141      |       | $          | 1,094 |   |
| Loans charged  off:                        |       |       |       |       |       |
| Real Estate                                |       | —     |       | —     |       |
| Commercial                                 |       | (102       | )          | (24        | )          |
| Consumer                                   |       | (19        | )          | (7         | )          |
| Other                                      |       | —     |       | —     |       |
| Total loans charged off                    |       | (121       | )          | (31        | )          |
| Recoveries:                                |       |       |       |       |       |
| Real Estate                                |       | —     |       | —     |       |
| Commercial                                 |       | 6          |       | 1          |       |
| Consumer                                   |       | —     |       | 2          |       |
| Other                                      |       | —     |       | —     |       |
| Total recoveries                           |       | 6          |       | 3          |       |
| Net recoveries  (charge-offs)              |       | (115       | )          | (28        | )          |
| Provision  charged to operations           |       | —     |       | 75         |       |
| Balance at end  of year                    |       | $          | 1,026      |       | $          | 1,141 |   |
|                                       |       |       |       |       |       |
| Ratio of net  charge-offs to average loans |       | 0.10       | %          | 0.03       | %          |
| Ratio of provision to  average loans       |       | 0.00       | %          | 0.07       | %          |

 

The Bank performs aquarterly detailed review to identify the risks inherent in the loan portfolio,to assess the overall quality of the loan portfolio and to determine theadequacy of the allowance for loan losses and the related provision for loanlosses to be charged to expense. Systematic reviews follow the methodology set forth by variousregulatory policy statements on the allowance for loan losses.

A key element of the Bank’smethodology is the previously discussed credit classification process.  As of December 31, 2006, the Bank did notestablish special reserves for individual loans based on specific anticipationof loss to the portfolio.  The inherentrisk present in the “acceptable” portion of the loan portfolio is taken intoconsideration and adjustments made for trends, changes in economic conditionsand other relevant factors that may affect repayment of the loans.

Management and the boardconsider the allowance for loan losses to be adequate to provide for lossesinherent in the loan portfolio. Although management uses available informationto recognize losses on loans and leases, future additions to the allowance maybe necessary based on changes in economic conditions.  In addition, federal regulators periodicallyreview our allowance for loan losses and may recommend additions based upontheir evaluation of the portfolio at the time of their examination.  Accordingly, there can be no assurance thatour allowance for loan losses will be adequate to cover future loan losses orthat significant additions to the allowance for loan losses will not berequired in the future.  Materialadditions to the allowance for loan losses would decrease earnings and capitaland would thereby reduce the Bank’s ability to pay dividends, among otheradverse consequences.

The ratio of allowancefor loan losses to total loans as of December 31, 2006 was 0.84%.  Management and the board consider this to beadequate based on their analysis and reviews of the portfolio.

 

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As part of the analysis of the allowance, the Bankassigns certain risk factors to the entire loan portfolio in addition to thespecific percentages used for classified loans. The following table summarizes the allocation of the allowance for loanlosses by general loan types based on collateral or security type as usedinternally by the Bank as of December 31, 2006 and 2005. 
| ** **                           | ** ** | **December 31, 2006** | ** ** | **December 31, 2005**   | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-----------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Loans**                       | ** ** | **Percent  of Total  Loans** | ** ** | **Allowance  Allocation** | ** ** | **% of Total  Allowance** | ** ** | **Loans** | ** ** | **Percent  of Total  Loans** | ** ** | **Allowance  Allocation** | ** ** | **% of Total  Allowance** | ** ** |
| Unclassified loans:                  |       |                            |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate                          |       | $                               | 94,772     |                              | 77.2       | % | $ | 447 |   | 43.6 | % | $ | 93,588 |   | 78.4 | % | $ | 431 |   | 37.8 | % |
| Other secured  loans                 |       | 23,220                          |       | 18.9                              | %          | 244 |   | 23.8 | % | 20,649 |   | 17.3 | % | 295 |   | 25.9 | % |
| Unsecured loans                      |       | 2,733                           |       | 2.2                               | %          | 32 |   | 3.1 | % | 1,006 |   | 0.8 | % | 21 |   | 1.8 | % |
| Total  unclassified loans            |       | 120,725                         |       | 98.3                              | %          | 723 |   | 70.5 | % | 115,243 |   | 96.5 | % | 747 |   | 65.5 | % |
| Classified loans                     |       | 2,074                           |       | 1.7                               | %          | 30 |   | 2.9 | % | 4,232 |   | 3.5 | % | 376 |   | 32.9 | % |
| Other economic factors               |       |                            |       |                              |       | 273 |   | 26.6 | % |   |   |   |   | 18 |   | 1.6 | % |
| Totals                               |       | $                               | 122,799    |                              | 100.0      | % | $ | 1,026 |   | 100.0 | % | $ | 119,475 |   | 100.0 | % | $ | 1,141 |   | 100.0 | % |

 

**Deposits**

Deposits are the primary source of funding for lendingand investing needs.  Total deposits were$124.3 million as of December 31, 2006, and $127.6 million at December 31,2005.  Deposits decreased by $3.3million, or 3%, following a $14.8 million, or 13%, increase in 2005.  Increasing competition for deposits in thelocal market and from other non-local financial institutions made depositgrowth a formidable challenge in 2006.

The Bank generally pricesdeposits at or above the median rate by classification based on periodicinterest rate surveys in the local market. Deposit rates are then adjusted to balance the cost of funds versus fundingneeds and asset and liability considerations. The Bank has used and expects to continue to use an Investor Savingsproduct that pays higher rates than normal savings, similar to money marketaccounts, as a special product unique in the Bank’s market, but management alsoexpects to see the relative percentage of Investor Savings to total deposits tocontinue to decline.  The *Net Interest Analysis* and *Rate/VolumeAnalysis* earlier in this Discussion contain information regardingthe average rates paid on deposits for 2006 and 2005.

In August 2005 the Banklaunched a new suite of deposit products: the Mission Community Clubprogram.  The Community Club provides newbank customers with free checking, higher-than-normal yields on savingsaccounts and certificates of deposit, and attractive interest rates on creditcards.  In exchange for the generation ofnew core deposit account balances, the Bank supported five local non-profitorganizations with grants of $5,000 each in the second quarter of 2006.  The Bank expects to make additional grants in2007 based on the success of the Community Club program.

During 2006 the Bankbegan to capitalize on its status as the only bank in San Luis Obispo countyparticipating in the Certificate of Deposit Account Registry Service (“CDARS”)program.  This program permits the Bank’scustomers to place all of their deposits at one institution—Mission CommunityBank—and have those deposits fully-insured by the FDIC, up to $30 million.  The CDARS program acts as a clearinghouse,matching deposits from one institution in the CDARS network of over 1,500 bankswith other network banks (in increments of less than the $100 thousand FDICinsurance limit), so funds that a customer places with the Bank essentiallyremain on the Bank’s balance sheet.  Asof December 31, 2006, the Bank had issued $2.5 million of certificates ofdeposit to local customers through the CDARS program.

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The following table reflects the maturity distributionof certificates of deposit in the amounts of $100,000 or more as of December31, 2006:

**Maturities of Time Deposits of $100,000 or More**

|                                          | ** ** | **(Dollars in thousands)** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|
| Three months or  less                    |       | $                                    | 20,562     |   |
| Three months to  six months              |       | 8,698                                |       |
| Six months to  one year                  |       | 7,110                                |       |
| Over one year                            |       | 1,284                                |       |
| Total time deposits of  $100,000 or more |       | $                                    | 37,654     |   |

 

#### **ShortTerm and Other Borrowings**

As of December 31, 2006,the Bank had $17.4 million in outstanding borrowings from the Federal Home LoanBank of San Francisco, $10.5 million of which matures during 2006, and thebalance matures on various dates from March 2008 through December 2013.  Note F to the consolidated financialstatements contains additional information regarding these borrowings.

#### **Off-Balance-SheetFinancial Instruments**

In the normal course of business,the Bank enters into financial commitments to customers, primarily to extendcredit.  Those instruments involve, tovarying degrees, elements of credit and interest rate risk not recognized inthe statement of financial position.  Asof December 31, 2006, the Bank had outstanding commitments to extend credittotaling $35.4 million and standby letters of credit totaling approximately$200 thousand.  See Note M to theconsolidated financial statements for additional information onoff-balance-sheet commitments and contingencies.

The Bank has not enteredinto any off-balance-sheet derivative financial instruments as of December 31,2006.

#### **Liquidity Management**

The objective of our asset/liability strategy is tomanage liquidity and interest rate risks to ensure the safety and soundness ofthe Bank and its capital base, while maintaining an adequate net interestmargin in order to provide an appropriate return to shareholders.

The Bank’s liquidity,which primarily represents the ability to meet fluctuations in deposit levelsand provide for customers’ credit needs, is managed through various fundingstrategies that reflect the maturity structures of the sources of funds and theassets being funded.  The Bank’sliquidity is further augmented by payments of principal and interest on loansand increases in short-term liabilities such as demand deposits and short-termcertificates of deposit.  Short-terminvestments, primarily federal funds sold, is the primary means for providingimmediate liquidity.  The Bank had $7.1million in federal funds sold on December 31, 2006, and $8.0 million onDecember 31, 2005.

In order to meet the Bank’sliquidity requirements, the Bank endeavors to maintain an appropriate liquidityratio.  The liquidity ratio is the sum ofcash and deposits at other banks, federal funds sold, and unpledgedavailable-for-sale securities, divided by total deposits.  As of December 31, 2006 and 2005, the Bank’sliquidity ratios were 13.3% and 14.6%, respectively.

While the Bank primarilyuses federal funds sold as the primary immediate source of cash liquidity, italso has established short-term borrowing lines (federal funds purchased) for atotal of $6.5 million from its correspondent banks.  These lines are for short-term needs and arerarely used.

The Bank also has asecured borrowing facility through the Federal Home Loan Bank of San Francisco(“FHLB”).  FHLB borrowings can bestructured over various terms ranging from overnight to ten years.  As of December 31, 2006, the Bank 

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had outstanding borrowingsfrom the FHLB totaling $17.4 million.  Ofthe $17.4 million, $3 million was borrowed for 10 years to offset a specificpool of the Bank’s fixed rate loans maturing in 2013.  Another $2.5 million was borrowed for fiveyears to “match-fund” a pool of fixed rate loans maturing in 2009.  Interest rates and terms for FHLB borrowingsare generally more favorable than the rates for similar term brokeredcertificates of deposit or for federal funds purchased.  The Bank has the potential (on a securedbasis) to borrow up to 25 percent of its total assets or an additional $17.4million from the FHLB.  The Bankanticipates utilizing FHLB borrowings in 2007 when needed as part of its normalliquidity management to fund asset growth on a cost-effective basis, and hasmore than adequate loans to pledge as collateral should it need additionalliquidity that cannot be funded by deposits.

Following is a summary ofthe Company’s contractual obligations extending beyond one year from December31, 2006:

**Long-Term Contractual Obligations**
| ** **                      | ** ** | **Less than**                   | ** ** | **1 thru 3** | ** ** | **3 thru 5** | ** ** | **More than** | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **                      | ** ** | **1 year**                      | ** ** | **years**              | ** ** | **years**              | ** ** | **5 years**   | ** ** | **Total**  | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Borrowed funds                  |       | $                                    | 10,500     |                   | $          | 3,900                  |       | $                  | —     |       | $          | 3,000 |   | $ | 17,400 |   |
| Junior  subordinated debentures |       | —                               |       | —                 |       | —                 |       | 3,093              |       | 3,093      |       |
| Operating leases                |       | 336                                  |       | 551                    |       | 325                    |       | 3,843              |       | 5,055      |       |
| Capital leases                  |       | —                               |       | —                 |       | —                 |       | —             |       | —     |       |
| Purchase  obligations           |       | —                               |       | —                 |       | —                 |       | —             |       | —     |       |
| Other long-term  liabilities    |       | —                               |       | —                 |       | —                 |       | —             |       | —     |       |
| Total  contractual obligations  |       | $                                    | 10,836     |                   | $          | 4,451                  |       | $                  | 325        |       | $          | 9,936 |   | $ | 25,548 |   |

 

While core, local depositsremain the primary source of deposits, the Bank continues to seek alternatesources for competitive rate deposits. Through the CDARS program (see *Deposits* earlierin this analysis), the Bank is able to bid on additional certificates ofdeposit through banks across the country to meet additional funding needs.  These “One-Way Buy” CDARS deposits aretypically priced comparable to FHLB secured borrowing rates, but with nocollateral required.  As of December 31,2006, the Bank had approximately $10 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 designationsto attract lower cost deposits.

Bancorp is a companyseparate and apart from the Bank and must provide for its own liquidity.  As of December 31, 2006, Bancorp had noborrowings other than the junior subordinated debentures reflected in the abovetable, and had approximately $246,000 in unrestricted cash.  See Note Q to the consolidated financialstatements for additional financial information regarding Bancorp.

Substantially all ofBancorp’s revenues are obtained from dividends declared and paid by theBank.  There are statutory and regulatoryprovisions that could limit the ability of the Bank to pay dividends toBancorp.  See Note O to the consolidatedfinancial statements for additional information regarding regulatory dividendand capital restrictions.  Managementbelieves that such restrictions will not have an impact on the ability ofBancorp to meet its ongoing cash obligations.

**Asset and Liability Management**

The objectives of interest rate risk management are tocontrol exposure of net interest income to risks associated with interest ratemovements in the market, to achieve consistent growth in net interest incomeand to profit from favorable market opportunities.  Even with perfectly matched repricing ofassets and liabilities, risks remain in the form of prepayment of assets, andtiming lags in adjusting certain assets and liabilities that have varyingsensitivities to market interest rates.

40

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The table below sets forth the interest ratesensitivity of interest-earning assets and interest-bearing liabilities as ofDecember 31, 2006.  For purposes of thetable, an asset or liability is considered rate-sensitive in the first periodwhen it can be repriced, matures within its contractual terms, or is expectedto be prepaid.  For example, all savings,NOW and money market accounts can be repriced immediately, so they are includedin the left-most column.  Based on theircontractual terms, loans may reprice or mature beyond one year, but ourprepayment assumptions would indicate that a certain percentage of them wouldlikely be paid off earlier.  That portionestimated to be paid off early would be shown in one of the columns to the leftof its actual maturity.

**Interest Sensitivity Gap***December 31, 2006*
| ** **                                  | ** ** | **Sensitive to Rate Changes Within** | ** ** | ** **            | ** ** | ** **           | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|
| ** **                                  | ** ** | **3**                                                    | ** ** | **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               |       | $                                                        | 81,437     |                  | $          | 19,627               |       | $ | 19,177 |   | $ | 2,648 |   | $ | (90 | ) | $ | 122,799 |   |
| Investment securities                       |       | 431                                                      |       | 3,701                 |       | 8,671                |       | 3,712 |   | (99 | ) | 16,416 |   |
| Other earning assets                        |       | 10,589                                                   |       |                  |       | 550                  |       |   |   | — |   | 11,139 |   |
| Non-interest-earning assets                 |       | —                                                   |       | —                |       | —               |       | — |   | 7,815 |   | 7,815 |   |
| Total assets                                |       | 92,457                                                   |       | 23,328                |       | 28,398               |       | 6,360 |   | 7,626 |   | 158,169 |   |
|                                        |       |                                                     |       |                  |       |                 |       |   |   |   |   |   |   |
| **Interest-Bearing  Liabilities:**          |       |                                                     |       |                  |       |                 |       |   |   |   |   |   |   |
| Interest-bearing deposits                   |       | 75,685                                                   |       | 21,089                |       | 1,518                |       | — |   | — |   | 98,292 |   |
| Borrowed funds                              |       | 8,500                                                    |       | 2,000                 |       | 3,900                |       | 3,000 |   | — |   | 17,400 |   |
| Junior subordinated debentures              |       | 3,093                                                    |       | —                |       | —               |       | — |   | — |   | 3,093 |   |
| Non-interest-bearing liabilities and equity |       | —                                                   |       | —                |       | —               |       | — |   | 39,384 |   | 39,384 |   |
| Total liabilities and equity                |       | 87,278                                                   |       | 23,089                |       | 5,418                |       | 3,000 |   | 39,384 |   | 158,169 |   |
|                                        |       |                                                     |       |                  |       |                 |       |   |   |   |   |   |   |
| Interest rate  sensitivity gap              |       | $                                                        | 5,179      |                  | $          | 239                  |       | $ | 22,980 |   | $ | 3,360 |   | $ | (31,758 | ) | $ | — |   |
|                                        |       |                                                     |       |                  |       |                 |       |   |   |   |   |   |   |
| Cumulative  interest rate sensitivity gap   |       | $                                                        | 5,179      |                  | $          | 5,418                |       | $ | 28,398 |   | $ | 31,758 |   | $ | — |   |   |   |
|                                        |       |                                                     |       |                  |       |                 |       |   |   |   |   |   |   |
| Cumulative gap to total  earning assets     |       | 3                                                        | %          | 3                     | %          | 18                   | %          | 20 | % |   |   |   |   |

 

Gap analysis attempts tocapture interest rate risk, which is attributable to the mismatching ofinterest rate sensitive assets and liabilities. A positive cumulative gap, as shown in the table, means that over the periodsindicated our assets will reprice faster than our liabilities.  During the first year $116 million of theinterest earning assets are expected to reprice, compared with $110 million ofinterest bearing liabilities—a slightly asset-sensitive structure.  More importantly, during the first threemonths $92 million of interest earning assets will reprice and only $87 millionof interest-bearing liabilities.  Ingeneral, this means that in a rising interest rate environment, with all otherconditions remaining constant, net interest income would be expected toincrease, and in a declining interest rate environment net interest incomewould be expected to decrease.

One should use caution ifattempting to predict future levels of net interest income through the use of “static”gap analysis, however.  The actual impactof interest rate movements on net interest income may differ significantly fromthat implied by any gap measurement, depending on the direction and magnitudeof the interest rate movements, the repricing characteristics of various on-and off-balance sheet instruments, as well as competitive pressures.  Changes in the mix of earning assets orsupporting liabilities can either increase or decrease the net interest marginwithout affecting interest rate sensitivity. In addition, varying interest rate environments can create unexpectedchanges in prepayment activity as compared to prepayments assumed in theinterest rate sensitivity analysis. Prepayments may have significant impact on our net interest margin.  These factors are not fully reflected in theforegoing gap analysis and, as a result, the gap report may not provide acomplete assessment of our interest rate risk.

Based on current economicforecasts, the Bank anticipates that interest rates will remain relatively flatfor the first half of 2007 and may decrease slightly in the second half, whichwould suggest that the interest margin may decline slightly in 2007.  However, with active asset and liabilitymanagement, the Bank expects to be able to maintain its net interest margin atapproximately its 2006 level.

41

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#### **Effects of Inflation and Economic Issues**

A financial institution’s asset and liabilitystructure is substantially different from that of an industrial firm in thatprimarily all assets and liabilities of a bank are monetary in nature, withrelatively little investments in fixed assets or inventories.  Inflation has an important impact on thegrowth of total assets and the resulting need to increase equity capital athigher than normal rates in order to maintain an appropriate equity to assetsratio.  Management believes that theimpact of inflation on financial results depends on the Company’s ability toreact to changes in interest rates and, by such reaction, reduce theinflationary impact on performance. Management has attempted to structure the mix of financial instrumentsand manage interest rate sensitivity in order to minimize the potential adverseeffects of inflation or other market forces on net interest income and,therefore, earnings and capital.

San Luis Obispo Countycontinues to have one of the lowest unemployment rates in California, yet realestate values have declined slightly in 2006. After several years of strong appreciation,  residential and commercial sale activity hasslowed somewhat in recent months.  Therecan be no assurance that the economy will continue to be strong or that realestate values will return to pre-2006 levels in the short term.  As such, the Bank closely monitors creditquality, interest rate risk and operational expenses.

**Return on Equity and Assets**

The following table showsthe Company’s return on average assets and return on average equity for pasttwo years:

|                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Return on  Average Assets |       | 0.58     | %          | 0.68     | %          |
| Return on Average  Equity |       | 7.53     | %          | 9.16     | %          |

 

42

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## **Item 7. Financial Statements**

**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATEDFINANCIAL STATEMENTS**

**WITH**

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**December31, 2006 and 2005**

**CONTENTS**

----

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**   ON THE CONSOLIDATED FINANCIAL STATEMENTS**

----

| **CONSOLIDATED FINANCIAL STATEMENTS**                               |
|---------------------------------------------------------------------|
| ** **                                                          |
| **Consolidated Balance  Sheets**                                    |
| **Consolidated  Statements of Income**                              |
| **Consolidated Statement of  Changes in Shareholders’ Equity** |
| **Consolidated Statements of Cash Flows**                           |
| **Notes to  Consolidated Financial Statements**                     |

----

 

43

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|  | **Vavrinek, Trine, Day & Co., LLP**Certified Public Accountants & Consultants   | ** ** |   | **VALUE  THE DIFFERENCE** |
|--|----------------------------------------------------------------------------------------------|------------|--------|---------------------------|

 

#### **REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

Board of Directors andShareholders ofMission Community Bancorp and Subsidiary

We have audited theaccompanying consolidated balance sheets of Mission Community Bancorp andSubsidiary as of December 31, 2006 and 2005 and the related consolidatedstatements of income, changes in shareholders’ equity, and cash flows of the yearsthen ended.  These consolidated financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

We conducted our auditsin accordance with the standards of the public company accounting oversightboard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether 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 financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Mission CommunityBancorp and Subsidiary as of December 31, 2006 and December 31, 2005, and theresults of its operations and its cash flows for the years then ended, inconformity with accounting principles generally accepted in the United Statesof America.

As discussed inNote A to the consolidated financial statements, the Company adopted newaccounting guidance which impacts the accounting for stock options.

Laguna Hills, CaliforniaMarch 5, 2007

 

25231 Paseo De Alicia, Suite 100   Laguna Hills, CA  92653    Tel: 949.768.0833    Fax: 949.768.8408    www.vtdcpa.comFRESNO  · LAGUNA HILLS  ·  PALOALTO  · PLEASANTON · RANCHO CUCAMONGA

 

44

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**MISSION COMMUNITY BANCORP ANDSUBSIDIARY**

**CONSOLIDATEDBALANCE SHEETS**

**December 31, 2006 and 2005**
| ** **                                             | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|--------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                             | ** ** | ** **  | ** **  | ** **  | ** ** |
|                                                   |       |        |        |        |       |
| Cash and Due from Banks                                |       | $           | 3,044,952   |        | $          | 4,432,733 |   |
| Federal Funds Sold                                     |       | 7,070,000   |        | 7,950,000   |       |
| **TOTAL  CASH AND CASH EQUIVALENTS**                   |       | 10,114,952  |        | 12,382,733  |       |
|                                                   |       |        |        |        |       |
| Certificates of Deposit  in Other Banks                |       | 550,000     |        | 550,000     |       |
|                                                   |       |        |        |        |       |
| Investment Securities  Available for Sale              |       | 16,415,903  |        | 15,815,704  |       |
| ** **                                             | ** ** | ** **  | ** **  | ** **  | ** ** |
| Loans held for sale                                    |       | 274,015     |        | 241,500     |       |
|                                                   |       |        |        |        |       |
| Loans:                                                 |       |        |        |        |       |
| Commercial                                             |       | 21,669,968  |        | 14,763,179  |       |
| Agricultural                                           |       | 123,000     |        | 152,573     |       |
| Construction                                           |       | 31,639,178  |        | 29,920,948  |       |
| Real Estate                                            |       | 66,590,505  |        | 71,878,354  |       |
| Consumer                                               |       | 2,502,159   |        | 2,518,701   |       |
| **TOTAL  LOANS**                                       |       | 122,524,810 |        | 119,233,755 |       |
| ** **                                             | ** ** | ** **  | ** **  | ** **  | ** ** |
| Allowance for Loan  Losses                             |       | (1,025,939  | )           | (1,141,096  | )          |
| **NET  LOANS**                                         |       | 121,498,871 |        | 118,092,659 |       |
|                                                   |       |        |        |        |       |
| Federal Home Loan Bank  Stock and Other Stock, at Cost |       | 1,311,225   |        | 1,499,225   |       |
| Premises and Equipment                                 |       | 3,723,808   |        | 3,331,475   |       |
| Cash Surrender Value of  Life Insurance                |       | 2,207,634   |        | 2,134,526   |       |
| Accrued Interest and  Other Assets                     |       | 2,072,116   |        | 2,239,784   |       |
|                                                   |       | $           | 158,168,524 |        | $          | 156,287,606 |   |

 

The accompanying notes are an integral of these consolidated financialstatements.

45

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**MISSION COMMUNITY BANCORP ANDSUBSIDIARY**

**CONSOLIDATEDBALANCE SHEETS**

**December 31, 2006 and 2005**
| ** **                                                       | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                   | ** ** | ** **  | ** **  | ** **  | ** ** |
|                                                             |       |        |        |        |       |
| Deposits:                                                        |       |        |        |        |       |
| Noninterest-Bearing  Demand                                      |       | $           | 25,988,437  |        | $          | 27,969,486 |   |
| Money Market,  NOW and Savings                                   |       | 36,935,546  |        | 39,280,290  |       |
| Time Deposits  Under $100,000                                    |       | 23,702,313  |        | 25,154,995  |       |
| Time Deposits  $100,000 and Over                                 |       | 37,654,383  |        | 35,183,125  |       |
| **TOTAL  DEPOSITS**                                              |       | 124,280,679 |        | 127,587,896 |       |
| ** **                                                       | ** ** | ** **  | ** **  | ** **  | ** ** |
| Other Borrowings                                                 |       | 17,400,000  |        | 13,400,000  |       |
| Junior Subordinated  Debt Securities                             |       | 3,093,000   |        | 3,093,000   |       |
| Accrued Interest and  Other Liabilities                          |       | 1,241,744   |        | 1,225,486   |       |
| **TOTAL  LIABILITIES**                                           |       | 146,015,423 |        | 145,306,382 |       |
| ** **                                                       | ** ** | ** **  | ** **  | ** **  | ** ** |
| Commitments and  Contingencies - Notes D and M                   |       | —      |        | —      |       |
| ** **                                                       | ** ** | ** **  | ** **  | ** **  | ** ** |
| Shareholders’ Equity:                                       |       |        |        |        |       |
| Preferred Stock —  Authorized 1,000,000 Shares:             |       |        |        |        |       |
| Series A — $5  Stated Value; 100,000 Issued and Outstanding |       |        |        |        |       |
| Liquidation  Value of $500,000                                   |       | 392,194     |        | 392,194     |       |
| Series B — $10  Stated Value; 20,500 Issued and Outstanding |       |        |        |        |       |
| Liquidation  Value of $205,000                                   |       | 191,606     |        | 191,606     |       |
| Series C — $10  Stated Value; 50,000 Issued and Outstanding |       |        |        |        |       |
| Liquidation Value  of $500,000                                   |       | 500,000     |        | 500,000     |       |
| Common Stock —  Authorized 1,000,000 Shares;                |       |        |        |        |       |
| Issued and  Outstanding: 673,399 in 2006 and 659,799 in 2005     |       | 6,858,648   |        | 6,655,784   |       |
| Additional  Paid-In Capital                                      |       | 60,798      |        | —      |       |
| Retained  Earnings                                               |       | 4,208,742   |        | 3,434,081   |       |
| Accumulated  Other Comprehensive Income — Unrealized        |       |        |        |        |       |
| Depreciation on  Available-for-Sale Securities, net of tax       |       | (58,887     | )           | (192,441    | )          |
| **TOTAL  SHAREHOLDERS’ EQUITY**                             |       | 12,153,101  |        | 10,981,224  |       |
|                                                             |       | $           | 158,168,524 |        | $          | 156,287,606 |   |

 

The accompanying notes are an integral of theseconsolidated financial statements.

46

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**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF INCOME**

**YearsEnded December 31, 2006 and 2005**

** **

 
| ** **                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|
| **INTEREST  INCOME**                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and Fees on Loans                         |       | $          | 10,385,886 |       | $          | 8,624,700 |   |
| Interest on Investment Securities                  |       | 685,466    |       | 624,902    |       |
| Other Interest Income                              |       | 283,109    |       | 185,640    |       |
| **TOTAL INTEREST INCOME**                          |       | 11,354,461 |       | 9,435,242  |       |
| **INTEREST  EXPENSE**                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest on Money Market, NOW and Savings Deposits |       | 1,020,225  |       | 872,986    |       |
| Interest on Time Deposits                          |       | 2,541,282  |       | 1,365,133  |       |
| Other Interest Expense                             |       | 879,596    |       | 640,765    |       |
| **TOTAL INTEREST EXPENSE**                         |       | 4,441,103  |       | 2,878,884  |       |
| **NET INTEREST INCOME**                            |       | 6,913,358  |       | 6,556,358  |       |
| Provision for  Loan Losses                         |       | —     |       | 75,000     |       |
| **NET INTEREST INCOME AFTER**                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **PROVISION FOR LOAN LOSSES**                      |       | 6,913,358  |       | 6,481,358  |       |
| **NON-INTEREST  INCOME**                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts                |       | 258,043    |       | 256,109    |       |
| Gain on sale of loans                              |       | 298,542    |       | 344,490    |       |
| Loan servicing fees, net of amortization           |       | (118,074   | )          | 15,627     |       |
| Grants and awards                                  |       | 100,188    |       | —     |       |
| Other income and fees                              |       | 95,826     |       | 188,121    |       |
| **TOTAL NON-INTEREST INCOME**                      |       | 634,525    |       | 804,347    |       |
| **NON-INTEREST  EXPENSE**                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                     |       | 3,410,679  |       | 3,137,693  |       |
| Occupancy expenses                                 |       | 583,841    |       | 568,971    |       |
| Furniture and equipment                            |       | 303,568    |       | 254,272    |       |
| Data processing                                    |       | 460,225    |       | 403,440    |       |
| Professional fees                                  |       | 176,660    |       | 175,782    |       |
| Marketing and business development                 |       | 313,599    |       | 273,792    |       |
| Office supplies and expenses                       |       | 210,805    |       | 241,719    |       |
| Insurance and regulatory assessments               |       | 153,000    |       | 93,352     |       |
| Loan and lease expenses                            |       | 80,002     |       | 102,348    |       |
| Provision for unfunded commitments                 |       | —     |       | 5,000      |       |
| Other expenses                                     |       | 447,108    |       | 457,961    |       |
| **TOTAL NON-INTEREST EXPENSE**                     |       | 6,139,487  |       | 5,714,330  |       |
| **INCOME BEFORE INCOME TAXES**                     |       | 1,408,396  |       | 1,571,375  |       |
| Income Tax  Expense                                |       | 538,827    |       | 614,847    |       |
| **NET INCOME**                                     |       | $          | 869,569    |       | $          | 956,528 |   |
| ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Per Share Data  (Notes A and N):                   |       |       |       |       |       |
| Net Income — Basic                            |       | $          | 1.10       |       | $          | 1.25 |   |
| Net Income —  Diluted                         |       | $          | 1.02       |       | $          | 1.14 |   |

 

 

The accompanyingnotes are an integral of these consolidated financial statements.

47

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**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENT OF CHANGESIN SHAREHOLDERS’ EQUITY**

**YearsEnded December 31, 2006 and 2005**
| ** **                                                                                      | ** ** | ** **    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------|------------|-----------------------|------------|-------------|------------|-------------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                      | ** ** | ** **    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**    | ** ** | ** **   | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                                      | ** ** | **Preferred** | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                                      | ** ** | **Stock**     | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income**   | ** ** | **Earnings**      | ** ** | **Income**      | ** ** | **Total**  | ** ** |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Balance  at**                                                                                 |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **January 1, 2005**                                                                             |       | $             | 1,083,800  |                  | 642,599    |        | $          | 6,387,326         |       | $            | —     |              |       |            | $          | 2,570,697  |       | $ | (14,507 | ) | $ | 10,027,316 |   |
| ** **                                                                                      |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| Dividends paid                                                                                  |       |          |       |                  |       |        |       |              |       |         |       | (93,144           | )          |            |       | (93,144    | )          |
| Exercise of stock  options, and related tax benefit of $107,170                                 |       |          |       | 17,200                |       | 268,458     |       |              |       |         |       |              |       |            |       | 268,458    |       |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Comprehensive  Income:**                                                                      |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| Net income                                                                                      |       |          |       |                  |       |        |       |              |       | $            | 956,528    |              | 956,528    |            |       |       | 956,528    |   |
| Net unrealized  loss on available-for-sale securities, net of taxes of $86,537                  |       |          |       |                  |       |        |       |              |       | (124,530     | )          |              |       | (124,530        | )          | (124,530   | )          |
| Net unrealized  loss on securities reclassified from held-to-maturity, net of taxes of  $37,111 |       |          |       |                  |       |        |       |              |       | (53,404      | )          |              |       | (53,404         | )          | (53,404    | )          |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Total  Comprehensive Income**                                                                 |       |          |       |                  |       |        |       |              |       | $            | 778,594    |              |       |            |       |       |       |   |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Balance  at**                                                                                 |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **December 31, 2005**                                                                           |       | $             | 1,083,800  |                  | 659,799    |        | $          | 6,655,784         |       | $            | —     |              |       |            | $          | 3,434,081  |       | $ | (192,441 | ) | $ | 10,981,224 |   |
| ** **                                                                                      |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| Dividends paid                                                                                  |       |          |       |                  |       |        |       |              |       |         |       | (94,908           | )          |            |       | (94,908    | )          |
| Exercise of stock  options, and related tax benefit of $68,062                                  |       |          |       | 13,600                |       | 202,864     |       | (302              | )          |         |       |              |       |            |       | 202,562    |       |
| Stock-based  compensation                                                                       |       |          |       |                  |       |        |       | 61,100            |       |         |       |              |       |            |       | 61,100     |       |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Comprehensive  Income:**                                                                      |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| Net income                                                                                      |       |          |       |                  |       |        |       |              |       | $            | 869,569    |              | 869,569    |            |       |       | 869,569    |   |
| Net unrealized  gain on available-for-sale securities, net of taxes of $92,809                  |       |          |       |                  |       |        |       |              |       | 133,554      |       |              |       | 133,554         |       | 133,554    |       |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Total  Comprehensive Income**                                                                 |       |          |       |                  |       |        |       |              |       | $            | 1,003,123  |              |       |            |       |       |       |   |
|                                                                                            |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **Balance  at**                                                                                 |       |          |       |                  |       |        |       |              |       |         |       |              |       |            |       |       |       |
| **December  31, 2006**                                                                          |       | $             | 1,083,800  |                  | 673,399    |        | $          | 6,858,648         |       | $            | 60,798     |              |       |            | $          | 4,208,742  |       | $ | (58,887 | ) | $ | 12,153,101 |   |

 

48

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**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2006 and 2005**
| ** **                                                                         | ** ** | **2006**   | ** ** | **2005**    | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|
| **OPERATING  ACTIVITIES**                                                          |       |       |       |        |       |
| Net income                                                                         |       | $          | 869,569    |        | $          | 956,528 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |       |       |        |       |
| Provision for deferred income taxes                                                |       | 102,418    |       | (3,298      | )          |
| Depreciation                                                                       |       | 325,146    |       | 279,753     |       |
| Accretion of discount on securities and loans, net                                 |       | (306,378   | )          | (282,333    | )          |
| Provision for credit losses                                                        |       | —     |       | 75,000      |       |
| Provision for losses on unfunded loan commitments                                  |       | —     |       | 5,000       |       |
| Stock-based compensation                                                           |       | 61,100     |       | —      |       |
| Loss on disposal of fixed assets                                                   |       | 6,161      |       | 30,262      |       |
| Gain on loan sales                                                                 |       | (298,542   | )          | (344,490    | )          |
| Proceeds from loan sales                                                           |       | 3,767,984  |       | 4,592,922   |       |
| Loans originated for sale                                                          |       | (3,484,238 | )          | (4,073,364  | )          |
| Increase in cash surrender value of life insusance                                 |       | (73,108    | )          | (74,721     | )          |
| Other, net                                                                         |       | (201,395   | )          | 328,643     |       |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                                      |       | 768,717    |       | 1,489,902   |       |
| ** **                                                                         |       |       |       |        |       |
| **INVESTING  ACTIVITIES**                                                          |       |       |       |        |       |
| Net change in Federal Home Loan Bank and other stock                               |       | 228,600    |       | (418,300    | )          |
| Purchase of available-for-sale securities                                          |       | (2,932,428 | )          | (3,240,255  | )          |
| Proceeds from maturities of available-for-sale  securities                         |       | 2,544,707  |       | 1,807,835   |       |
| Proceeds from maturities of held-to-maturity  securities                           |       | —     |       | 1,055,446   |       |
| Net increase in loans                                                              |       | (2,954,174 | )          | (15,949,680 | )          |
| Proceeds from sale of fixed assets                                                 |       | 14,400     |       | 3,295       |       |
| Purchases of premises and equipment                                                |       | (738,040   | )          | (1,164,905  | )          |
| **NET CASH USED IN INVESTING ACTIVITIES**                                          |       | (3,836,935 | )          | (17,906,564 | )          |
| ** **                                                                         |       |       |       |        |       |
| **FINANCING  ACTIVITIES**                                                          |       |       |       |        |       |
| Net decrease in demand deposits and savings accounts                               |       | (4,325,793 | )          | (316,486    | )          |
| Net increase in time deposits                                                      |       | 1,018,576  |       | 15,068,332  |       |
| Net increase in other borrowings                                                   |       | 4,000,000  |       | 900,000     |       |
| Payment of dividends                                                               |       | (94,908    | )          | (93,144     | )          |
| Proceeds from exercise of stock options                                            |       | 202,562    |       | 268,458     |       |
| **NET CASH PROVIDED BY FINANCING ACTIVITIES**                                      |       | 800,437    |       | 15,827,160  |       |
|                                                                               |       |       |       |        |       |
| **NET DECREASE IN CASH AND CASH EQUIVALENTS**                                      |       | (2,267,781 | )          | (589,502    | )          |
| Cash and cash  equivalents at beginning of year                                    |       | 12,382,733 |       | 12,972,235  |       |
| **CASH AND CASH EQUIVALENTS AT END OF YEAR**                                       |       | $          | 10,114,952 |        | $          | 12,382,733 |   |
| ** **                                                                         |       |       |       |        |       |
| **Supplemental  Disclosures of Cash Flow Information:**                            |       |       |       |        |       |
| Interest paid                                                                      |       | $          | 4,226,061  |        | $          | 2,798,589 |   |
| Taxes paid                                                                         |       | 415,000    |       | 510,090     |       |
| Reclassification  of securities from held-to-maturity to available-for-sale        |       | —     |       | 7,891,643   |       |

 

The accompanying notes are an integral of theseconsolidated financial statements.

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**NOTE A—SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

Principles of Consolidation

The financial statements include the accounts ofMission Community Bancorp (“Bancorp”) and its subsidiary, Mission CommunityBank (“the Bank”), and the Bank’s subsidiary, Mission Community DevelopmentCorporation, collectively referred to herein as “the Company.”

Nature of Operations

The Bank has been organizedas a single reporting segment and operates three branches in the Central Coastarea of California (in the cities of San Luis Obispo, Paso Robles and ArroyoGrande).  On July 29, 2005 the Bankclosed its branch office which was located in Nipomo, California.  The deposit and loan business of the Nipomobranch was transferred to the Arroyo Grande branch.  In conjunction with the branch consolidation,the Bank recognized $30 thousand in losses and write-downs on fixed assets soldor abandoned and $15 thousand of other expenses.  These costs are included in non-interestexpenses in the Consolidated Statements of Income for 2005.  No additional costs are expected to beincurred in connection with this branch consolidation.

The Bank’s primary source ofrevenue is providing real estate, commercial (including Small BusinessAdministration (“SBA”) guaranteed loans) and consumer loans to customers, whoare predominately small and middle-market businesses and individuals.  The Company and the Bank are certified by theDepartment of Treasury as Community Development Financial Institution(s) (“CDFI”)with a commitment to focus on providing financial services to low- andmoderate-income communities.

Mission Community Development Corporation

Mission Community Development Corporation (“MCDC”) is a communitydevelopment corporation which provides financing for small businesses andprojects in low- to moderate-income areas. The Board of Directors of Mission Community Development Corporationconsists of four members of the Board of Directors of the Company and threeoutside members who are actively involved in supporting community affairs andactivities. Community development investment is limited to 5% of the Bank’scapital and up to 10% with prior approval by the Federal Reserve Board.  Operations of MCDC were not material for theyears ended December 31, 2006 or 2005.

MissionCommunity Services Corporation

Mission Community Services Corporation (“MCSC”), anaffiliate organization, was organized in 1998 and the corporation wasestablished as a not-for-profit company with Section 501(c)(3) status.  This company’s primary focus is to providetechnical support and training services to the underserved segments of thecommunity including small businesses, minorities and low-incomeentrepreneurs.  The Board of Directors ofMission Community Services Corporation includes representatives from theCompany, together with members representing the communities represented.  The accounts of MCSC are not included in theCompany’s consolidated financial statements. See Note L for additional information regarding MCSC.

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Use of Estimates in the Preparation of FinancialStatements

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cashequivalents include cash, amounts due from other banks and federal fundssold.  Generally, federal funds are soldfor one-day periods.

Cash and Due From Banks

Banking regulations require that all banks maintain apercentage of their deposits as reserves in cash or on deposit with the FederalReserve Bank (“FRB”).  The Bank was incompliance with this requirement, which was $598,000 as of December 31, 2006.

The Company maintains amounts due from other banks whichexceed federally insured limits.  TheCompany has not experienced any losses in such accounts.

Investment Securities

Bonds, notes, and debentures for which the Company hasthe positive intent and ability to hold to maturity are reported at cost,adjusted for premiums and discounts that are recognized in interest incomeusing the interest method over the period to maturity.

Investments not classified as trading securities noras held-to-maturity securities are classified as available-for-sale securities andrecorded at fair value.  Unrealized gainsor losses on available-for-sale securities are excluded from net income andreported as an amount net of taxes as a separate component of comprehensiveincome included in shareholders’ equity. Premiums or discounts are amortized or accreted into income using theinterest method.  Realized gains orlosses on sales of securities are recorded using the specific identificationmethod.

Other-than-temporary declines in the fair value ofindividual held-to-maturity and available-for-sale securities below their costresult in write-downs of the individual securities to their fair value.  The related write-downs are included inearnings as realized losses.  Inestimating other-than-temporary impairment losses, management considers thelength 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 intentand ability of the Bank to retain its investment in the issuer for a period oftime sufficient to allow for any anticipated recovery in fair value.

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Loans 

Loans are reported at the principal amountoutstanding, net of any deferred loan origination fee income and deferreddirect loan origination costs, and net of any unearned interest on discountedloans.  Deferred loan origination feeincome and direct loan origination costs are amortized to interest income overthe life of the loan using the interest method. Interest on loans is accrued to income daily based upon the outstandingprincipal balances.

Loans for which the accrual of interest has beendiscontinued are designated as non-accrual loans.  Loans are classified as non-accrual whenprincipal or interest is past due 90 days based on the contractual terms of theloan or when, in the opinion of management, there exists a reasonable doubt asto the full and timely collection of either principal or interest, unless theloan is well secured and in the process of collection.  Income on such loans is then only recognizedto the extent that cash is received and where the future collection ofprincipal is probable.  Accrual ofinterest is resumed only when principal and interest are brought fully currentand when such loans are considered to be collectible as to both principal andinterest.

For impairment recognized in accordance with FinancialAccounting Standards Board (“FASB”) Statement of Financial Accounting Standards(“SFAS”) No. 114, *“Accounting by Creditors for Impairment of aLoan,”* as amended by SFAS No. 118, the entire change in the presentvalue of expected cash flows is reported as either provision for credit lossesin the same manner in which impairment initially was recognized, or as areduction in the amount of provision for credit losses that otherwise would bereported.

### Loans Held for Sale

Mortgage loans and SBA loans originated and intendedfor sale in the secondary market are carried at the lower of cost or estimatedmarket value in the aggregate.  Netunrealized losses are recognized through a valuation allowance by charges toincome.  Gains or losses realized on thesales of loans are recognized at the time of sale and are determined by thedifference between the net sales proceeds and the carrying value of the loanssold, adjusted for any servicing asset or liability.  Gains and losses on sales of loans areincluded in non-interest income.

The Bank has adopted SFASNo. 140, *“Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.”*  The Statement provides accounting andreporting standards for transfers and servicing of financial assets andextinguishments of liabilities.  Underthis Statement, after a transfer of financial assets, an entity recognizes thefinancial and servicing assets it controls and liabilities it has incurred,derecognizes financial assets when control has been surrendered, andderecognizes liabilities when extinguished.

To calculate the gain(loss) on sale of loans, the Bank’s investment in the loan is allocated amongthe retained portion of the loan, the servicing retained and the sold portionof the loan, based on the relative fair market value of each portion.  That portion of the excess servicing feesthat represents contractually specified servicing fees (contractual servicing)is reflected as a servicing asset which is amortized over an estimated lifeusing a method approximating the level yield method.  The gain (loss) on the sold portion of theloan is recognized at the time of sale based on the difference between the saleproceeds and the allocated investment.  Asa result of the relative fair value allocation, the carrying value of theretained portion is discounted, with the discount accreted to interest incomeover the life of the loan.

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Allowance for LoanLosses

The allowance for loan losses is increased by charges to income anddecreased by charge-offs (net of recoveries). Charge-offs are loans and leases deemed uncollect­ible, which arecharged to the allowance.  Managementperforms, at least quarterly, an analysis of the allowance for loan losses todetermine its adequacy.  In thisanalysis, all non-classified loans are segmented into components by loan typeand internal risk rating.  Estimated lossfactors are applied to each loan pool based on historical losses as well asmanagement’s assessment of current factors that may impact these historicalfactors, such as changes in the local economy, changes in underwritingstandards, changes in loans concentrations and trends in past due andnon-performing loans.  Significant loansclassified as less than acceptable by management, the Bank’s regulators orexternal credit review consultants are evaluated separately in theprocess.  In this evaluation, managementreviews the borrower’s ability to repay as well as the estimated value of anyunderlying collateral.

Premises and Equipment

###### Land iscarried at cost.  Premises and equipmentare carried at cost less accumulated depreciation and amortization.  Depreciation is computed using thestraight-line method over the estimated useful lives, which range from three toten years for furniture and fixtures and forty years for buildings.  Leasehold improvements are amortized usingthe straight-line method over the estimated useful lives of the improvements orthe remaining lease term, whichever is shorter. Expenditures for betterments or major repairs are capitalized and thosefor ordinary repairs and maintenance are charged to operations as incurred.

AdvertisingCosts

The Bank expenses the costs of advertising in the period incurred.

Income Taxes

Deferred tax assets andliabilities are reflected at currently enacted income tax rates applicable tothe period in which the deferred tax assets or liabilities are expected to berealized or settled.  As changes in taxlaws or rates are enacted, deferred tax assets and liabilities are adjustedthrough the provision for income taxes.

Comprehensive Income

SFAS No. 130, *“Reporting Comprehensive Income*,*”*requires the disclosure of comprehensive income and its components.  Changes in unrealized gain or loss onavailable-for-sale securities net of income taxes is the only component ofaccumulated other comprehensive income for the Company.

Financial Instruments

In the ordinary course ofbusiness, the Company has entered into off-balance sheet financial instrumentsconsisting of commitments to extend credit, commercial letters of credit andstandby letters of credit.  Suchfinancial instruments are recorded in the financial statements when they arefunded or related fees are incurred or received.

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Earnings Per Share (“EPS”)

EPS is computed under theprovisions of Statement of Accounting Standards No. 128, *Earnings perShare,* (“SFAS 128”) and the Emerging Issues Task Force (“EITF”)Consensus on Issue No. 03-6, *Participating Securitiesand the Two-Class Method under FASB Statement No. 128.*  EITF 03-6 requires that income per share forthe Company’s common stock be calculated assuming 100% of the Company’searnings are distributed as dividends to its common and preferred shareholdersbased on their respective dividend rights, even though the Company does notanticipate distributing 100% of its earnings as dividends.   Basic EPS is computed by dividing incomeavailable to common shareholders, using the method prescribed above under EITF03-6, by the weighted-average number of common shares outstanding for theperiod.  Diluted EPS reflects thepotential dilution that could occur if options or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the Company.

Stock-BasedCompensation

During 2005 and 2006 the Company had one stock option plan (see Note Ito the consolidated financial statements). On January 1, 2006, the Company implemented Statement of FinancialAccounting Standards No. 123 (Revised 2004), *Share-BasedPayment* (“SFAS 123R”), which addresses accounting for equity-basedcompensation arrangements, including employee stock options.  SFAS 123R replaced SFAS 123 and supersededAccounting Principles Board (APB) Opinion No. 25, *Accounting forStock Issued to Employees,*and the related guidance.  SFAS 123R generally requires entities torecognize the cost of employee services received in exchange for awards ofstock options or other equity instruments based on the grant-date fair value ofthose awards.  This cost is recognizedover the period which an employee is required to provide services in exchangefor the award, generally the vesting period.

Change inAccounting Principle

TheCompany adopted SFAS 123R on January 1, 2006, using the “modified prospectivemethod.”  Under this method, compensationexpense is recognized using the fair-value method for all new stock optionawards as well as any existing awards that are modified, repurchased orcancelled after January 1, 2006; prior periods are not restated.  Additionally, compensation expense forunvested options that were outstanding at December 31, 2005, is recognized overthe requisite service period based on the fair value of those options aspreviously calculated under the pro forma disclosures of SFAS 123.  The fair value of each grant is estimatedusing the Black-Scholes option pricing model. During 2006 the Company recognized pre-tax stock-based compensation expenseof $61 thousand as a result of adopting SFAS 123R, which reduced net income by$59 thousand, basic EPS by $0.08 and diluted EPS by $0.07.

Prior to the adoption of SFAS 123R, the Company accounted forstock-based compensation using the intrinsic value method prescribed inAccounting Principles Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees,* and related guidance.  Accordingly, compensation cost for stockoptions was measured as the excess, if any, of the quoted market price of theCompany’s stock at the date of grant over the amount an employee must pay to acquirethe stock.  All of the Company’s stockoption grants included exercise prices equal to the Company’s current marketprice per share.  Accordingly, nocompensation expense was recognized for stock options for periods prior to2006.

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Had previously recognizedcompensation cost (prior to 2006) for the Company’s stock option plan beendetermined based on the fair value at the grant dates for awards under thoseplans consistent with the method of SFAS 123, the Company’s net income andearnings per share would have changed to the pro forma amounts indicated below:

|                                                                                                              | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Net Income:                                                                                                  |       |     |       |
| As Reported                                                                                                  |       | $        | 956,528    |   |
| Stock-based compensation recognized                                                                          |       | —   |       |
| Stock-based compensation that would have been  reported  using the fair value method of SFAS 123, net of tax |       | (60,012  | )          |
| Pro Forma                                                                                                    |       | $        | 896,516    |   |
|                                                                                                         |       |     |       |
| Basic Income Per  Share:                                                                                     |       |     |       |
| As Reported                                                                                                  |       | $        | 1.25       |   |
| Pro Forma                                                                                                    |       | 1.17     |       |
| Diluted Income  Per Share:                                                                                   |       |     |       |
| As Reported                                                                                                  |       | 1.14     |       |
| Pro Forma                                                                                                    |       | 1.07     |       |

Recent****Accounting Pronouncements

In March 2006 the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 156 (“SFAS 156”), *Accounting for Servicing of Financial Assets—an Amendment of FASBStatement No. 140,* which will permit the Bank, beginning in 2007, tochoose between two different methods of measuring ongoing changes in the valueof its SBA loan servicing asset: the amortization method or the fair valuemeasurement method.  Currently, underSFAS 140, the Bank amortizes the SBA loan servicing asset over the period thatservicing fees are expected to be received, and recognizes an impairment lossif the value of the servicing asset is determined to be impaired.  We plan to adopt the amortization method in2007, so we expect that adopting SFAS 156 will not have a material effect onour 2007 financial statements.

In July 2006 the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 48 (“FIN 48”), *Accounting for Uncertaintyin Income Taxes,* which clarifies the accounting for uncertainty intax positions taken or expected to be taken on a tax return.  FIN 48 provides that the tax effects from anuncertain tax position can be recognized in our financial statements only if,based on its technical merits, the position is more likely than not to besustained on audit.  The provisions ofFIN 48 are effective for the 2007 calendar year, with the cumulative effect ofthe change in accounting principle recorded as an adjustment to openingretained earnings.  Because we don’tbelieve the Company or the Bank have taken any material uncertain taxpositions, we do not expect that FIN 48 will have a material effect on our 2007financial statements.

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 pershare.

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**NOTE B—INVESTMENT SECURITIES**

Investment securitieshave been classified in the consolidated balance sheets according to management’sintent.  The amortized cost of securitiesand their approximate fair values at December 31 were as follows:
| ** **                          | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|-------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                          | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market**    | ** ** |
| ** **                          | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**     | ** ** |
| **Securities  Available for Sale:** |       |          |       |           |       |           |       |          |       |
| **December 31, 2006:**              |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies            |       | $             | 7,492,390  |           | $          | 5,297          |       | $             | (127,932   | ) | $ | 7,369,755 |   |
| Mortgage-backed securities          |       | 6,850,095     |       | 3,674          |       | (111,923       | )          | 6,741,846     |       |
| Municipal securities                |       | 1,940,944     |       | 9,328          |       | (7,640         | )          | 1,942,632     |       |
| Asset-backed securities             |       | 232,282       |       | 130,310        |       | (922           | )          | 361,670       |       |
|                                |       | $             | 16,515,711 |           | $          | 148,609        |       | $             | (248,417   | ) | $ | 16,415,903 |   |
|                                |       |          |       |           |       |           |       |          |       |
| **December 31, 2005:**              |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies            |       | $             | 6,997,448  |           | $          | —         |       | $             | (189,423   | ) | $ | 6,808,025 |   |
| Mortgage-backed securities          |       | 8,828,346     |       | 7,565          |       | (191,575       | )          | 8,644,336     |       |
| Asset-backed securities             |       | 316,081       |       | 48,616         |       | (1,354         | )          | 363,343       |       |
|                                |       | $             | 16,141,875 |           | $          | 56,181         |       | $             | (382,352   | ) | $ | 15,815,704 |   |

During the first quarter of2005, the Bank transferred one of its held-to-maturity securities to theavailable-for-sale category, due to management’s desire to sell the security inthe event a suitable opportunity should arise. This decision was based on a significant deterioration in the issuer’screditworthiness that has occurred subsequent to its original classification asa held-to-maturity security.  During2004, management established a loss reserve for this security after concludingit was “other than temporarily impaired.” The security is in non-accrual status, with any interest paymentsreceived being credited to the reserve. As of March 31, 2005, the date of transfer, the gross book value of thesecurity was $391,000 and the reserve was $250,000, for a net book value of$141,000.  The fair value on March 31,2005, was $163,000, resulting in an unrealized gain of $22,000 on the date oftransfer.

Dueto a change in investment strategy in the third quarter of 2005, all remainingsecurities in the held-to-maturity category were reclassified toavailable-for-sale on September 30, 2005. This change in investment strategy was intended to improve the Bank’s financialflexibility.  The amortized cost (bookvalue) of those securities was $7,841,000 on the date of transfer, and the fairvalue was $7,729,000 on that date.

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The scheduled maturities of investment securities at December 31, 2006,were as follows.  Actual maturities maydiffer from contractual maturities because some investment securities may allowthe right to call or prepay the obligation with or without call or prepaymentpenalties.

|                                 | ** ** | **Amortized** | ** ** | **Fair**  | ** ** |
|---------------------------------|------------|---------------|------------|-----------|------------|
| ** **                      | ** ** | **Cost**      | ** ** | **Value** | ** ** |
|                            |       |          |       |      |       |
| Within one year                 |       | $             | 2,001,711  |      | $          | 1,984,452 |   |
| Due in one year  to five years  |       | 4,349,051     |       | 4,274,019 |       |
| Due in five  years to ten years |       | 1,236,244     |       | 1,220,349 |       |
| Due in greater  than ten years  |       | 8,928,705     |       | 8,937,083 |       |
|                            |       | $             | 16,515,711 |      | $          | 16,415,903 |   |

### Included in accumulatedother comprehensive income at December 31, 2006 were net unrealized losses oninvestment securities available for sale of $99,808 less applicable incometaxes of $40,921.  At December 31, 2005,accumulated other comprehensive income included net unrealized losses onavailable-for-sale securities of $326,171 less applicable income taxes of$133,730.  No securities were sold in2006 or 2005.

Investmentsecurities in a temporary unrealized loss position as of December 31, 2006 and2005 are shown in the following table, based on the length of time they havebeen continuously in an unrealized loss position:
| ** **                 | ** ** | **Less than 12 Months** | ** ** | **12 Months or Longer** | ** ** | **Total** | ** ** |
|----------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------|------------|
| ** **                 | ** ** | **Fair**                               | ** ** | **Unrealized**                         | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                 | ** ** | **Value**                              | ** ** | **Losses**                             | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| **December  31, 2006:**    |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies   |       | $                                      | —     |                                   | $          | —    |       | $ | 6,370,690 |   | $ | 127,932 |   | $ | 6,370,690 |   | $ | 127,932 |   |
| Mortgage-backed securities |       | 154,675                                |       | 50                                     |       | 6,156,761 |       | 111,873 |   | 6,311,436 |   | 111,923 |   |
| Municipal securities       |       | 1,224,764                              |       | 7,640                                  |       | —    |       | — |   | 1,224,764 |   | 7,640 |   |
| Asset-backed securities    |       | —                                 |       | —                                 |       | 144,257   |       | 922 |   | 144,257 |   | 922 |   |
|                       |       | $                                      | 1,379,439  |                                   | $          | 7,690     |       | $ | 12,671,708 |   | $ | 240,727 |   | $ | 14,051,147 |   | $ | 248,417 |   |
|                       |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
|                       |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| **December  31, 2005:**    |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies   |       | $                                      | 1,967,580  |                                   | $          | 31,298    |       | $ | 4,840,445 |   | $ | 158,125 |   | $ | 6,808,025 |   | $ | 189,423 |   |
| Mortgage-backed securities |       | 3,918,662                              |       | 68,455                                 |       | 4,274,393 |       | 123,120 |   | 8,193,055 |   | 191,575 |   |
| Asset-backed securities    |       | 198,763                                |       | 1,354                                  |       | —    |       | — |   | 198,763 |   | 1,354 |   |
|                       |       | $                                      | 6,085,005  |                                   | $          | 101,107   |       | $ | 9,114,838 |   | $ | 281,245 |   | $ | 15,199,843 |   | $ | 382,352 |   |

 

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The unrealized losses oninvestments in U.S. Government agency and mortgage-backed securities which havebeen in an unrealized loss position for one year or longer as of December 31,2006 (a total of 27 securities), were caused by market interest rate increasessubsequent to the purchase of the securities. The unrealized losses on all but one of these 27 securities havedecreased from December 31, 2005 to December 31, 2006.  Because the Bank has the ability to hold allthese investments until a recovery in fair value, which may be maturity, theunrealized losses on these investments are not considered to beother-than-temporarily impaired as of December 31, 2006.  Other than the one impaired asset-backedsecurity footnoted above, none of the Bank’s securities has exhibited a declinein value as a result of changes in credit risk.

Investments securitiescarried at $10,598,000 and $10,140,000 as of December 31, 2006 and 2005,respectively, were pledged to secure public deposits as required by law.

### **NOTEC—LOANS**

The Bank’s loan portfolioconsists primarily of loans to borrowers within the Central Coast area ofCalifornia.  Although the Bank seeks toavoid concentrations of loans to a single industry or based upon a single classof collateral, real estate and real estate associated businesses are among theprincipal industries in the Bank’s market area and, as a result, the Bank’sloan and collateral portfolios are concentrated in those industries and in thatgeographic area.  As of December 31,2006, 70% of the loan portfolio was secured by commercial real estate(including construction and land development loans as well as loans secured bynon-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 generallyexcludes owner-occupied properties from the definition of commercial realestate, CRE loans represented 57% of the loan portfolio as of December 31,2006.

Included in total loansare net deferred loan fees of $192,000 and $297,000 at December 31, 2006 and2005, respectively.

The following is asummary of the investment in impaired loans as of December 31, including therelated allowance for loan losses and cash-basis income recognized.  Also shown are loans on non-accrual and thosethat are past due and still accruing interest:
| ** **                                                   | ** ** | **2006**  | ** ** | **2005** | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|----------|------------|
| Impaired Loans:                                              |       |      |       |     |       |
| Impaired loans  with a related allowance for loan losses     |       | $         | 136,000    |     | $          | 48,000 |   |
| Impaired loans  with no related allowance for loan losses    |       | 104,000   |       | 28,000   |       |
| Total impaired  loans                                        |       | 240,000   |       | 76,000   |       |
| Related  Allowance for Loan Losses                           |       | 12,000    |       | 9,000    |       |
| Average Recorded  Investment in Impaired Loans               |       | 271,600   |       | 124,400  |       |
| Interest Income  Recognized for Cash Payments While Impaired |       | —    |       | —   |       |
| Total Loans on  Non-accrual                                  |       | 240,000   |       | 76,000   |       |
| Total Loans Past Due 90 Days or More and Still Accruing      |       | 1,929,000 |       | —   |       |
|                                                              |            |           |            |          |            |  |  |

 

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Following is asummary of the changes in the allowance for possible loan losses for the yearsended December 31:
| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Balance at Beginning  of Year                    |       | $        | 1,141,096  |     | $          | 1,093,838 |   |
| Additions to the  Allowance Charged to Expense   |       | —   |       | 75,000   |       |
| Less Loans Charged Off                           |       | (121,374 | )          | (30,402  | )          |
| Plus Recoveries on  Loans Previously Charged Off |       | 6,217    |       | 2,660    |       |
| Balance at End of Year                           |       | $        | 1,025,939  |     | $          | 1,141,096 |   |

 

The Bank also originates SBA-guaranteed loans for sale to institutionalinvestors.  At December 31, 2006 and 2005the Bank was servicing $23,306,000 and $32,205,000, respectively, in loanspreviously sold or participated.  TheBank has recorded servicing assets related to these sold loans of approximately$283,000 and $574,000 at December 31, 2006 and 2005, respectively.  In calculating the gain on sale of SBA loansand the related servicing asset, the Bank used the following assumptions forsales recorded in 2006:

|                | ** ** | **Range**        | ** ** | **Weighted Average** | ** ** |
|----------------|------------|------------------|------------|---------------------------|------------|
| Discount rate  |       | 10.25% to 12.25% |       | 11.14                     | %          |
| Estimated life |       | 17 to 105 months |       | 57 months                 |       |

 

Management performs an analysis each quarter to reassess theseassumptions, which are significant determinants on the value ascribed to theservicing asset.  Following is a summaryof the changes in the balances of the SBA loan servicing asset for 2006 and2005:

|                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Balance at Beginning of Year |       | $        | 574,302    |     | $          | 750,234 |   |
| Additions to the  Asset      |       | 78,046   |       | 130,434  |       |
| Less  amortization           |       | (369,652 | )          | (306,366 | )          |
| Balance at End  of Year      |       | $        | 282,696    |     | $          | 574,302 |   |

 

The estimated fair valueof the servicing assets approximated the carrying amount at December 31, 2006and 2005.  These assets are included inaccrued interest and other assets in the consolidated balance sheets.  Amortization of these assets is nettedagainst loan servicing fees in the consolidated statements of income.

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**NOTE D—PREMISES AND EQUIPMENT**

A summary of premises and equipment as of December 31follows: 
| ** **                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| Land                                       |       | $          | 2,171,007  |       | $          | 1,678,180 |   |
| Buildings                                  |       | 763,418    |       | 722,333    |       |
| Leasehold  improvements                    |       | 338,359    |       | 344,245    |       |
| Furniture,  fixtures, and equipment        |       | 2,197,931  |       | 2,021,678  |       |
|                                       |       | 5,470,715  |       | 4,766,436  |       |
| Accumulated  depreciation and amortization |       | (1,746,907 | )          | (1,434,961 | )          |
|  Net premises and equipment           |       | $          | 3,723,808  |       | $          | 3,331,475 |   |

 

The Bank has entered intooperating leases for its branches and operating facilities, which expire atvarious dates through 2011.  These leasesinclude provisions for periodic rent increases as well as payment by the lesseeof certain operating expenses.  Rentalexpense relating to these leases was $278,000 in 2006 and $282,000 in 2005.

At December 31, 2006, theapproximate future minimum annual payments under these leases for the next fiveyears are as follows:

| 2007        |   | $         | 335,524   |   |
|-------------|--------|-----------|-----------|--------|
| 2008        |   | 312,220   |      |
| 2009        |   | 238,867   |      |
| 2010        |   | 202,172   |      |
| 2011        |   | 123,106   |      |
| Later years |   | 3,843,000 |      |
|        |   | $         | 5,054,889 |   |

 

The minimum rentalpayments shown above are given for the existing lease obligations and do notreflect any increases in rent unless the increases are scheduled and currentlydeterminable.  It does not represent aforecast of future rental expenses. Included in the above table are obligations under a 50-year land leasefor property in San Luis Obispo, California, upon which the Bank intends tobuild a full-service branch and administrative office.  Currently the lease provides for rentals of$7,000 per month, but this rate could be reduced in the future under certainconditions.  The terms of the lease givethe Bank early termination rights through September 30, 2007.

**NOTE E—DEPOSITS**

At December 31, 2006, the scheduled maturities of timedeposits are as follows:

| Due in one year           |   | $         | 59,838,142 |   |
|---------------------------|--------|-----------|------------|--------|
| Due in one to  five years |   | 1,518,554 |       |
|                      |   | $         | 61,356,696 |   |

 

Ten deposit customerscomprised $26.6 million, or 21.4%, of the Bank’s total deposits as of December31, 2006.

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**NOTE F—OTHERBORROWINGS**

Other borrowingsat December 31, 2006 are comprised of the following advances from the FederalHome Loan Bank of San Francisco:

| Maturity  Date | ** ** | **Interest  Rate** | ** ** | **Amount** | ** ** |
|----------------|------------|--------------------|------------|------------|------------|
| 1/4/2007       |       | 5.38               | %          | $          | 2,500,000  |   |
| 1/29/2007      |       | 5.38               | %          | 3,000,000  |       |
| 3/21/2007      |       | 5.38               | %          | 3,000,000  |       |
| 8/13/2007      |       | 4.37               | %          | 2,000,000  |       |
| 3/31/2008      |       | 4.34               | %          | 1,400,000  |       |
| 3/30/2009      |       | 3.19               | %          | 2,000,000  |       |
| 5/13/2009      |       | 4.48               | %          | 500,000    |       |
| 11/19/2013     |       | 4.82               | %          | 1,000,000  |       |
| 12/11/2013     |       | 4.98               | %          | 1,000,000  |       |
| 12/16/2013     |       | 4.88               | %          | 1,000,000  |       |
|           |       |               |       | $          | 17,400,000 |   |

 

These advances are secured by loans of approximately $72 million.  As of December 31, 2006, the Bank had aborrowing capacity of approximately $17.4 million with the Federal Home LoanBank of San Francisco in addition to the borrowings listed above.

The Bank also has unsecured borrowing lines with correspondent bankstotaling $6.5 million.  As of December31, 2006, there were no balances outstanding on these lines.

**NOTE G—JUNIOR SUBORDINATED DEBT SECURITIES**

On October 14, 2003, the Company issued $3,093,000 ofjunior subordinated debt securities (the “debt securities”) to MissionCommunity Capital Trust, a statutory trust created under the laws of the Stateof Delaware.  These debt securities aresubordinated to effectively all borrowings of the Company and are due andpayable on October 7, 2033.  Interest ispayable quarterly on these debt securities at LIBOR plus 2.95% for an effectiverate of 8.32% as of December 31, 2006. The debt securities can be redeemed for 105% of the principal balancethrough October 7, 2008 and at par thereafter. They can also be redeemed at par if certain events occur that impact thetax treatment or the capital treatment of the issuance.

The Company also purchased a 3% minority interest inMission Community Capital Trust. The balance of the equity of Mission CommunityCapital Trust is comprised of mandatorily redeemable preferred securities.  Under FASB Interpretation No. 46 (FIN 46), “*Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51,”*Mission Community Capital Trust isnot consolidated into the Company’s financial statements.  Prior to the issuance of FIN 46, bank holdingcompanies typically consolidated these entities.  The Federal Reserve Board has ruled thatsubordinated notes payable to unconsolidated special purpose entities (“SPE’s”)such as Mission Community Capital Trust, net of the bank holding company’sinvestment in the SPE, qualify as Tier 1 Capital, subject to certain limits.

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**NOTE H—INCOME TAXES**

 

Theincome tax expense for the years ended December 31, 2006 and 2005 is comprisedof the following:

 

|                | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| Current Taxes: |       |     |       |     |       |
| Federal        |       | $        | 311,061    |     | $          | 475,707 |   |
| State          |       | 125,348  |       | 142,438  |       |
|           |       | 436,409  |       | 618,145  |       |
| Deferred       |       | 102,418  |       | (3,298   | )          |
|           |       | $        | 538,827    |     | $          | 614,847 |   |

 

A comparison of the federal statutory income tax ratesto the Company’s effective income tax follows:

 
| ** **                                                     | ** ** | **2006**   | ** ** | **2005** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|----------|------------|
| ** **                                                     | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| Federal tax rate                                               |       | $          | 478,855    |     | 34.0       | % | $ | 534,268 |   | 34.0 | % |
| California franchise taxes, net of federal tax  benefit        |       | 96,190     |       | 6.8      | %          | 107,430 |   | 6.8 | % |
| Interest on municipal securities and loans                     |       | (32,669    | )          | (2.3     | )%         | (1,619 | ) | (0.1 | )% |
| Increase in cash surrender value of bank-owned life  insurance |       | (24,857    | )          | (1.7     | )%         | (25,405 | ) | (1.6 | )% |
| Other items—net                                           |       | 21,308     |       | 1.5      | %          | 173 |   | — |   |
|                                                           |       | $          | 538,827    |     | 38.3       | % | $ | 614,847 |   | 39.1 | % |

 

 

Deferred taxes are a resultof differences between income tax accounting and generally accepted accountingprinciples with respect to income and expense recognition.  The Company’s principal timing differencesare from the cash basis of tax reporting and the allowance for loan and leaselosses.

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**NOTE H—INCOMETAXES—Continued**

The following is asummary of the components of the net deferred tax asset accounts recognized inthe accompanying consolidated balance sheets:

|                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred Tax Assets:                              |       |     |       |     |       |
| Allowance for Loan  Losses Due to Tax Limitations |       | $        | 410,505    |     | $          | 432,375 |   |
| Unrealized Loss  on Available-for-Sale Securities |       | 40,921   |       | 133,730  |       |
| Other                                             |       | 219,559  |       | 216,372  |       |
|                                              |       | 670,985  |       | 782,477  |       |
| Deferred Tax  Liabilities:                        |       |     |       |     |       |
| Deferred loan  costs                              |       | (145,150 | )          | (141,296 | )          |
| Depreciation  Differences                         |       | (106,896 | )          | (96,043  | )          |
| Other                                             |       | (95,634  | )          | (26,606  | )          |
|                                              |       | (347,680 | )          | (263,945 | )          |
| Net Deferred Tax Assets                           |       | $        | 323,305    |     | $          | 518,532 |   |

 

**NOTE I—STOCK OPTION PLAN**

During 1998, theBoard of Directors adopted a stock option plan, which was approved by theshareholders, under which 180,000 shares of the Company’s common stock may beissued.  Options are granted at a pricenot 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 fiveyears.  The stock option plan providesfor acceleration of vesting of all options upon change in control of theBank.  The Bank recognized in 2006stock-based compensation of $61 thousand and income tax benefits related tothat stock-based compensation of $2 thousand.

Nooptions were granted in 2006.  The fairvalue of the options granted in 2005 were estimated on the date of grant usingthe Black-Scholes option pricing model with the following assumptions:  risk-free rate of 4.41%, expected lives ofsix years, no dividend payments and 35.4% stock price volatility.  The volatility assumption was based on actualweekly stock price volatility for the Company from May 2001 to the date ofgrant.  The risk-free rate of returnreflects the average of the grant date yield for 5-year and 7-year U.S.Treasury securities.  The expected lifeof six years represents the estimated average period of time the options willremain outstanding.

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**NOTE I—STOCKOPTION PLAN—Continued**

A summary of the statusof the Company’s fixed stock option plan as of December 31, 2006 and changesduring the year is presented below:
| ** **                        | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|-----------------------------------|------------|------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Weighted-** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Average**   | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Exercise**  | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Price**     | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding at  Beginning of Year |       | 143,233    |       | $             | 12.20      |            |       |          |       |   |
| Granted                           |       | —     |       | —        |       |            |       |          |       |
| Exercised                         |       | (13,600    | )          | 9.89          |       |            |       |          |       |
| Forfeited                         |       | (3,500     | )          | 21.44         |       |            |       |          |       |
| Outstanding at End of  Year       |       | 126,133    |       | $             | 12.19      |            | 3.1 Years  |          | $          | 1,358,443 |   |
|                              |       |       |       |          |       |            |       |          |       |
| Options Exercisable at Year-End   |       | 108,033    |       | $             | 10.29      |            | 2.3 Years  |          | $          | 1,330,443 |   |

 

The total intrinsic value of optionsexercised during the years ended December 31, 2006 and 2005 were $212,000 and$284,000, respectively.

As of December 31, 2006, the Company hasunvested options outstanding with unrecognized compensation expense totaling$132 thousand, which is scheduled to be recognized as follows (in thousands):

| 2007                                  |   | $  | 48     |   |
|---------------------------------------|--------|----|--------|--------|
| 2008                                  |   | 42 |   |
| 2009                                  |   | 42 |   |
| Total unrecognized  compensation cost |   | $  | 132    |   |

 

**NOTE J—DEFINED CONTRIBUTION PLAN**

The Company has adopted a defined contribution plan,the Mission Community Bank 401k Profit Sharing Plan (“the 401k Plan”), coveringsubstantially all employees fulfilling minimum age and servicerequirements.  Matching and discretionaryemployer contributions to the 401k Plan are determined annually by the Board ofDirectors.  The expense for the 401k Planwas approximately $116,000 in 2006 and $124,000 in 2005.

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**NOTE K—PREFERREDSTOCK**

Series A — theSeries A Preferred Stock has a $5.00 stated value and is non-voting,convertible and redeemable.  Each shareis convertible into one-half share of voting common stock of the Company.  Series A shares are not entitled to any fixedrate of return, but do participate on the same basis (as if converted on atwo-for-one exchange) in any dividends declared on the Company’s commonstock.  Series A shares may be redeemedupon request of the holder at their stated value if the Bank is found to be indefault under any Community Development Financial Institutions ProgramAssistance Agreement for Equity Investments in Regulated Institutions, or anysuccessor agreement.  In the event ofliquidation, the holders of Series A shares will be entitled to a liquidationpreference of $5.00 per share before the holders of common stock receive anydistributions and after the holders of common stock receive distributions of$10.00 per share, all distributions will be on the same basis (as if convertedon a one-for-two exchange).  These shareswere issued for $392,194 (net of issuance costs of $107,806) pursuant to anaward from the Community Development Financial Institutions Fund of theDepartment of the Treasury.

Series B — theSeries 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 doparticipate on the same basis in any dividends declared on the Company’s commonstock. In the event of liquidation, the holders of Series B shares will beentitled to a liquidation preference of $10.00 per share before the holders ofcommon 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 BPreferred Stock shall be entitled to receive payment on the same basis as theholders 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 alsopurchased 29,500 shares of the Company’s common stock for $10.00 pershare.  As part of the investmentagreement, the Company by covenant agreed that so long as NCIF or any successorowns and holds any of the Shares to remain a CDFI and to meet certain reportingrequirements.

Series C — the Series C Preferred Stock has $10.00stated value and is non-voting, convertible and redeemable.  Each share is convertible into one share ofvoting common stock of the Company. Series C shares are not entitled to any fixed rate of return, but doparticipate on the same basis (as if converted on a one-to-one exchange) in anydividends declared on the Company’s common stock.  Series C shares may be redeemed upon requestof the holder at their stated value if the Bank is found to be in default underany Community Development Financial Institutions Program Assistance Agreementfor Equity Investments in Regulated Institutions, or any successor agreement.  In the event of liquidation, the holders ofSeries C shares will be entitled to a liquidation preference of $10.00 pershare (as adjusted for any stock dividends, combinations or splits with respectto such shares) before the holders of common stock receive any distributions.  These shares were issued for $500,000pursuant to an award from the Community Development Financial Institutions Fundof the Department of the Treasury.

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### **NOTE L—RELATED PARTY TRANSACTIONS**

In the ordinary course of business, the Bank has granted loans tocertain directors and the companies with which they are associated.  In the Bank’s opinion, all loans and loancommitments to such parties are made on substantially the same terms, includinginterest rate and collateral, as those prevailing at the time for comparabletransactions with other persons.

The following is a summaryof the activity in these loans:
| ** **                                                        | ** ** | **2006** | ** ** | **2005**  | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|-----------|------------|
|                                                              |       |     |       |      |       |
| Balance at the  beginning of the year                             |       | $        | 3,348,855  |      | $          | 3,417,952 |   |
| New loans and  advances                                           |       | 169,142  |       | 1,581,015 |       |
| Repayments                                                        |       | (787,015 | )          | (658,847  | )          |
| Reclassifications  (persons no longer considered related parties) |       | —   |       | (991,265  | )          |
| Balance at the end of  the year                                   |       | $        | 2,730,982  |      | $          | 3,348,855 |   |

 

Deposits from relatedparties held by the Bank totaled approximately $3,790,000 at December 31, 2006,and $2,809,000 at December 31, 2005.

During 2003,Bancorp pledged a $250,000 certificate of deposit in an unaffiliated bank ascollateral for borrowings of MCSC.  As ofDecember 31, 2005, MCSC had drawn $75,000 on its line of credit with theunaffiliated bank, and Bancorp recognized a $75,000 contribution to MCSCrelated to its potential liability for this borrowing.  The line of credit was not in use as ofDecember 31, 2006 and, accordingly, no potential liability for the line ofcredit was recognized as of December 31, 2006. During 2006 Bancorp made cash contributions to MCSC totaling$163,987.  Of that amount, $88,987 wasrecognized as expense and the remaining $75,000 was applied against the $75,000accrued liability that was established in 2005.

**NOTE M—COMMITMENTS AND CONTINGENCIES**

In the normal course ofbusiness, the Bank enters into financial commitments to meet the financingneeds of its customers.  These financialcommitments 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 offinancial position.

The Bank’s exposure tocredit loss in the event of nonperformance on commitments to extend credit andstandby letters of credit is represented by the contractual amount of thoseinstruments.  The Bank uses the samecredit policies in making commitments as it does for loans reflected in thefinancial statements.

As of December 31, theBank had the following outstanding financial commitments whose contractualamount represents credit risk:

|                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |
| Commitments to  Extend Credit |       | $        | 35,375,000 |     | $          | 37,379,000 |   |
| Standby Letters  of Credit    |       | 213,000  |       | 203,000  |       |
|                          |       | $        | 35,588,000 |     | $          | 37,582,000 |   |

 

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**NOTE M—COMMITMENTSAND CONTINGENCIES - continued**

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract.  Standby letters of credit are conditionalcommitments to guarantee the performance of a Bank customer to a thirdparty.  Since many of the commitments andstandby letters of credit are expected to expire without being drawn upon, thetotal amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Bank isbased on management’s credit evaluation of the customer.

The Bank has established an allowance for possiblelosses on unfunded loan commitments in the amount of $55,000, which is includedin other liabilities in the consolidated statements of condition.  To date, no losses have been charged againstthis allowance.

Inthe ordinary course of business, various claims and lawsuits are brought by andagainst the Company and the Bank.  In theopinion of management, there is no pending or threatened proceeding in which anadverse decision could result in a material adverse change in the consolidated financialcondition or results of operations of the Company.

**NOTE N—EARNINGSPER SHARE**

The following is a reconciliation of net income and shares outstandingto the income and number of shares used in the computation of earnings pershare:
| ** **                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                    |       |     |       |     |       |
| Average common  shares outstanding during the year (used for basic EPS) |       | 667,810  |       | 646,617  |       |
| Dilutive effect  of outstanding stock options                           |       | 52,891   |       | 61,459   |       |
| Average common shares used for diluted EPS                              |       | 720,701  |       | 708,076  |       |
|                                                                    |       |     |       |     |       |
| Net income                                                              |       | $        | 869,569    |     | $          | 956,528 |   |
| Less income  allocated to preferred stock                               |       | (132,874 | )          | (150,082 | )          |
| Income allocated to common stock                                        |       | $        | 736,695    |     | $          | 806,446 |   |
|                                                                    |       |     |       |     |       |
| Basic earnings  per common share                                        |       | $        | 1.10       |     | $          | 1.25 |   |
| Diluted earnings per  common share                                      |       | 1.02     |       | 1.14     |       |

 

 

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**NOTE O—REGULATORYMATTERS**

The Bank issubject to various regulatory capital requirements administered by the federalbank regulatory agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory, and possiblydiscretionary, actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classification are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

Quantitative measures established by regulation toensure 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 theregulations) to risk-weighted assets (as defined), and of Tier 1 capital (asdefined) to average assets (as defined). Management believes, as of December 31, 2006, that the Bank meets allcapital adequacy requirements to which it is subject.

As of December 31,2006, the most recent notification from the Federal Reserve Board categorizedthe Bank as well-capitalized under the regulatory framework for promptcorrective action.  There are noconditions or events since that notification that management believes havechanged the Bank’s category.  To becategorized as well-capitalized, the Bank must maintain minimum ratios as setforth in the table below.  The followingtable also sets forth the Bank’s actual capital amounts and ratios (dollaramounts in thousands):
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                                | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of December 31, 2006:**              | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets)  |       | $          | 15,390     |                 | 11.35      | %                                             | $          | 13,564 |   | 10.0 | % | $ | 10,851 |   | 8.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $          | 14,309     |                 | 10.55      | %                                             | $          | 8,139 |   | 6.0 | % | $ | 5,426 |   | 4.0 | % |
| Tier 1 Capital  (to Average Assets)       |       | $          | 14,309     |                 | 9.34       | %                                             | $          | 7,657 |   | 5.0 | % | $ | 6,126 |   | 4.0 | % |
|                                      |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31, 2005:**              | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets)  |       | $          | 14,599     |                 | 10.69      | %                                             | $          | 13,651 |   | 10.0 | % | $ | 10,920 |   | 8.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |       | $          | 13,403     |                 | 9.82       | %                                             | $          | 8,190 |   | 6.0 | % | $ | 5,460 |   | 4.0 | % |
| Tier 1 Capital (to  Average Assets)       |       | $          | 13,403     |                 | 9.23       | %                                             | $          | 7,263 |   | 5.0 | % | $ | 5,810 |   | 4.0 | % |

 

The Company is not subject to similar regulatorycapital requirements because its consolidated assets do not exceed $500million, the minimum asset size criteria for bank holding companies subject tothose requirements.

Banking regulations limit the amount of cash dividendsthat may be paid without prior approval of the Bank’s primary regulatoryagency.  Cash dividends are limited bythe California Financial Code to the lesser of the Bank’s retained earnings orits net income for the last three fiscal years, net of the amount of anydividends or other capital distributions made during those periods.  As of December 31, 2006, $3,643,000 wasavailable for cash dividend distributions from the Bank to Bancorp withoutprior regulatory approval.  However,dividend distributions from the Bank in excess of $1,739,000 would change theBank’s prompt corrective action status from well-capitalized toadequately-capitalized.

68

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### **NOTE P—GRANTSAND AWARDS**

During2005 the Company received a $135,000 technical assistance grant from theCommunity Development Financial Institutions Fund.  As of December 31, 2005, this grant wasreflected in other liabilities in the consolidated balance sheet because therelated eligible expenses had not been incurred as of that date.    During 2006 the Bank incurred approximately$100,000 of qualifying expenses under the grant.  Accordingly, the Bank recognized $100,000 ofthis grant as non-interest income in 2006. The remainder of the grant will be recognized in 2007 or future years,to the extent that eligible expenditures are incurred in accordance with theterms of the grant.

Althoughthe Bank is a certified CDFI bank and expects to continue to apply for variousgrants and awards, there can be no assurance that it will receive similarfuture grants or awards.

**NOTE Q—MISSION COMMUNITY BANCORP (Parent CompanyOnly)**

On December 15, 2000, Mission Community Bancorpacquired Mission Community Bank by issuing 600,566 shares of common stock inexchange for all outstanding shares of the Bank’s common stock.  There was no cash involved in thistransaction.

Following are the separate financial statements forMission Community Bancorp (parent company only):

**MissionCommunity Bancorp (Parent Company Only)**

**CONDENSED BALANCE SHEETS**
| ** **                                     | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash                                           |       | $          | 383,135    |       | $          | 396,217 |   |
| Deposits in  other banks                       |       | 250,000    |       | 250,000    |       |
| Investment in  subsidiary bank                 |       | 14,270,445 |       | 13,256,705 |       |
| Loans receivable                               |       | —     |       | —     |       |
| Other assets                                   |       | 545,262    |       | 437,887    |       |
| **TOTAL ASSETS**                               |       | $          | 15,448,842 |       | $          | 14,340,809 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Junior  subordinated debentures                |       | $          | 3,093,000  |       | $          | 3,093,000 |   |
| Due to Mission  Community Bank                 |       | 113,685    |       | —     |       |
| Other  liabilities                             |       | 89,056     |       | 266,585    |       |
| **TOTAL LIABILITIES**                          |       | 3,295,741  |       | 3,359,585  |       |
| **TOTAL SHAREHOLDERS’ EQUITY**            |       | 12,153,101 |       | 10,981,224 |       |
|                                           |       | $          | 15,448,842 |       | $          | 14,340,809 |   |

 

69

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**NOTE Q—MISSIONCOMMUNITY BANCORP (Parent Company Only)—Continued**

**CONDENSED STATEMENTS OF INCOME**
| ** **                                                | ** ** | **2006** | ** ** | **2005**  | ** ** |
|-----------------------------------------------------------|------------|----------|------------|-----------|------------|
| Interest income                                           |       | $        | 10,019     |      | $          | 6,389 |   |
| Interest expense                                          |       | 270,942  |       | 216,115   |       |
| Net interest (expense)                                    |       | (260,923 | )          | (209,726  | )          |
| Dividends  received from subsidiary                       |       | 300,283  |       | 90,085    |       |
| Less contributions to Mission Community Services  Corp.   |       | 88,987   |       | 75,000    |       |
| Less other expenses                                       |       | 73,480   |       | 57,424    |       |
| Loss before taxes                                         |       | (123,107 | )          | (252,065  | )          |
| Income taxes expense  (benefit)                           |       | (173,590 | )          | (140,282  | )          |
| Loss before equity in undistributed income of  subsidiary |       | 50,483   |       | (111,783  | )          |
| Equity in  undistributed income of subsidiary             |       | 819,086  |       | 1,068,311 |       |
| Net income                                                |       | $        | 869,569    |      | $          | 956,528 |   |

 

**CONDENSED STATEMENTS CASH FLOWS**
| ** **                                                                     | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Operating  activities:**                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                     |       | $          | 869,569    |       | $          | 956,528 |   |
| Adjustments to  reconcile net income to net cash used by operating activities: |       |       |       |       |       |
| Income of subsidiary                                                           |       | (1,119,369 | )          | (1,158,396 | )          |
| Amortization expense                                                           |       | 17,232     |       | 17,232     |       |
| Other, net                                                                     |       | (188,451   | )          | 129,975    |       |
| Net cash used by operating activities                                          |       | (421,019   | )          | (54,661    | )          |
| **Investing  activities:**                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans repaid                                                                   |       | —     |       | 150,000    |       |
| Dividends  received from subsidiary                                            |       | 300,283    |       | 90,085     |       |
| Net cash provided by investing activities                                      |       | 300,283    |       | 240,085    |       |
| **Financing  activities:**                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  issuance of common stock                                        |       | 202,562    |       | 268,458    |       |
| Cash dividends  paid                                                           |       | (94,908    | )          | (93,144    | )          |
| Net cash provided by financing activities                                      |       | 107,654    |       | 175,314    |       |
| Net increase (decrease) in cash                                                |       | (13,082    | )          | 360,738    |       |
| Cash at  beginning of year                                                     |       | 396,217    |       | 35,479     |       |
| Cash at end of  year                                                           |       | $          | 383,135    |       | $          | 396,217 |   |

 

70

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**NOTE R—FAIRVALUE OF FINANCIAL INSTRUMENTS**

The fair value ofa financial instrument is the amount at which the asset or obligation could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale.  Fair valueestimates are made at a specific point in time based on relevant marketinformation and information about the financial instrument.  These estimates do not reflect any premium ordiscount that could result from offering for sale at one time the entireholdings of a particular financial instrument. Because no market value exists for a significant portion of thefinancial instruments, fair value estimates are based on judgments regardingfuture expected loss experience, current economic conditions, riskcharacteristics of various financial instruments, and other factors.  These estimates are subjective in nature,involve uncertainties and matters of judgment and, therefore, cannot bedetermined with precision.  Changes inassumptions could significantly affect the estimates.

Fair value estimates are based on financialinstruments both on and off the balance sheet without attempting to estimatethe value of anticipated future business and the value of assets andliabilities that are not considered financial instruments.  Additionally, tax consequences related to therealization of the unrealized gains and losses can have a potential effect onfair value estimates and have not been considered in many of the estimates.

The following methods and assumptions were used toestimate the fair value of significant financial instruments:

## Financial Assets

The carrying amounts of cash and short-term investments are consideredto approximate fair value.  Short-terminvestments include federal funds sold and interest bearing deposits withBanks.  The fair values of investmentsecurities, including available-for-sale, are generally based on quoted marketprices.  The fair value of loans are estimatedusing a combination of techniques, including discounting estimated future cashflows and quoted market prices of similar instruments, where available.

## Financial Liabilities

The carrying amounts of deposit liabilities payable ondemand and short-term borrowed funds are considered to approximate fairvalue.  For fixed maturity deposits, fairvalue is estimated by discounting estimated future cash flows using currentlyoffered rates for deposits of similar remaining maturities.  The fair value of long-term debt is based onrates currently available to the Bank for debt with similar terms and remainingmaturities.

## Off-Balance Sheet FinancialInstruments

The fair value ofcommitments to extend credit and standby letters of credit is estimated usingthe fees currently charged to enter into similar agreements.  The fair value of these financial instrumentsis not material.

71

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## **NOTE R—FAIR VALUE OF FINANCIAL INSTRUMENTS—Continued**

The estimated fairvalue of financial instruments is summarized as follows:
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ** **                               | ** ** | **Carrying**          | ** ** | **Fair** | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                               | ** ** | **Value**             | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| **Financial  Assets:**                   | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and due from banks                  |       | $                     | 3,045,000  |   | $ | 3,045,000 |   | $ | 4,433,000 |   | $ | 4,433,000 |   |
| Federal funds sold                       |       | 7,070,000             |       | 7,070,000 |   | 7,950,000 |   | 7,950,000 |   |
| Interest-bearing deposits in other banks |       | 550,000               |       | 550,000 |   | 550,000 |   | 550,000 |   |
| Investment securities                    |       | 16,416,000            |       | 16,416,000 |   | 15,816,000 |   | 15,816,000 |   |
| Loans, net                               |       | 121,773,000           |       | 121,837,000 |   | 118,334,000 |   | 118,205,000 |   |
| Federal Home Loan Bank and other stocks  |       | 1,311,000             |       | 1,311,000 |   | 1,499,000 |   | 1,499,000 |   |
| Accrued interest receivable              |       | 841,000               |       | 841,000 |   | 622,000 |   | 622,000 |   |
|                                     |       |                  |       |   |   |   |   |   |   |
| **Financial  Liabilities:**              | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                                 |       | 124,281,000           |       | 124,224,000 |   | 127,588,000 |   | 127,569,000 |   |
| Other borrowings                         |       | 17,400,000            |       | 17,175,000 |   | 13,400,000 |   | 13,166,000 |   |
| Junior subordinated debt securities      |       | 3,093,000             |       | 3,537,000 |   | 3,093,000 |   | 3,727,000 |   |
| Accrued interest  and other liabilities  |       | 1,242,000             |       | 1,242,000 |   | 1,225,000 |   | 1,225,000 |   |
|                                          |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

72

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**Item 8.  Changes In and Disagreements With Accountantson Accounting and Financial Disclosure**

There have been nochanges in or disagreements with the Company’s accountants.

**Item 8A.  Controls and Procedures**

Within the 90 days prior tothe date of this report, our Chief Executive Officer and our Chief FinancialOfficer carried out an evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures pursuant to Exchange ActRule 15a-15.  Based upon that evaluation,the Chief Executive Officer and the Chief Financial Officer concluded thatcurrent disclosure controls and procedures are effective in timely alertingthem to material information relating to the Company and/or Bank that isrequired to be included in our periodic filings with the Securities andExchange Commission and also with bank or bank holding company regulatoryagencies.

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting for the Company and the Bank including periodic filings with theSecurities Exchange Commission, the Federal Deposit Insurance Corporation (“FDIC”),the Federal Reserve Bank of San Francisco (“FRBSF”) and the CaliforniaDepartment of Financial Institutions (“DFI”). Such periodic financial reports are prepared internally and reviewed bymanagement prior to filing.  Thesefinancial reports are also reviewed for timely filing, completeness andaccuracy with possible civil monetary penalties for late filing and intentionalinaccurate reporting by the various agencies where the reports are filed.

Internal controls overthe Bank’s operational, lending procedures and underwriting, financial systemsand other systems are reviewed by internal auditors, holding company and/orbank examiners, and by registered public accountants.  At present, Bancorp, based on its asset sizeand lack of activity other than banking, is not independently examined by theFRB.

Bancorp and the Bank haveelected to outsource the internal audit function to firms who specialize inperforming such auditing functions for community banks.  Internal audit engagements are in writing,including the anticipated scope, and are generally for 18 to 24 months withinterim auditing during the term of the engagement.  Engagements are presented to and approved bythe Board Audit Committee.  Each of theinternal audits, along with management’s response to any observations, iscompleted in writing and presented to the Board Audit Committee.  Management is then responsible to take anycorrective action required to modify procedures or policies to improve internalcontrols and procedures. Based on internal audits performed in 2005 and 2006,neither management nor the Board Audit Committee has been informed of anymaterial weaknesses in internal controls over financial reporting.  Beginning with the year ending December 31,2007, the Company will be required to report on management’s assessment ofinternal controls over financial reporting under Sarbanes Oxley Sec. 404.

Internal controls, lending,and financial reporting are also periodically reviewed by bank and bank holdingcompany examiners.  As a state chartedbank, the Bank is examined by the FRBSF and the DFI.  Prior to the December 2003 charterconversion, the Bank was periodically examined by the Comptroller of theCurrency (OCC) as required by law, including examinations for safety andsoundness, lending, compliance, Community Reinvestment Act, and informationtechnology.  Written reports of examinationby state or federal regulators are provided to the Bank, reviewed by managementand by the Board Audit Committee.  If anexamination revealed material issues, the Bank could be subject to regulatoryaction including formal or informal agreements to take corrective action.  Bank examination reports are confidential,and the results are not disclosed unless there are material exceptionsnoted.  In the event of materialexceptions, a bank could be required to enter into a formal agreement (such asa Memorandum of Understanding or Cease and Desist Order) which would documentthe specific weaknesses and corrective action that must be taken.  These formal agreements are generallyrequired to be disclosed to the public. As of December 2006, the Bank is not operating under any formal orinformal agreement with the FRB, DFI or OCC nor is any such agreement pendingor anticipated.

Finally, internal controlsand financial reporting is reviewed by independent registered publicaccountants on an annual basis.  Theseaudited reports, including any recommendations for improvements in accountingor internal controls, are presented to management and the Board’s AuditCommittee.  As of December 31, 2006, theCompany’s independent registered public accountants have certified the auditedfinancial statements of the Company, with no material weaknesses identified ininternal controls or financial reporting.

No material changes havebeen made in internal controls during the past year.  However, the Bank did engage a firm toperform a specific internal assessment of the Bank’s information technology andinformation security systems for a three-year period beginning in 2006.  It has made minor staffing changes to improveinternal controls based on recommendations made during the internal auditingprocess.

73

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**Item 8B.  OtherInformation**

All information requiredto be reported on a Form 8-K during the fourth quarter of 2006 has been soreported, except as set forth below.

On August 28, 2006 theBank and Anita M. Robinson, the Bank’s President and Chief Executive Officer,entered into an Amended and Restated Employment Agreement pursuant to which Ms.Robinson agreed to continue to serve as the President and Chief ExecutiveOfficer of Mission Community Bancorp. The agreement will terminate on December 31, 2007.  Pursuant to the employment agreement, Ms.Robinson receives an annual base salary of $165,000.  In addition, the agreement provides that Ms.Robinson is entitled to receive an incentive bonus as determined in accordancewith the Bank’s Officers’ Incentive Compensation Program.  Pursuant to the agreement Ms. Robinson isentitled to severance benefits of six months’ base salary and incentive bonusearned prior to the date of termination. Further, if Ms. Robinson’s employmentis terminated following a change in control, or if Ms. Robinson or leave theemployment of the Bank following a change in control for “good cause” asdefined in the employment agreement, Ms. Robinson is entitled to receiveseverance benefits of sixty months’ base salary in one lump sum payment.

On February 8, 2007 theBoard of Directors of Mission Community bank approved an increase in Ms.Robinson’s base salary to $175,000 annually, an increase in her auto allowanceand the participation by Ms. Robinson in a new CEO Bonus Program.  Ms. Robinson has agreed to participate in thenew CEO Bonus Program rather than in the Officers’ Incentive CompensationProgram as provided for in her employment agreement.  Ms. Robinson is the only participant in theCEO Bonus Program and bonuses are paid under the Program as follows:

 
| Achievement of Budget @ | ** ** | **Bonus Amount** | ** ** | **Achievement of Budget @** | ** ** | **Bonus Amount** |
|-------------------------|------------|------------------|------------|-----------------------------|------------|------------------|
| 80%                     |       | $25,000          |       | 120%                        |       | $125,000         |
| 90%                     |       | $50,000          |       | 130%                        |       | $150,000         |
| 100%                    |       | $75,000          |       | 140%                        |       | $175,000         |
| 110%                    |       | $100,000         |       | 150%                        |       | $200,000         |

 

74

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**PART III**

**Item 9. Directors, Executive Officers, Promoters, Control Persons and CorporateGovernance; Compliance With Section 16(a) of the Exchange Act.**

Information for this item is incorporated by reference to the Company’sproxy statement for the annual meeting of shareholders to be held April 24,2007.

**Section16(a) Beneficial Ownership Reporting Compliance**

The Company does not have aclass of equity securities registered pursuant to Section 12 of the SecuritiesExchange Act of 1934 (the “Exchange Act”). Therefore, the Company’s officers and directors, and persons who ownmore than 10% of the Company’s Common Stock, are not subject to the reportingrequirements under Section 16(a) of the Exchange Act.

**Item 10.  Executive Compensation**

The information for this item is incorporated by reference to theCompany’s proxy statement for the annual meeting of shareholders to be heldApril 24, 2007.

**Item 11.****     Security Ownership of CertainBeneficial Owners and Management and Related Shareholder Matters**

The information requiredby Item 11 with respect to securities authorized for issuance under equitycompensation plans is set forth under “Item 5—Market for Common Equity, RelatedShareholder Matters and Issuer Purchases of Equity Securities,” above.  The other information for this item isincorporated by reference to the Company’s proxy statement for the annualmeeting of shareholders to be held April 24, 2007.

**Item 12.  Certain Relationships and RelatedTransactions, and Director Independence**

The information for this item is incorporated by reference to theCompany’s proxy statement for the annual meeting of shareholders to be heldApril 24, 2007.

75

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**Item 13. Exhibits**

**Exhibit Index:**
| Exhibit # | ** ** | ** **                                                                                                                                                                                                                                                |
|-----------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1       |       | Plan  of Reorganization and Agreement of Merger dated as of October 4, 2000 (A)                                                                                                                                                                           |
|      |       | ** **                                                                                                                                                                                                                                                |
| 3.1       |       | Articles  of Incorporation (J)                                                                                                                                                                                                                            |
|      |       |                                                                                                                                                                                                                                                      |
| 3.2       |       | 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. (F)                                                                                                             |
|      |       |                                                                                                                                                                                                                                                      |
| 4.5       |       | Indenture  dated as of October 14, 2003 by and between Registrant and Wells Fargo Bank,  National Association, as trustee (F)                                                                                                                             |
|      |       |                                                                                                                                                                                                                                                      |
| 4.6       |       | Declaration  of Trust Mission Community Capital Trust I dated October 10, 2003 (F)                                                                                                                                                                        |
|      |       |                                                                                                                                                                                                                                                      |
| 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 (F) |
|      |       |                                                                                                                                                                                                                                                      |
| 4.8       |       | Guarantee  Agreement dated October 14, 2003 between Registrant, as Guarantor, and Wells  Fargo Bank, National Association, as Guarantee Trustee (F)                                                                                                       |
|      |       |                                                                                                                                                                                                                                                      |
| 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 (F)                                                                               |
|      |       |                                                                                                                                                                                                                                                      |
| 10.1      |       | Purchase  and Sale Agreement and Lease dated January, 1997, as amended (B)                                                                                                                                                                                |
|      |       |                                                                                                                                                                                                                                                      |
| 10.2      |       | Intentionally  omitted                                                                                                                                                                                                                                    |
|      |       |                                                                                                                                                                                                                                                      |
| 10.3      |       | 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 CA (C)                                                                                                                                                                                                   |
|      |       |                                                                                                                                                                                                                                                      |
| 10.9      |       | Intentionally  omitted                                                                                                                                                                                                                                    |
|      |       |                                                                                                                                                                                                                                                      |
| 10.10     |       | Lease  Agreement — 3480 S. Higuera, San Luis Obispo (G)                                                                                                                                                                                              |
|      |       |                                                                                                                                                                                                                                                      |
| 10.11     |       | Salary  Protection Agreement — Mr. Pigeon (H)                                                                                                                                                                                                        |
|      |       |                                                                                                                                                                                                                                                      |
| 10.12     |       | Salary  Protection Agreement — Mr. Judge (I)                                                                                                                                                                                                         |
|      |       |                                                                                                                                                                                                                                                      |
| 10.13     |       | Amended  and Restated Employment Agreement dated August 28, 2006 between Anita M.  Robinson and Mission Community Bank __                                                                                                                                 |
|      |       |                                                                                                                                                                                                                                                      |
| 21        |       | Subsidiaries  of the registrant __                                                                                                                                                                                                                        |
|      |       |                                                                                                                                                                                                                                                      |
| 23.1      |       | Independent  Auditors’ Consent __                                                                                                                                                                                                                    |
|      |       |                                                                                                                                                                                                                                                      |
| 31.1      |       | Certification  of CEO pursuant to Section 302 of Sarbanes Oxley Act __                                                                                                                                                                                    |
|      |       |                                                                                                                                                                                                                                                      |
| 31.2      |       | Certification  of CFO pursuant to Section 302 of Sarbanes Oxley Act __                                                                                                                                                                                    |
|      |       |                                                                                                                                                                                                                                                      |
| 32.1      |       | Certification  of CEO pursuant to Section 906 of Sarbanes Oxley Act __                                                                                                                                                                                    |
|      |       |                                                                                                                                                                                                                                                      |
| 32.2      |       | Certification  of CFO pursuant to Section 906 of Sarbanes Oxley Act __                                                                                                                                                                                    |

----

(A)               Included in the Company’s Form8-K filed on December 18, 2000

(B)                Included in the Company’s Form10-KSB filed on April 2, 2001

(C)                Included in the Company’s Form10-QSB filed August 12, 2002

(D)                Included in the Company’s Form10-QSB filed on November 12, 2002

(E)                Included in the Company’s Form10-QSB filed on August 13, 2003

(F)                Included in the Company’s Form8-K filed on October 21, 2003

(G)                Amendment included in theCompany’s Form 10-QSB filed on August 10, 2004

(H)                Includedin the Company’s Form 8-K filed on January 19, 2005

(I)                 Includedin the Company’s Form 8-K filed on February 17, 2005

(J)                 Includedin the Company’s Form 10-QSB filed on August 14, 2006

** **

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**Item 14. Principal Accountant Fees and Services**

The information for this item is incorporated by reference to theCompany’s proxy statement for the annual meeting of shareholders to be heldApril 24, 2007.

**Signatures**

Pursuant to therequirements of Section 13 of the Securities Exchange Act of 1934, the Companyhas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.
| **MISSION COMMUNITY BANCORP**                        |
|------------------------------------------------------|
| ** **                                           |   |   |
| ** **                                           |   |   |
| ** **                                           |   |   |
| By:                                                  | /s/ Anita M. Robinson |   |
| ANITA M. ROBINSON                                    |
| President and Chief Executive Officer                |
| Dated: March 26, 2007                                |
|                                                 |   |   |
|                                                 |   |   |
|                                                 |   |   |
| By:                                                  | /s/ Ronald B.  Pigeon |   |
| RONALD B. PIGEON                                     |   |
| Executive Vice President and Chief Financial Officer |
| Dated: March 26, 2007                                |   |

 

[Signaturescontinue on next page]

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Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
|  /s/ Bruce M. Breault  |   | Founding Chairman of the Board (Emeritus)            | ** ** | March 26, 2007 |
|-----------------------------|--------|------------------------------------------------------|------------|----------------|
| BRUCE M. BREAULT            |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Roxanne M. Carr   |   | Vice Chairman of the Board                           |       | March 26, 2007 |
| ROXANNE M. CARR             |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ William B. Coy    |   | Chairman of the Board                                |       | March 26, 2007 |
| WILLIAM B. COY              |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Richard Korsgaard |   | Director                                             |       | March 26, 2007 |
| RICHARD  KORSGAARD          |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Ronald B. Pigeon  |   | Executive Vice President and Chief Financial Officer |       | March 26, 2007 |
| RONALD B. PIGEON            |   | (Principal Accounting Officer)                       |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Anita M. Robinson |   | Director, President and Chief Executive Officer      |       | March 26, 2007 |
| ANITA M.  ROBINSON          |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Robin L. Rossi    |   | Director                                             |       | March 26, 2007 |
| ROBIN L. ROSSI              |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Gary E. Stemper   |   | Immediate Past Chairman of the Board                 |       | March 26, 2007 |
| GARY E. STEMPER             |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|                        |   |                                                 |       |           |
|  /s/ Karl F. Wittstrom |   | Director and Secretary                               |       | March 26, 2007 |
| KARL F.  WITTSTROM          |   |                                                 |       |           |

 

 

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