SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 Form
10-K
 
 þ
              ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 For
the Fiscal Year ended December 31,
2009
 OR
 o
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 Commission
file number 333-12892
 
 MISSION COMMUNITY
BANCORP
 (Exact
name of registrant as specified in its charter)
 
 California                                                                                                                                         
              77-0559736
 State or
other jurisdiction of incorporation or
organization                                                                              
   I.R.S. Employer Identification No.
 
 3380 S. Higuera St.,
San Luis Obispo,
California  93401                                                                                                  (805)
782-5000
 (Address of principal executive
offices)                                                                                                            
 Issuer’s telephone number
 
 Securities
registered pursuant to Section 12(b) of the Exchange Act: None
 Securities
registered pursuant to Section 12(g) of the Exchange Act:  None
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.oYes.þNo
 
 Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act.   þ
 
 Indicate
by check mark whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days.   Yes þNo o
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).  Yes oNoo  (This
requirement is not yet applicable to registrant)
 
 Check if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not
contained in this form, and no disclosure will be contained, to the best of the
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K þ.
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 Large
      accelerated filer o
              Accelerated
      filer  oNon-accelerated
      filer o
      (Do not check if a smaller
      reporting company)
              Smaller
      reporting company þ
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes oNo þ
 
 The
aggregate market value of the voting and non-voting common equity held by
non-affiliates, computed by reference to the price at which the common equity
was last sold, or the average bid and asked prices of such common equity, as of
the last business day of the registrant’s most recently completed second fiscal
quarter, was $6,229,966.
 
 As of
March 25, 2010, the
Registrant had 1,345,602 shares of Common Stock outstanding.
  Documents Incorporated by
Reference:  Portions of the definitive proxy statement for the
2010 Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission pursuant to SEC regulation 14A are incorporated by reference in Part
III, Items 10-14.
  
  Forward
Looking Statements
  This
Annual Report on Form 10-K includes forward-looking information, which is
subject to the “safe harbor” created by Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act and the Private
Securities Litigation Reform Act of 1995.  When the Company uses or
incorporates by reference in this Annual Report on Form 10-K the words
“anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and
similar expressions, the Company intends to identify forward-looking
statements.  Such statements are subject to certain risks,
uncertainties and assumptions, including those described in this Annual Report
on Form 10-K.  Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, estimated, expected, projected,
intended, committed or believed.  Such risks and uncertainties
include, but are not limited to, the following factors: (i) general economic
conditions, whether national or regional, that could affect the demand for loans
and other banking services or lead to increased loan losses; (ii) competitive
factors, including increased competition with community, regional and national
financial institutions that may lead to pricing pressures on rates the Bank
charges on loans and pays on deposits or reduce the value of real estate
collateral securing the Bank's loans; (iii) loss of customers of greatest value
to the Bank or other losses; (iv) increasing or decreasing interest rate
environments that could lead to decreased net interest margin and increased
volatility of rate sensitive loans and deposits; (v) changing business
conditions in the banking industry; (vi) changes in the regulatory environment
or new legislation; (vii) changes in technology or required investments in
technology; (viii) credit quality deterioration which could cause an increase in
the provision for loan losses; (ix) dividend restrictions; (x) continued
tensions in Iraq and elsewhere in the Middle East; and (xi) increased regulation
of the securities markets, whether pursuant to the Sarbanes-Oxley Act of 2002 or
otherwise.
 
 Investors
and other readers are cautioned not to place undue reliance on forward-looking
statements, which reflect management's analysis only as of the date of the
statement.
 
 The
Company undertakes no obligation to revise any forward-looking statement to
reflect later events or circumstances.
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2 -
  
  Table of Contents
  
 Mission
Community Bancorp
 Form
10-K
 December
31, 2009
 
 
 
 Part
I
 
  Item 1.
              Description of
Business
  Item 1A.
              Risk Factors
  Item 2.
              Properties
  Item 3.
              Legal
Proceedings
  Item
      4.
              Reserved
 
 
 
 Part
II
 
  Item 5.
              Market for Common Equity, Related Shareholder Matters and
      Issuer Purchases of Equity
Securities
  Item 6.
              Selected Financial
Data
  Item 7.
              Management’s Discussion and
  Analysis
  Item 8.
              Financial
Statements
 Report
      of Independent Registered Public Accounting Firm on the Consolidated
      Financial Statements
 Consolidated
      Balance Sheets
 Consolidated
      Statements of Income
 Consolidated
      Statements of Changes of Shareholders’
Equity
 Consolidated
      Statements of Cash Flows
 Notes
      to Consolidated Financial
Statements
  Item 9.
              Changes In and Disagreements With Accountants on Accounting
      and Financial Disclosure
  Item 9AT.
              Controls and
Procedures
  Item
      9B.
              Other
      Information
 
 
 
 Part
III
 
  Item 10.
              Directors, Executive Officers, and Corporate
      Governance
  Item 11.
              Executive
Compensation
  Item 12.
              Security Ownership of Certain Beneficial Owners and
      Management and Related Shareholder
Matters
  Item 13.
              Certain Relationships and Related Transactions, and
      Director Independence
  Item 14.
              Principal Accountant Fees and
    Services
  Item 15.
              Exhibits
  Signatures
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 Table of Contents
  
  PART I
  
 Item
      1.  Description of
Business
  Business
Development
 
 The
Company
 
 Mission
Community Bancorp (“Bancorp”) is a California corporation that was formed in
September 2000 and acquired all of the outstanding shares of Mission Community
Bank (the “Bank”) in a one-bank holding company reorganization effective
December 15, 2000.  It is registered as a bank holding company under
the Bank Holding Company Act of 1956, as amended, and is headquartered in San
Luis Obispo, California.  Bancorp’s principal business is to serve as
a bank holding company for the Bank.  Bancorp and the Bank are
collectively referred to herein as “the Company.”
  As of
December 31, 2009, the Company had approximately $193 million in total assets
and $19 million in shareholders’ equity.
  On
October 14, 2003, Bancorp formed Mission Community Capital Trust I in order to
complete a trust preferred security transaction and raised approximately
$3,000,000 in long-term borrowings that qualifies as regulatory
capital.
  On
January 9, 2009, the Company issued to the United States Department of the
Treasury (“Treasury Department”) 5,116 shares of Mission Community Bancorp
Series D Fixed Rate Perpetual Preferred Stock (the “Series D Preferred Stock”),
having a liquidation amount per share equal to $1,000 for a total price of
$5,116,000.  The Preferred Stock was issued pursuant to the Treasury
Department’s Capital Purchase Program under the Troubled Asset Relief Program
(“TARP”).  See also Note K to the Notes to Consolidated Financial
Statements.
  The U.S.
Department of the Treasury, Community Development Financial Institutions Fund,
has certified Bancorp and the Bank as Community Development Financial
Institutions (“CDFI”).  This status also conveys possible Community
Reinvestment Act (“CRA”) credit to institutional depositors and investors in the
Bank and Bancorp.  It also opens to the Bank and Bancorp various
government sponsored programs, grants, and awards in which they may
participate.  The Bank and Bancorp are also certified by the CDFI Fund
as Community Development Entities (“CDE’s”).  As CDE’s, qualifying
investments made in the Bank or Bancorp provide the investor with a New Markets
Tax Credit equal to 39% of the investment, to be realized over a seven-year
period.
  With its
status as a CDFI, Bancorp completed the private placement of $500,000 in
preferred stock during December 2000 with the CDFI Fund.  Bancorp also
was awarded a second $500,000 Core Award in 2001 from the CDFI Fund, which was
funded in December 2002 in the form of preferred stock.  This was
matched with a combination of preferred and common shares through an investment
of $500,000 from the National Community Investment Fund (“NCIF”).  Due
to the Company’s recent entry into a Securities Purchase Agreement to sell a
significant amount of its issued and outstanding shares to an existing principal
shareholder, which principal shareholder would not itself qualify as a CDFI, it
is possible that the Company and the Bank may not qualify as a CDFI in the
future.  See “Recent Developments,” below and “Item 1A—Risk Factors—If
the Company or the Bank were to lose its status as a Community Development
Financial Institution, its ability to carry out certain portions of its business
plan would be adversely affected.”
  Mission
Community Bank
  The Bank
is a California state-chartered bank headquartered in San Luis Obispo,
California.  It is also a member of the Federal Reserve
System.  Its deposits are insured by the FDIC up to the applicable
limits of the law.  The Bank commenced operations at its main office
in San Luis Obispo on December 18, 1997 and opened its first branch office in
the city of Paso Robles in San Luis Obispo County in 1998 and a second branch
office in Arroyo Grande in San Luis Obispo County in 2002.  The Bank
also opened a loan production office, the Business Banking Center, in San Luis
Obispo in January 2005.  The Business Banking Center is primarily
engaged in originating and servicing SBA-guaranteed loans.  In
December 2008 the Bank opened a new branch office in Santa Maria, in northern
Santa Barbara county.
  The Bank
is a community bank engaged in the general commercial banking business in the
Central Coast of California.  It offers a variety of deposit and loan
products to individuals and small businesses and a specialization
in
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 Table of Contents
  community
development financial services and SBA loans.  Through its community
development activities, the Bank seeks to provide financial support and services
by promoting community development and economic vitality.
  At
December 31, 2009, the Bank, on a stand-alone basis, had approximately $192.7
million in assets, $136.4 million in loans, $164.6 million in deposits, and
$20.6 million in stockholders’ equity.
  The Bank
is also certified by the State of California Department of Insurance to accept
deposits or investments under the California Organized Investment Network (the
“COIN”).  The COIN program provides California tax credits and/or CRA
credit to individuals, corporations, or partnerships that invest at below market
rates for specified terms.  In addition, the Bank has obtained
preferred lender status with the Small Business Administration which generally
allows it to approve and fund SBA loans without the necessity of having the loan
approved in advance by the SBA.
  Mission
Community Development Corporation (“MCDC”)
  Mission
Community Development Corporation, a community development corporation which was
incorporated in August 1997, is a wholly-owned subsidiary of the
Bank.  MCDC is a “for-profit” Community Development Corporation
(“CDC”), which provides financing for small businesses and low- to
moderate-income area development and/or affordable housing
projects.  Its purpose is to benefit small business and low- to
moderate-income areas/residents.  The board of directors of MCDC
consists of the members of the Board of Directors of the Bank.
  At
December 31, 2009, MCDC had approximately $5,000 in net loans and $144,000 in
shareholder’s equity, and provides loan accounting services for a very small
pool of community development micro loans which have been funded by a group of
banks through the Economic Vitality Corporation, as well as management of an
emergency assistance loan pool created after the San Simeon earthquake of
December 2003.  MCDC also manages a loan pool for the San Luis Obispo
County Housing Trust Fund to assist in providing affordable housing within the
county.  Loans serviced by MCDC as of December 31, 2009, totaled
approximately $1,367,000.
  Mission
Community Services Corporation (“MCSC”)
  Bancorp
and the Bank have an affiliate relationship with, but no ownership of, MCSC,
which was incorporated in August 1997 and which was established in September
2003 as a “not-for-profit” public charitable corporation under Internal Revenue
Code Section 501(c)(3).  The accounts of MCSC are not included in the
Company’s consolidated financial statements or elsewhere in this Form
10-K.  MCSC’s primary focus is to provide technical assistance and
training services to the community, including small business, minority and
low-income entrepreneurs.  The Board of Directors of MCSC includes
representatives from the Company, together with members representing the
low-income and business community.  Over the five-year period ended
December 31, 2009, Bancorp has provided $205 thousand in cash contributions and
$64 thousand in in-kind (non-cash) contributions to MCSC.
  In 2006,
MCSC was awarded a five-year, $750,000 grant from the U.S. Small Business
Administration to fund one of 99 Women’s Business Centers
nationwide.  MCSC is also “COIN”-certified as a CDFI.  See
also Note L to the Consolidated Financial Statements for additional information
regarding MCSC.
  The
“Mission” Group
  Bancorp,
the Bank and its subsidiary MCDC, and MCSC form an organizational structure
intended to provide traditional community bank financial services and to foster
economic revitalization and community development to its target market areas
through its CDFI enhancements.
  
  Business
of Issuer
  Principal
Products, Services, and Markets
 Other
than holding the shares of the Bank, Bancorp conducts no significant activities.
Bancorp is authorized with the prior approval of the Board of Governors of the
Federal Reserve System (the “Federal Reserve Board”), its principal regulator,
to engage in a variety of activities which are deemed closely related to the
business of banking.
  The Bank
offers checking and savings accounts, money market accounts and time
certificates of deposits; offers commercial, agribusiness, government
guaranteed, real estate, automobile and other installment and term loans and
leases; issues drafts, sells travelers’ checks and provides other customary
banking services. Although the Bank does not operate a
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 Table of Contents
  trust
department or provide international services, it makes trust services or
international services available through correspondent
institutions.
  The areas
in which the Bank has directed virtually all of its lending activities are
commercial loans (including government-guaranteed and agricultural loans), real
estate loans, construction loans, consumer loans and lease
financing  As of December 31, 2009, these five categories accounted
for approximately 14.9%, 71.1%, 9.2%, 1.3%, and 1.0% respectively, of the Bank’s
gross loan portfolio.  As of that date, $109.5 million, or 80.3%, of
the Bank’s loans consisted of real estate loans, for single family residences or
for commercial development, and interim construction loans.  This
represents an $11.4 million decrease in real estate and construction loans from
the prior year’s combined total of $120.9 million.  In percentage
terms, however, real estate and construction loans increased from 78.9% to 80.3%
of the loan portfolio.  Under the regulatory definition of commercial
real estate—which excludes owner-occupied properties—the Bank’s commercial real
estate concentration is reduced to $52.2 million, or 38.3% of total
loans.  See Loan
Concentrations in Management’s Discussion and Analysis under Item 7 of
Part II of this report.
  As of
December 31, 2009, the Bank had 5,068 deposit accounts, including 2,927 demand
accounts (both non-interest-bearing and interest-bearing, including NOW and
money market deposit accounts) totaling $57.2 million; 1,152 savings accounts
with balances totaling $21.6 million; and 989 time certificates of deposit
totaling $85.0 million.
  The
principal sources of the Bank’s revenues are interest and fees on loans,
interest on investments including federal funds sold and deposits in other
banks, gain on sales of loans, service charges on deposit accounts and gain on
sales of securities.  For the year ended December 31, 2009, these
sources comprised 76.7%, 12.1%, 3.3%, 2.9%, and 2.1%, respectively, of the
Bank’s total operating income.
  Distribution
Methods of the Products and Services
  The
Bank’s primary service area consists of San Luis Obispo county and northern
Santa Barbara county, which lie centrally within the State of California along
the Pacific Ocean.  Secondary market areas include cities and
unincorporated areas in the neighboring counties, including Monterey, Kern,
Kings, and Fresno.
  The Bank
operates out of four full service offices (in the cities of San Luis Obispo,
Paso Robles, Arroyo Grande and Santa Maria) plus an administrative and loan
production facility, which is located in the city of San Luis
Obispo.  The Bank provides some financial services through direct
contact by calling officers who travel into the neighboring
counties.  Physical expansion into the neighboring counties would most
likely come from acquisitions or in the form of loan production offices although
there are no immediate plans for acquisitions or loan production
offices.
  The
Bank’s operating policy since its inception has emphasized community development
through small business, commercial and retail banking.  Most of the
Bank’s customers are retail customers, farmers and small to medium-sized
businesses and their owners.  As a CDFI, the Bank also emphasizes
loans and financial services to low- to moderate-income communities within its
target market area.  Most of the Bank’s deposits are attracted by
relationship banking, local activities, and advertising.
  The
business plan of the Bank emphasizes providing highly specialized financial
services in a professional and personalized manner to individuals and businesses
in its service area.  Its key strengths are customer service and an
experienced management team familiar with the community through the Bank’s
involvement in various community lending and development projects.
  Since
2007, the Bank has extended its use of Internet technology as a distribution
tool to improve its customer service by making available a “remote capture”
deposit product, as well as enhanced Internet Banking, electronic Bill-Pay and
ACH origination.
  During
2006 the Bank began to capitalize on its status as one of only four banks in its
primary service area participating in the Certificate of Deposit Account
Registry Service (“CDARS”) program.  This program permits the Bank’s
customers to place all of their certificates of deposit at the Bank and have
those deposits fully-insured by the FDIC, up to $50 million.  The
CDARS program acts as a clearinghouse, matching deposits from one institution in
the CDARS network of nearly 3,000 banks with other network banks (in increments
of less than the $250 thousand FDIC insurance limit), so funds that a customer
places with the Bank essentially remain on the Bank’s balance
sheet.  While the Bank continues to focus its extension of CDARS to
client relationships in its local market area who are seeking additional FDIC
insurance coverage, its participation in the CDARS program also permits it to
bid on additional certificates of deposit through banks across the country to
meet additional funding needs.  These “One-Way Buy” CDARS deposits
would be considered to be brokered deposits.  When the Bank has excess
funds, the CDARS program enables the Bank to place those
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  funds in
CD’s with CDARS network banks (known as the “One-Way Sell” program), which
generally results in a higher yield than if those funds were invested in Federal
Funds.
  Status
of and Publicly Announced New Products or Services
  In an
effort to reach out to the community to share sound money management practices
and habits to the target market of low-income and under-banked individuals, the
Bank has formed a Financial Education team of bank employees.  A series of
training workshops covering the fundamentals of banking and financial services
have been developed in English and Spanish.  The Bank expects to
increase its focus on profitable financial services for the un- and under-banked
customers in its market area, but does not expect these services will be a
material percentage of its deposit activities.
  The Bank
plans to create a new division at Mission Community Bank: the “Hispanic Banking
Division,” staffed with employees who are bilingual in English and
Spanish.  The new division would be dedicated to working closely in the
Hispanic communities it serves, including Santa Maria.  The division will
offer specifically designed deposit and loan products and services benefiting
the Hispanic community.
  In 2009
the Bank received from the Bank Enterprise Award program of the Department of
the Treasury the remaining $81 thousand portion of a 2008 grant, which was based
on lending activity of the Bank in 2008.  That grant was recognized in
non-interest income in 2009.
  Competition
  The
banking and financial services business in the Bank’s market area is highly
competitive.  The increasingly competitive environment is a result
primarily of changes in regulation, and changes in technology and product
delivery systems.  The Bank emphasizes to its customers the advantages
of dealing with a locally owned and community development oriented institution.
Larger banks may have a competitive advantage because of higher lending limits
and major advertising and marketing campaigns in addition to expanded products
like trust services, international banking, discount brokerage and insurance
services that the Bank does not offer.  As a service to its customers,
the Bank has made arrangements with other financial service providers to extend
such services to its customers where possible.  For borrowers
requiring loans in excess of the Bank’s legal lending limits, the Bank makes use
of loan participations with its correspondent banks and with other independent
banks, retaining the portion of such loans which is within its legal lending
limits.  Commercial banks compete with savings and loan associations,
credit unions, other financial institutions, securities brokerage firms, and
other entities for funds.  For instance, yields on corporate and
government debt securities and other commercial paper affect the ability of
commercial banks to attract and hold deposits.
  The Bank
utilizes technology to improve its competitive advantages by use of ATMs,
Internet Banking, ACH origination, electronic bill pay, email, remote deposit
capture and credit card and merchant card relationships.
  In
addition, in order to compete effectively, the Bank has created a sales and
service culture that combines the experience of its senior officers with the
commitment to service and a focus on the individual needs of its customers that
is found at the best community banks.  The Bank also relies on local
advertising programs, direct personal contact by its officers, directors,
employees and shareholders and specialized services such as courier pick-up and
remote deposit capture.  The Bank believes it provides a level of
service and decision-making responsiveness not generally offered by larger
institutions.
  The
Bank’s primary service area consists of the county of San Luis Obispo and
northern Santa Barbara county.    As in most major U.S.
cities, large banks compete in our service area.  However, rather than
these large financial institutions, community banks are more prominent in our
market.  As such, we believe our primary competitors for individuals
and small and medium-sized business customers are the community banks, which can
provide the service and responsiveness attractive to this customer
base.
  Within
San Luis Obispo county and northern Santa Barbara county, and based on data from
the FDIC as of June 30, 2009, there were 20 banks with 107 branches with
aggregate deposits of $6.5 billion.  The Bank’s deposits represent a
2.5% share of this market.  Of the 20 banks, 10 were community banks
(banks with less than $1 billion in assets), with 7 of these banks headquartered
in San Luis Obispo county and 3 headquartered in Santa Barbara
county.  There were also 7 credit unions operating in San Luis Obispo
and northern Santa Barbara Counties.  Three of those credit unions are
headquartered in the Bank’s target market area.
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  Dependence
on One or a Few Major Customers
  The Bank
is limited, due to legal lending limits, in the size of loans it can make to any
one individual borrower (in the aggregate).  It has in its portfolio
approximately 540 loans to approximately 415 loan customers.  As of
December 31, 2009, the Bank’s legal lending limit to a single borrower, and such
borrower’s related parties, was approximately $6.5 million on a secured basis,
and was $3.9 million for unsecured loans, based on regulatory capital plus
reserves of approximately $26.1 million.
  The Bank
has a higher than average dependence (as measured by peer group analysis) on
larger deposit balances (deposits of $100,000 or more) with a total of 426
deposit accounts holding $101.5 million in deposits as of December 31,
2009.  Included in those totals are 15 customers with deposits of $1
million or more totaling $56.9 million, with one local customer relationship
representing 18% of the Bank’s total deposits as of December 31,
2009.  Management works with large depositors to “ladder out”
certificate of deposit maturities in order to both minimize liquidity risk for
the Bank and provide a better return for the customer on their deposited
funds.  These large deposit balances have been reasonably stable
during the past several years and are consistent with the Bank’s deposit/funding
strategy.  Also included in the totals above are 18
non-interest-bearing transaction accounts, of which $17.0 million exceeds the
normal FDIC insurance limit, but which are subject to unlimited FDIC insurance
coverage under the Temporary Liquidity Guarantee Program (“TLGP”) through June
30, 2010, and the expiration of that program may result in the loss of a portion
of those deposits.  The Bank has a contingency funding plan in place
to address any potential loss of these deposits.  On April 13, 2010,
the FDIC announced an extension of the TLGP through December 31, 2010, for
institutions that do not opt out by April 30, 2010.  At this time the
Bank has not made a decision as to whether it will continue in the TLGP after
June 30, 2010.
  The
Bank’s business does not appear to be seasonal.
  Recent
Developments
  On
December 22, 2009, the Company entered into a Securities Purchase Agreement (the
“Agreement”) with Carpenter Fund Manager GP, LLC, (the “Manager”) on behalf of
and as General Partner of Carpenter Community BancFund, L.P., Carpenter
Community BancFund-A, L.P. and Carpenter Community BancFund—CA, L.P. (the
“Investors”).  The Manager was an existing principal shareholder of
the Company prior to its entry into the Agreement.  Pursuant to the
Agreement the Manager has agreed to cause the Investors to purchase an aggregate
of 3,040,000 shares of the Company’s authorized but unissued common stock, with
each share of common stock paired with a warrant to purchase one additional
share of common stock.  Each “unit” of one common share and one
warrant would be purchased for $5.00.  The warrants are exercisable
for a term of ten years from issuance at an exercise price of $5.00 per share
and contain customary anti-dilution provisions.  The Company entered
into the Agreement in order to take advantage of the Manager’s investment and
strategic counsel and to assist in further strengthening the capital position of
the Bank during the current period of significant economic
uncertainty.
  The
Agreement contemplates that the Units will be purchased in two separate
closings.  At the first closing the Investors will purchase an
aggregate of 2,000,000 shares of Common Stock, paired with warrants to purchase
2,000,000 shares of Common Stock, for an aggregate purchase price of $10
million.  At the second closing, the Investors will purchase an
aggregate of 1,040,000 shares of Common Stock, paired with warrants to purchase
1,040,000 shares of Common Stock, for an aggregate purchase price of
$5,200,000.  The second closing is contingent upon the approval of the
Company and the Manager of the Company’s redemption of the TARP Preferred
Stock (Series D), as well as the receipt of all regulatory and other approvals
required with respect to a redemption of the TARP Preferred
Stock.  The Agreement further provides that the Company will conduct a
rights offering to its existing shareholders following the initial closing
pursuant to which each shareholder will be offered the right to purchase
additional shares of common stock, paired with a warrant, at a price of $5.00
per unit of common stock and warrant.  The warrants issuable in the
rights offering will also be for a term of 10 years and will be exercisable at a
price of $5.00 per share.
  The sale
of the units is subject to receipt of all required regulatory approvals and the
closings are subject to other customary conditions.
  On March
17, 2010 the Company and the Manager entered into an amendment to the Agreement,
extending the date by which the initial closing must occur to May 30,
2010.  The closing date was amended in order to allow for adequate
time for receipt of all required regulatory approvals to close the
transaction.  Further, it is anticipated that the rights offering will
now occur in the second quarter of 2010, or as soon thereafter as practicable,
following the initial closing under the Securities Purchase
Agreement.
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  Upon the
initial closing under the Securities Purchase Agreement, it is likely that each
of the Company and the Bank will no longer be eligible as a CDFI since in order
to maintain such status, any bank holding company which owns more than 25% of
the voting shares or otherwise controls through a majority of directors of a
company or bank with CDFI status must itself be a CDFI.  The Manager
is not a CDFI and does not intend to become a CDFI.  The Company and
the Bank have approached the U.S. Treasury with various alternatives which might
be possible to enable the Bank and the Company to retain their respective CDFI
status, but there can be no assurance that any of these alternatives will be
acceptable to the U.S. Treasury.
  Effect
of Government Policies and Regulations
  Banking
is a business that depends on rate differentials.  In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowings and the interest rate received by the Bank on loans extended to
its customers and securities held in the Bank’s portfolio comprise the major
portion of the Bank’s earnings.  These rates are highly sensitive to
many factors that are beyond the control of the Bank. Accordingly, the earnings
and growth of the Bank are subject to the influence of domestic and foreign
economic conditions, including inflation, recession and
unemployment.
  The
commercial banking business is not only affected by general economic conditions
but is also influenced by the monetary and fiscal policies of the federal
government and the policies of regulatory agencies, particularly the Federal
Reserve Board.  The Federal Reserve Board implements national monetary
policies (with objectives such as curbing inflation and combating recession) by
its open-market operations in U.S. Government securities, by adjusting the
required level of reserves for financial institutions subject to its reserve
requirements and by varying the discount rates applicable to borrowings by
depository institutions. The actions of the Federal Reserve Board in these areas
influence the growth of bank loans, investments and deposits and also affect
interest rates charged on loans and paid on deposits.  The nature and
impact of any future changes in monetary policies cannot be
predicted.
  From time
to time, legislation is enacted which has the effect of increasing the cost of
doing business, limiting or expanding permissible activities or affecting the
competitive balance between banks and other financial
institutions.  Proposals to change the laws and regulations governing
the operations and taxation of banks, bank holding companies and other financial
institutions are frequently made in Congress, in the California legislature and
before various bank regulatory and other professional agencies.  For
example, the Bank’s ability to originate and sell SBA loans would be severely
impacted if federal appropriations for the SBA lending program were curtailed or
eliminated.
  Supervision
and Regulation
  Both
federal and state law extensively regulates banks and bank holding
companies.  This regulation is intended primarily for the protection
of depositors and the deposit insurance fund and not for the benefit of
shareholders of the Company.  The following is a summary of particular
statutes and regulations affecting the Company and the Bank.  This
summary is qualified in its entirety by the statutes and
regulations.  No assurance can be given that such statutes or
regulations will not change in the future.
  Regulation
of Mission Community Bancorp
  Mission
Community Bancorp is a registered bank holding company under the Bank Holding
Company Act of 1956, as amended, and is regulated by the Federal Reserve
Board.  The Company is required to file periodic reports with the
Federal Reserve Board and such additional information as the Federal Reserve
Board may require pursuant to the Bank Holding Company Act.  The
Federal Reserve Board may conduct examinations of the Company and its
subsidiaries, which includes the Bank.
  The Bank
Holding Company Act requires every bank holding company to obtain the prior
approval of the Federal Reserve Board before acquiring substantially all the
assets of any bank or bank holding company or ownership or control of any voting
shares of any bank or bank holding company, if, after the acquisition, it would
own or control, directly or indirectly, more than 5% of the voting shares of the
bank or bank holding company.  The Securities Purchase Agreement
referred to above is subject to such approval under the Bank Holding Company
Act.
  The
Company is prohibited by the Bank Holding Company Act, except in statutorily
prescribed instances, from acquiring direct or indirect ownership or control of
more than 5% of the outstanding voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks or furnishing
services to its subsidiaries.  However, the Company, subject to
notification or the prior approval of the Federal Reserve Board, as applicable
in each specific case, may engage in any, or acquire shares of
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  companies
engaged in, activities that are deemed by the Federal Reserve Board to be “so
closely related to banking” or managing or controlling banks as to be a “proper
incident thereto.”
  In
approving acquisitions by bank holding companies of companies engaged in
banking-related activities, the Federal Reserve Board considers whether the
performance of any activity by a subsidiary of the holding company reasonably
can be expected to produce benefits to the public, including greater
convenience, increased competition, or gains in efficiency, which outweigh
possible adverse effects, including over-concentration of resources, decrease of
competition, conflicts of interest, or unsound banking practices.
  Regulations
and policies of the Federal Reserve Board require a bank holding company to
serve as a source of financial and managerial strength to its subsidiary
banks.  It is the Federal Reserve Board’s policy that a bank holding
company should stand ready to use available resources to provide adequate
capital funds to a subsidiary bank during periods of financial stress or
adversity and should maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting a subsidiary
bank.  Under certain conditions, the Federal Reserve Board may
conclude that certain actions of a bank holding company, such as a payment of a
cash dividend, would constitute an unsafe and unsound banking
practice.
  The
Company is required to give the Federal Reserve Board prior written notice of
any repurchase of its outstanding equity securities which (for a period of 12
months) is equal to 10% or more of the Company’s consolidated net worth, unless
certain conditions are met.
  Bank
holding company transactions with subsidiaries and other affiliates are
restricted, including qualitative and quantitative restrictions on extensions of
credit and similar transactions.
  The
Company and the Bank are deemed to be affiliates of one another within the
meaning set forth in the Federal Reserve Act and are subject to Sections 23A and
23B of the Federal Reserve Act.  This means, for example, that there
are limitations on loans by the Bank to affiliates, and that all affiliate
transactions must satisfy certain limitations and otherwise be on terms and
conditions at least as favorable to the Bank as would be available for
non-affiliates.
  The
securities of the Company are also subject to the requirements of the Securities
Act, and matters related thereto are regulated by the Securities and Exchange
Commission.  Certain issuances may also be subject to the California's
corporate securities law as administered by the California Commissioner of
Corporations.  The Company is subject to the public reporting
requirements of the Securities and Exchange Act of 1934, as amended, generally
applicable to publicly held companies, under Section 15(d) of the Exchange
Act.  Companies which file a registration statement under the
Securities Act are required under Section 15(d) of the Exchange Act for at least
a 12-month period after the effectiveness of such registration statement to file
periodic quarterly and annual reports under the Securities Act.  If
and when the Company has more than 500 shareholders of record, it will be
required to register its securities with the Securities and Exchange Commission
under Section 12(g) of the Exchange Act at which time its filing of periodic
reports, as well as certain other reporting obligations, will become
mandatory.
  Regulation
of Mission Community Bank
  As a
California state-chartered bank, the Bank is subject to regulation, supervision
and examination by the California Department of Financial
Institutions.  It is also a member of the Federal Reserve System and,
as such, is subject to applicable provisions of the Federal Reserve Act and the
related regulations promulgated by the Board of Governors of the Federal Reserve
System.  In addition, the deposits of the Bank are currently insured
by the Federal Deposit Insurance Corporation (“FDIC”) to a maximum of $250,000
per depositor, and potentially higher limits with respect to certain retirement
accounts, until December 31, 2013.  It is currently anticipated that,
with the exception of retirement accounts, the limits will return to a maximum
of $100,000 per depositor after that date if the provisions increasing deposit
insurance coverage under the Emergency Economic Stabilization Act of 2008 are
not extended.  Beginning December 5, 2008, the Bank elected to
participate in the FDIC’s Transaction Account Guarantee Program (“TLGP”), which
provides, through June 30, 2010, an unlimited guarantee of funds in
noninterest-bearing transaction accounts (including NOW accounts restricted
during the guarantee period to interest rates of 0.50% or less).  [On
April 13, 2010, the FDIC announced an extension of the TLGP through December 31,
2010, for institutions that do not opt out by April 30, 2010.  At this
time the Bank has not made a decision as to whether it will continue in the TLGP
after June 30, 2010.]  For deposit insurance protection, the Bank pays
a quarterly assessment, and occasional mandated special assessments, to the FDIC
and is subject to the rules and regulations of the FDIC pertaining to deposit
insurance and other matters.  The regulations of those agencies will
govern most aspects of the Bank’s business, including the making of periodic
reports by the Bank, and the Bank’s activities relating to dividends,
investments, loans, borrowings, capital requirements, certain
check-clearing
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  activities,
branching, mergers and acquisitions, reserves against deposits, the issuance of
securities and numerous other areas.
  The
earnings and growth of the Bank is largely dependent on its ability to maintain
a favorable differential or “spread” between the yield on its interest-earning
assets and the rate paid on its deposits and other interest-bearing
liabilities.  As a result, the Bank's performance is influenced by
general economic condi­tions, both domestic and foreign, the monetary and
fiscal policies of the federal government, and the policies of the regulatory
agencies, particularly the Federal Reserve Board.  The Federal Reserve
Board implements national monetary policies (such as seeking to curb inflation
and combat recession) by its open-market operations in United States Government
securities, by adjusting the required level of reserves for financial
institutions subject to its reserve requirements and by varying the discount
rate applicable to borrowings by banks which are members of the Federal Reserve
System.  The actions of the Federal Reserve Board in these areas
influence the growth of bank loans, investments and deposits and also affect
interest rates charged on loans and deposits.  The nature and impact
of any future changes in monetary policies cannot be predicted.
  Capital
Adequacy Requirements
  The
Company and the Bank are subject to the regulations of the Federal Reserve Board
governing capital adequacy.  Those regulations incorporate both
risk-based and leverage capital requirements.  Under existing
regulations, the capital requirements for a bank holding company whose
consolidated assets are less than $500 million, like the Company, are deemed to
be the same as that of its subsidiary bank.  The Federal Reserve Board
has established risk-based and leverage capital guidelines for the banks it
regulates, which set total capital requirements and define capital in terms of
“core capital elements,” or Tier 1 capital and “supplemental capital elements,”
or Tier 2 capital.  Tier 1 capital is generally defined as the sum of
the core capital elements less goodwill and certain intangibles.  The
following items are defined as core capital elements:  (i) common
stockholders' equity; (ii) qualifying non-cumulative perpetual preferred stock
and related surplus; and (iii) minority interests in the equity accounts of
consolidated subsidiaries.  Supplementary capital elements
include:  (i) allowance for loan and lease losses (but not more than
1.25% of an institution's risk-weighted assets); (ii) perpetual preferred stock
and related surplus not qualifying as core capital; (iii) hybrid capital
instruments, perpetual debt and mandatory convertible debt instruments; and (iv)
term subordinated debt and intermediate-term preferred stock and related
surplus.  The maximum amount of supplemental capital elements which
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of
goodwill.
  The Bank
is required to maintain a minimum ratio of qualifying total capital to total
risk-weighted assets of 8.0% (“Total Risk-Based Capital Ratio”), at least
one-half of which must be in the form of Tier 1 capital (“Tier 1 Risk-Based
Capital Ratio”).  Risk-based capital ratios are calculated to provide
a measure of capital that reflects the degree of risk associated with a banking
organization’s operations for both transactions reported on the balance sheet as
assets, and transactions, such as letters of credit and recourse arrangements,
which are recorded as off-balance sheet items.  Under the risk-based
capital guidelines, the nominal dollar amounts of assets and credit-equivalent
amounts of off-balance sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with very low credit
risk, such as certain U. S. Treasury securities, to 100% for assets with
relatively high credit risk, such as business loans.  As of December
31, 2009 and December 31, 2008, the Bank’s Total Risk-Based Capital Ratio was
14.5% and 13.3%, respectively, and its Tier 1 Risk-Based Capital Ratio was 13.2%
and 12.0%, respectively.
  The
risk-based capital standards also take into account concentrations of credit and
the risks of “non-traditional” activities (those that have not customarily been
part of the banking business). The regulations require institutions with high or
inordinate levels of risk to operate with higher minimum capital standards, and
authorize the regulators to review an institution’s management of such risks in
assessing an institution’s capital adequacy.
  Additionally,
the regulatory statements of policy on risk-based capital include exposure to
interest rate risk as a factor that the regulators will consider in evaluating a
bank’s capital adequacy, although interest rate risk does not impact the
calculation of a bank’s risk-based capital ratios.  Interest rate risk
is the exposure of a bank's current and future earnings and equity capital
arising from adverse movements in interest rates.  While interest risk
is inherent in a bank's role as financial intermediary, it introduces volatility
to bank earnings and to the economic value of the bank or bank holding
company.
  Banks are
also required to maintain a leverage capital ratio designed to supplement the
risk-based capital guidelines.  Banks that have received the highest
rating of the five categories used by regulators to rate banks and are not
anticipating or experiencing any significant growth must maintain a ratio of
Tier 1 capital (net of all intangibles) to adjusted total assets (“Leverage
Capital Ratio”) of at least 3%.  All other institutions are required
to maintain a leverage ratio of at least 100 to 200 basis points above the 3%
minimum, for a minimum of 4% to 5%.  Pursuant to federal regulations,
banks must maintain capital levels commensurate with the level of risk to which
they are exposed, including the volume and
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  severity
of problem loans, and federal regulators may set higher capital requirements
when a bank’s particular circumstances warrant.   The Bank’s
Leverage Capital Ratio was 9.83% as of December 31, 2009 and 9.5% at December
31, 2008.  See also Note O to the Consolidated Financial Statements
for additional information regarding regulatory capital.
  In 2005,
the Federal Reserve Board adopted a final rule that allows the continued
inclusion of trust-preferred securities in the Tier I capital of bank holding
companies.  However, under the final rule, after a five-year
transition period, the aggregate amount of trust preferred securities and
certain other capital elements that could qualify as Tier I capital would be
limited to 25 percent of Tier I capital elements, net of goodwill
  Prompt
Corrective Action Provisions
  Federal
law requires each federal banking agency to take prompt corrective action to
resolve the problems of insured financial institutions, including but not
limited to those that fall below one or more prescribed minimum capital
ratios.  The federal banking agencies have by regulation defined the
following five capital categories: “well capitalized” (Total Risk-Based Capital
Ratio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Capital Ratio
of 5%); “adequately capitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1
Risk-Based Capital Ratio of 4%; and Leverage Capital Ratio of 4%) (or 3% if the
institution receives the highest rating from its primary regulator);
“undercapitalized” (Total Risk-Based Capital Ratio of less than 8%; Tier 1
Risk-Based Capital Ratio of less than 4%; or Leverage Capital Ratio of less than
4%) (or 3% if the institution receives the highest rating from its primary
regulator); “significantly undercapitalized” (Total Risk-Based Capital Ratio of
less than 6%; Tier 1 Risk-Based Capital Ratio of less than 3%; or Leverage
Capital Ratio less than 3%); and “critically undercapitalized” (tangible equity
to total assets less than 2%).  A bank may be treated as though it
were in the next lower capital category if, after notice and the opportunity for
a hearing, the appropriate federal agency finds an unsafe or unsound condition
or practice so warrants, but no bank may be treated as “critically
undercapitalized” unless its actual capital ratio warrants such
treatment.
  At each
successively lower capital category, an insured bank is subject to increased
restrictions on its operations.  For example, a bank is generally
prohibited from paying management fees to any controlling persons or from making
capital distributions if to do so would make the bank
“undercapitalized.”  Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit written capital restoration
plans meeting specified requirements (including a guarantee by the parent
holding company, if any).  “Significantly undercapitalized” banks are
subject to broad regulatory authority, including among other things, capital
directives, forced mergers, restrictions on the rates of interest they may pay
on deposits, restrictions on asset growth and activities, and prohibitions on
paying bonuses or increasing compensation to senior executive officers without
regulatory approval.  Even more severe restrictions apply to
critically undercapitalized banks.  Most importantly, except under
limited circumstances, not later than 90 days after an insured bank becomes
critically undercapitalized, the appropriate federal banking agency is required
to appoint a conservator or receiver for the bank.
  In
addition to measures taken under the prompt corrective action provisions,
insured banks may be subject to potential actions by the federal regulators for
unsafe or unsound practices in conducting their businesses or for violations of
any law, rule, regulation or any condition imposed in writing by the agency or
any written agreement with the agency.  Enforcement actions may
include the issuance of cease and desist orders, termination of insurance of
deposits (in the case of a bank), the imposition of civil money penalties, the
issuance of directives to increase capital, formal and informal agreements, or
removal and prohibition orders against “institution-affiliated”
parties.
  Safety
and Soundness Standards
  The
federal banking agencies have also adopted guidelines establishing safety and
soundness standards for all insured depository institutions.  Those
guidelines relate to internal controls, information systems, internal audit
systems, loan underwriting and documentation, compensation and interest rate
exposure.  In general, the standards are designed to assist the
federal banking agencies in identifying and addressing problems at insured
depository institutions before capital becomes impaired.  If an
institution fails to meet these standards, the appropriate federal banking
agency may require the institution to submit a compliance plan and institute
enforcement proceedings if an acceptable compliance plan is not
submitted.
  The
Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief
Program
  In
response to unprecedented market turmoil and the financial crises affecting the
overall banking system and financial markets in the United States, the Emergency
Economic Stabilization Act of 2008 (“EESA”) was enacted in
October 2008.  On February 17, 2009, the American Recovery and
Reinvestment Act of 2009 (the “Stimulus Bill”) was enacted, which among other
things augmented certain provisions of the EESA.  Under the EESA, the
Treasury Department
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  was given
the authority, among other authorizations, to purchase up to $700 billion in
mortgage loans, mortgage-related securities and certain other financial
instruments, including debt and equity securities issued by financial
institutions in the Troubled Asset Relief Program (the “TARP”).  The
purpose of the TARP was to restore confidence and stability to the U.S. banking
system and to encourage financial institutions to increase their lending to
customers and to each other.
  Pursuant
to the EESA, the Treasury Department was initially authorized to use
$350 billion for the TARP. Of this amount, the Treasury Department
allocated $250 billion to the TARP Capital Purchase Program (see
description below). On January 15, 2009, the second $350 billion of
TARP monies was released to the Treasury Department.
  The TARP
Capital Purchase Program (“CPP) was developed to purchase $250 billion in senior
preferred stock from qualifying financial institutions, and was designed to
strengthen the capital and liquidity positions of viable institutions and to
encourage banks and thrifts to increase lending to creditworthy
borrowers.  The amount of the Treasury Department’s preferred stock a
particular qualifying financial institution could be approved to issue would be
not less than 1% of risk-weighted assets and not more than the lesser of
$25 billion or 3% of risk-weighted assets.
  The
general terms of the TARP CPP include:
  ·
              Dividends
      on the Treasury Department’s preferred stock at a rate of five percent for
      the first five years and nine percent
  thereafter;
 ·
              Common
      stock dividends cannot be increased for three years while the Treasury
      Department is an investor unless preferred stock is redeemed or consent
      from the Treasury is received;
 ·
              The
      Treasury Department must consent to any buyback of other stock (common or
      other preferred);
 ·
              The
      Treasury Department’s preferred stock will have the right to elect two
      directors if dividends have not been paid for six
  periods;
 ·
              The
      Treasury Department receives warrants equal to 15 percent of the Treasury
      Department’s total investment in the participating institution (provided,
      however, that the Company was not required to issue any warrants due to
      its status as a Community Development Financial Institution);
      and
 ·
              The
      participating institution’s executives must agree to certain compensation
      restrictions, and restrictions on the amount of executive compensation
      that is tax deductible.
 ·
              The
      Company elected to participate in the TARP CPP and in January 2009 issued
      $5.1 million worth of preferred stock to the Treasury Department pursuant
      to this program.  See “The Company”
  above.
 
 The EESA
also established a Temporary Liquidity Guarantee Program (“TLGP”) that gave the
FDIC the ability to provide a guarantee for newly-issued senior unsecured debt
and non-interest bearing transaction deposit accounts at eligible insured
institutions.  The Company is not participating in the senior
unsecured debt of the TLGP. The Company is currently participating in the
guarantee program, which fully guarantees non-interest bearing transaction
deposit accounts of any amount, which program is scheduled to continue through
June 30, 2010. For non-interest bearing transaction deposit accounts, a 10 basis
point annual FDIC insurance premium surcharge is being applied to deposit
amounts in excess of $250,000.  [On April 13, 2010, the FDIC announced
an extension of the TLGP through December 31, 2010, for institutions that do not
opt out by April 30, 2010.  At this time the Bank has not made a
decision as to whether it will continue in the TLGP after June 30,
2010.]
  On
February 3, 2010, the Treasury Department announced a new Capital Initiative
Program limited to CDFI’s.  The Community Development Capital
Initiative (“CDCI”), provides that CDFI banks and thrifts would be eligible to
receive investments of capital—up to 5% of risk-weighted assets—with an initial
dividend rate of 2 percent, compared to the 5% rate offered under the Capital
Purchase Program.  To encourage repayment while recognizing the unique
circumstances facing CDFIs, the dividend rate will increase to 9 percent after
eight years, compared to five years under CPP.  CDFI’s that
participated in CPP, such as the Company, and are in good standing will be
eligible to exchange those investments into this program.  The Company
has submitted an application with the Treasury Department to exchange its Series
D preferred stock for preferred stock that would be issued under the CDCI
program.  It is not yet known whether the Company’s application will
be accepted by the Treasury.
  Deposit
Insurance
  The
Bank’s deposits are insured under the Federal Deposit Insurance Act, up to the
maximum applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and
are subject to deposit insurance assessments to maintain the DIF. The Bank paid
no deposit insurance assessments on its deposits under the risk-based assessment
system utilized by the FDIC through December 31, 2006.
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  Effective
January 1, 2007 the FDIC adopted a new risk-based insurance assessment
system designed to tie what banks pay for deposit insurance more closely to the
risks they pose to the insurance fund. The FDIC also adopted a new base schedule
of rates that the FDIC could adjust up or down, depending on the needs of the
DIF, and set initial premiums for 2007 that ranged from 5 cents per $100 of
domestic deposits in the lowest risk category to 43 cents per $100 of
domestic deposits for banks in the highest risk category. The new assessment
system resulted in annual assessments on the Bank’s deposits of 7 cents per $100
of domestic deposits for 2007.
  On
October 16, 2008, in response to the problems facing the financial markets and
the economy, the Federal Deposit Insurance Corporation published a restoration
plan (Restoration Plan) designed to replenish the Deposit Insurance Fund (DIF)
such that the reserve ratio would return to 1.15% within five
years.  On December 16, 2008, the FDIC adopted a final rule increasing
risk-based assessment rates uniformly by seven basis points, on an annual basis,
for the first quarter of 2009.  On February 27, 2009, the FDIC
concluded that the problems facing the financial services sector and the economy
at large constituted extraordinary circumstances and amended the Restoration
Plan and extended the time within which the reserve ratio would return to 1.15%
from five to seven years (Amended Restoration Plan).  In May 2009,
Congress amended the statutory provision governing establishment and
implementation of a Restoration Plan to allow the FDIC eight years to bring the
reserve ratio back to 1.15%, absent extraordinary circumstances.  On
May 22, 2009, the FDIC adopted a final rule imposing a five basis point special
assessment on each insured depository institution’s assets minus Tier 1 capital
as of June 30, 2009.  The Bank paid $97 thousand for its special
assessment, which was collected in September 2009.
  In a
final rule issued on September 29, 2009, the FDIC amended the Amended
Restoration Plan as follows:
  ·
              The
      period of the Amended Restoration Plan was extended from seven to eight
      years.
  ·
              The
      FDIC announced that it will not impose any further special assessments
      under the final rule it adopted in May
2009.
  ·
              The
      FDIC announced plans to maintain assessment rates at their current levels
      through the end of 2010.  The FDIC also immediately adopted a
      uniform three basis point increase in assessment rates effective January
      1, 2011 to ensure that the DIF returns to 1.15% within the Amended
      Restoration Plan period of eight
years.
  ·
              The
      FDIC announced that, at least semi-annually following the adoption of the
      Amended Restoration Plan, it will update its loss and income projections
      for the DIF.  The FDIC also announced that it may, if necessary,
      adopt a new rule prior to the end of the eight-year period to increase
      assessment rates in order to return the reserve ratio to 1.15
      percent.
  In
addition, banks must pay an amount which fluctuates but is currently 0.265 cents
per $100 of insured deposits per quarter, towards the retirement of the
Financing Corporation bonds issued in the 1980’s to assist in the recovery of
the savings and loan industry. These assessments will continue until the
Financing Corporation bonds mature in 2019.
  The
enactment of the EESA (discussed above) temporarily raised the basic limit on
federal deposit insurance coverage from $100,000 to $250,000 per depositor. The
temporary increase in deposit insurance coverage became effective on
October 3, 2008. EESA provides that the basic deposit insurance limit will
return to $100,000 after December 31, 2013.  In addition,
pursuant to the guarantee program for non-interest bearing transaction deposit
accounts under the TLGP in which the Bank has elected to participate, which
provides a temporary unlimited guarantee of funds in non-interest bearing
accounts, as defined, a 10 basis point annual rate surcharge is being applied to
deposit amounts in excess of $250,000.   As of December 31, 2009,
the Bank had approximately $17.0 million in non-interest bearing accounts
exceeding $250,000.
  Community
Reinvestment Act
  The Bank
is subject to certain requirements and reporting obligations involving Community
Reinvestment Act activities.  The Community Reinvestment Act generally
requires the federal banking agencies to evaluate the record of a financial
institution in meeting the credit needs of its local communities, including low
and moderate income neighborhoods. The Community Reinvestment Act further
requires the agencies to take a financial institution's record of meeting its
community credit needs into account when evaluating applications for, among
other things, domestic branches, consummating mergers or acquisitions, or
holding company formations.  In measuring a bank's compliance with its
Community Reinvestment Act obligations, the regulators utilize a
performance-based evaluation system which bases Community Reinvestment Act
ratings on the bank's actual lending service and investment performance, rather
than on the extent to which the institution conducts needs assessments,
documents community outreach activities or complies with other procedural
requirements.  In connection with its assessment of Community
Reinvestment Act performance, the
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  agencies
assign a rating of “outstanding,” “satisfactory,” “needs to improve” or
“substantial noncompliance.”  The Bank received an “outstanding”
rating in its last completed Community Reinvestment Act examination in
2005.  The results of the most recent examination in January 2010 are
not yet known.
  Privacy
and Data Security
  The
Gramm-Leach-Bliley Act, also known as the “Financial Modernization Act”, which
became effective in 2000, imposed new requirements on financial institutions
with respect to consumer privacy.  The statute generally prohibits
disclosure of consumer information to non-affiliated third parties unless the
consumer has been given the opportunity to object and has not objected to such
disclosure.  Financial institutions are further required to disclose
their privacy policies to consumers annually.  Financial institutions,
however, are required to comply with state law if it is more protective of
consumer privacy than the Gramm-Leach-Bliley Act.  The statute also
directed federal regulators, including the Federal Reserve and the FDIC, to
prescribe standards for the security of consumer information.  Bancorp
and Bank are subject to such standards, as well as standards for notifying
consumers in the event of a security breach.
  Other
Consumer Protection Laws and Regulations
  Activities
of all insured banks are subject to a variety of statutes and regulations
designed to protect consumers, such as the Fair Credit Reporting Act, Equal
Credit Opportunity Act, and Truth-in-Lending Act.  Interest and other
charges collected or contracted for by the Bank are also subject to state usury
laws and certain other federal laws concerning interest rates. The Bank’s loan
operations are also subject to federal laws and regulations applicable to credit
transactions.  Together, these laws and regulations include provisions
that:
  ·
              govern
      disclosures of credit terms to consumer
  borrowers;
  ·
              require
      financial institutions to provide information to enable the public and
      public officials to determine whether a financial institution is
      fulfilling its obligation to help meet the housing needs of the community
      it serves;
  ·
              prohibit
      discrimination on the basis of race, creed, or other prohibited factors in
      extending credit;
  ·
              govern
      the use and provision of information to credit reporting agencies;
      and
  ·
              govern
      the manner in which consumer debts may be collected by collection
      agencies.
  The
      Bank’s deposit operations are also subject to laws and regulations
      that:
  ·
              impose
      a duty to maintain the confidentiality of consumer financial records and
      prescribe procedures for complying with administrative subpoenas of
      financial records; and
  ·
              govern
      automatic deposits to and withdrawals from deposit accounts and customers’
      rights and liabilities arising from the use of automated teller machines
      and other electronic banking
services.
  On
November 17, 2009, the Board of Governors of the Federal Reserve System
promulgated a rule entitled “Electronic Fund Transfers”, with an effective date
of January 19, 2010 and a mandatory compliance date of July 1,
2010.  The rule, which applies to all FDIC-regulated institutions,
prohibits financial institutions from assessing an overdraft fee for paying
automated teller machine (ATM) and one-time point-of-sale debit card
transactions, unless the customer affirmatively opts in to the overdraft service
for those types of transactions.  The opt-in provision establishes
requirements for clear disclosure of fees and terms of overdraft services for
ATM and one-time debit card transactions.  The rule does not apply to
other types of transactions, such as check, automated clearinghouse (ACH) and
recurring debit card transactions.  Since none of the Company’s
service charges on deposits are in the form of overdraft fees on ATM or
point-of-sale transactions, this would not have an adverse impact on our
non-interest income.
  Interstate
Banking and Branching
  The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 regulates
the interstate activities of banks and bank holding companies and establishes a
framework for nationwide interstate banking and branching.  Since
June 1, 1997, a bank in one state has generally been permitted to merge
with a bank in another state without the need for explicit state law
authorization.  However, states were given the ability to prohibit
interstate mergers with banks in their
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  own state
by “opting-out” (enacting state legislation applying equally to all out-of-state
banks prohibiting such mergers) prior to June 1, 1997.
  Since
1995, adequately capitalized and managed bank holding companies have been
permitted to acquire banks located in any state, subject to two exceptions:
first, any state may still prohibit bank holding companies from acquiring a bank
which is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquirer would control more then
10% of the deposits held by insured depository institutions nationwide or 30%
percent or more of the deposits held by insured depository institutions in any
state in which the target bank has branches.
  In 1995
California enacted legislation to implement important provisions of the
Riegle-Neal Act discussed above and to repeal California’s previous interstate
banking laws, which were largely preempted by the Riegle-Neal Act.
  A bank
may establish and operate de novo branches in any state in which the bank does
not maintain a branch if that state has enacted legislation to expressly permit
all out-of-state banks to establish branches in that state.  However,
California law expressly prohibits an out-of-state bank which does not already
have a California branch office from (i) purchasing a branch office of a
California bank (as opposed to purchasing the entire bank) and thereby
establishing a California branch office or (ii) establishing a de novo branch in
California.
  The
changes effected by the Riegle-Neal Act and California laws have increased
competition in the environment in which the Bank operates to the extent that
out-of-state financial institutions may directly or indirectly enter the Bank's
market areas.  It appears that the Riegle-Neal Act has contributed to
the accelerated consolidation of the banking industry.  While many
large out-of-state banks have already entered the California market as a result
of this legislation, it is not possible to predict the precise impact of this
legislation on the Bank and the competitive environment in which it
operates.
  Financial
Modernization Act
  Effective
March 11, 2000, the Gramm-Leach-Bliley Financial Modernization Act enabled full
affiliations to occur between banks and securities firms, insurance companies
and other financial service providers.  This legislation permits bank
holding companies to become “financial holding companies” and thereby acquire
securities firms and insurance companies and engage in other activities that are
financial in nature.  A bank holding company may become a financial
holding company if each of its subsidiary banks is “well capitalized” and “well
managed” under applicable definitions, and has at least a satisfactory rating
under the CRA by filing a declaration that the bank holding company wishes to
become a financial holding company.
  The
Financial Modernization Act defines “financial in nature” to include securities
underwriting, dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agency; merchant banking activities; and
activities that the Federal Reserve Board has determined to be closely related
to banking.  A national bank also may engage, subject to limitations
on investment, in activities that are financial in nature, other than insurance
underwriting, insurance company portfolio investment, real estate development
and real estate investment, through a financial subsidiary of the bank, if the
bank is well capitalized, well managed and has at least a satisfactory CRA
rating.  Subsidiary banks of a financial holding company or national
banks with financial subsidiaries must continue to be well capitalized and well
managed in order to continue to engage in activities that are financial in
nature without regulatory actions or restrictions, which could include
divestiture of financial subsidiaries.  In addition, a financial
holding company or a bank may not acquire a company that is engaged in
activities that are financial in nature unless each of the subsidiary banks of
the financial holding company or the bank has a CRA rating of satisfactory or
better.
  USA
Patriot Act of 2001
  The USA
Patriot Act of 2001 was enacted in October 2001 in response to the terrorist
attacks on September 11, 2001.  The Patriot Act was intended to
strengthen United States law enforcement’s and the intelligence community’s
ability to work cohesively to combat terrorism on a variety of
fronts.  The impact of the Patriot Act on financial institutions of
all kinds has been significant and wide ranging.  The Patriot Act
substantially enhanced existing anti-money laundering and financial transparency
laws, and required appropriate regulatory authorities to adopt rules to promote
cooperation among financial institutions, regulators, and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering.  Under the Patriot Act, financial institutions are subject
to prohibitions regarding specified financial transactions and account
relationships, as well as enhanced due diligence and “know your customer”
standards in their dealings with foreign financial institutions and foreign
customers.  For example, the enhanced due diligence policies,
procedures, and controls generally require financial institutions to take
reasonable steps:
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  ·
              to
      conduct enhanced scrutiny of account relationships to guard against money
      laundering and report any suspicious
  transactions;
 ·
              to
      ascertain the identity of the nominal and beneficial owners of, and the
      source of funds deposited into, each account as needed to guard against
      money laundering and report any suspicious
  transactions;
 ·
              to
      ascertain for any foreign bank, the shares of which are not publicly
      traded, the identity of the owners of the foreign bank, and the nature and
      extent of the ownership interest of each such owner;
  and
 ·
              to
      ascertain whether any foreign bank provides correspondent accounts to
      other foreign banks and, if so, the identity of those foreign banks and
      related due diligence information.
 
 The
Patriot Act also requires all financial institutions to establish anti-money
laundering programs, which must include, at minimum:
 
 ·
              the
      development of internal policies, procedures, and
  controls;
 ·
              the
      designation of a compliance
officer;
 ·
              an
      ongoing employee training program;
and
 ·
              an
      independent audit function to test the
programs.
 
 The Bank
has adopted comprehensive policies and procedures, and has taken all necessary
actions, to ensure compliance with all financial transparency and anti-money
laundering laws, including the Patriot Act.
 
 Sarbanes-Oxley
Act of 2002
  As a
public company, the Company is subject to the Sarbanes-Oxley Act of 2002, which
implements a broad range of corporate governance and accounting measures for
public companies designed to promote honesty and transparency in corporate
America and better protect investors from corporate wrongdoing.  The
Sarbanes-Oxley Act’s principal legislation and the derivative regulation and
rule making promulgated by the Securities and Exchange Commission
includes:
 
 ·
              the
      creation of an independent accounting oversight
  board;
 ·
              auditor
      independence provisions that restrict non-audit services that accountants
      may provide to their audit clients;
 ·
              additional
      corporate governance and responsibility measures, including the
      requirement that the chief executive officer and chief financial officer
      certify financial statements;
 ·
              a
      requirement that companies establish and maintain a system of internal
      control over financial reporting and that a company’s management provide
      an annual report regarding its assessment of the effectiveness of such
      internal control over financial reporting to the company’s independent
      accountants;
 ·
              a
      requirement that the company’s independent accountants provide an
      attestation report with respect to management’s assessment of the
      effectiveness of the company’s internal control over financial reporting
      (this requirement is currently proposed to become effective for entities
      like the Company, which is not an accelerated SEC filer, for our first
      fiscal year ending on or after June 15,
2010);
 ·
              the
      forfeiture of bonuses or other incentive-based compensation and profits
      from the sale of an issuer’s securities by directors and senior officers
      in the twelve month period following initial publication of any financial
      statements that later require
restatement;
 ·
              an
      increase in the oversight of, and enhancement of certain requirements
      relating to audit committees of public companies and how they interact
      with the company’s independent
auditors;
 ·
              the
      requirement that audit committee members must be independent and are
      absolutely barred from accepting consulting, advisory or other
      compensatory fees from the issuer;
 ·
              the
      requirement that companies disclose whether at least one member of the
      committee is a “financial expert” (as such term is defined by the SEC) and
      if not, why not;
 ·
              expanded
      disclosure requirements for corporate insiders, including accelerated
      reporting of stock transactions by insiders and a prohibition on insider
      trading during pension blackout
periods;
 ·
              a
      prohibition on personal loans to directors and officers, except certain
      loans made by insured financial
institutions;
 ·
              disclosure
      of a code of ethics and the requirement of filing of a Form 8-K for a
      change or waiver of such code;
 ·
              mandatory
      disclosure by analysts of potential conflicts of interest;
    and
 ·
              a
      range of enhanced penalties for fraud and other
  violations.
 
 Commercial
Real Estate Lending and Concentrations
  On
December 2, 2006, the federal bank regulatory agencies released Guidance on
Concentrations in Commercial Real Estate Lending, Sound Risk Management
Practices (“the Guidance”).  The Guidance, which was issued in
response to
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  the
agencies’ concern that rising CRE concentrations might expose institutions to
unanticipated earnings and capital volatility in the event of adverse changes in
the commercial real estate market, reinforces existing regulations and
guidelines for real estate lending and loan portfolio management.
  Highlights
of the Guidance include the following:
  ·
              The
      agencies have observed that CRE concentrations have been rising over the
      past several years with small to mid-size institutions showing the most
      significant increase in CRE concentrations over the last
      decade.  However, some institutions’ risk management practices
      are not evolving with their increasing CRE concentrations, and therefore,
      the Guidance reminds institutions that strong risk management practices
      and appropriate levels of capital are important elements of a sound CRE
      lending program.
 ·
              The
      Guidance applies to national banks and state chartered banks and is also
      broadly applicable to bank holding companies.  For purposes of
      the Guidance, CRE loans include loans for land development and
      construction, other land loans and loans secured by multifamily and
      nonfarm nonresidential properties.  The definition also extends
      to loans to real estate investment trusts and unsecured loans to
      developers if their performance is closely linked to the performance of
      the general CRE market.
 ·
              The
      agencies recognize that banks serve a vital role in their communities by
      supplying credit for business and real estate
      development.  Therefore, the Guidance is not intended to limit
      banks’ CRE lending.  Instead, the Guidance encourages
      institutions to identify and monitor credit concentrations, establish
      internal concentration limits, and report all concentrations to management
      and the board of directors on a periodic
basis.
 ·
              The
      agencies recognized that different types of CRE lending present different
      levels of risk, and therefore, institutions are encouraged to segment
      their CRE portfolios to acknowledge these
      distinctions.  However, the CRE portfolio should not be divided
      into multiple sections simply to avoid the appearance of risk
      concentration.
 ·
              Institutions
      should address the following key elements in establishing a risk
      management framework for identifying, monitoring, and controlling CRE
      risk: (1) board of directors and management oversight; (2) portfolio
      management; (3) management information systems; (4) market analysis; (5)
      credit underwriting standards; (6) portfolio stress testing and
      sensitivity analysis; and (7) credit review
  function.
 ·
              As
      part of the ongoing supervisory monitoring processes, the agencies will
      use certain criteria to identify institutions that are potentially exposed
      to significant CRE concentration risk.  An institution that has
      experienced rapid growth in CRE lending, has notable exposure to a
      specific type of CRE, or is approaching or exceeds specified supervisory
      criteria may be identified for further supervisory
    analysis.
 
 The
Company believes that the Guidance is applicable to it, as it has a
concentration in CRE loans.  The Company and its board of directors
have discussed the Guidance and believe that Mission Community Bank’s
underwriting policy, management information systems, independent credit
administration process and monthly monitoring of real estate loan concentrations
adequately address the Guidance. See Loan Concentrations in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations under Item 6 of Part II of this report.
  Allowance
for Loan and Lease Losses
  On
December 13, 2006, the federal bank regulatory agencies released
Interagency Policy Statement on the Allowance for Loan and Lease Losses
(“ALLL”), which revised and replaced the banking agencies’ 1993 policy statement
on the ALLL.  The revised statement was issued to ensure consistency
with generally accepted accounting principles (GAAP) and more recent supervisory
guidance.  The revised statement also extended the applicability of
the policy to credit unions.  Additionally, the agencies issued 16
FAQs to assist institutions in complying with both GAAP and ALLL supervisory
guidance.
  Highlights
of the revised statement include the following:
  ·
              The
      revised statement emphasizes that the ALLL represents one of the most
      significant estimates in an institution’s financial statements and
      regulatory reports and that an assessment of the appropriateness of the
      ALLL is critical to an institution’s safety and
  soundness.
 ·
              Each
      institution has a responsibility to develop, maintain, and document a
      comprehensive, systematic, and consistently applied process for
      determining the amounts of the ALLL.  An institution must
      maintain an ALLL that is sufficient to cover estimated credit losses on
      individual impaired loans as well as estimated credit losses inherent in
      the remainder of the portfolio.
 ·
              The
      revised statement updated the previous guidance on the following issues
      regarding ALLL: (1) responsibilities of the board of directors,
      management, and bank examiners; (2) factors to be considered in the
      estimation of ALLL; and (3) objectives and elements of an effective loan
      review system.
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  The
Company believes that its ALLL methodology is comprehensive, systematic, and
that it is consistently applied across the Company.  The Company also
believes its management information systems, independent credit administration
process, policies and procedures adequately address the supervisory
guidance.
 
 Transactions
Between Affiliates
  Transactions
between a bank and its “affiliates” are quantitatively and qualitatively
restricted under the Federal Reserve Act.  The FRB has also issued
Regulation W, which codifies prior regulations under Sections 23A and 23B of the
Federal Reserve Act and interpretative guidance with respect to affiliate
transactions.  Regulation W incorporates the exemption from the
affiliate transaction rules but expands the exemption to cover the purchase of
any type of loan or extension of credit from an affiliate.  Affiliates
of a bank include, among other entities, companies that are under common control
with the bank.  In general, subject to certain specified exemptions, a
bank or its subsidiaries are limited in their ability to engage in “covered
transactions” with affiliates:
  ·
              to
      an amount equal to 10% of the bank’s capital and surplus, in the case of
      covered transactions with any one affiliate;
and
 ·
              to
      an amount equal to 20% of the bank’s capital and surplus, in the case of
      covered transactions with all
affiliates.
 
 In
addition, a bank and its subsidiaries may engage in covered transactions and
other specified transactions only on terms and under circumstances that are
substantially the same, or at least as favorable to the bank or its subsidiary,
as those prevailing at the time for comparable transactions with nonaffiliated
companies. A “covered transaction” includes:
  ·
              a
      loan or extension of credit to an
affiliate;
 ·
              a
      purchase of, or an investment in, securities issued by an
      affiliate;
 ·
              a
      purchase of assets from an affiliate, with some
  exceptions;
 ·
              the
      acceptance of securities issued by an affiliate as collateral for a loan
      or extension of credit to any party;
and
 ·
              the
      issuance of a guarantee, acceptance or letter of credit on behalf of an
      affiliate.
  In
addition, under Regulation W:
  ·
              a
      bank and its subsidiaries may not purchase a low-quality asset from an
      affiliate;
 ·
              covered
      transactions and other specified transactions between a bank or its
      subsidiaries and an affiliate must be on terms and conditions that are
      consistent with safe and sound banking practices;
  and
 ·
              with
      some exceptions, each loan or extension of credit by a bank to an
      affiliate must be secured by collateral with a market value ranging from
      100% to 130%, depending on the type of collateral, of the amount of the
      loan or extension of credit.
 
 Regulation
W generally excludes all non-bank and non-savings association subsidiaries of
banks from treatment as affiliates, except to the extent that the FRB decides to
treat these subsidiaries as affiliates.
  
 Employees
  As of
December 31, 2009 the Bank had a total of 56 employees.  Neither
Bancorp nor MCDC had salaried employees; Bancorp’s officers all hold similar
positions at the Bank.  The Bank, under inter-company arrangements,
may charge Bancorp and/or MCDC for management, staff, and
services.  For 2009, the Bank charged Bancorp a total of $202,000 for
services performed on its behalf by Bank employees.
  
  Reports
to Security Holders.
  Annual
Report
  An annual
report to security holders including audited financial statements is sent each
year by the Company.
  Certain
reports are filed by the Company with the Securities Exchange Commission
pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934.   The SEC maintains an Internet site (www.sec.gov/edgar.shtml)
that
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  contains
reports and other information statements that the Company files electronically
via the SEC’s EDGAR system, and which may be viewed on the site.  The
public may also request public documents by calling the SEC at
202-551-8090.
  Reports
filed with the SEC by the Company may also be viewed on the Company’s Internet
site (www.missioncommunitybank.com)
on the “About Us / Investor Information” page.
  
  Item 1A.  Risk Factors
  In
addition to other information contained in this Report, the following risks may
affect the Company.  If any of these risks occur, the Company’s
business, financial condition and operations results could be adversely
affected
  The
Company’s business has been and may continue to be adversely affected by
volatile conditions in the financial markets and deteriorating economic
conditions generally.
  In
December 2007, the United States entered a recession.  Negative
developments in the latter half of 2007 and in 2008 in the financial services
industry resulted in uncertainty in the financial markets in general and a
related general economic downturn, which continued into
2009.  Business activity across a wide range of industries and regions
was greatly reduced and local governments and many businesses found themselves
in serious difficulty due to the lack of consumer spending and the lack of
liquidity in the credit markets. Unemployment also increased
significantly.
  Since
mid-2007, and particularly during the second half of 2008 and continuing through
2009, the financial services industry and the securities markets generally were
materially and adversely affected by significant declines in the values of
nearly all asset classes and by a serious lack of liquidity. This was initially
triggered by declines in home prices and the values of subprime mortgages, but
spread to all mortgage and real estate asset classes, to leveraged bank loans
and to nearly all asset classes, including equities. The global markets were
characterized by substantially increased volatility and short-selling and an
overall loss of investor confidence, initially in financial institutions, but
later in companies in a number of other industries and in the broader
markets.
  Market
conditions also led to the failure or merger of a number of prominent financial
institutions. Financial institution failures or near-failures resulted in
further losses as a consequence of defaults on securities issued by them and
defaults under contracts entered into with such entities as counterparties.
Furthermore, declining asset values, defaults on mortgages and consumer loans,
and the lack of market and investor confidence, as well as other factors, all
combined to increase credit default swap spreads, to cause rating agencies to
lower credit ratings, and to otherwise increase the cost and decrease the
availability of liquidity, despite very significant declines in Federal Reserve
borrowing rates and other government actions. Some banks and other lenders have
suffered significant losses and have become reluctant to lend, even on a secured
basis, due to the increased risk of default and the impact of declining asset
values on the value of collateral. The foregoing has significantly weakened the
strength and liquidity of some financial institutions worldwide. In 2008 and
2009, the U.S. government, the Federal Reserve and other regulators took
numerous steps to increase liquidity and to restore investor confidence,
including investing approximately $245 billion in the equity of banking
organizations, but asset values continued to decline and access to liquidity
remains limited for weakened institutions.
  As a
result of these financial and economic crises, many lending institutions,
including the Company, have experienced declines in the performance of their
loans.  Total nonperforming loans, including troubled debt
restructurings, increased to $6.7 million as of December 31, 2009, from $4.5
million as of December 31, 2008, and $2.1 million as of December 31,
2007.  This represents 4.93%, 2.93% and 1.63%, respectively, of total
loans. Total nonperforming loans, net of SBA guarantees, were $5.6 million as of
December 31, 2009, as compared with $3.1 million as of December 31, 2008,
and $1.8 million as of December 31, 2007.
  Moreover,
competition among depository institutions for deposits and quality loans has
increased significantly. In addition, the values of real estate collateral
supporting many commercial loans and home mortgages have declined and may
continue to decline.  Bank and bank holding company stock prices have
been negatively affected, and the ability of banks and bank holding companies to
raise capital or borrow in the debt markets has become more difficult compared
to recent years. As a result, there is a potential for new federal or state laws
and regulations regarding lending and funding practices and liquidity standards,
and bank regulatory agencies are expected to be very aggressive in responding to
concerns and trends identified in examinations, including the expected issuance
of many formal or informal enforcement actions or orders. The impact of new
legislation in response to those developments may negatively impact the
Company’s operations
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20 -
 Table of Contents
  by
restricting its business operations, including the ability to originate or sell
loans, and may adversely impact the Company’s financial performance or stock
price.
  In
addition, further negative market developments may affect consumer confidence
levels and may cause adverse changes in payment patterns, causing increased
delinquencies and default rates, which may impact the Company’s charge-offs and
provision for loan losses. A worsening of these conditions would likely
exacerbate the adverse effects of these difficult market conditions on the
Company and others in the financial services industry.
  While the
Company’s market areas have not experienced the same degree of challenges as
other parts of the country or the state, no assurance can be given that this
will continue to be the case.  Overall, during the past year, the
general business environment has had an adverse effect on the Company’s
business, and there can be no assurance that the environment will improve in the
near term.  Until conditions improve, it is expected that the
Company’s business, financial condition and results of operations will be
adversely affected.
  Significant
reliance on loans secured by real estate may increase the Bank’s vulnerability
to the current downturn in the California real estate market and other variables
impacting the value of real estate
  A
substantial portion of the Bank’s assets consist of real estate loans (including
construction loans) which are generally secured by real estate in the Central
Coast of California.  At December 31, 2009, approximately $109 million
or 80% of the Bank’s loans were real estate and construction loans, and at
December 31, 2008, approximately $121 million or 79% of its loans were real
estate and construction loans. A prolonged and deepening of the current real
estate contraction in the Central Coast of California could increase the level
of non-performing assets and adversely affect results of operations. During 2008
and 2009, the real estate market in the Central Coast of California deteriorated
significantly, as evidenced by declining prices, reduced transaction volume,
decreased rents and increased foreclosure rates, and this deterioration resulted
in an increase in the level of the Company’s nonperforming loans, particularly
commercial real estate loans.  The Company had nonperforming
commercial real estate and construction loans of $2.7 million and $2.0 million,
respectively, as of December 31 2009, compared to $1.6 million and $1.6 million
respectively, as of December 31, 2008.  If this real estate trend in
the Company’s market areas continues or worsens, the result could be reduced
income, increased expenses, and less cash available for lending and other
activities, which could have a material impact on the Company’s financial
condition and results of operations.
  In
addition, banking regulators are now giving commercial real estate loans greater
scrutiny, due to risks relating to the cyclical nature of the real estate market
and related risks for lenders with high concentrations of such
loans.  The regulators have required banks with higher levels of
commercial real estate loans to implement enhanced underwriting, internal
controls, risk management policies and portfolio stress testing, which has
resulted in higher allowances for possible loan losses.  Expectations
for higher capital levels have also materialized.
  Our
provision for loan losses and net loan charge-offs have increased significantly
and we may be required to make further increases in our provisions for loan
losses and to charge off additional loans in the future, which could adversely
affect our results of operations
  For the
year ended December 31, 2009, we recorded a provision for loan losses and net
loan charge-offs of $4.6 million and $3.5 million, respectively, compared to
$4.2 million and $1.5 million for the same periods in 2008.  We are
experiencing elevated levels of loan delinquencies and credit
losses.  At December 31, 2009, our total non-performing assets,
including foreclosed real estate, had increased to $8.4 million compared to $4.6
million at December 31, 2008.   If current weak economic
conditions continue, particularly in the construction and real estate markets,
we expect that we will continue to experience higher than normal delinquencies
and credit losses, and if the recession is prolonged, we could experience
significantly higher delinquencies and credit losses.  As a result, we
may be required to make further increases in our provision for loan losses and
to charge off additional loans in the future, which could materially adversely
affect our financial condition and results of operations.
  Our
use of appraisals in deciding whether to make a loan on, or secured by, real
property does not ensure the value of the real property collateral
  In
considering whether to make a loan secured by real property, we require a recent
appraisal of the property.  However, an appraisal is only an estimate
of the value of the property at the time the appraisal is made.  If
the appraisal does not reflect the amount adequate to cover the indebtedness in
the event of sale or foreclosure, the loan may not be granted.
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  All
of our lending involves underwriting risks, especially in a competitive lending
market
  At
December 31, 2009, commercial real estate loans (excluding residential and
farmland) and construction loans represented 64% of the Company’s total loan
portfolio.  Real estate lending involves risk associated with the
potential decline in the value of underlying real estate collateral and the cash
flow from income producing properties.  Declines in real estate values
and cash flows can be caused by a number of factors, including adversity in
general economic conditions, rising interest rates, changes in tax and other
governmental and other policies affecting real estate holdings, environmental
conditions, governmental and other use restrictions, development of competitive
properties and increasing vacancy rates.  The Company’s dependence on
commercial real estate loans increases the risk of loss both in the Company’s
loan portfolio and with respect to any other real estate owned when real estate
values decline.  The Company seeks to reduce risk of loss through
underwriting and monitoring procedures.
  If
a significant number of customers fail to perform under their loans, the
Company’s business, profitability, and financial condition would be adversely
affected
  As a
lender, the largest risk is the possibility that a significant number of client
borrowers will fail to pay their loans when due.  If borrower defaults
cause losses in excess of the allowance for loan losses, it could have an
adverse effect on the Bank’s business, profitability, and financial
condition.  A regular evaluation process designed to determine the
adequacy of the allowance for loan losses is in place.  Although this
evaluation process uses historical and other objective information, the
classification of loans and the establishment of loan losses are dependent to a
great extent upon experience and judgment.  Although management
believes that the allowance for loan losses is at a level adequate to absorb any
inherent losses in the loan portfolio, there is no assurance that there will not
be further increases to the allowance for loan losses or that the regulators
will not require an increase to this allowance.
  The
Bank’s earnings are subject to interest rate risks, especially if rates continue
to decline
  Traditionally,
the major portion of the Bank’s net income comes from the interest rate spread,
which is the difference between the interest rates paid on interest-bearing
liabilities, such as deposits and other borrowings, and the interest rates
received on interest-earning assets, such as loans extended to clients and
securities held in the investment portfolio.  Interest rates are
highly sensitive to many factors beyond our control, such as inflation,
recession, global economic disruptions, and
unemployment.  Fluctuations in interest rates affect the demand of
customers for products and services.  The Bank is subject to interest
rate risk to the degree that interest-bearing liabilities reprice or mature more
slowly or more rapidly or on a different basis from interest-earning
assets.  Given the current volume and mix of interest-bearing
liabilities and interest earning assets, the interest rate spread can be
expected to increase when market interest rates are rising, and to decline when
market interest rates are declining, i.e., the Bank is “asset
sensitive.”  Although management believes our current level of
interest rate sensitivity is reasonable, significant fluctuations in interest
rates may have an adverse impact on the interest rate spread.  Any
material decline in the interest rate spread would have a material adverse
effect on the Bank’s business and profitability.
  The
Bank has specific risks associated with Small Business Administration
Loans
  The Bank
originated $5.8 million and $4.0 million in SBA loans in 2009 and 2008,
respectively, and intends to increase its SBA loan origination in the
future.  The Bank recognized $379,000 and $187,000, respectively, in
2009 and 2008 in gains recognized on secondary market sales of SBA
loans.  The Bank has regularly sold the guaranteed portions of these
loans in the secondary market in previous years.  We can provide no
assurance that Mission Community Bank will be able to continue originating these
loans, or that a secondary market will exist for, or that it will continue to
realize premiums upon the sale of the SBA loans.  The federal
government presently guarantees from 50% to 90% of the principal amount of each
qualifying SBA loan, with most loans receiving a guarantee of at least
75%.  We can provide no assurance that the federal government will
maintain the SBA program, or if it does, that such guaranteed portion will
remain at its current funding level.  Furthermore, it is possible that
the Bank could lose its preferred lender status which, subject to certain
limitations, allows it to approve and fund SBA loans without the necessity of
having the loan approved in advance by the SBA.  It is also possible
that the federal government could reduce the amount of loans that it
guarantees.  We believe that the SBA loan portfolio does not involve
more than a normal risk of collectibility.  However, since the Bank
has sold some of the guaranteed portions of the SBA loan portfolio, it incurs a
pro rata credit risk on the non-guaranteed portion of the SBA loans since the
Bank shares pro rata with the SBA in any recoveries.
  In
addition, we are dependent on the expertise of the personnel in our SBA loan
department in order to originate and service SBA loans.  If we are
unable to retain qualified employees in our SBA Department in the future our
income from the origination, sale and servicing of SBA loans could be
substantially reduced.  Further, in 2006, as rates on SBA loans
climbed, a significant portion of SBA borrowers prepaid their loans,
substantially reducing the servicing income we
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 Table of Contents
  receive
on these loans.  If there are similar increases in interest rates in
the future, our income from servicing of SBA loans could be substantially
reduced.
  If
we are not successful in carrying out the new aspects of our business plan our
profitability will be adversely affected
  We have
implemented a strategy to grow our general commercial banking activities and
have implemented new initiatives in this regard, including increased emphasis on
our business banking and business development activities, the creation of a new
Hispanic Banking Division, the expansion of our physical presence into northern
Santa Barbara County through a new branch office located in the city of Santa
Maria, and a future branch expansion at our new South Higuera facility in San
Luis Obispo.  If we are not successful in implementing any or all of these
new aspects of our business plan, this would have a negative impact on our
earnings.
  If
the Company or the Bank were to lose its status as a Community Development
Financial Institution, its ability to carry out certain portions of its business
plan would be adversely affected
  Although
the Bank’s primary focus is as a community bank engaged in the general
commercial banking business, a portion of our business is augmented by our
status as a Community Development Financial Institution.  That status
increases the potential for receiving grants and awards that, in turn, enable us
to increase the level of community development financial services that we
provide in the communities we serve and to provide CRA credit for deposits and
investments.
  Upon the
initial closing under the Securities Purchase Agreement with Manager currently
anticipated to occur in the second quarter of 2010, it is likely that each of
the Company and the Bank will lose its CDFI status.  See “Item
1—Business—Recent Developments.”  The Company and the Bank have
approached the U.S. Treasury with various alternatives which might be possible
to enable the Bank and the Company to retain their respective CDFI status, but
there can be no assurance that any of these alternatives will be acceptable to
the U.S. Treasury.  In addition to losing the benefits of CDFI status,
including the ability to attract awards and grants, if the Company should lose
its CDFI status, it may have to redeem its Series A and Series C preferred stock
that were issued to the Community Development Financial Institution Fund and the
Series B preferred stock that was issued to the National Community Investment
Fund.  The cost of redeeming this preferred stock would be
approximately $1.2 million.
  In order
to maintain our status as a certified Community Development Financial
Institution 60% of our lending must meet Community Development Financial
Institutions Fund requirements.  As our business has continued to
expand, the proportion of our business which meets Community Development
Financial Institutions Fund requirements has decreased, causing us to
affirmatively expand our business into areas which will afford us an opportunity
to provide more community development activities, such as our recent expansion
to the city of Santa Maria in northern Santa Barbara county, and our proposed
Hispanic Banking Division.  In 2009, 61% of the number of loans we
made, and 79% of the dollar amount of the loans made, were in compliance with
the Community Development Financial Institution Fund requirements.  If
we are unsuccessful in expanding our community development activities, and if we
are ultimately unable to maintain a sufficient portion of our business in
Community Development Financial Institutions Fund qualifying business, we could
lose our status as a Community Development Financial Institution as well as the
benefits that go with that status.
  Mission
Community Bank is a community development bank which seeks to provide financial
support and services by promoting community development and economic
vitality.  Most community development banks are located in urban
areas, with very few exclusively community-development banks in rural
areas.  A significant portion of San Luis Obispo County is
rural.  Because of our market area, we may have difficulty locating
the types of community development projects that would likely attract awards and
grants that might be conferred to other financial institutions in urban
areas.  Although we intend to continue to apply for community
development related grants awards in the future, as long as we continue to
retain our CDFI status, there can be no assurance that we will receive any
future grants or awards.
  The
availability of government grants and awards to community development financial
institutions has declined in recent years, and there can be no assurance that
the Company and the Bank will receive any grants or awards in the
future
  Grants
and awards that we have received in the past with respect to our community
development activities have strengthened our capital position and increased our
profitability.  The Community Development Financial Institutions Fund
and other similar programs are an important source of capital for community
development banks such as us.  In 2009 the Bank received the remaining
$81 thousand portion of a 2008 Bank Enterprise Award (“BEA”) from the CDFI Fund.
The award was made under the Fiscal Year 2008 BEA program, which provides an
incentive for any FDIC insured bank to
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 Table of Contents
  annually
increase the levels of financial services provided to economically distressed
communities.  In 2007, 2004 and 2001 the Bank received similar BEA
awards totaling $326,000, $1,241,000 and $990,000, respectively.  The
Company received a technical assistance grant of $134,935 in 2005 to help offset
any costs associated with providing services to the un- and under-banked in our
market areas.  Although we intend to continue to apply for community
development related grants and awards in the future, there can be no assurance
that we will receive any future grants or awards.
  Maintaining
or increasing the Bank’s market share depends on the introduction and market
acceptance of new products and services
  Our
success depends, in part, upon our ability to adapt our products and services to
evolving industry standards and consumer demand.  There is increasing
pressure on financial services companies to provide products and services at
lower prices.  In addition, the widespread adoption of new
technologies, including Internet-based services, could require us to make
substantial expenditures to modify or adapt our existing products or
services.  A failure to achieve market acceptance of any new products
we introduce, or a failure to introduce products that the market may demand,
could have an adverse effect on our business, profitability, or growth
prospects.
  The
Bank faces substantial competition in its primary market area
  We
conduct our banking operations primarily in San Luis Obispo County and northern
Santa Barbara County in the Central Coast of California.  Increased
competition in our market may result in reduced loans and
deposits.  Ultimately, we may not be able to compete successfully
against current and future competitors.  Many competitors offer the
same banking services that we offer in our service area.  These
competitors include national banks, regional banks and other community
banks.  We also face competition from many other types of financial
institutions, including without limitation, savings and loan institutions,
finance companies, brokerage firms, insurance companies, credit unions, mortgage
banks and other financial intermediaries.  Additionally, banks and
other financial institutions with larger capitalization and financial
intermediaries not subject to bank regulatory restrictions have larger lending
limits and are thereby able to serve the credit needs of larger
customers.  Areas of competition include interest rates for loans and
deposits, efforts to obtain deposits, and range and quality of products and
services provided, including new technology-driven products and
services.
  Technology
and other changes are allowing parties to complete financial transactions that
historically have involved banks through alternative methods.  For
example, consumers can now maintain funds that would have historically been held
as bank deposits in brokerage accounts or mutual funds.  Consumers can
also complete transactions such as paying bills and/or transferring funds
directly without the assistance of banks.  The process of eliminating
banks as intermediaries, known as “disintermediation,” could result in the loss
of fee income, as well as the loss of customer deposits and the related income
generated from those deposits.  The loss of these revenue streams and
the lower cost deposits as a source of funds could have a material adverse
effect on the Company’s financial condition and results of
operations.
  In
addition, with recent increased concerns about bank failures, customers
increasingly are concerned about the extent to which their deposits are insured
by the FDIC.  Customers may withdraw deposits in an effort to ensure
that the amount they have on deposit with their bank is fully
insured.  Decreases in deposits may adversely affect the Company’s
funding costs and net income.
  If
the Bank fails to retain its key employees, its growth and profitability could
be adversely affected
  Our
future success depends in large part upon the continuing contributions of our
key management personnel.  If we lose the services of one or more key
employees within a short period of time, we could be adversely
affected.  Our future success is also dependent upon our continuing
ability to attract and retain highly qualified personnel.  Competition
for such employees among financial institutions in California is
intense.  Due to the lack of an experienced candidate pool in the San
Luis Obispo area for the types of personnel we need to operate the Bank, we may
be unable to quickly recruit new candidates to fill the positions of key
personnel which we are unable to retain.  For example, the Bank
operated without a Chief Credit Officer from July 2008 through August
2009.  Qualified employees demand competitive salaries which we may
not be able to offer.  Also, the Company is a recipient of capital
funding through the Treasury’s Troubled Asset Relief Program (“TARP”), and the
recently-enacted American Recovery and Reinvestment Act of 2009 places
significant constraints on executive compensation paid by recipients of TARP
funds.  Any inability to attract and retain additional key personnel
in the future could adversely affect us.  We can provide no assurance
that we will be able to retain any of our key officers and employees or attract
and retain qualified personnel in the future.  However, we have
entered into an employment agreement with Anita Robinson, the Company’s
President and Chief Executive Officer, which continues until December 31,
2012, and an employment agreement with Brooks W. Wise, the Bank’s President,
which continues until April 1, 2011.
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  The
Company may be unable to manage future growth
  We may
encounter problems in managing our future planned growth.  In December
2008 we opened an additional “de novo” branch in Santa Maria,
California.  We may open other branches and loan production offices in
the future, including a planned full-service branch at 3380 S. Higuera Street in
San Luis Obispo, though the Bank has not decided on an opening date for that
branch.  In addition, we intend to investigate opportunities to invest
in other financial institutions that would complement our existing business, as
such opportunities may arise.  No assurance can be provided, however,
that we will be able to identify additional locations to open additional
branches or to identify a suitable acquisition target or consummate any such
acquisition.  Further, our ability to manage growth will depend
primarily on our ability to attract and retain qualified personnel, monitor
operations, maintain earnings and control costs.  Any failure by us to
accomplish these goals could result in interruptions in our business plans and
could also adversely affect current operations.
  Increases
in the Bank’s allowance for loan losses could materially affect its earnings
adversely
  Like all
financial institutions, we maintain an allowance for loan losses to provide for
loan defaults and non-performance.  Our allowance for loan losses is
based on prior experience, as well as an evaluation of the risks in the current
portfolio.  However, actual loan losses could increase significantly
as the result of changes in economic, operating and other conditions, including
changes in interest rates, which are generally beyond our
control.  Thus, such losses could exceed our current allowance
estimates.  Although we believe that our allowance for loan losses is
at a level adequate to absorb any inherent losses in our loan portfolio, we
cannot assure you that we will not further increase the allowance for loan
losses.  Any increase in our allowance for loans losses could
materially affect our earnings adversely.
  In
addition, the Federal Reserve Board and the California Department of Financial
Institutions, as an integral part of their respective supervisory functions,
periodically review our allowance for loan losses.  Such regulatory
agencies may require us to increase our provision for loan losses or to
recognize further loan charge-offs, based upon judgments different from those of
management.  Any increase in our allowance required by the Federal
Reserve Board or the Department of Financial Institutions could adversely affect
us.
  The Bank’s larger funding sources
could strain the Bank’s liquidity resources if a substantial amount is withdrawn
in a short period of time
  The Bank
has a mix of deposits which includes 15 customers with deposits of $1 million or
more totaling $56.9 million, approximately $33.0 million of which has been
placed into the CDARS program.  In addition, $6.0 million of the
Bank’s funding sources is represented by borrowings from the Federal Home Loan
Bank of San Francisco (“FHLB”).  If a substantial number of these
large deposit customers choose to withdraw their funds when they mature, or if
the Bank’s borrowing facility through the FHLB is reduced, and the Bank is
unable to develop alternate funding sources, the Bank may have difficulty
funding loans or meeting deposit withdrawal requirements.
  Legislation
enacted in 2008 and 2009 and the Company’s participation in the TARP Capital
Purchase Program may increase costs and limit the Company’s ability to pursue
business opportunities.
  The
Emergency Economic Stabilization Act of 2008 (the “EESA”), as augmented by the
American Recovery and Reinvestment Act of 2009 (the “Stimulus Bill”), was
intended to stabilize and provide liquidity to the U.S. financial
markets.  Though EESA, the Stimulus Bill and other emergency measures
had the desired effect of providing liquidity and stabilizing the financial
markets, it is impossible to predict what longer-term impacts this legislation,
the related regulations and other governmental programs will have on such
markets.  A continuation or worsening of current financial market
conditions could adversely affect the Company’s business, financial condition
and results of operations.  The programs established or to be
established under the EESA and the Troubled Asset Relief Program (“TARP”) have
resulted in increased regulation of TARP Capital Purchase Program participants
and may result in increased regulation of the industry in
general.  Compliance with such regulations may increase the Company’s
costs and limit its ability to pursue business opportunities.
  The
Company’s participation in the TARP Capital Purchase Program may adversely
affect the value of the Company’s common stock and the rights of the Company’s
common shareholders.
  The terms
of the preferred stock the Company issued under the Treasury’s Capital Purchase
Program could reduce investment returns to the Company’s common shareholders by
restricting dividends, diluting existing shareholders’ ownership interests, and
restricting capital management practices. Without the prior consent of the
Treasury, the Company is prohibited from increasing the Company’s common stock
dividends for the first three years while the Treasury holds the preferred
stock.
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 Table of Contents
  Also, the
preferred stock requires quarterly dividends to be paid at the rate of 5% per
annum for the first five years and 9% per annum thereafter until the stock is
redeemed by the Company. The payments of these dividends will decrease the
excess cash the Company otherwise has available to pay dividends on the
Company’s common stock and other series of preferred stock and to use for
general corporate purposes, including working capital.
  Finally,
the Company will be prohibited from continuing to pay dividends on its common
stock and other series of preferred stock unless the Company has fully paid all
required dividends on the preferred stock issued to the Treasury.  If
for any reason the Company is unable to pay all required dividends on the TARP
preferred stock, then the Company would be precluded from paying dividends on
its common stock and other series of preferred stock.
  The
Company’s expenses have increased and may continue to increase as a result of
increases in FDIC insurance premiums.
  Under the
Federal Deposit Insurance Act, the FDIC, absent extraordinary circumstances,
must establish and implement a plan to restore the deposit insurance reserve
ratio to 1.15% of insured deposits at any time that the reserve ratio falls
below 1.15%. Recent bank failures coupled with deteriorating economic conditions
have significantly reduced the deposit insurance fund’s reserve
ratio.
  The FDIC
currently has eight years to bring the reserve ratio back to the statutory
minimum.  The FDIC expects insured institution failures to peak in
2010 which will result in continued charges against the Deposit Insurance Fund,
and they have implemented a restoration plan that changes both its risk-based
assessment system and its base assessment rates.  As part of this
plan, the FDIC imposed a special assessment in 2009.  See “Regulation
and Supervision—Deposit Insurance,” above.  It is generally expected
that assessment rates will continue to increase in the near term due to the
significant cost of bank failures and a relatively large number of troubled
banks, thereby adversely impacting the Company’s future earnings.
  If
the Company’s information systems were to experience a system failure or a
breach in its network security, the Company’s business and reputation could
suffer.
  The
Company relies heavily on communications and information systems to conduct its
business. The computer systems and network infrastructure we use could be
vulnerable to unforeseen problems.  The Company’s operations are
dependent upon its ability to protect its computer equipment against damage from
fire, power loss, telecommunications failure or a similar catastrophic
event.  In addition, the Company must be able to protect its computer
systems and network infrastructure against physical damage, security breaches
and service disruption caused by the Internet or other users.  Such
computer break-ins and other disruptions would jeopardize the security of
information stored in and transmitted through the Company’s computer systems and
network infrastructure.  The Company has policies and procedures
designed to prevent or limit the effect of the failure, interruption or security
breach of its information systems and will continue to implement security
technology and monitor and update operational procedures to prevent such
damage.  However, if such failures, interruptions or security breaches
were to occur, they could result in damage to the Company’s reputation, a loss
of customer business, increased regulatory scrutiny, or possible exposure to
financial liability, any of which could have a material adverse effect on the
Company’s financial condition and results of operations.
  The Company’s business may be
adversely affected by the highly regulated environment in which it
operates
  Our
operations are subject to extensive governmental supervision, regulation and
control and recent legislation has substantially affected the banking
business.  It cannot presently be predicted whether or in what form
any pending or future legislation may be adopted or the extent to which the
banking industry and our operations would be affected. Some of the legislative
and regulatory changes may benefit us.  However, other changes could
increase our costs of doing business or reduce our ability to compete in certain
markets.
  
  Item
      2.
              Properties
  The
Company occupies a property owned by the Bank at 581 Higuera Street, San Luis
Obispo, California, where the Bank’s Downtown San Luis Obispo branch office is
located.  For its administration offices, the Bank had been leasing,
until December 2009, approximately 2,950 square feet at 569 Higuera St. in San
Luis Obispo at a cost of $6,328 per month.  The lease expires on June
30, 2011.  A reserve has been set aside to either buy out the
remainder of the lease or to apply to remaining lease
payments.  Management is currently negotiating with the landlord on
the termination of these leases.  The administration office was
located next to the Bank’s main branch office.
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 Table of Contents
  In
October 2007, the Bank executed a 15-year build-to-suit triple-net lease for a
full-service branch and administrative office at South Higuera Street and Prado
Road (3380 S. Higuera Street) in San Luis Obispo, California.  The
Bank moved its Administrative and Business Banking Center employees into this
new facility in December 2009.  The opening of a full-service branch
at this location has been delayed at this time.  Currently the lease
provides for lease payments of $37,999 per month.  The lease provides
for two five-year renewal options.
  The Bank
also leases a branch office at 1226 Park Street, Paso Robles, California, at a
cost of $4,995 per month.  The lease expires on July 31,
2013.
  The
Bank’s branch office at 154 West Branch Street, Arroyo Grande, California, is
leased at a cost of $3,091 per month, plus common area operating
expenses.  The lease expires in December 2010 and provides for one
five-year option period.
  In March
2008, the Bank entered into a 5-year lease for an office building at 1670 South
Broadway in Santa Maria, California, where the Bank opened a full-service branch
office in December 2008.  The current rental cost is $8,939 per
month.  The lease provides for two 5-year renewal options and an
option to purchase the property for a specified amount during the last two
months of 2010.
  The
Bank’s Business Banking Center facility at 3440 and 3480 S. Higuera Street, San
Luis Obispo, was leased for a five-year period at a cost of $6,925 per
month.  The lease expired on December 31, 2009 and the Bank vacated
the premises, moving the Business Banking Center’s operations to the new main
office at 3380 S. Higuera Street.
  During
2005, the Bank purchased a parcel located near the intersection of 6th and
Spring Streets in Paso Robles, where the Bank was planning to build a new branch
office to replace our existing branch office in Paso Robles.  An
adjacent parcel was purchased in 2006.  The property is carried as
other real estate owned in the consolidated balance
sheet.   Management and the Board of Directors are evaluating the
future plan for this site, which is either to sell or plan for a future branch
office.
  For the
years ended December 31, 2009 and 2008, the Bank’s total occupancy costs were
approximately $1,002,000 and $586,000, respectively.  In the opinion
of management, the premises are adequate for the Bank’s purposes and the Bank
has sufficient insurance to cover its interest in the premises.  Note
D to the Consolidated Financial Statements contains additional information about
properties.
  Bancorp
is restricted by the bank holding company regulations in its power to hold real
estate property for investment.  The Company does not currently invest in
real estate, other than for purposes of operations and mortgage interests in
real estate securing loans made by the Bank in the ordinary course of business,
and has no plans to do so in the future.
  
 Item
3.              Legal
Proceedings
  The
Company is, from time to time, subject to various pending and threatened legal
actions which arise out of the normal course of its business.  After
taking into consideration information furnished by counsel to the Company as to
the current status of these claims or proceedings to which the Bank is a party,
Management is of the opinion that the ultimate aggregate liability represented
by these claims, if any, will not have a material adverse affect on the
financial condition or results of operations of the Company.
  There are
no material proceedings adverse to the Company to which any director, officer,
affiliate of the Company or 5% shareholder of the Company, or any associate of
any such director, officer, affiliate or 5% shareholder is a party, and none of
the above persons has a material interest adverse to the Company.
  
  Item
4.              Reserved
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 Table of Contents
   PART
II
  
 Item 5.
              Market  for
      Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
      Securities
  Market
Information
 
 The
Company’s common stock is not listed on any exchange or market though it has
traded infrequently in the over-the-counter market under the symbol
“MISS.”  Howe Barnes Hoefer & Arnett, Wedbush Morgan Securities,
Stone & Youngberg LLC, and Monroe Securities, Inc. make a market in the
Company’s Common Stock.  Certain information concerning the Common
Stock is reported on the Nasdaq OTC Bulletin Board (www.otcbb.com).
  The
information in the following table indicates the daily high and low bid prices
of the Company’s Common Stock for each quarterly period during the last two
years based upon information provided by the OTC Bulletin Board. These prices do
not include retail mark-ups, mark-downs or commission.
  
 Bid
      PricesLow
              
              
              High2008
              1st
      Quarter
              
              
              15.10
              
              
              
              18.002nd
      Quarter
              
              
              12.50
              
              
              
              16.003rd
      Quarter
              
              
              11.05
              
              
              
              12.604th
      Quarter
              
              
              10.05
              
              
              
              12.002009
              1st
      Quarter
              
              
              6.00
              
              
              
              10.052nd
      Quarter
              
              
              7.30
              
              
              
              9.003rd
      Quarter
              
              
              7.30
              
              
              
              7.454th
      Quarter
              
              
              5.50
              
              
              
              7.45
 
 
 Holders
 
 As of
March 25, 2010, there were 323 holders of record of Bancorp’s Common
Stock.
  
 Dividends
 
 The
Company’s shareholders are entitled to receive dividends, when and as declared
by its Board of Directors, out of funds legally available therefor, subject to
the restrictions set forth in the California General Corporation Law (the
“Corporation Law”).  The Corporation Law provides that a corporation
may make a distribution to its shareholders if the corporation’s retained
earnings equal at least the amount of the proposed distribution.  The
Corporation Law also provides that, in the event that sufficient retained
earnings are not available for the proposed distribution, a corporation may
nevertheless make a distribution to its shareholders if it meets two conditions,
which generally stated are as follows: (i) the corporation’s assets equal at
least 1.25 times its liabilities, and (ii) the corporation’s current assets
equal at least its current liabilities or, if the average of the corporation’s
earnings before taxes on income and before interest expenses for the two
preceding fiscal years was less than the average of the corporation’s interest
expenses for such fiscal years, then the corporation’s current assets must equal
at least 1.25 times its current liabilities.
  The
availability of operating funds for the Company and the ability of the Company
to pay a cash dividend depends largely on the Bank’s ability to pay a cash
dividend to Bancorp.  The payment of cash dividends by the Bank is
subject to restrictions.  In general, dividends may not be paid from
any of the Bank’s capital or surplus.  Dividends must be paid out of
available net profits, after deduction of all current operating expenses, actual
losses, accrued dividends on preferred stock, if any, and all federal and state
taxes.  Additionally, a bank is prohibited from declaring a dividend
on its shares of common stock until its surplus fund equals its common capital,
or, if its surplus fund does not equal its common capital, until at least
one-tenth of the bank’s net profits, for the preceding half year in the case of
quarterly or semi-annual dividends, or the preceding full year in the case of an
annual dividend, are transferred to its surplus fund each time dividends are
declared.  Regulatory approval is required if the total of all
dividends declared by a bank in any calendar year exceeds the total of its net
profits for that year combined with its retained net profits of the two
preceding years, less any required transfers to surplus or a fund for the
retirement of any preferred stock.  Furthermore, bank regulators also
have authority to prohibit the payment of dividends by a bank when it determines
such payment to be an unsafe and unsound banking practice.
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 Table of Contents
  Additionally,
bank regulatory agencies have authority to prohibit banks from engaging in
activities that, in their opinion, constitute unsafe and unsound practices in
conducting its business.  It is possible, depending upon the financial
condition of the bank in question and other factors, that the bank regulatory
agencies could assert that the payment of dividends or other payments might,
under some circumstances, be an unsafe or unsound practice.  Further,
the bank regulatory agencies have established guidelines with respect to the
maintenance of appropriate levels of capital by banks or bank holding companies
under their jurisdiction.  Compliance with the standards set forth in
such guidelines and the restrictions that are or may be imposed under the prompt
corrective action provisions of federal law could limit the amount of dividends
which the Bank may pay.
  Due to
the Company’s and the Bank’s net losses in 2008 and 2009, the Company’s and the
Bank’s regulators have required that the Company and the Bank obtain approval in
advance prior to the payment of any dividends, even though each remains well
capitalized.
  Quarterly
dividends totaling $217,430 were paid on the Company’s Series D (TARP) preferred
stock in 2009.  No dividends were declared or paid on the Company’s
common or Series A through C preferred stock in 2008 or 2009.
  Whether
or not stock or cash dividends will be paid in the future by the Company and/or
the Bank will be determined by the Board of Directors after consideration of
various factors including, but not limited to, profitability, regulatory capital
ratios, and financial condition. Additionally, certain provisions of the
preferred stock issuances restrict the ability of the Company to pay cash
dividends on common stock unless the required dividends on the preferred stock
are also paid.
  The
Company has issued and outstanding $3,093,000 of junior subordinated debt
securities due October 2033.  The indenture pursuant to which these
debt securities were issued provides that the Company must make interest
payments on the debentures before any dividends can be paid on its capital stock
and, in the event of the Company’s bankruptcy, dissolution or liquidation, the
holder of the debt securities must be paid in full before any distributions may
be made to the holders of our capital stock.  In addition, the Company
has the right to defer interest payments on the junior subordinated debt
securities for up to five years, during which time no dividends may be paid to
holders of the Company’s capital stock.
  On
January 9, 2009, in exchange for aggregate consideration of $5,116,000, Mission
Community Bancorp issued to the Treasury Department a total of 5,116 shares of a
new Series D Preferred Stock having a liquidation preference of $1,000 per
share.  This transaction is a part of the TARP Program.  The
Series D Preferred pays cumulative dividends at a rate of 5% per annum for the
first five years and 9% per annum thereafter.  The Series D Preferred
may not be redeemed during the first three years after issuance except from the
proceeds of a “Qualified Equity Offering.”  Thereafter, Mission
Community Bancorp may elect to redeem the Series D Preferred at the original
purchase price plus accrued but unpaid dividends, if any.  Until
January 1, 2012, the consent of the Treasury Department will be required for the
Company to issue dividends other than consistent with past practice and certain
other circumstances.  Further, if the Company should miss six
quarterly dividend payments due on the Series D Preferred Stock, whether or not
consecutive, the holders of the Series D Preferred Stock (currently the U.S.
Treasury) would have the right to elect two directors to the Company’s Board of
Directors.
   -
29 -
 Table of Contents
  Equity
Compensation Plans
 
 The
following table shows, as of December 31, 2009, each category of equity
compensation along with i) the number of securities to be issued upon the
exercise of outstanding options, warrants and rights, ii) the weighted-average
exercise price of the outstanding options, warrants and rights, and iii) the
remaining number of securities available for future issuance under the plans,
excluding stock options currently outstanding.
  
  Equity
      Compensation Plan InformationNumber
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
              
              
              Weighted
      average exercise price of outstanding options, warrants and
      rights
              
              
              Number
      of additional securities available for future grant under the
      planEquity
      compensation plans approved by security holders
              
              
              87,564
              
              
              $
              16.44
              
              
              
              160,776Equity
      compensation plans not approved by security holders
              
              
              -
              
              
              
              -
              
              
              
              -Total
              
              
              87,564
              
              
              $
              16.44
              
              
              
              160,776
 
  See Note
I to the consolidated financial statements for a discussion of the Company’s
Stock Option Plans.
  Purchases
of equity securities by Bancorp and affiliated purchasers
 
 On August
10, 2007, in a privately negotiated transaction, Mission Community Bancorp
(“Mission”) purchased 29,400 shares of its common stock held by Fannie Mae, at a
per share price of $15.62 for a total purchase price of
$459,228.  Other than this one transaction, neither Bancorp nor any
affiliate of Bancorp has repurchased any of its common or preferred stock during
the period covered by this report, and no stock repurchase plan has been
adopted.
  Report
of Offering of Securities and Use of Proceeds Therefrom
  A
registration statement with respect to a secondary public offering of securities
by Bancorp became effective on August 13, 2007.  The offering was a
best efforts offering to sell an aggregate of between 166,667 and 597,000 shares
of the Bancorp’s authorized but unissued common stock at a price of $18.00 per
share.   Seapower Carpenter Capital, Inc., dba Carpenter &
Company acted as Bancorp’s placement agent in the offering.  The
offering closed on February 15, 2008 with the sale of 410,644 shares for total
gross proceeds to the Company of approximately $7.4 million (net cash proceeds
of $6.8 million after offering expenses).  Bancorp invested $6.4
million of the net proceeds in the Bank as additional capital to support its
planned growth.
   -
30 -
 Table of Contents
  Item 6.
              Selected
      Financial Data
  The
following is selected consolidated financial data with respect to the Company’s
consolidated financial statements for the three years ended December 31, 2009,
2008 and 2007. The information presented has been derived from the audited
consolidated financial statements included in Item 7 of Part II of this Form
10-K.  This information should be read in conjunction with such
consolidated financial statements and the notes thereto.
 
 
 Year
      Ended December 31,In
      thousands, except share and per share data
              
              2009
              
              
              2008
              
              
              2007Interest
      income
              
              $
              10,283
              
              
              $
              11,073
              
              
              $
              11,759Interest
      expense
              
              
              3,877
              
              
              
              4,830
              
              
              
              5,129Net
      interest income
              
              
              6,406
              
              
              
              6,243
              
              
              
              6,630Provision
      for loan losses
              
              
              5,056
              
              
              
              4,245
              
              
              
              150Non-interest
      income
              
              
              833
              
              
              
              346
              
              
              
              1,257Non-interest
      expense
              
              
              8,275
              
              
              
              7,121
              
              
              
              6,594Income
      (loss) before income taxes
              
              
              (6,092
              )
              
              
              (4,777
              )
              
              
              1,143Income
      tax expense (benefit)
              
              
              835
              
              
              
              (929
              )
              
              
              378Net
      income (loss)
              
              $
              (6,927
              )
              
              $
              (3,848
              )
              
              $
              765Net
      income (loss) allocable to preferred stock
              
              $
              (370
              )
              
              $
              (383
              )
              
              $
              115Balance
      Sheet Data at End of YearAssets
              
              $
              193,105
              
              
              $
              215,490
              
              
              $
              158,329Earning
      assets
              
              
              179,980
              
              
              
              202,543
              
              
              
              149,439Total
      loans
              
              
              136,410
              
              
              
              153,311
              
              
              
              126,429Deposits
              
              
              163,770
              
              
              
              144,804
              
              
              
              112,433Total
      shareholders' equity
              
              
              18,638
              
              
              
              20,517
              
              
              
              13,138Preferred
      equity
              
              
              6,227
              
              
              
              1,686
              
              
              
              1,955Common
      equity
              
              
              12,411
              
              
              
              18,831
              
              
              
              11,183Number
      of common shares outstanding
              
              
              1,345,602
              
              
              
              1,345,602
              
              
              
              689,232Average
      Balance Sheet DataAssets
              
              $
              217,268
              
              
              $
              190,792
              
              
              $
              157,869Earning
      assets
              
              
              207,865
              
              
              
              181,232
              
              
              
              148,197Loans
              
              
              148,636
              
              
              
              142,342
              
              
              
              125,691Deposits
              
              
              159,866
              
              
              
              130,841
              
              
              
              121,480Shareholders'
      equity
              
              
              24,791
              
              
              
              18,451
              
              
              
              12,610Per
      Common Share DataBasic
      earnings (loss) per share
              
              $
              (4.87
              )
              
              $
              (3.18
              )
              
              $
              0.96Diluted
      earnings (loss) per share
              
              
              (4.87
              )
              
              
              (3.18
              )
              
              
              0.91Average
      number of common shares outstanding - basic
              
              
              1,345,602
              
              
              
              1,090,569
              
              
              
              679,144Average
      number of common shares outstanding - diluted
              
              
              1,345,602
              
              
              
              1,090,569
              
              
              
              713,152Book
      value per common share
              
              $
              9.22
              
              
              $
              13.99
              
              
              $
              16.23Cash
      dividends declared
              
              
              -
              
              
              
              -
              
              
              
              0.12Performance
      RatiosReturn
      (loss) on average assets
              
              
              (3.19
              )%
              
              
              (2.02
              )%
              
              
              0.48
              %Return
      (loss) on average shareholders' equity
              
              
              (27.94
              )%
              
              
              (20.86
              )%
              
              
              6.07
              %Average
      equity to average assets
              
              
              11.41
              %
              
              
              9.67
              %
              
              
              7.99
              %Efficiency
      ratio
              
              
              118.35
              %
              
              
              108.07
              %
              
              
              83.61
              %Leverage
      ratio
              
              
              10.06
              %
              
              
              10.70
              %
              
              
              9.97
              %Net
      interest margin
              
              
              3.15
              %
              
              
              3.53
              %
              
              
              4.57
              %Non-interest
      revenue to total revenue
              
              
              11.51
              %
              
              
              5.25
              %
              
              
              15.94
              %Asset
      QualityNon-performing
      assets
              
              $
              8,363
              
              
              $
              4,580
              
              
              $
              2,056Allowance
      for loan losses
              
              
              5,537
              
              
              
              3,942
              
              
              
              1,150Net
      charge-offs
              
              
              3,461
              
              
              
              1,453
              
              
              
              26Non-performing
      assets to total assets
              
              
              4.33
              %
              
              
              2.13
              %
              
              
              1.30
              %Allowance
      for loan losses to loans
              
              
              4.06
              %
              
              
              2.57
              %
              
              
              0.91
              %Net
      charge-offs to average loans
              
              
              2.33
              %
              
              
              1.02
              %
              
              
              0.02
              %
 
  -
31 -
 Table of Contents
  Item 7.  Management’s Discussion and
Analysis
 
 Executive
      Summary
 
 The
Company incurred a net loss of $(6.9) million for 2009, as compared to a net
loss of $(3.8) million in 2008.  Although a pre-tax loss was incurred
in 2009, income tax expense of $835 thousand was recognized, resulting from an
increased valuation allowance for deferred tax assets.  During 2008
the Company’s balance sheet grew to $215.5 million in total consolidated assets,
a 36.1% increase from December 31, 2007.  However, as the recession
wore on into 2009, demand for quality loans slacked off and total assets
decreased to $193.1 million, a 10.4% decline from December 31,
2008.  Deposits increased 13.1% in 2009, to $163.8 million, while
borrowed funds were reduced by $39.7 million, or 86.9%.
 
 On a per
share basis, the Company’s net loss for the year ended December 31, 2009, was
$(4.87) per diluted share.  This compares with a net loss of $(3.18)
per diluted share in 2008.
 
 The
following are the major factors impacting the Company’s results of operations
and financial condition over the past two years.
 ·
              A
      high level of provision for loan losses.  Real estate conditions
      weakened in 2007 and 2008 and the overall economy contracted, causing us
      to charge off a few large credits in 2008.  As the real estate
      contraction became more prolonged in 2009, more of our borrowers were
      unable to weather the storm and we charged off $1.8 million of
      construction and land development loans and $0.9 million of commercial and
      residential real estate loans.  Net charge-offs for 2009 totaled
      $3.5 million, up from $1.5 million in 2008.  We had set aside
      additional reserves in 2008 that covered the 2009
      charge-offs.  In 2009 we increased the allowance for loan and
      lease losses to a level approximately $1.6 million higher than at the end
      of 2008.
 ·
              An
      increase in non-performing assets.  Even as some portions of the
      economy seemed to begin to recover in 2009, real estate related segments
      of the economy remained in recessionary territory, further stressing our
      loan portfolio.  Non-performing loans, including troubled debt
      restructurings, increased in 2009 to $6.7 million, up from $4.5 million at
      the end of 2008.  And foreclosed real estate increased from $83
      thousand a year ago to $1.6 million as of December 31,
    2009.
 ·
              A
      decrease in the net interest margin.  The net interest margin
      for 2009 was 3.15%, down 0.38 percentage points from
      2008.  Short-term interest rates dropped 4 full percentage
      points in 2008 and remained at that low level throughout
      2009.  The relatively steep rate drop in 2008 put downward
      pressure on the margin, as competition for deposits in the local market
      would not permit decreases in deposit rates at the same speed or to the
      same degree as loan rates were falling.  Although the margin was
      lower for the full year of 2009 as compared to 2008, it began a steady
      improvement in April 2009, which continued beyond the end of the
      year.
 ·
              We
      increased our valuation allowance for deferred tax assets.  The
      valuation allowance ($1.1 million in 2008 and an additional $3.4 million
      in 2009) was established because the Company’s losses in 2008 and 2009
      exceeded its ability to fully recognize deferred tax assets by carrying
      the losses back to previous tax years.  The valuation allowance
      can begin to be reversed—providing a potential increase to net income in
      future years—as the Company returns to
  profitability.
 ·
              We
      raised additional capital.  During 2008 the Company issued
      410,644 common shares in a secondary public offering for net cash proceeds
      of $6.8 million, and an additional 225,026 shares of common stock were
      issued to the Carpenter Community BancFund-A, L.P., in a private
      placement, for net cash proceeds of $3.9 million.  In 2009
      the Company issued to the United States Department of the Treasury (“the
      Treasury”) a total of 5,116 shares of Series D Fixed Rate Cumulative
      Perpetual Preferred Stock at $1,000 per share.  This transaction
      was a part of the Capital Purchase Program of the TARP.  The
      $5.1 million in new capital was subsequently invested in Mission Community
      Bank as Tier 1 capital.
 
 Critical
Accounting Policies
  A
critical accounting policy is defined as one that is both material to the
presentation of the Company’s financial statements and requires management to
make difficult, subjective or complex judgments that could have a material
effect on the Company’s financial condition and results of operations and may
change in future periods.  Note A to the Consolidated Financial
Statements describes the significant accounting policies used in the preparation
of the Consolidated Financial Statements.  Not all of these accounting
policies require management to make difficult, subjective or complex judgments
or estimates.  However, management believes that the following
policies could be considered critical.
 
 Reserves
and Contingencies
 
 In the
normal course of business, the Company must manage and control certain risks
inherent to the business of banking.  These include credit risk,
interest rate risk, fraud risk, and operations and settlement
risk.  The Company has established
  -
32 -
 Table of Contents
  reserves
for risk of losses, including loan losses.  The allowance for loan
losses represents management’s estimate of the probable credit losses that have
occurred as of the date of the financial statements, as further described in
Note A in the Notes to the Consolidated Financial Statements.  See
also Allowance for Loan
Losses below.  These reserves or accruals are reviewed by
management at least quarterly.  If the latest estimate of loss (or the
actual loss) differs from the accrual or reserve recorded to date, the financial
impact is reflected in the period in which the estimate is revised (or the
actual loss is determined).
 
 Revenue
recognition
 
 The
Company’s primary source of revenue is interest income from loans and investment
securities.  Interest income is recorded on an accrual
basis.  Note A in the Notes to the Consolidated Financial Statements
contains an explanation of the process for determining when the accrual of
interest income is discontinued on impaired loans and under what circumstances
loans are returned to an accruing status.
 
 The
Company also records gains in connection with the sale of the guaranteed portion
of certain SBA-guaranteed loans for which the Bank retains the right to service
the loans.  Recording of such gains involves the use of estimates and
assumptions related to the expected life of the loans and future cash
flows.  Notes A and C in the Notes to the Consolidated Financial
Statements contain additional information regarding the Company’s accounting
policy for revenue recorded in connection with the sale of loans.  SBA
loan servicing rights are based upon estimates and are subject to the risk of
prepayments and market value fluctuation.
 
 Basis
of Presentation
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the Company’s
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period.  Actual results could differ
from those estimates.
 
 The
following discussion and analysis is intended to assist in an understanding of
the significant factors that affected our consolidated financial condition and
results of operations for the years ended December 31, 2009 and
2008.  This discussion, which refers to the Company on a consolidated
basis, should be read in conjunction with the Company’s consolidated financial
statements and corresponding notes.
 
 Bancorp
is inactive except for interest expense associated with the junior subordinated
debentures (related to the trust preferred securities) and minimal other
expenses.  Therefore, the financial information is primarily
reflective of the Bank.
 
 The Bank
operates as a traditional community bank, but has also used management’s
expertise as a CDFI to provide a selection of financial services identified as
“community development” activities, with a focus on financial services to
under-served markets, small businesses and business
professionals.  Bancorp and the Bank have received and used both
grants and deposits under programs authorized by CDFI and continuously review
various options for grants and deposit programs from various government and
public/private entities.  The CDFI status is dependent on management’s
specialized knowledge of working with various governmental programs and requires
a significant increase in reporting and documentation as compared with
traditional bank activities.
 
 MCDC
provides financing for small businesses and low- to moderate-income areas based
on direct loans or funding pools established in conjunction with
others.  MCDC provides loan servicing for several small loans owned by
the San Luis Obispo County Economic Vitality Corporation.  MCDC also
manages a loan pool for the San Luis Obispo County Housing Trust Fund to assist
in providing affordable housing.  MCDC had also been servicing the San
Simeon Earthquake Recovery Loan Fund (the “Earthquake Fund”), a loan pool funded
by the Bank and other local banks.  The Earthquake Fund was structured
to provide low cost financing to individuals and businesses in San Luis Obispo
and northern Santa Barbara counties which experienced severe damage in the
December 22, 2003, San Simeon Earthquake.  During 2008, as the loans
made by the Earthquake Fund had been substantially paid off, the full amount of
the participating banks’ initial investments was returned.  As of
December 31, 2009, the Earthquake Fund had $8,000 in remaining loans
outstanding.  The consortium is considering alternative community
development uses for the loan pool.
 
 MCSC
provides technical assistance services and training to the underserved segments
of the community including small businesses, minorities and low-income
entrepreneurs, and provided technical assistance to applicants for the
Earthquake Fund.  During 2006, MCSC was awarded a five-year, $750,000
grant from the U.S. Small Business Administration to fund one of 99 Women’s
Business Centers nationwide.  While MCSC has not engaged in any direct
lending, it may provide some lending in
   -
33 -
 Table of Contents
  the near
future.  As of December 31, 2009, the Bank has had limited direct
benefit from its association with MCSC.  See also Note L to the
Consolidated Financial Statements for additional information regarding
MCSC.
  Results
of Operations
 
 Average Balance Sheets and Analysis
of Net Interest Income
 
 The
principal component of earnings for most banks is net interest
income.  Net interest income is the difference between the interest
earned on loans and investments and the interest paid on deposits and other
interest-bearing liabilities.
 
 The
banking industry uses two key ratios to measure relative profitability of net
interest income.  The net interest rate spread measures the difference
between the average yield on earning assets and the average rate paid on
interest bearing liabilities.  The interest rate spread ignores the
beneficial impact of non-interest bearing deposits and capital, and provides a
direct perspective on the effect of market interest rate movements.  The
net interest margin is defined as net interest income as a percentage of average
interest-earning assets.  This ratio includes the positive impact of
obtaining a portion of the funding for earning assets with non-interest bearing
deposits and capital.
 
 The
following table presents, for the periods indicated, the total dollar amounts of
interest income from average interest-earning assets and the resultant yields.
Also presented are the dollar amounts of interest expense and average
interest-bearing liabilities, expressed both in dollars and in
rates.
 
 Net
      Interest Analysis(Dollars
      in thousands)For
      the Year EndedDecember
      31, 2009
              
              December
      31, 2008
              
              December
      31, 2007Average
              
              Average
              
              Average
              
              Average
              
              Average
              
              AverageBalance
              Interest
              Rate
              
              Balacce
              Interest
              Rate
              
              Balance
              Interest
              RateASSETSInterest-earning
      assets:Loans,
      net of unearned income*
              
              $148,636
              $8,889
              6.03%
              *
              $142,342
              $9,598
              6.80%
              *
              $125,691
              $10,764
              8.64%
              *Investment
      securities*
              
              35,945
              1,259
              3.70%
              *
              23,966
              1,122
              4.99%
              *
              16,071
              699
              4.64%
              *Federal
      funds sold
              
              7,419
              16
              0.21%
              
              7,314
              122
              1.67%
              
              2,814
              140
              4.98%Other
      interest income
              
              15,865
              119
              0.75%
              
              7,610
              231
              3.03%
              
              3,621
              156
              4.32%Total
      interest-earning assets / interest income
              207,865
              10,283
              5.02%
              
              181,232
              11,073
              6.19%
              
              148,197
              11,759
              8.03%Non-interest-earning
      assets:Allowance
      for loan losses
              
              (3,635)
              
              
              
              (2,118)
              
              
              
              (1,051)Cash
      and due from banks
              
              2,720
              
              
              
              2,987
              
              
              
              2,511Premises
      and equipment
              
              2,833
              
              
              
              3,529
              
              
              
              3,648Other
      assets
              
              7,485
              
              
              
              5,162
              
              
              
              4,564Total
      assets
              
              $217,268
              
              
              
              $190,792
              
              
              
              $157,869LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-bearing
      deposits:Interest-bearing
      demand accounts
              
              $12,594
              145
              1.15%
              
              $17,187
              361
              2.10%
              
              $13,611
              421
              3.09%Savings
      and Money Market deposit accounts
              
              30,585
              370
              1.21%
              
              19,309
              327
              1.70%
              
              22,988
              575
              2.50%Certificates
      of deposit
              
              93,540
              2,150
              2.30%
              
              72,187
              2,471
              3.42%
              
              60,893
              2,931
              4.81%Total
      interest-bearing deposits
              
              136,719
              2,665
              1.95%
              
              108,683
              3,159
              2.91%
              
              97,492
              3,927
              4.03%Federal
      funds purchased
              
              10
              -
              0.61%
              
              34
              1
              2.81%
              
              4
              -
              6.34%Federal
      Home Loan Bank advances
              
              28,161
              1,096
              3.89%
              
              37,232
              1,450
              3.89%
              
              19,383
              925
              4.77%Subordinated
      debt
              
              3,093
              116
              3.75%
              
              3,093
              220
              7.12%
              
              3,093
              277
              8.95%Total
      borrowed funds
              
              31,264
              1,212
              3.88%
              
              40,359
              1,671
              4.14%
              
              22,480
              1,202
              5.35%Total
      interest-bearing liabilities / interest expense
              167,983
              3,877
              2.31%
              
              149,042
              4,830
              3.24%
              
              119,972
              5,129
              4.28%Non-interest-bearing
      liabilities:Non-interest-bearing
      deposits
              
              23,147
              
              
              
              22,158
              
              
              
              23,988Other
      liabilities
              
              1,347
              
              
              
              1,141
              
              
              
              1,299Total
      liabilities
              
              192,477
              
              
              
              172,341
              
              
              
              145,259Shareholders'
      equity
              
              24,791
              
              
              
              18,451
              
              
              
              12,610Total
      liabilities and shareholders' equity
              
              $217,268
              
              
              
              $190,792
              
              
              
              $157,869Net
      interest-rate spread
              
              
              
              2.71%
              
              
              
              2.95%
              
              
              
              3.75%Impact
      of non-interest-bearingsources
      and other changes inbalance
      sheet composition
              
              
              
              0.44%
              
              
              
              0.58%
              
              
              
              0.82%Net
      interest income / margin on earning assets
              
              $6,406
              3.15%
              **
              
              $6,243
              3.53%
              **
              
              $6,630
              4.57%
              ***Yields
      on municipal securities and loans have been adjusted to their
      fully-taxable equivalents**
      Net interest income as a % of earning assets
 Non-accrual
loans are included in the calculation of the average balances of loans; interest
not accrued is excluded.
 
 Net
interest income is affected by changes in the amount and mix of our
interest-earning assets and interest-bearing liabilities, referred to as the
change due to volume.  Average
interest-earning assets grew by $33.0 million in 2008 over 2007 and by $26.6
million in 2009 over 2008.  All categories of interest-earning
assets—both long-term and liquid assets—grew substantially in 2008 and 2009
(based on average balances outstanding during the
year).  Interest-bearing liabilities increased $29.1 million in 2008
as compared to 2007, and grew another $18.9 million in 2009.  Borrowed
funds—a relatively high cost source of funds—were allowed to roll off in 2009,
as the Bank experienced strong growth in deposits.
 
 Net
interest income is also affected by changes in the yields we earn on
interest-earning assets and the rates we pay on interest-bearing deposits and
borrowed funds, referred to as the change due to rate.  The average
yield on interest-earning
  -
34 -
 Table of Contents
  assets
decreased by 117 basis points (1.17%) in 2009, while the average rate paid on
interest-bearing liabilities decreased by only 93 basis points, causing
continued pressure on the net interest margin.  As a result, the net
interest margin decreased 38 basis points in 2009, from 3.53% to
3.15%.  The 400-basis-point drop in the prime interest rate in 2008
put downward pressure on the margin, as competition for deposits in the local
market would not permit decreases in deposit rates at the same speed or to the
same degree as loan rates were falling.  Although lower for the full
year of 2009 as compared to 2008, the margin began a steady improvement in April
2009, which continued through the end of the year.
 
 The
following table sets forth changes in interest income and interest expense for
each major category of interest-earning assets and interest-bearing liabilities,
and the amount of those variances attributable to volume and rate changes for
the years indicated.
 
 
 Rate
      / Volume Variance Analysis(In
      thousands)
              
              Year
      Ended December 31, 2009
              
              
              Year
      Ended December 31, 2008Compared
      to 2008
              
              
              Compared
      to 2007Increase
      (Decrease)
              
              
              Increase
      (Decrease)in
      interest income and expense
              
              
              in
      interest income and expensedue
      to changes in:
              
              
              due
      to changes in:Volume
              
              
              Rate
              
              
              Total
              
              
              Volume
              
              
              Rate
              
              
              TotalInterest-earning
      assets:Loans,
      net of unearned income
              
              $
              411
              
              
              $
              (1,120
              )
              
              $
              (709
              )
              
              $
              1,310
              
              
              $
              (2,476
              )
              
              $
              (1,166
              )Investment
      securities
              
              
              467
              
              
              
              (330
              )
              
              
              137
              
              
              
              366
              
              
              
              57
              
              
              
              423Federal
      funds sold
              
              
              2
              
              
              
              (108
              )
              
              
              (106
              )
              
              
              119
              
              
              
              (137
              )
              
              
              (18
              )Other
      interest income
              
              
              139
              
              
              
              (251
              )
              
              
              (112
              )
              
              
              132
              
              
              
              (57
              )
              
              
              75Total
      increase (decrease) in interest income
              
              
              1,019
              
              
              
              (1,809
              )
              
              
              (790
              )
              
              
              1,927
              
              
              
              (2,613
              )
              
              
              (686
              )Interest-bearing
      liabilities:Transaction
      accounts
              
              
              (80
              )
              
              
              (136
              )
              
              
              (216
              )
              
              
              95
              
              
              
              (155
              )
              
              
              (60
              )Savings
      deposits
              
              
              155
              
              
              
              (112
              )
              
              
              43
              
              
              
              (82
              )
              
              
              (166
              )
              
              
              (248
              )Certificates
      of deposit
              
              
              617
              
              
              
              (938
              )
              
              
              (321
              )
              
              
              482
              
              
              
              (942
              )
              
              
              (460
              )Total
      interest-bearing deposits
              
              
              692
              
              
              
              (1,186
              )
              
              
              (494
              )
              
              
              495
              
              
              
              (1,263
              )
              
              
              (768
              )Federal
      funds purchased
              
              
              (1
              )
              
              
              -
              
              
              
              (1
              )
              
              
              1
              
              
              
              -
              
              
              
              1FHLB
      advances
              
              
              (353
              )
              
              
              (1
              )
              
              
              (354
              )
              
              
              721
              
              
              
              (196
              )
              
              
              525Subordinated
      debt
              
              
              -
              
              
              
              (104
              )
              
              
              (104
              )
              
              
              -
              
              
              
              (57
              )
              
              
              (57
              )Total
      borrowed funds
              
              
              (354
              )
              
              
              (105
              )
              
              
              (459
              )
              
              
              722
              
              
              
              (253
              )
              
              
              469Total
      increase (decrease) in interest expense
              
              
              338
              
              
              
              (1,291
              )
              
              
              (953
              )
              
              
              1,217
              
              
              
              (1,516
              )
              
              
              (299
              )Increase
      (decrease) in net interest income
              
              $
              681
              
              
              $
              (518
              )
              
              $
              163
              
              
              $
              710
              
              
              $
              (1,097
              )
              
              $
              (387
              )
 
 Changes
not solely attributable to rate or volume have been allocated to volume and rate
changes in proportion to the relationship of the absolute dollar amounts of the
changes in each.
 
 The Bank
is asset sensitive (see the Asset and Liability
Management section of this discussion).  Short-term rates
dropped precipitously in early 2008 and remained at a very low level throughout
2009.  The relatively steep rate drop in 2008 put downward pressure on
the margin, as competition for deposits in the local market would not permit
decreases in deposit rates at the same speed or to the same degree as loan rates
were falling.  Although the margin was lower for the full year of 2009
as compared to 2008, it began a steady improvement in April 2009, which
continued beyond the end of the year.  That improvement was due to
rates on deposits declining to a greater degree than loan rates, and higher-cost
borrowed funds being paid off as they matured.
 
 For 2009,
the positive change in net interest income due to volume more than offset the
negative change due to rates, as the average balance of interest-earning assets
increased to a greater extent than interest-bearing liabilities over the course
of the year.  The result was a $163 thousand increase in net interest
income in 2009 as compared to 2008.
 
 
 Provision
for Loan Losses
 
 Credit
risk is inherent in the business of making loans.  The Bank makes
provisions for loan losses when required to bring the total allowance for loan
losses to a level deemed appropriate for the risk in the loan portfolio. The
determination of the appropriate level for the allowance is based on such
factors as historical loss experience, the volume and type of lending conducted,
the amount of nonperforming loans, regulatory policies, general economic
conditions, and other factors related to the collectibility of loans in the
portfolio.  The provision for loan losses is charged to earnings and
totaled $5,056,000 for 2009 and $4,245,000 for 2008.
 
 See Allowance for Loan Losses
below for additional information on the procedures for monitoring the adequacy
of the allowance, as well as detailed information concerning the allowance for
loan losses.
  -
35 -
 Table of Contents
  
 Non-interest
Income
 
 Non-interest
income increased $737 thousand in 2009 as compared to 2008, due to $247 thousand
in gains realized on the sale of securities, as well as increased SBA loan
origination, sale and servicing activity, and $81 thousand in grants and awards
related to the Bank’s community development activity.
 
 The Bank
historically has derived a material portion of its non-interest income from the
sale and servicing of SBA guaranteed loans.  Gain on sale of SBA loans
increased $192 thousand in 2009 as compared to 2008, after decreasing $121
thousand in 2008.  Loan servicing fees (net of amortization) increased
$6 thousand in 2008 and increased another $42 thousand in 2009.
 
 For both
2009 and 2008, non-interest income included one negative item: write-downs on
fixed assets and other real estate.  In 2008, property that had been
held for a future branch site was transferred to other real estate and written
down to its estimated fair value.  In addition, equipment no longer
used for information technology (“IT”) purposes after that function was
outsourced was written off in 2008.  These 2008 write-downs totaled
$379 thousand.  In 2009, write-downs on other real estate (both
foreclosed properties and the branch site property mentioned above) totaled $472
thousand.  An additional $2 thousand write-down was taken on
abandonment of leasehold improvements.
 
 
 Non-interest
Expense
 
 Non-interest
expense increased in 2009 by $1.154 million, or 16%.
 
 Non-interest
expenses that had material changes from 2008 to 2009 were:
 ·
              Insurance
      and regulatory assessments increased by $424 thousand, or 201%, primarily
      because FDIC deposit insurance assessments were up by $381
      thousand.  These increased assessments were the result of
      scheduled increases to deposit insurance rates as well as special
      “one-time” assessments intended to shore up the FDIC’s Deposit Insurance
      Fund.
 ·
              Occupancy
      expense increased by $416 thousand, due primarily to costs associated with
      the Bank’s new main office at South Higuera Street and Prado Road in San
      Luis Obispo.  Although the Bank’s administrative and Business
      Banking Center employees only moved into this new facility in December
      2009, the Bank was obligated for lease payments during the four-month
      pre-occupancy period in which tenant improvements were
      underway.
 ·
              Salary
      and benefits increased by $118 thousand, or 3%.  Actual outlays
      and accruals for salaries and benefits increased by only $36 thousand from
      2008 to 2009.  However, salary and benefit costs deferred as
      loan origination costs (an offset to salaries and benefits) were $82
      thousand less in 2009 as compared to 2008.  The deferrals of
      loan origination costs in accordance with FASB Statement 91 are amortized
      against interest income on loans over the life of the
    loans.
 ·
              Data
      processing expenses increased by $106 thousand, or 17%, principally due to
      the cost of outsourcing the management of the Bank’s information
      technology (“IT”) function, beginning in September 2008.  Thus,
      2009 includes the cost of outsourced IT for twelve months, while 2008
      includes this expense for only approximately four
  months.
 ·
              Professional
      fees—including legal, accounting, internal audit, loan review and other
      consultants—were up $58 thousand, or 14%, in 2009, primarily due to legal,
      loan review and consulting fees related to non-performing
      assets.
 ·
              Marketing
      costs decreased
      $74 thousand, or 35% in 2009 as compared to 2008, as reductions were made
      in the Bank’s budget for advertising and
  sponsorships.
 
 
 Income
Taxes
 
 The
Company’s combined federal and state effective income tax rate was (26.8)% (tax
expense) in 2009 and 19.4% (tax benefit) in 2008.  The change in the
effective rate from 2008 to 2009 was primarily due to a $2.3 million increase in
the deferred tax valuation allowance that was established because the Bank’s
losses in 2008 and 2009 exceeded its ability to fully recognize deferred tax
assets by carrying the loss back to previous tax years.  As of
December 31, 2009, the ability of the Bank to reduce the deferred tax valuation
allowance and recognize those deferred tax assets was dependent on the Bank
generating taxable income in future years.  The valuation allowance
can begin to be reversed—providing a potential increase to net income in future
years—as the Company returns to profitability.  See Note H to the
consolidated financial statements for more information on income
taxes.
  -
36 -
 Table of Contents
  
 Financial
Condition
 
 Investment
Activities
 
 Banks
purchase and own investment securities for yield, to provide liquidity and to
balance the overall interest-rate sensitivity of its assets and liabilities. The
Bank does not maintain a trading account.
 
 Investment
goals are to obtain the highest yield consistent with maintaining a stable
overall asset and liability position while limiting economic
risks.  In accordance with this policy, management actively manages
its investment portfolio between available for sale and held to maturity
investments, the composition of which has shifted over time.  All
securities in the Bank’s portfolio are classified as available for
sale.
 
 Investment
policies and limits have been established by the board of
directors.  Investments can include federally-insured certificates of
deposit, obligations of the U.S. Treasury and U.S. agencies, mortgage-related
instruments issues or backed by U.S. agencies, municipal bonds rated Baa or
better (Moody’s), Aaa-rated private label mortgage-backed and asset-backed
securities, and corporate securities rated A or A-1.  Guidelines have
been established for diversification of the portfolio among these investment
categories and per-transaction limits have been established as
well.  The Bank’s chief financial officer reports investment purchase
and sale activity to the Board on a monthly basis and more detailed quarterly
reports are presented to the Investment Committee.
 
 The
following table presents the distribution of investments by sector, the maturity
dates of the investments, and the weighted average yields of the
investments:
 
 Investment
      securities compositionDecember
      31, 2009
              
              December
      31, 2008
              
              December
      31, 2007Approx.
              
              
              
              Approx.
              
              
              
              Approx.Amortized
              Market
              %
              
              Amortized
              Market
              %
              
              Amortized
              Market
              %Cost
              Value
              Yield
              
              Cost
              Value
              Yield
              
              Cost
              Value
              Yield(Dollars
      in thousands)U.S.
      Government agencies:Within
      one year
              $500
              $502
              4.00%
              
              $2,000
              $2,036
              3.38%
              
              $1,998
              $2,000
              4.43%One
      to five years
              14,442
              14,465
              2.12%
              
              500
              518
              4.00%
              
              1,995
              2,010
              4.24%Five
      to ten years
              500
              502
              5.05%
              
              1,000
              1,016
              5.18%
              
              1,000
              1,001
              4.97%After
      10 years
              -
              -
              
              
              -
              -
              
              
              1,000
              999
              4.31%Total
      U.S. Government agencies
              15,442
              15,469
              2.27%
              
              3,500
              3,570
              3.98%
              
              5,993
              6,010
              4.44%Mortgage-backedand
      asset-backed securities:Within
      one year
              245
              249
              4.28%
              
              334
              334
              4.07%
              
              130
              128
              3.88%One
      to five years
              18
              17
              6.49%
              
              577
              582
              4.66%
              
              1,003
              997
              4.61%Five
      to ten years
              8,674
              8,747
              3.50%
              
              1,810
              1,873
              4.83%
              
              1,105
              1,108
              4.87%After
      10 years
              9,522
              9,698
              3.96%
              
              14,689
              15,053
              4.94%
              
              5,738
              5,917
              4.82%Total
      mortgage-backedand
      asset-backed securities
              18,459
              18,711
              3.75%
              
              17,410
              17,842
              4.90%
              
              7,976
              8,150
              4.79%Municipal
      securities:Within
      one year
              -
              -
              
              
              -
              -
              
              
              -
              -One
      to five years
              -
              -
              
              
              -
              -
              
              
              -
              -Five
      to ten years
              -
              -
              
              
              -
              -
              
              
              -
              -After
      10 years
              2,918
              2,974
              5.99%
              
              3,581
              3,434
              5.95%
              
              2,972
              2,964
              6.00%Total
      municipal securities
              2,918
              2,974
              5.99%
              
              3,581
              3,434
              5.95%
              
              2,972
              2,964
              6.00%Corporate
      debt securities:Within
      one year
              959
              997
              5.96%
              
              -
              -
              
              
              -
              -One
      to five years
              1,882
              1,991
              5.48%
              
              -
              -
              
              
              -
              -Five
      to ten years
              -
              -
              
              
              -
              -
              
              
              -
              -After
      10 years
              -
              -
              
              
              -
              -
              
              
              -
              -Total
      corporate securities
              2,841
              2,988
              5.64%
              
              -
              -
              
              
              -
              -Total
      investment securities
              $39,660
              $40,142
              3.47%
              
              $24,491
              $24,846
              4.92%
              
              $16,941
              $17,124
              4.88%
 
 The
non-accrual security is included in the amortized cost and market value of
securities.  Yields reflect no interest income on the non-accrual
security.  Yields on tax-exempt municipal securities have been
adjusted to their fully-taxable equivalents.
 
 During
2008, the Bank purchased $0.9 million of municipal securities in order to take
advantage of their higher yields on a fully taxable equivalent
basis.  All of the municipal securities purchased to date are within
California, bank qualified, insured and are rated at least AA+ by Standard &
Poor’s or Aa2 by Moody’s.  Except for one security carried at $311
thousand, all municipal securities are insured by a company rated AAA by
S&P.
  -
37 -
 Table of Contents
  
 In 2004,
management established a loss reserve for one of the Bank’s asset-backed
securities after concluding it was “other than temporarily
impaired.”  The security is in non-accrual status, with any interest
payments received being credited to the reserve.  As of December 31,
2009, the gross book value of the security was $300,000 and the reserve was
$292,000, for a net book value of $8,000.
 
 See Note
B in the notes to the consolidated financial statements for additional
information on investment securities.
 
 
 Lending
Activities
 
 The Bank
originates loans, participates in loans from other banks and structures loans
for possible sale in the secondary market.
 
 The
following table sets forth the composition of our loan portfolio by type of loan
as of the dates indicated:
 
 
 Loan
      Portfolio Composition(Dollars
      in thousands)As
      of December 31,Type of Loan
              
              2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005Commercial
              
              $
              19,633
              
              
              $
              24,454
              
              
              $
              25,653
              
              
              $
              18,000
              
              
              $
              14,190Agricultural
              
              
              750
              
              
              
              -
              
              
              
              122
              
              
              
              123
              
              
              
              152Leases,
      net of unearned income
              
              
              1,335
              
              
              
              1,491
              
              
              
              839
              
              
              
              1,041
              
              
              
              815Municipal
      loans
              
              
              3,476
              
              
              
              2,729
              
              
              
              2,789
              
              
              
              2,903
              
              
              
              -Real
      estate
              
              
              96,956
              
              
              
              98,049
              
              
              
              72,009
              
              
              
              66,591
              
              
              
              71,878Construction
              
              
              12,512
              
              
              
              22,857
              
              
              
              22,513
              
              
              
              31,639
              
              
              
              29,921Consumer
              
              
              1,748
              
              
              
              3,731
              
              
              
              2,504
              
              
              
              2,502
              
              
              
              2,519Total
      loans
              
              $
              136,410
              
              
              $
              153,311
              
              
              $
              126,429
              
              
              $
              122,799
              
              
              $
              119,475Off-balance-sheet
      commitments:Undisbursed
      loan commitments
              
              $
              18,219
              
              
              $
              28,427
              
              
              $
              28,608
              
              
              $
              35,375
              
              
              $
              37,379Standby
      letters of credit
              
              
              301
              
              
              
              304
              
              
              
              693
              
              
              
              213
              
              
              
              203
 
 
 The
following table sets forth as of December 31, 2009, the maturities and
sensitivities of loans to interest rate changes:
 
 
 Maturity
      and Rate Sensitivity of Loans(Dollars
      in thousands)Rate
      Structure for LoansMaturity
              
              
              Maturing
      Beyond One YearOne
      year
              
              
              One
      through
              
              
              Over
      five
              
              
              
              
              
              Fixed
              
              
              Floatingor
      less
              
              
              five
      years
              
              
              years
              
              
              Total
              
              
              Rate
              
              
              RateCommercial
              
              $
              4,088
              
              
              $
              7,785
              
              
              $
              7,760
              
              
              $
              19,633
              
              
              $
              7,653
              
              
              $
              7,892Agricultural
              
              
              419
              
              
              
              331
              
              
              
              -
              
              
              
              750
              
              
              
              331
              
              
              
              -Leases,
      net of unearned income
              
              
              44
              
              
              
              1,291
              
              
              
              -
              
              
              
              1,335
              
              
              
              1,291
              
              
              
              -Municipal
      loans
              
              
              -
              
              
              
              998
              
              
              
              2,478
              
              
              
              3,476
              
              
              
              771
              
              
              
              2,705Real
      estate
              
              
              1,302
              
              
              
              17,124
              
              
              
              78,530
              
              
              
              96,956
              
              
              
              59,557
              
              
              
              36,097Construction
              
              
              10,782
              
              
              
              1,507
              
              
              
              223
              
              
              
              12,512
              
              
              
              -
              
              
              
              1,730Consumer
      Loans
              
              
              513
              
              
              
              1,070
              
              
              
              165
              
              
              
              1,748
              
              
              
              1,235
              
              
              
              -Total
      Loans
              
              $
              17,148
              
              
              $
              30,106
              
              
              $
              89,156
              
              
              $
              136,410
              
              
              $
              70,838
              
              
              $
              48,424
 
 
 The Bank
funds commercial loans to provide working capital, to finance the purchase of
equipment and for other business purposes.  These loans can be short-term, with maturities
ranging from thirty days to one year, or term loans, with maturities
normally ranging from one to twenty-five years.  Short-term loans are
generally intended to finance current transactions and typically provide for
periodic principal payments, with interest payable monthly.
 
 Included
in commercial loans are SBA loans.  The Bank originates and services
SBA loans and is active in specific SBA programs.  Further, the Bank
is designated as an SBA preferred lender which allows greater flexibility to
meet small business loan requests with delegated authority, creating a more
timely credit approval process.
  -
38 -
 Table of Contents
  
 The Bank
makes adjustable rate SBA-guaranteed loans and generally sells the guaranteed
portion of the SBA loans in the secondary market while retaining the servicing
rights for those loans.  At December 31, 2009 and 2008, the Bank
serviced approximately $26.9 million and $23.2 million, respectively, in SBA
loans.
 
 Consumer
loans are used to finance automobiles, various types of consumer goods, and
other personal purposes.  Consumer loans generally provide for the
monthly payment of principal and interest.  Most consumer loans are
secured by the personal property being purchased.
 
 The Bank
has been active in construction lending for interim loans to finance the
construction of commercial and single family residential
property.  Construction loans totaled $12.5 million as of December 31,
2009, a $10.3 million decrease from a year earlier, as few construction loans
were originated or funded in 2009 due to economic
conditions.  Construction loans are typically extended for terms of no
more than 12 to 18 months.  Generally, the Bank does not provide loans
for speculative purposes except to known builders who have a track record of
successful projects and the expertise and financial strength for the particular
type of building.
 
 Residential
real estate loans are generally limited to home equity loans and home equity
lines of credit.  The Bank has not been active in other forms of
residential real estate lending.
 
 Other
real estate loans consist primarily of commercial and industrial real estate
loans.  These loans are made based on the income generating capacity
of the property or the cash flow of the borrower and are secured by the
property.  The Bank offers both fixed and variable rate loans with
maturities which generally do not exceed ten years.  Exceptions are
made for SBA-guaranteed loans secured by real estate, or for other commercial
real estate loans which can be readily sold in the secondary
market.
 
 
 Asset
Quality
 
 The risk
of nonpayment of loans is inherent in the banking business. That risk varies
with the type and purpose of the loan, the collateral which is utilized to
secure payment and, ultimately, the creditworthiness of the
borrower.  In order to minimize this credit risk, all loans exceeding
lending officers’ individual lending limits are reviewed and approved by a
Management Loan Committee.  Loans exceeding the Management Loan
Committee’s authorization are reviewed and approved by the Loan Committee of the
board of directors.  The Board Loan Committee is comprised of outside
directors as well as the Bank’s chief executive officer, chief credit officer
and its president.
 
 The Bank
employs both an internal and an external loan review
process.  Monthly, all new loans are reviewed internally for asset
quality and an independent external loan portfolio review is performed
semi-annually by an outside credit review firm.  Loan grades are
assigned based on a risk assessment of each loan.  Loans with minimum
risk are graded as “pass,” with other classifications of “watch,” “special
mention,” “substandard,” “doubtful” and “loss,” depending on credit
quality.  Loans graded substandard or doubtful are considered
“classified” loans, and loans graded loss are charged
off.  As an adjunct to the loan review process, an internal “stress
test” is applied to the commercial real estate portfolio at least annually to
determine the potential financial impact on the Bank under stressed real estate
conditions, and semi-annually by an independent third party.
 
 An
allowance for loan losses is provided for all loans, including those graded
pass.  As
watch, special mention
and classified loans
are identified in our review process, they are added to the internal watch list
and an increased loan loss allowance is established for them.  See
Allowance for Loan
Losses below for additional information on how the amount of allowance
for loan losses is determined.
 
 
 The
following table provides year-end information with respect to the components of
our impaired or nonperforming assets at the dates indicated:
 
 Non-Performing
      Assets(Dollars
      in thousands)
              
              As
      of December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005Loans
      in nonaccrual status:Commercial
              
              $
              1,139
              
              
              $
              578
              
              
              $
              254
              
              
              $
              240
              
              
              $
              76Real
      estate
              
              
              2,724
              
              
              
              1,427
              
              
              
              190
              
              
              
              -
              
              
              
              -Construction
      & land development
              
              
              2,028
              
              
              
              1,552
              
              
              
              1,544
              
              
              
              -
              
              
              
              -Total
      nonaccrual loans
              
              
              5,891
              
              
              
              3,557
              
              
              
              1,988
              
              
              
              240
              
              
              
              76Loans
      past due 90 days or more and accruing:Commercial
              
              
              -
              
              
              
              -
              
              
              
              54
              
              
              
              -
              
              
              
              -Lease
      financing
              
              
              -
              
              
              
              -
              
              
              
              14
              
              
              
              -
              
              
              
              -Real
      estate
              
              
              -
              
              
              
              265
              
              
              
              -
              
              
              
              -
              
              
              
              -Construction
      & land development
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,929
              
              
              
              -Total
      loans 90 days past due and accruing
              
              
              -
              
              
              
              265
              
              
              
              68
              
              
              
              1,929
              
              
              
              -Restructured
      loans:Commercial
              
              
              731
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Construction
      & land development
              
              
              -
              
              
              
              675
              
              
              
              -
              
              
              
              -
              
              
              
              -Consumer
              
              
              100
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      restructured loans
              
              
              831
              
              
              
              675
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      nonperforming loans
              
              
              6,722
              
              
              
              4,497
              
              
              
              2,056
              
              
              
              2,169
              
              
              
              76Foreclosed
      real estate
              
              
              1,641
              
              
              
              83
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      nonperforming assets
              
              $
              8,363
              
              
              $
              4,580
              
              
              $
              2,056
              
              
              $
              2,169
              
              
              $
              76Allowance
      for loan losses
              
              $
              5,537
              
              
              $
              3,942
              
              
              $
              1,150
              
              
              $
              1,026
              
              
              $
              1,141Asset
      quality ratios:Non-performing
      assets to total assets
              
              
              4.33
              %
              
              
              2.13
              %
              
              
              1.30
              %
              
              
              1.37
              %
              
              
              0.05
              %Non-performing
      loans to total loans
              
              
              4.93
              %
              
              
              2.93
              %
              
              
              1.63
              %
              
              
              1.77
              %
              
              
              0.06
              %Allowance
      for loan losses to total loans
              
              
              4.06
              %
              
              
              2.57
              %
              
              
              0.91
              %
              
              
              0.84
              %
              
              
              0.96
              %Allowance
      for loan losses to totalnon-performing
      loans
              
              
              82
              %
              
              
              88
              %
              
              
              56
              %
              
              
              47
              %
              
              
              1501
              %
 
 
 Non-accrual
loans are loans which management believes may not be fully collectible as to
principal and interest.  Generally, loans are placed in non-accrual
status when they are 90 days or more past due unless they are well-secured and
in the process of collection.  Once placed in non-accrual status, a
loan is not returned to accrual status until it is brought current with respect
to both principal and interest payments, the loan is performing to current terms
and conditions, the interest rate is commensurate with market interest rates and
future principal and interest payments are no longer in doubt, at which time a
further review of the loan is conducted.
 
 The
increase in non-accrual loans in 2008 and 2009 was due to the significant
downturn in the economy and reduction in real estate collateral
values.  Approximately 29%, or $1.106 million, of the non-accrual
commercial and real estate loans are in our SBA loan portfolio, with $995
thousand of the total guaranteed by the SBA.  At December 31, 2008,
$1.640 million of the Bank’s non-accrual loans were SBA loans, and $1.361
million of the total was guaranteed by the SBA.
 
 Restructured
loans are those loans with concessions in interest rates or repayment terms due
to a decline in the financial condition of the
borrower.  Approximately 25%, or $178 thousand, of the restructured
commercial loans were SBA loans, with $136 thousand of the total guaranteed by
the SBA.
 
 Other
real estate owned is acquired in satisfaction of loans through foreclosure or
other means and is carried on an individual asset basis at the lower of the
recorded investment in the related loan or the estimated fair value of the
property, less selling expenses.
 
 The Bank
has no foreign loans.
  -
39 -
 Table of Contents
  Potential
Problem Loans
  At
December 31, 2009, the Company had approximately $24.6 million of loans that
were not categorized as non-performing, but for which known information about
the borrower’s financial condition caused management to have concern about the
ability of the borrowers to comply with the repayment terms of the
loans.  These loans were identified through the loan review process
described above.  The $24.6 million of potential problem loans are
supported by $2.1 million of SBA loan guarantees.  Potential problem
loans are subject to continuing management attention and management has provided
in the allowance for loan and lease losses for potential losses related to these
loans, based on an evaluation of current market conditions, loan collateral,
other secondary sources of repayment and cash flow generation.
  While
credit quality, as measured by loan delinquencies and by the Bank’s internal
risk grading system, appears to be manageable as of December 31, 2009, there can
be no assurances that new problem loans will not develop in future
periods.  A further decline in economic conditions in the Bank’s
market area or other factors could adversely impact individual borrowers or the
loan portfolio in general.  The Bank has well defined underwriting
standards and expects to continue with prompt collection efforts, but economic
uncertainties or changes may cause one or more borrowers to experience problems
in the coming months.
 
 
 Loan
Concentrations
  The Board
of Directors has approved concentration levels (as a percentage of capital) for
various loan types based on the Bank’s business plan and historical loss
experience.  On a quarterly basis, management provides a loan
concentration report to the board with information relating to
concentrations.  Management’s review of possible concentrations
includes an assessment of loans to multiple borrowers engaged in similar
activities which would cause them to be similarly impacted by economic or other
conditions.
 
 The
following table reflects the major concentrations in the loan portfolio, by type
of loan, as of December 31, 2009:
 
 
 Loan
      ConcentrationsDecember
      31, 2009(Dollars
      in thousands)Type
      of Loan
              
              Amount
              
              
              Percent
      of Total LoansConstruction
      and land development
              
              $
              12,512
              
              
              
              9.2
              %Other
      real estate loans (by type of collateral):Non-farm,
      non-residential property:Owner-occupied
              
              
              37,337
              
              
              
              27.4
              %Non-owner-occupied
              
              
              36,940
              
              
              
              27.1
              %1
      to 4 family residential:First
      liens
              
              
              3,963
              
              
              
              2.9
              %Junior
      liens
              
              
              12,678
              
              
              
              9.3
              %Multi-family
      residential
              
              
              2,757
              
              
              
              2.0
              %Farmland
              
              
              3,281
              
              
              
              2.4
              %Total
      real estate-secured loans
              
              
              109,468
              
              
              
              80.3
              %Commercial
      loans
              
              
              19,633
              
              
              
              14.4
              %Agricultural
      loans
              
              
              750
              
              
              
              0.5
              %Lease
      financing
              
              
              1,335
              
              
              
              1.0
              %Municipal
      loans
              
              
              3,476
              
              
              
              2.5
              %Consumer
      loans
              
              
              1,748
              
              
              
              1.3
              %Total
      loans, including loans held for sale
              
              $
              136,410
              
              
              
              100.0
              %
 
 
 The table
indicates a concentration in commercial real estate loans (loans secured by
non-farm, non-residential and multi-family residential properties, including
construction loans) totaling $89.5 million.  However, under the
regulatory definition of commercial real estate—which excludes owner-occupied
properties—the Bank’s commercial real estate concentration is reduced to $52.2
million, or 38.3% of total loans.  Prior to 2009, the Bank had had
only two losses on construction and land development loans (both occurring in
2008) and none with other types of commercial real estate loans.  In
2009, however, The Bank experienced $1.8 million in losses on construction and
land development loans and approximately $900 thousand
  -
40 -
 Table of Contents
  in losses
on commercial and residential real estate loans.
 
 The
Bank’s analysis of loan concentrations compared to a California peer group of 50
banks suggests that the Bank does not have an unusually high real estate
concentration compared to other similar sized banks in
California.  Banks in California typically are more prone than banks
in other states to use real estate collateral for many commercial loans for
business purposes where collateral is taken as an abundance of
caution.  In its analysis of real estate concentrations, the Bank
carefully considers economic trends and real estate values.  The
commercial real estate market in San Luis Obispo county weakened in 2008 and
2009, rents and values have decreased and vacancies have increased. Although the
local market has not seen the severe weakness seen in many other areas of
California and the U.S., management continues to monitor closely trends in real
estate in light of the Bank’s level of real estate lending.
 
 Allowance
for Loan Losses
 
 The
following table summarizes, for each reported period, changes in the allowance
for loan losses arising from loans charged off, recoveries on loans previously
charged off, additions to the allowance which have been charged to operating
expenses, and certain ratios relating to the allowance for loan
losses:
 
 
 Summary
      of Loan Loss Experience(Dollars
      in thousands)
              
              For
      the Year Ended December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005Allowance
      for loan and lease lossesat
      beginning of year
              
              $
              3,942
              
              
              $
              1,150
              
              
              $
              1,026
              
              
              $
              1,141
              
              
              $
              1,094Loans
      charged off:Construction
      and  land development
              
              
              (1,778
              )
              
              
              (547
              )
              
              
              -
              
              
              
              -
              
              
              
              -Other
      real estate loans
              
              
              (911
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
              
              
              (738
              )
              
              
              (880
              )
              
              
              (13
              )
              
              
              (102
              )
              
              
              (24
              )Consumer
              
              
              (78
              )
              
              
              (52
              )
              
              
              (4
              )
              
              
              (19
              )
              
              
              (7
              )Other
              
              
              -
              
              
              
              -
              
              
              
              (14
              )
              
              
              -
              
              
              
              -Total
      loans charged off
              
              
              (3,505
              )
              
              
              (1,479
              )
              
              
              (31
              )
              
              
              (121
              )
              
              
              (31
              )Recoveries:Construction
      and  land development
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Other
      real estate loans
              
              
              1
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
              
              
              42
              
              
              
              22
              
              
              
              4
              
              
              
              6
              
              
              
              1Consumer
              
              
              1
              
              
              
              3
              
              
              
              -
              
              
              
              -
              
              
              
              2Other
              
              
              -
              
              
              
              1
              
              
              
              1
              
              
              
              -
              
              
              
              -Total
      recoveries
              
              
              44
              
              
              
              26
              
              
              
              5
              
              
              
              6
              
              
              
              3Net
      charge-offs
              
              
              (3,461
              )
              
              
              (1,453
              )
              
              
              (26
              )
              
              
              (115
              )
              
              
              (28
              )Provision
      charged to operations
              
              
              5,056
              
              
              
              4,245
              
              
              
              150
              
              
              
              -
              
              
              
              75Allowance
      for loan and lease lossesat
      end of year
              
              $
              5,537
              
              
              $
              3,942
              
              
              $
              1,150
              
              
              $
              1,026
              
              
              $
              1,141Ratio
      of net charge-offs to average loans
              
              
              2.33
              %
              
              
              1.02
              %
              
              
              0.02
              %
              
              
              0.10
              %
              
              
              0.03
              %Ratio
      of provision to average loans
              
              
              3.40
              %
              
              
              2.98
              %
              
              
              0.12
              %
              
              
              0.00
              %
              
              
              0.07
              %
 
 
 The Bank
performs a quarterly detailed review to identify the risks inherent in the loan
portfolio, to assess the overall quality of the loan portfolio and to determine
the adequacy of the allowance for loan losses and the related provision for loan
losses to be charged to expense.  Systematic reviews follow the
methodology set forth by various regulatory policy statements on the allowance
for loan losses.
 
 A key
element of the Bank’s methodology is the previously discussed credit
classification process.  The amount determined by management to be an
appropriate level for the allowance is based on the Bank’s historical loss rate
for each type of loan and risk grade, with adjustments made for certain
qualitative factors such as current and expected economic conditions, trends in
collateral values, the quality of the Bank’s loan review process,
etc.  For loans identified as impaired under Statement of
Financial Accounting Standards No. 114, the allowance allocated to the loan is
the deficiency, if any, in either the present value of expected cash flows from
the loan or the fair value of the collateral, as compared to the Bank’s
investment in the loan.  The Bank engages an outside firm to perform,
at least semi-annually, a review of the loan portfolio and to test the adequacy
of the allowance for loan losses.  In addition, loans are examined
periodically by the Bank’s federal and state regulators.
  -
41 -
 Table of Contents
  
 Management
considers the allowance for loan losses to be adequate to provide for losses
inherent in the loan portfolio. Although management uses all available
information to recognize losses on loans and leases, future additions to the
allowance may be necessary based on changes in economic
conditions.  In addition, federal and state regulators periodically
review our allowance for loan losses and may recommend additions based upon
their evaluation of the portfolio at the time of their
examination.  Accordingly, there can be no assurance that our
allowance for loan losses will be adequate to cover future loan losses or that
significant additions to the allowance for loan losses will not be required in
the future.  Material additions to the allowance for loan losses would
decrease earnings and capital and would thereby reduce the Bank’s ability to pay
dividends, among other adverse consequences.
 
 The ratio
of allowance for loan losses to total loans as of December 31, 2009 was
4.06%.  Management and the board consider this to be adequate based on
their analysis and reviews of the portfolio. As part of the analysis of the
allowance, the Bank assigns certain risk factors to unclassified loans in
addition to the specific percentages used for classified loans.  The
following tables summarize the allocation of the allowance for loan losses by
general loan types, based on collateral or security type, as used internally by
the Bank as of the end of each of the past five years.
 
 
 December
      31, 2009Percent
      of Total
              
              
              Allowance
              
              
              Percent
      of Total(dollars
      in thousands)
              
              Loans
              
              
              Loans
              
              
              Allocation
              
              
              AllowanceUnclassified
      loans:Commercial
              
              $
              16,073
              
              
              
              11.8
              %
              
              $
              690
              
              
              
              12.5
              %Agricultural
              
              
              750
              
              
              
              0.5
              %
              
              
              24
              
              
              
              0.4
              %Leases
              
              
              1,335
              
              
              
              1.0
              %
              
              
              4
              
              
              
              0.1
              %Municipal
      loans
              
              
              3,476
              
              
              
              2.5
              %
              
              
              27
              
              
              
              0.5
              %Real
      estate
              
              
              76,568
              
              
              
              56.1
              %
              
              
              374
              
              
              
              6.8
              %Construction
              
              
              5,296
              
              
              
              3.9
              %
              
              
              125
              
              
              
              2.3
              %Consumer
              
              
              1,604
              
              
              
              1.2
              %
              
              
              93
              
              
              
              1.7
              %Total
      unclassified loans
              
              
              105,102
              
              
              
              77.0
              %
              
              
              1,337
              
              
              
              24.3
              %Classified
      loans:Commercial
              
              
              3,560
              
              
              
              2.6
              %
              
              
              288
              
              
              
              5.2
              %Agricultural
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Leases
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Municipal
      loans
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Real
      estate
              
              
              20,388
              
              
              
              15.0
              %
              
              
              3,260
              
              
              
              59.0
              %Construction
              
              
              7,216
              
              
              
              5.3
              %
              
              
              122
              
              
              
              2.2
              %Consumer
              
              
              144
              
              
              
              0.1
              %
              
              
              17
              
              
              
              0.3
              %Total
      classified loans
              
              
              31,308
              
              
              
              23.0
              %
              
              
              3,687
              
              
              
              66.7
              %Other
      economic factors
              
              
              
              
              
              
              
              
              
              
              513
              
              
              
              9.3
              %Total
      loans and allowance
              
              $
              136,410
              
              
              
              100.0
              %
              
              $
              5,537
              
              
              
              100.3
              %
 
 
 
 December
      31, 2008Percent
      of Total
              
              
              Allowance
              
              
              Percent
      of Total(dollars
      in thousands)
              
              Loans
              
              
              Loans
              
              
              Allocation
              
              
              AllowanceUnclassified
      loans:Commercial
              
              $
              22,252
              
              
              
              14.5
              %
              
              $
              860
              
              
              
              21.8
              %Agricultural
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Leases
              
              
              1,491
              
              
              
              1.0
              %
              
              
              14
              
              
              
              0.4
              %Municipal
      loans
              
              
              2,729
              
              
              
              1.8
              %
              
              
              16
              
              
              
              0.4
              %Real
      estate
              
              
              88,735
              
              
              
              57.9
              %
              
              
              719
              
              
              
              18.2
              %Construction
              
              
              15,430
              
              
              
              10.1
              %
              
              
              200
              
              
              
              5.1
              %Consumer
              
              
              3,723
              
              
              
              2.4
              %
              
              
              91
              
              
              
              2.3
              %Total
      unclassified loans
              
              
              134,360
              
              
              
              87.7
              %
              
              
              1,900
              
              
              
              48.2
              %Classified
      loans:Commercial
              
              
              2,202
              
              
              
              1.4
              %
              
              
              454
              
              
              
              11.5
              %Agricultural
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Leases
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Municipal
      loans
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Real
      estate
              
              
              9,314
              
              
              
              6.1
              %
              
              
              337
              
              
              
              8.5
              %Construction
              
              
              7,427
              
              
              
              4.8
              %
              
              
              1,057
              
              
              
              26.9
              %Consumer
              
              
              8
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Total
      classified loans
              
              
              18,951
              
              
              
              12.3
              %
              
              
              1,848
              
              
              
              46.9
              %Other
      economic factors
              
              
              
              
              
              
              
              
              
              
              194
              
              
              
              4.9
              %Total
      loans and allowance
              
              $
              153,311
              
              
              
              100.0
              %
              
              $
              3,942
              
              
              
              100.0
              %
 
  -
42 -
 Table of Contents
  
 
 December
      31, 2007Percent
      of Total
              
              
              Allowance
              
              
              Percent
      of Total(dollars
      in thousands)
              
              Loans
              
              
              Loans
              
              
              Allocation
              
              
              AllowanceUnclassified
      loans:Commercial
              
              $
              25,238
              
              
              
              20.0
              %
              
              $
              390
              
              
              
              33.9
              %Agricultural
              
              
              122
              
              
              
              0.1
              %
              
              
              1
              
              
              
              0.1
              %Leases
              
              
              811
              
              
              
              0.6
              %
              
              
              7
              
              
              
              0.6
              %Municipal
      loans
              
              
              2,789
              
              
              
              2.2
              %
              
              
              14
              
              
              
              1.2
              %Real
      estate
              
              
              72,009
              
              
              
              57.0
              %
              
              
              261
              
              
              
              22.7
              %Construction
              
              
              18,433
              
              
              
              14.6
              %
              
              
              192
              
              
              
              16.7
              %Consumer
              
              
              2,491
              
              
              
              2.0
              %
              
              
              22
              
              
              
              1.9
              %Total
      unclassified loans
              
              
              121,893
              
              
              
              96.5
              %
              
              
              887
              
              
              
              77.1
              %Classified
      loans:Commercial
              
              
              415
              
              
              
              0.3
              %
              
              
              76
              
              
              
              6.6
              %Agricultural
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Leases
              
              
              28
              
              
              
              0.0
              %
              
              
              2
              
              
              
              0.2
              %Municipal
      loans
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Real
      estate
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Construction
              
              
              4,080
              
              
              
              3.2
              %
              
              
              30
              
              
              
              2.6
              %Consumer
              
              
              13
              
              
              
              0.0
              %
              
              
              1
              
              
              
              0.1
              %Total
      classified loans
              
              
              4,536
              
              
              
              3.5
              %
              
              
              109
              
              
              
              9.5
              %Other
      economic factors
              
              
              
              
              
              
              
              
              
              
              154
              
              
              
              13.4
              %Total
      loans and allowance
              
              $
              126,429
              
              
              
              100.0
              %
              
              $
              1,150
              
              
              
              100.0
              %
 
 
 
 December
      31, 2006Percent
      of Total
              
              
              Allowance
              
              
              Percent
      of Total(dollars
      in thousands)
              
              Loans
              
              
              Loans
              
              
              Allocation
              
              
              AllowanceUnclassified
      loans:Commercial
              
              $
              17,855
              
              
              
              14.6
              %
              
              $
              234
              
              
              
              22.8
              %Agricultural
              
              
              123
              
              
              
              0.1
              %
              
              
              1
              
              
              
              0.1
              %Leases
              
              
              1,041
              
              
              
              0.8
              %
              
              
              5
              
              
              
              0.5
              %Municipal
      loans
              
              
              2,903
              
              
              
              2.4
              %
              
              
              15
              
              
              
              1.5
              %Real
      estate
              
              
              66,591
              
              
              
              54.2
              %
              
              
              313
              
              
              
              30.5
              %Construction
              
              
              29,710
              
              
              
              24.2
              %
              
              
              135
              
              
              
              13.2
              %Consumer
              
              
              2,502
              
              
              
              2.0
              %
              
              
              20
              
              
              
              1.9
              %Total
      unclassified loans
              
              
              120,725
              
              
              
              98.3
              %
              
              
              723
              
              
              
              70.5
              %Classified
      loans:Commercial
              
              
              145
              
              
              
              0.1
              %
              
              
              30
              
              
              
              2.9
              %Agricultural
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Leases
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Municipal
      loans
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Real
      estate
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Construction
              
              
              1,929
              
              
              
              1.6
              %
              
              
              -
              
              
              
              0.0
              %Consumer
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Total
      classified loans
              
              
              2,074
              
              
              
              1.7
              %
              
              
              30
              
              
              
              2.9
              %Other
      economic factors
              
              
              
              
              
              
              
              
              
              
              273
              
              
              
              26.6
              %Total
      loans and allowance
              
              $
              122,799
              
              
              
              100.0
              %
              
              $
              1,026
              
              
              
              100.0
              %
 
 
 December
      31, 2005Percent
      of Total
              
              
              Allowance
              
              
              Percent
      of Total(dollars
      in thousands)
              
              Loans
              
              
              Loans
              
              
              Allocation
              
              
              AllowanceUnclassified
      loans:Commercial
              
              $
              11,890
              
              
              
              10.0
              %
              
              $
              287
              
              
              
              25.2
              %Agricultural
              
              
              152
              
              
              
              0.1
              %
              
              
              1
              
              
              
              0.1
              %Leases
              
              
              814
              
              
              
              0.7
              %
              
              
              7
              
              
              
              0.6
              %Municipal
      loans
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Real
      estate
              
              
              71,878
              
              
              
              60.2
              %
              
              
              308
              
              
              
              27.0
              %Construction
              
              
              27,992
              
              
              
              23.4
              %
              
              
              123
              
              
              
              10.8
              %Consumer
              
              
              2,517
              
              
              
              2.1
              %
              
              
              21
              
              
              
              1.8
              %Total
      unclassified loans
              
              
              115,243
              
              
              
              96.5
              %
              
              
              747
              
              
              
              65.5
              %Classified
      loans:Commercial
              
              
              2,300
              
              
              
              1.9
              %
              
              
              87
              
              
              
              7.6
              %Agricultural
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Leases
              
              
              1
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Municipal
      loans
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Real
      estate
              
              
              -
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Construction
              
              
              1,929
              
              
              
              1.6
              %
              
              
              -
              
              
              
              0.0
              %Consumer
              
              
              2
              
              
              
              0.0
              %
              
              
              -
              
              
              
              0.0
              %Total
      classified loans
              
              
              4,232
              
              
              
              3.5
              %
              
              
              87
              
              
              
              7.6
              %Other
      economic factors
              
              
              
              
              
              
              
              
              
              
              307
              
              
              
              26.9
              %Total
      loans and allowance
              
              $
              119,475
              
              
              
              100.0
              %
              
              $
              1,141
              
              
              
              100.0
              %
 
 
 Deposits
 
 Deposits
are the primary source of funding for lending and investing
needs.  Total deposits were $163.8 million as of December 31, 2009,
and $144.8 million at December 31, 2008.  Deposits increased by $19.0
million, or 13%, following a $32.4 million, or 29%, increase in
2008.  Much of the Bank’s deposit growth in 2008 was from the Bank’s
CDARS product, as discussed below.  In 2009, however, most of the
growth was in core deposits: interest-bearing and non-interest-bearing checking
accounts, money market accounts and savings accounts.
 
 The Bank
generally prices deposits at or above the median rate by classification based on
periodic interest rate surveys in the local market.  Deposit rates are
then adjusted to balance the cost of funds versus funding needs and asset and
liability considerations.  The Net Interest Analysis and
Rate/Volume Analysis
earlier in this Discussion contain information regarding the average rates paid
on deposits for 2009 and 2008.
 
 The Bank
is one of only four banks in its primary service area participating in the
Certificate of Deposit Account Registry Service (“CDARS”)
program.  This program permits the Bank’s customers to place their
certificates of deposit at one institution—Mission Community Bank—and have those
deposits fully-insured by the FDIC, up to $50 million.  The CDARS
program acts as a clearinghouse, matching deposits from one institution in the
CDARS network of nearly 3,000 banks with other network banks (in increments of
less than the $250 thousand FDIC insurance limit), so funds that a customer
places with the Bank essentially remain on the Bank’s balance
sheet.  The CDARS program became very attractive in the second half of
2008 and throughout 2009 as local depositors sought out safety and
yield.  As of December 31, 2009, the Bank had issued $44.2 million of
certificates of deposit to local customers through the CDARS program, up from
$30.2 million as of December 31, 2008.
 
 The
following table reflects the maturity distribution of certificates of deposit in
the amounts of $100,000 or more as of December 31, 2009:
 
 
 Maturities
      of Time Deposits of $100,000 or More(Dollars
      in thousands)Three
      months or less
              
              $
              18,768Three
      months to six months
              
              
              13,048Six
      months to one year
              
              
              12,750Over
      one year
              
              
              8,379Total
      time deposits of $100,000 or more
              
              $
              52,945
 
  -
43 -
 Table of Contents
  
 Short
Term and Other Borrowings
 
 As of
December 31, 2009, the Bank had $6.0 million in outstanding borrowings from the
Federal Home Loan Bank of San Francisco, $3.0 million of which matures during
2010, and the balance matures in 2013.  The $6.0 million in borrowings
at the end of 2009 represents a $39.7 million reduction in borrowing from
December 31, 2008.  Note F to the consolidated financial statements
contains additional information regarding these borrowings.
 
 
 Off-Balance-Sheet
Financial Instruments
 
 In the
normal course of business, the Bank enters into financial commitments to
customers, primarily to extend credit.  Those instruments involve, to
varying degrees, elements of credit and interest rate risk not recognized in the
consolidated balance sheets.  As of December 31, 2009, the Bank had
outstanding commitments to extend credit totaling $18.2 million and standby
letters of credit totaling approximately $300 thousand.  See Note M to
the consolidated financial statements for additional information on
off-balance-sheet commitments and contingencies.
 
 The Bank
has not entered into any off-balance-sheet derivative financial instruments as
of December 31, 2009.
 
 Liquidity
Management
 
 The
objective of our asset/liability strategy is to manage liquidity and interest
rate risks to ensure the safety and soundness of the Bank and its capital base,
while maintaining an adequate net interest margin in order to provide an
appropriate return to shareholders.
 
 The
Bank’s liquidity, which primarily represents the ability to meet fluctuations in
deposit levels and provide for customers’ credit needs, is managed through
various funding strategies that reflect the maturity structures of the sources
of funds and the assets being funded.  The Bank’s liquidity is further
augmented by payments of principal and interest on loans and securities, as well
as increases in short-term liabilities such as demand deposits and short-term
certificates of deposit.  Cash in the Federal Reserve Bank and other
correspondent banks and short-term investments such as federal funds sold are
the primary means for providing immediate liquidity.  The Bank had
$8.6 million in cash and cash equivalents on December 31, 2009, and $17.7
million on December 31, 2008.
 
 In order
to meet the Bank’s liquidity requirements, the Bank endeavors to maintain
appropriate liquidity ratios through policies set by the board of
directors.  These include, but are not limited to, a ratio of loans to
deposits no higher than 95%, core deposits at least 50% of total assets,
short-term investments at least 2% of total assets, and short-term non-core
funding less than 35% of total assets.
 
 While the
Bank uses cash and cash equivalents as the primary immediate source of cash
liquidity, it has also established a short-term borrowing line (federal funds
purchased) for $4.0 million from a correspondent bank.  This line of
credit is for short-term needs and is rarely used.
 
 The Bank
also has a secured borrowing facility through the FHLB.  FHLB
borrowings can be structured over various terms ranging from overnight to ten
years.  As of December 31, 2009, the Bank had outstanding borrowings
from the FHLB totaling $6.0 million.  Interest rates and terms for
FHLB borrowings are generally more favorable than the rates for similar term
brokered certificates of deposit or for federal funds purchased.  The
Bank has the potential (on a secured basis) to borrow up to approximately 25
percent of its total assets. Based on this limitation and loans and securities
pledged as of December 31, 2009, an additional $32.6 million could be borrowed
from the FHLB if needed.  The Bank has substantially reduced its FHLB
borrowings in 2009, paying off $39.7 million in borrowings over the course of
the year.  FHLB borrowings may be used from time to time when needed
as part of the Bank’s normal liquidity management to fund asset growth on a
cost-effective basis.  The Bank has adequate loans to pledge as
collateral should it need additional liquidity that cannot be funded by
deposits.
 
 The Bank
also has the ability to access the Federal Reserve Board’s “Discount Window” for
additional secured borrowing should the need arise.
  -
44 -
 Table of Contents
  Following
is a summary of the Company’s contractual obligations extending beyond one year
from December 31, 2009:
 
 Long-Term
      Contractual ObligationsLess
      than
              
              
              1
      thru 3
              
              
              3
      thru 5
              
              
              More
      than1 year
              
              
              years
              
              
              years
              
              
              5 years
              
              
              Total(Dollars
      in thousands)Borrowed
      funds
              
              $
              3,000
              
              
              $
              -
              
              
              $
              3,000
              
              
              $
              -
              
              
              $
              6,000Junior
      subordinated debentures
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,093
              
              
              
              3,093Operating
      leases
              
              
              745
              
              
              
              1,383
              
              
              
              1,089
              
              
              
              5,845
              
              
              
              9,062Capital
      leases
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Purchase
      obligations
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Other
      long-term liabilities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      contractual obligations
              
              $
              3,745
              
              
              $
              1,383
              
              
              $
              4,089
              
              
              $
              8,938
              
              
              $
              18,155
 
 
 While
local deposits remain the primary source of deposits, the Bank also has
alternate sources for competitive rate deposits.  Through the CDARS
program (see Deposits
earlier in this analysis), the Bank has the ability to bid on additional
certificates of deposit through banks across the country if necessary to meet
additional funding needs.  These “One-Way Buy” CDARS deposits, which
are considered to be brokered deposits, are typically priced comparable to FHLB
secured borrowing rates, but with no collateral required.  As of
December 31, 2009, the Bank had no “One-Way Buy” CDARS deposits.
 
 The Bank
has a mix of deposits which includes some large deposit relationships, including
15 customers with deposits of $1 million or more totaling $56.9 million,
approximately $33.0 million of which has been placed into the CDARS
program.  Although these large deposit sources have been relatively
stable in the past, should a substantial number of these large deposit customers
choose to withdraw their funds when they mature, or if the Bank’s borrowing
facility through the FHLB were reduced, and the Bank is unable to develop
alternate funding sources, the Bank might have difficulty funding loans or
meeting deposit withdrawal requirements.
 
 Bancorp
is a company separate and apart from the Bank and must provide for its own
liquidity.  As of December 31, 2009, Bancorp had no borrowings other
than the junior subordinated debentures reflected in the above table, and had
approximately $843,000 in unrestricted cash.  See Note Q to the
consolidated financial statements for additional financial information regarding
Bancorp.
 
 Under
normal circumstances, substantially all of Bancorp’s revenues would be obtained
from dividends declared and paid by the Bank.  However, because of the
Bank’s net losses in 2008 and 2009, statutory and regulatory provisions have
constrained the ability of the Bank to pay dividends to
Bancorp.  Under these statutes and regulations, approval of the Bank’s
regulatory authorities is required before any dividend distributions can be made
from the Bank to Bancorp.  See “Item 5—Market for Common Equity,
Related Shareholder Matters and Issuer Purchases of Equity Securities—Dividends”
and Note O to the consolidated financial statements for additional information
regarding regulatory dividend and capital restrictions.
 
 
 Asset
and Liability Management
 
 The
objectives of interest rate risk management are to control exposure of net
interest income to risks associated with interest rate movements in the market,
to achieve consistent growth in net interest income and to profit from favorable
market opportunities.  Even with perfectly matched repricing of assets
and liabilities, risks remain in the form of prepayment of assets, and timing
lags in adjusting certain assets and liabilities that have varying sensitivities
to market interest rates.
  -
45 -
 Table of Contents
  Interest
rate sensitivity gap analysis attempts to capture interest rate risk, which is
attributable to the mismatching of interest rate sensitive assets and
liabilities.  A positive cumulative gap would mean that over the
indicated period our assets would be expected to reprice faster than our
liabilities (an asset-sensitive structure), and a negative gap would mean that
our liabilities would likely reprice faster than our assets
(liability-sensitive).
 
 The
Interest Rate Sensitivity table below sets forth a “static” gap analysis of the
interest rate sensitivity of interest-earning assets and interest-bearing
liabilities as of December 31, 2009.  For purposes of the table, an
asset or liability is considered rate-sensitive in the first period when it can
be repriced, matures within its contractual terms, or is expected to be
prepaid.  For example, based on their contractual terms, loans may
reprice or mature beyond one year, but our prepayment assumptions would indicate
that a certain percentage of them would likely be paid off
earlier.  That portion estimated to be paid off early would be shown
in one of the columns to the left of its actual maturity.
 
 
 Interest
      Sensitivity - Static Gap AnalysisDecember
      31, 2009
              
              Sensitive
      to Rate Changes Within3
              
              
              4
      to 12
              
              
              1
      to 5
              
              
              Over
      5
              
              
              Non-Rate-Months
              
              
              Months
              
              
              Years
              
              
              Years
              
              
              Sensitive
              
              
              Total(Dollars
      in thousands)Earning
      Assets:Loans,
      net of unearned income
              
              $
              43,573
              
              
              $
              30,543
              
              
              $
              52,313
              
              
              $
              9,981
              
              
              $
              -
              
              
              $
              136,410Investment
      securities
              
              
              3,778
              
              
              
              14,883
              
              
              
              15,432
              
              
              
              6,049
              
              
              
              -
              
              
              
              40,142Other
      earning assets
              
              
              12,341
              
              
              
              323
              
              
              
              102
              
              
              
              -
              
              
              
              -
              
              
              
              12,766Non-interest-earning
      assets
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,787
              
              
              
              3,787Total
      assets
              
              
              59,692
              
              
              
              45,749
              
              
              
              67,847
              
              
              
              16,030
              
              
              
              3,787
              
              
              
              193,105Interest-Bearing
      Liabilities:Non-maturity
      interest-bearing deposits
              
              
              31,378
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              22,766
              
              
              
              54,144Certificates
      of deposit
              
              
              29,151
              
              
              
              46,017
              
              
              
              9,842
              
              
              
              -
              
              
              
              
              
              
              
              85,010Borrowed
      funds
              
              
              -
              
              
              
              3,000
              
              
              
              3,000
              
              
              
              -
              
              
              
              -
              
              
              
              6,000Junior
      subordinated debentures
              
              
              3,093
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,093Non-interest-bearing
      liabilities and equity
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              44,858
              
              
              
              44,858Total
      liabilities and equity
              
              
              63,622
              
              
              
              49,017
              
              
              
              12,842
              
              
              
              -
              
              
              
              67,624
              
              
              
              193,105Interest
      rate sensitivity gap
              
              $
              (3,930
              )
              
              $
              (3,268
              )
              
              $
              55,005
              
              
              $
              16,030
              
              
              $
              (63,837
              )
              
              $
              -Cumulative
      interest rate sensitivity gap
              
              $
              (3,930
              )
              
              $
              (7,198
              )
              
              $
              47,807
              
              
              $
              63,837
              
              
              $
              -Cumulative
      gap to total earning assets
              
              
              -2
              %
              
              
              -4
              %
              
              
              25
              %
              
              
              33
              %
 
 
 The table
shows that during the first year $105 million of the interest earning assets are
expected to reprice, as well as $112 million of interest bearing liabilities,
which would indicate a slightly liability-sensitive structure over that time
period.  In general, this means that in a rising interest rate
environment, with all other conditions remaining constant, net interest income
would be expected to decrease, and in a declining interest rate environment net
interest income would be expected to increase.  Although not detailed
in the table, during the second year, $30 million of assets reprice and $9
million of liabilities, indicating an asset-sensitive structure ($14 million
cumulative sensitivity gap through 24 months).
 
 One
should use caution if attempting to predict future levels of net interest income
through the use this type of static gap analysis,
however.  Significant adjustments can be, and often are, made to the
balance sheet in the short-term.  Thus, although the Bank is in a
slightly liability-sensitive posture through one year on a static gap basis, in
a practical sense management views the Bank as slightly
asset-sensitive.  The actual impact of interest rate movements on net
interest income often differs significantly from that implied by any gap
measurement, depending on the direction and magnitude of the interest rate
movements, the repricing characteristics of various on- and off-balance sheet
instruments, as well as competitive pressures.  For example, many of
the Bank’s loans are tied to the prime rate, which declined in the second half
of 2007, throughout 2008 and remained very low in 2009.  However,
competitive pressures often keep deposit rates from dropping to the same degree
and as quickly as loan rates, and this resulted in a reduction in the net
interest margin even though the gap analysis in 2007 and 2008 showed the Bank in
a more balanced posture.
 
 Also,
changes in the mix of earning assets or supporting liabilities can either
increase or decrease the net interest margin without affecting this particular
measure of interest rate sensitivity.  In addition, prepayments may
have significant impact on our net interest margin.  Varying interest
rate environments can create unexpected changes in prepayment activity as
compared to prepayments assumed in the interest rate
sensitivity  analysis.  These factors are not fully
reflected in the gap analysis above and, as a result, the gap report may not
provide a complete assessment of our interest rate risk.
  -
46 -
 Table of Contents
  
 Based on
current economic forecasts, the Bank anticipates that short-term interest rates
will remain at a very low level through much of 2010 and, if so, we expect to
see certificate of deposit rates continue to decline to a greater degree than
loan rates, relieving some pressure on the net interest margin.  In
the early stage of the next cycle of rising interest rates we would expect to
see deposits repricing slightly faster, but to a lesser degree, than loans
because “floors” (minimum rates) have been implemented on much of the variable
rate loan portfolio.  Many of those floor rates are currently higher
than the rate would be without the imposition of the floor.
 
 
 Effects
of Inflation and Economic Issues
 
 A
financial institution’s asset and liability structure is substantially different
from that of an industrial firm in that primarily all assets and liabilities of
a bank are monetary in nature, with relatively little investments in fixed
assets or inventories.  Inflation has an important impact on the
growth of total assets and the resulting need to increase equity capital at
higher than normal rates in order to maintain an appropriate equity to assets
ratio.  Management believes that the impact of inflation on financial
results depends on the Company’s ability to react to changes in interest rates
and, by such reaction, reduce the inflationary impact on
performance.  Management has attempted to structure the mix of
financial instruments and manage interest rate sensitivity in order to minimize
the potential adverse effects of inflation or other market forces on net
interest income and, therefore, earnings and capital.
 
 San Luis
Obispo and Santa Barbara Counties continue to have lower than average
unemployment rates (9.4% and 9.3%, respectively, as of December 2009, as
compared to a California statewide seasonally-adjusted rate of 12.4% and a
nationwide seasonally-adjusted rate of 10.0%).  Local unemployment has
increased in 2009—up from 7.1% for both counties in December 2008—and real
estate values declined significantly from 2007 through 2009.  After
several years of strong appreciation, residential and commercial sale
activity—and especially construction activity—slowed
dramatically.  There can be no assurance that the local economy will
rebound quickly or that real estate values will return to pre-2006 levels in the
near term.  As such, the Bank closely monitors credit quality,
interest rate risk and operational expenses.
 
 
 Return
on Equity and Assets
 
 The
following table shows the Company’s return on average assets and return on
average equity for past five years:
 
 
 2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005Return
      (Loss) on Average Assets
              
              
              (3.19
              )%
              
              
              (2.02
              )%
              
              
              0.48
              %
              
              
              0.58
              %
              
              
              0.68
              %Return
      (Loss) on Average Equity
              
              
              (27.94
              )%
              
              
              (20.86
              )%
              
              
              6.07
              %
              
              
              7.53
              %
              
              
              9.16
              %
 
 
  -
47 -
 Table of Contents
  Item 8.  Financial
  Statements
  
 
 
 
 MISSION
COMMUNITY BANCORPAND
SUBSIDIARY
 
 CONSOLIDATED
FINANCIAL STATEMENTS
 WITH
 INDEPENDENT
AUDITOR’S REPORT
 
 December
31, 2009 and 2008
 
  -
48 -
 Table of Contents
  
 
 
 
 
 
 
 
 
 
 
 
 CONTENTS
 
 
 
 
 REPORT
OF INDEPENDENT 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
 
 
 
  -
49 -
 Table of Contents
  
 
 
 
 
 
 
 
  REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  
 Board of
Directors and Shareholders of
 Mission
Community Bancorp and Subsidiary
 
 We have
audited the accompanying consolidated balance sheets of Mission Community
Bancorp and Subsidiary as of December 31, 2009 and 2008 and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows of the years then ended.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the public company
accounting oversight board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Mission Community Bancorp
and Subsidiary as of December 31, 2009 and December 31, 2008, and the results of
its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of
America.
 
 Laguna
Hills, California
 April 14,
2010
 
 
 
 
 
 
  -
50 -
 Table of Contents
  MISSION
COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2009 and 2008
 
 
 
 2009
              
              
              2008ASSETSCash
      and Due from Banks
              
              $
              8,595,410
              
              
              $
              7,804,306Federal
      Funds Sold
              
              
              -
              
              
              
              9,920,000TOTAL
      CASH AND CASH EQUIVALENTS
              
              
              8,595,410
              
              
              
              17,724,306Certificates
      of Deposit in Other Banks
              
              
              425,000
              
              
              
              11,710,000Investment
      Securities Available for Sale
              
              
              40,142,412
              
              
              
              24,845,839Loans
      held for sale
              
              
              903,680
              
              
              
              1,264,251Loans:Commercial
              
              
              22,200,974
              
              
              
              25,918,262Agricultural
              
              
              749,721
              
              
              
              -Leases,
      Net of Unearned Income
              
              
              1,334,740
              
              
              
              1,490,668Construction
              
              
              12,511,994
              
              
              
              22,857,024Real
      Estate
              
              
              96,954,983
              
              
              
              98,049,035Consumer
              
              
              1,754,054
              
              
              
              3,731,566TOTAL
      LOANS
              
              
              135,506,466
              
              
              
              152,046,555Allowance
      for Loan and Lease Losses
              
              
              (5,536,929
              )
              
              
              (3,942,220
              )NET
      LOANS
              
              
              129,969,537
              
              
              
              148,104,335Federal
      Home Loan Bank Stock and Other Stock, at Cost
              
              
              3,002,575
              
              
              
              2,756,525Premises
      and Equipment
              
              
              3,254,511
              
              
              
              2,598,697Other
      Real Estate Owned
              
              
              2,205,882
              
              
              
              983,100Company
      Owned Life Insurance
              
              
              2,885,659
              
              
              
              2,789,366Accrued
      Interest and Other Assets
              
              
              1,720,799
              
              
              
              2,713,426$
              193,105,465
              
              
              $
              215,489,845
  The
accompanying notes are an integral part of these consolidated financial
statements.
 -
51 -
 Table of Contents
  MISSION
COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2009 and 2008
 
 
 
 
 2009
              
              
              2008LIABILITIES
      AND SHAREHOLDERS' EQUITYDeposits:Noninterest-Bearing
      Demand
              
              $
              24,615,530
              
              
              $
              22,802,269Money
      Market, NOW and Savings
              
              
              54,144,513
              
              
              
              32,668,070Time
      Deposits Under $100,000
              
              
              32,064,624
              
              
              
              51,550,524Time
      Deposits $100,000 and Over
              
              
              52,945,030
              
              
              
              37,783,195TOTAL
      DEPOSITS
              
              
              163,769,697
              
              
              
              144,804,058Other
      Borrowings
              
              
              6,000,000
              
              
              
              45,700,000Junior
      Subordinated Debt Securities
              
              
              3,093,000
              
              
              
              3,093,000Accrued
      Interest and Other Liabilities
              
              
              1,605,053
              
              
              
              1,375,964TOTAL
      LIABILITIES
              
              
              174,467,750
              
              
              
              194,973,022Commitments
      and Contingencies - Notes D and  M
              
              
              -
              
              
              
              -Shareholders'
      Equity:Preferred
      Stock -Note K - Authorized 10,000,000 Shares:Series
      A - $5 Stated Value; 100,000 Issued and OutstandingLiquidation
      Value of $500,000
              
              
              392,194
              
              
              
              392,194Series
      B - $10 Stated Value; 20,500 Issued and OutstandingLiquidation
      Value of $205,000
              
              
              191,606
              
              
              
              191,606Series
      C - $10 Stated Value; 50,000 Issued and OutstandingLiquidation
      Value of $500,000
              
              
              500,000
              
              
              
              500,000Series
      D - $1,000 Par Value; 5,116 shares Issued and OutstandingLiquidation
      Value of $5,116,000
              
              
              5,067,722
              
              
              
              -Common
      Stock - Authorized 10,000,000 Shares;Issued
      and Outstanding: 1,345,602 in 2009 and 2008
              
              
              18,041,851
              
              
              
              18,041,851Additional
      Paid-In Capital
              
              
              242,210
              
              
              
              172,285Retained
      Earnings (Deficit)
              
              
              (6,280,239
              )
              
              
              863,750Accumulated
      Other Comprehensive Income - UnrealizedAppreciation
      on Available-for-Sale Securities
              
              
              482,371
              
              
              
              355,137TOTAL
      SHAREHOLDERS' EQUITY
              
              
              18,637,715
              
              
              
              20,516,823$
              193,105,465
              
              
              $
              215,489,845
 
 
  -
52 -
 Table of Contents
  
 MISSION
COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF INCOME
 Years
Ended December 31, 2009 and 2008
 
 2009
              
              
              2008INTEREST
      INCOMEInterest
      and Fees on Loans
              
              $
              8,889,166
              
              
              $
              9,598,625Interest
      on Investment Securities
              
              
              1,259,017
              
              
              
              1,122,021Other
      Interest Income
              
              
              134,476
              
              
              
              352,752TOTAL
      INTEREST INCOME
              
              
              10,282,659
              
              
              
              11,073,398INTEREST
      EXPENSEInterest
      on Money Market, NOW and Savings Deposits
              
              
              514,393
              
              
              
              688,256Interest
      on Time Deposits
              
              
              2,150,036
              
              
              
              2,470,919Other
      Interest Expense
              
              
              1,212,181
              
              
              
              1,671,320TOTAL
      INTEREST EXPENSE
              
              
              3,876,610
              
              
              
              4,830,495NET
      INTEREST INCOME
              
              
              6,406,049
              
              
              
              6,242,903Provision
      for Loan and Lease Losses
              
              
              5,055,722
              
              
              
              4,245,000NET
      INTEREST INCOME AFTERPROVISION
      FOR LOAN LOSSES
              
              
              1,350,327
              
              
              
              1,997,903NON-INTEREST
      INCOMEService
      Charges on Deposit Accounts
              
              
              333,583
              
              
              
              350,763Gain
      on Sale of Loans
              
              
              379,186
              
              
              
              186,816Loan
      Servicing Fees, Net of Amortization
              
              
              114,049
              
              
              
              72,519Grants
      and Awards
              
              
              80,948
              
              
              
              -Loss
      on Writedown of Fixed Assets and Other Real Estate
              
              
              (474,565
              )
              
              
              (378,585
              )Gain
      on Sale of Available-For-Sale Securities
              
              
              246,982
              
              
              
              -Other
      Income and Fees
              
              
              153,084
              
              
              
              114,575TOTAL
      NON-INTEREST INCOME
              
              
              833,267
              
              
              
              346,088NON-INTEREST
      EXPENSESalaries
      and Employee Benefits
              
              
              3,816,574
              
              
              
              3,698,559Occupancy
      Expenses
              
              
              1,002,440
              
              
              
              586,435Furniture
      and Equipment
              
              
              456,878
              
              
              
              440,329Data
      Processing
              
              
              740,870
              
              
              
              634,508Professional
      Fees
              
              
              478,353
              
              
              
              420,379Marketing
      and Business Development
              
              
              134,580
              
              
              
              208,621Office
      Supplies and Expenses
              
              
              255,609
              
              
              
              234,266Insurance
      and Regulatory Assessments
              
              
              634,657
              
              
              
              211,000Loan
      and Lease Expenses
              
              
              156,837
              
              
              
              106,115Other
      Expenses
              
              
              598,404
              
              
              
              580,805TOTAL
      NON-INTEREST EXPENSE
              
              
              8,275,202
              
              
              
              7,121,017(LOSS)
      BEFORE INCOME TAXES
              
              
              (6,091,608
              )
              
              
              (4,777,026
              )Income
      Tax Expense (Benefit)
              
              
              834,951
              
              
              
              (928,656
              )NET
      (LOSS)
              
              $
              (6,926,559
              )
              
              $
              (3,848,370
              )Per
      Share Data (Notes A and N):Net
      (Loss) - Basic
              
              $
              (4.87
              )
              
              $
              (3.18
              )Net
      (Loss) - Diluted
              
              $
              (4.87
              )
              
              $
              (3.18
              )
 
  -
53 -
 Table of Contents
  
 MISSION
COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
 Years
Ended December 31, 2009 and 2008
 
 
 AccumulatedAdditional
              
              
              
              
              
              
              
              
              OtherPreferred
              
              
              Common
      Stock
              
              
              Paid-In
              
              
              Comprehensive
              
              
              Retained
              
              
              ComprehensiveStock
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Income
      (Loss)
              
              
              Earnings
              
              
              Income
              
              
              TotalBalance
      atJanuary
      1, 2008
              
              $
              1,083,800
              
              
              
              689,232
              
              
              $
              7,125,819
              
              
              $
              108,340
              
              
              
              
              
              $
              4,712,120
              
              
              $
              108,225
              
              
              $
              13,138,304Exercise
      of stock options,and
      related tax benefitof
      $28,772
              
              
              
              
              
              
              20,700
              
              
              
              235,772
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              235,772Issuance
      of common stockin
      public offering, netof
      offering expenses of $556,413
              
              
              
              
              
              
              410,644
              
              
              
              6,835,179
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              6,835,179Issuance
      of common stockin
      private placement, netof
      offering expenses
              
              
              
              
              
              
              225,026
              
              
              
              3,845,081
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,845,081Stock-based
      compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              63,945
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              63,945Comprehensive
      Income (Loss):Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (3,848,370
              )
              
              
              (3,848,370
              )
              
              
              
              
              
              
              (3,848,370
              )Net
      unrealized gain onavailable-for-sale
      securities,net
      of taxes of $75,207
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              246,912
              
              
              
              
              
              
              
              246,912
              
              
              
              246,912Total
      Comprehensive Loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (3,601,458
              )Balance
      atDecember
      31, 2008
              
              $
              1,083,800
              
              
              
              1,345,602
              
              
              $
              18,041,851
              
              
              $
              172,285
              
              
              
              
              
              
              $
              863,750
              
              
              $
              355,137
              
              
              $
              20,516,823Issuance
      of Series D preferred stockto
      U.S. Treasury under TARP,net
      of issuance costs of $48,278
              
              $
              5,067,722
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              5,067,722TARP
      dividends paid
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (217,430
              )
              
              
              
              
              
              
              (217,430
              )Stock-based
      compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              69,925
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              69,925Comprehensive
      Income (Loss):Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (6,926,559
              )
              
              
              (6,926,559
              )
              
              
              
              
              
              
              (6,926,559
              )Less
      beginning of year unrealizedgain
      on securities sold duringthe
      period, net of taxes of $-0-
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (271,447
              )
              
              
              
              
              
              $
              (271,447
              )
              
              
              (271,447
              )Plus
      net unrealized gain onavailable-for-sale
      securities,net
      of taxes of $-0-
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              398,681
              
              
              
              
              
              
              
              398,681
              
              
              
              398,681Total
      Comprehensive Loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (6,799,325
              )Balance
      atDecember
      31, 2009
              
              $
              6,151,522
              
              
              
              1,345,602
              
              
              $
              18,041,851
              
              
              $
              242,210
              
              
              
              
              
              
              $
              (6,280,239
              )
              
              $
              482,371
              
              
              $
              18,637,715
 
 
  -
54 -
 Table of Contents
  MISSION
COMMUNITY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
Ended December 31, 2009 and 2008
 
 
 2009
              
              
              2008OPERATING
      ACTIVITIESNet
      income (loss)
              
              $
              (6,926,559
              )
              
              $
              (3,848,370
              )Adjustments
      to reconcile net income (loss)to
      net cash provided by (used in) operating activities:Provision
      (credit) for deferred income taxes
              
              
              832,551
              
              
              
              (494,803
              )Depreciation
              
              
              440,940
              
              
              
              347,294Accretion
      of discount on securities and loans, net
              
              
              (136,294
              )
              
              
              (177,922
              )Provision
      for loan losses
              
              
              5,055,722
              
              
              
              4,245,000Provision
      for losses on unfunded loan commitments
              
              
              35,000
              
              
              
              15,000Stock-based
      compensation
              
              
              69,925
              
              
              
              63,945(Gain)
      on sale of securities
              
              
              (246,982
              )
              
              
              -Write-downs
      on other real estate
              
              
              472,019
              
              
              
              -Loss
      on disposal or abandonment of fixed assets
              
              
              2,545
              
              
              
              378,584Gain
      on loan sales
              
              
              (379,186
              )
              
              
              (186,816
              )Proceeds
      from loan sales
              
              
              6,250,455
              
              
              
              6,038,681Loans
      originated for sale
              
              
              (5,780,076
              )
              
              
              (4,026,298
              )Increase
      in company owned life insurance
              
              
              (96,293
              )
              
              
              (94,998
              )Decrease
      (increase) in accrued taxes receivable
              
              
              617,932
              
              
              
              (497,625
              )Other,
      net
              
              
              (308,972
              )
              
              
              342,721NET
      CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
              
              
              (97,273
              )
              
              
              2,104,393INVESTING
      ACTIVITIESNet
      increase in Federal Home Loan Bank and other stock
              
              
              (246,050
              )
              
              
              (651,150
              )Maturity
      (placement) of time deposits in other banks
              
              
              11,285,000
              
              
              
              (11,160,000
              )Purchase
      of available-for-sale securities
              
              
              (34,441,942
              )
              
              
              (14,880,260
              )Proceeds
      from maturities, calls and paydowns of available-for-sale
      securities
              
              
              10,399,966
              
              
              
              7,388,852Proceeds
      from sales of available-for-sale securities
              
              
              9,135,234
              
              
              
              -Net
      decrease (increase) in loans
              
              
              11,819,537
              
              
              
              (30,298,532
              )Purchase
      of company-owned life insurance
              
              
              -
              
              
              
              (404,961
              )Proceeds
      from sale of fixed assets
              
              
              -
              
              
              
              4,708Purchases
      of premises and equipment
              
              
              (1,099,299
              )
              
              
              (692,082
              )NET
      CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
              
              
              6,852,446
              
              
              
              (50,693,425
              )FINANCING
      ACTIVITIESNet
      increase (decrease) in demand deposits and savings
accounts
              
              
              23,289,704
              
              
              
              (324,416
              )Net
      increase (decrease) in time deposits
              
              
              (4,324,065
              )
              
              
              32,695,018Net
      increase (decrease) in other borrowings
              
              
              (39,700,000
              )
              
              
              17,500,000Proceeds
      from issuance of common stock
              
              
              -
              
              
              
              10,916,032Proceeds
      from issuance of preferred stock
              
              
              5,116,000
              
              
              
              -Preferred
      stock issuance costs
              
              
              (48,278
              )
              
              
              -Payment
      of dividends
              
              
              (217,430
              )
              
              
              -NET
      CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
              
              
              (15,884,069
              )
              
              
              60,786,634NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              
              (9,128,896
              )
              
              
              12,197,602Cash
      and cash equivalents at beginning of year
              
              
              17,724,306
              
              
              
              5,526,704CASH
      AND CASH EQUIVALENTS AT END OF YEAR
              
              $
              8,595,410
              
              
              $
              17,724,306Supplemental
      disclosures of cash flow information:Interest
      paid
              
              $
              4,039,470
              
              
              $
              4,708,982Taxes
      paid (refunds received)
              
              
              (615,532
              )
              
              
              35,000Supplemental
      schedule of non-cash investing activities:Real
      estate acquired by foreclosure
              
              $
              1,694,801
              
              
              $
              83,100
 
  The
accompanying notes are an integral part of these consolidated financial
statements.
 -
55 -
 Table of Contents
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Principles of
Consolidation
 
 The
financial statements include the accounts of Mission Community Bancorp
(“Bancorp”) and its subsidiary, Mission Community Bank (“the Bank”), and the
Bank’s subsidiary, Mission Community Development Corporation, collectively
referred to herein as “the Company.”  All significant intercompany
transactions have been eliminated.
 
 Nature of
Operations
 
 The Bank
has been organized as a single reporting segment and operates four branches in
the Central Coast area of California (in the cities of San Luis Obispo, Paso
Robles, Arroyo Grande and Santa Maria).
 
 The
Bank’s primary source of revenue is providing real estate, commercial (including
Small Business Administration (“SBA”) guaranteed loans) and consumer loans to
customers, who are predominately small and middle-market businesses and
individuals.  The Company and the Bank are certified by the Department
of Treasury as Community Development Financial Institution(s) (“CDFI”) with a
commitment to focus on providing financial services to low- and moderate-income
communities.
 
 Mission Community
Development Corporation
 
 Mission
Community Development Corporation (“MCDC”) is a community development
corporation which provides financing for small businesses and projects in low-
to moderate-income areas.  The Board of Directors of Mission Community
Development Corporation consists of all members of the Board of Directors of the
Company. Community development investment is limited to 5% of the Bank’s capital
and up to 10% with prior approval by the Federal Reserve
Board.  Operations of MCDC were not material for the years ended
December 31, 2009 or 2008.
 
 Mission Community Services
Corporation
 
 Mission
Community Services Corporation (“MCSC”), an affiliate organization, was
organized in 1998 and the corporation was established as a not-for-profit
company with Section 501(c)(3) status.  This company’s primary focus
is to provide technical support and training services to the underserved
segments of the community including small businesses, minorities and low-income
entrepreneurs.  The Board of Directors of Mission Community Services
Corporation includes two representatives from the Company, together with members
representing the communities represented.  The accounts of MCSC are
not included in the Company’s consolidated financial statements.  See
Note L for additional information regarding MCSC.
 
 Use of Estimates in the
Preparation of Financial Statements
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ from those
estimates.
  -
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 Table of Contents
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Cash and Cash
Equivalents
 
 For
purposes of reporting cash flows, cash and cash equivalents include cash,
amounts due from other banks and federal funds sold.  Generally,
federal funds are sold for one-day periods.
 
 Cash and Due From
Banks
 
 Banking
regulations require that all banks maintain a percentage of their deposits as
reserves in cash or on deposit with the Federal Reserve Bank
(“FRB”).  The Bank was in compliance with this requirement, which was
$917,000 as of December 31, 2009.
 
 The
Company maintains amounts due from other banks which exceed federally insured
limits.  The Company has not experienced any losses in such
accounts.
 
 Investment
Securities
 
 Bonds,
notes, and debentures for which the Company has the positive intent and ability
to hold to maturity are reported at cost, adjusted for premiums and discounts
that are recognized in interest income using the interest method over the period
to maturity.
 
 Investments
not classified as trading securities nor as held-to-maturity securities are
classified as available-for-sale securities and recorded at fair
value.  Unrealized gains or losses on available-for-sale securities
are excluded from net income and reported net of taxes as a separate component
of comprehensive income, which is included in shareholders’
equity.  Premiums or discounts are amortized or accreted into income
using the interest method.  Realized gains or losses on sales of
securities are recorded using the specific identification method.
 
 Other-than-temporary
declines in the fair value of individual held-to-maturity and available-for-sale
securities below their cost result in write-downs of the individual securities
to their fair value.  The amount of impairment related to credit
losses is reflected as a charge to earnings, while the amount deemed to be
related to other factors is reflected as an adjustment to shareholders’ equity
through other comprehensive income.  In estimating
other-than-temporary impairment (“OTTI”) losses, management considers the length
of time and the extent to which the fair value has been less than cost, the
financial condition and near-term prospects of the issuer, and the intent and
ability of the Bank to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair
value.  Management evaluates securities for OTTI on at least a
quarterly basis, and more frequently when economic or market conditions
warrant.
 
  -
57 -
 Table of Contents
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Loans
 
 Loans are
reported at the principal amount outstanding, net of any deferred loan
origination fee income and deferred direct loan origination costs, and net of
any unearned interest on discounted loans.  Deferred loan origination
fee income and direct loan origination costs are amortized to interest income
over the life of the loan using the interest method.  Interest on
loans is accrued to income daily based upon the outstanding principal
balances.
 
 Loans for
which the accrual of interest has been discontinued are designated as
non-accrual loans.  Loans are classified as non-accrual when principal
or interest is past due 90 days or more based on the contractual terms of the
loan or when, in the opinion of management, there exists a reasonable doubt as
to the full and timely collection of either principal or interest, unless the
loan is well secured and in the process of collection.  Income on such
loans is then only recognized to the extent that cash is received and where the
future collection of principal is probable.  Accrual of interest is
resumed only when principal and interest are brought fully current and when such
loans are considered to be collectible as to both principal and
interest.
 
 The Bank
considers a loan to be impaired when it is probably that the Bank will be unable
to collect all amounts due (principal and interest) according to the contractual
terms of the loan agreement.  Loans for which the terms have been
modified, and for which the borrower is experiencing financial difficulties, are
considered troubled debt restructurings.  Both non-accrual loans and
troubled debt restructurings are generally considered to be
impaired.  Impairment is measured based on the expected future cash
flows of an impaired loan, which are to be discounted at the loan’s effective
interest rate, or measured by reference to an observable market value, if one
exists, or the fair value of the collateral for a collateral-dependent
loan.  The Bank selects the measurement method on a loan-by-loan basis
except that collateral-dependent loans for which foreclosure is probable are
measured at the fair value of the collateral.  The change in the
amount of impairment is reported as either an increase or decrease in the
provision for credit losses that otherwise would be reported.
 
 Loans Held for
Sale
 
 SBA loans
originated and intended for sale in the secondary market are carried at the
lower of cost or estimated market value in the aggregate.  Net
unrealized losses are recognized through a valuation allowance by charges to
income.  Gains or losses realized on the sales of loans are recognized
at the time of sale and are determined by the difference between the net sales
proceeds and the carrying value of the loans sold, adjusted for the relative
fair value of any servicing asset or liability.  Gains and losses on
sales of loans are included in non-interest income.
 
 The Bank
has adopted accounting standards issued by the Financial Accounting Standards
Board (“FASB”) that provide accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of
liabilities.  Under these standards, after a transfer of financial
assets, an entity recognizes the financial and servicing assets it controls and
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished.
 
  -
58 -
 Table of Contents
  NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Allowance for Loan
Losses
 
 The
allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries).  Charge-offs are loans and leases, or
portions of loans, deemed uncollect­ible and which are charged to the
allowance.  Management performs, at least quarterly, an analysis of
the allowance for loan losses to determine its adequacy.  In this
analysis, all loans are segmented into components by loan type and internal risk
rating.  Estimated loss factors are applied to each loan pool based on
historical losses as well as management’s assessment of current factors that may
impact these historical factors, such as changes in the local economy, changes
in underwriting standards, changes in loans concentrations and trends in past
due and non-performing loans.  Significant loans considered impaired
by management, the Bank’s regulators or external credit review consultants are
evaluated separately in the process.  In this evaluation, management
reviews the borrower’s ability to repay as well as the estimated value of any
underlying collateral.
 
 Federal Home Loan Bank
(FHLB) Stock
 
 The Bank
is a member of the Federal Home Loan Bank system.  Members are
required to own a certain amount of FHLB stock based on the level of borrowings
and other factors, and may invest additional amounts.  FHLB stock is
carried at cost, classified as a restricted security, and periodically evaluated
for impairment based on the ultimate recovery of par value. Both cash and stock
dividends are reported as income.
 
 Premises and
Equipment
 
 Land is
carried at cost.  Premises and equipment are carried at cost less
accumulated depreciation and amortization.  Depreciation is computed
using the straight-line method over the estimated useful lives, which range from
three to ten years for furniture and fixtures and forty years for
buildings.  Leasehold improvements are amortized using the
straight-line method over the estimated useful lives of the improvements or the
remaining lease term, whichever is shorter.  Expenditures for
betterments or major repairs are capitalized and those for ordinary repairs and
maintenance are charged to operations as incurred.
 
 Other Real Estate
Owned
 
 Real
estate acquired by foreclosure or deed in lieu of foreclosure is recorded at
fair value at the date of foreclosure, establishing a new cost basis by a charge
to the allowance for loan loss, if necessary.  Other real estate owned
is carried at the lower of the Bank’s cost basis or fair value, less estimated
costs of disposition.  Fair value is based on current appraisals less
estimated selling costs.  Any subsequent write-downs are charged
against operating expenses and recognized as a valuation
allowance.  Operating expenses of such properties, net of related
income, and gains and losses on their disposition are included in other
operating expenses.
 
 Company Owned Life
Insurance
 
 Company
owned life insurance is recorded at the amount that can be realized under the
insurance contract at the balance sheet date, which is the cash surrender value
adjusted for other charges or amounts due that are probable at
settlement.
 
  -
59 -
 Table of Contents
  
 NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 Advertising
Costs
 
 The Bank
expenses the costs of advertising in the period incurred.
 
 Income
Taxes
 
 Deferred
tax assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled.  As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.  To the extent that evidence indicates
deferred tax assets might not be realizable, through probable future taxable
income or carry-backs to prior years, a deferred tax valuation allowance is
provided.  The Company classifies any interest or penalties related to
income taxes as a part of income tax expense when incurred.  No such
interest or penalties were incurred for in 2008 or 2009.
 
 The
Company has adopted guidance issued by the FASB that clarifies the accounting
for uncertainty in tax positions taken or expected to be taken on a tax return
and provides that the tax effects from an uncertain tax position can be
recognized in the financial statements only if, based on its merits, the
position is more likely than not to be sustained on audit by the taxing
authorities.  Any interest and penalties related to uncertain tax
positions would be recorded as part of income tax expense.
 
 Comprehensive
Income
 
 Changes
in unrealized gain or loss on available-for-sale securities net of income taxes
is the only component of accumulated other comprehensive income for the
Company.
 
 
 Financial
Instruments
 
 In the
ordinary course of business, the Company has entered into off-balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit and standby letters of credit.  Such financial
instruments are recorded in the financial statements when they are funded or
related fees are incurred or received.
 
 Earnings Per Share
(“EPS”)
 
 EPS is
computed under FASB and Emerging Issues Task Force (“EITF”) guidance that
requires income per share for the Company’s common stock be calculated assuming
100% of the Company’s earnings are distributed as dividends to its common and
preferred shareholders based on their respective dividend rights, even though
the Company does not anticipate distributing 100% of its earnings as
dividends.   Basic EPS is computed by dividing the resulting
income available to common shareholders by the weighted-average number of common
shares outstanding for the period.  Diluted EPS reflects the potential
dilution that could occur if options or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the Company, if the result is
more dilutive than basic EPS.
 
  -
60 -
 Table of Contents
  
 NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 Stock-Based
Compensation
 
 The cost
of equity-based compensation arrangements, including employee stock options, is
recognized based on the grant-date fair value of those awards, over the period
which an employee is required to provide services in exchange for the award,
generally the vesting period.  The fair value of each grant is
estimated using the Black-Scholes option pricing model.
 
 Fair Value
Measurement
 
 Fair
value is the exchange price that would be received for an asset or paid to
transfer a liability (an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants on the measurement date. Current accounting guidance establishes a
fair value hierarchy, which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair
value.  The guidance describes three levels of inputs that may be used
to measure fair value:
 
 Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement
date.
 
 Level 2:
Significant other observable inputs other than Level 1 prices such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable
market data.
 
 Level 3:
Significant unobservable inputs that reflect the Company’s own assumptions about
the assumptions that market participants would use in pricing an asset or
liability.
 
 See Note
R for more information and disclosures relating to the Company’s fair value
measurements.
 
 Adoption of New Accounting
Standards
 
 Subsequent
Events
 In May
2009, the FASB issued guidance (“ASC 855”) which requires the effects of events
that occur subsequent to the balance sheet date be evaluated through the date
the financial statements are either issued or available to be
issued.  Entities are to disclose the date through which subsequent
events have been evaluated and whether that date is the date the financial
statements were issued or the date the financial statements were available to be
issued.  Entities are required to reflect in their financial
statements the effects of subsequent events that provide additional evidence
about conditions that existed at the balance-sheet date (recognized subsequent
events).  Entities are also prohibited from reflecting in their
financial statements the effects of subsequent events that provide evidence
about conditions that arose after the balance-sheet date (non-recognized
subsequent events), but requires information about those events to be disclosed
if the financial statements would otherwise be misleading.  This
guidance was effective for annual financial periods ended after June 15, 2009
with prospective application.   In February 2010, the FASB issued
ASU 2010-09, Subsequent Events (“ASU 2010-09”), effective immediately, which
amends ASC 855 to clarify that an SEC filer is not required to disclose the date
through which subsequent events have been evaluated in the financial statements.
The adoption of ASU 2010-09 did not have a material effect on the Company’s
consolidated results of operations or consolidated financial
position.
 
  -
61 -
 Table of Contents
  
 NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles
 In June
2009, accounting standards were revised to establish the Accounting Standards
Codification (the “Codification”) as the source of authoritative accounting
principles recognized by the FASB to be applied by nongovernmental entities in
the preparation of financial statements in conformity with Generally Accepted
Accounting Principles (“GAAP”).  The Codification does not change
current GAAP, but is intended to simplify user access to all authoritative GAAP
by providing all the authoritative literature related to a particular topic in
one place.  The Codification is effective for annual periods ended
after September 15, 2009, and as of the effective date, all existing accounting
standard documents were superseded.  Adoption of the Codification in
2009 did not have a material impact on the Company’s financial
statements.
 
 Fair
Value Measurements
 In April
2009, accounting standards were amended to provide additional guidance for
determining the fair value of a financial asset or financial liability when the
volume and level of activity for such asset or liability decreased significantly
and also to provide guidance for determining whether a transaction is
orderly.  The amendments were effective for annual reporting periods
ended after June 15, 2009.  Adoption of the amendments in 2009 did not
have a material impact on the Company’s financial statements.
 
 In
February 2008, the FASB issued instructions that delayed the effective date of
fair value measurement for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value on a
recurring basis (at least annually) for fiscal years beginning after November
15, 2008.  Adoption of the fair value measurement rules in 2009 for
non-financial assets and non-financial liabilities subject to the delay did not
have a material impact on Company’s financial statements.
 
 Other-Than-Temporary
Impairment
 In April
2009, accounting standards were amended to provide expanded guidance concerning
the recognition and measurement of other-than-temporary impairments (OTTI) of
debt securities classified as available for sale or held to
maturity.  The amendments require an entity to recognize in earnings
the credit component of an OTTI of a debt security.  The non-credit
component of the OTTI would be recognized in other comprehensive income when the
entity does not intend to sell the security and it is more likely than not that
the entity will not be required to sell the security prior to
recovery.  Expanded disclosures are also required concerning such
impairments.  The amendments were effective for annual reporting
periods ended after June 15, 2009.  Adoption of the amendments in 2009
did not have a material impact on the Company’s financial
statements.
 
 New Pronouncements Not Yet
Adopted
 
 Loan
Sales
 In June
2009, the FASB issued a revision to its guidance on accounting for transfers of
financial assets (ASC 860).  The new guidance establishes more
stringent requirements for derecognition of a portion of a financial asset and
creates new conditions for reporting the transfer of a portion of a financial
asset as a sale.
 
 Terms of
the Bank’s SBA loan sales typically provide for limited recourse if the borrower
defaults on any of the first three payments after the sale.  The
revised guidance would not permit a loan transfer to the buyer to be recognized
as a sale until that recourse period has expired, which would result in
a  delay of approximately three months in recognizing gains on most
sales of SBA loans beginning January 1, 2010, the date the Company will adopt
the new guidance.
 
  -
62 -
 Table of Contents
  NOTE
B - INVESTMENT SECURITIES
 
 Investment
securities have been classified in the consolidated balance sheets according to
management's intent.  The amortized cost of securities and their
approximate fair values at December 31 were as follows:
 
 Gross
              
              
              Gross
              
              
              EstimatedAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              MarketCost
              
              
              Gains
              
              
              Losses
              
              
              ValueSecurities
      Available for Sale:December
      31, 2009:U.S.
      Government agencies
              
              $
              15,442,231
              
              
              $
              40,425
              
              
              $
              (14,139
              )
              
              $
              15,468,517Mortgage-backed
      securities
              
              
              16,631,325
              
              
              
              243,491
              
              
              
              (40,158
              )
              
              
              16,834,658Municipal
      securities
              
              
              2,917,693
              
              
              
              61,066
              
              
              
              (5,235
              )
              
              
              2,973,524Corporate
      debt securities
              
              
              2,840,493
              
              
              
              147,297
              
              
              
              -
              
              
              
              2,987,790Asset-backed
      securities
              
              
              1,828,299
              
              
              
              49,624
              
              
              
              -
              
              
              
              1,877,923$
              39,660,041
              
              
              $
              541,903
              
              
              $
              (59,532
              )
              
              $
              40,142,412December
      31, 2008:U.S.
      Government agencies
              
              $
              3,500,000
              
              
              $
              70,155
              
              
              $
              -
              
              
              $
              3,570,155Mortgage-backed
      securities
              
              
              15,972,382
              
              
              
              459,930
              
              
              
              (24,700
              )
              
              
              16,407,612Municipal
      securities
              
              
              3,581,152
              
              
              
              -
              
              
              
              (146,784
              )
              
              
              3,434,368Asset-backed
      securities
              
              
              1,437,168
              
              
              
              14,372
              
              
              
              (17,836
              )
              
              
              1,433,704$
              24,490,702
              
              
              $
              544,457
              
              
              $
              (189,320
              )
              
              $
              24,845,839
 
 During
2004, one of the Bank’s asset-backed securities was identified as “other than
temporarily impaired,” and a loss reserve was established for this
security.  The security is in non-accrual status, with any interest
payments received being credited to the reserve.  As of December 31,
2009, the gross book value of the security was $301,000 and the reserve was
$292,000, for a net book value of $9,000.  Management estimates that
the fair value of this security is approximately equal to the $9,000 net book
value.
 
 The
scheduled maturities of investment securities at December 31, 2009, were as
follows.  Actual maturities may differ from contractual maturities
because some investment securities may allow the right to call or prepay the
obligation with or without call or prepayment penalties.
 
 
 Available-for-Sale
      SecuritiesAmortized
              
              
              FairCost
              
              
              ValueWithin
      one year
              
              $
              1,704,346
              
              
              $
              1,747,982Due
      in one year to five years
              
              
              16,341,495
              
              
              
              16,472,699Due
      in five years to ten years
              
              
              9,174,310
              
              
              
              9,249,599Due
      in greater than ten years
              
              
              12,439,890
              
              
              
              12,672,132$
              39,660,041
              
              
              $
              40,142,412
 
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63 -
 Table of Contents
  NOTE
B - INVESTMENT SECURITIES – Continued
 
 Included
in accumulated other comprehensive income at December 31, 2009 were net
unrealized gains on investment securities available for sale of
$482,371.  At December 31, 2008, accumulated other comprehensive
income included net unrealized gains on available-for-sale securities of
$355,137.  No deduction was made for income taxes on net unrealized
gains as of December 31, 2009 or 2008.  During 2009, the Bank sold
$9,135,234 of investment securities for net gains of $246,982.  No
securities were sold in 2008.
 
 Investment
securities in a temporary unrealized loss position as of December 31, 2009 and
2008 are shown in the following table, based on the length of time they have
been continuously in an unrealized loss position:
 
 Less
      than 12 Months
              
              
              12
      Months or Longer
              
              
              TotalFair
              
              
              Unrealized
              
              
              Fair
              
              
              Unrealized
              
              
              Fair
              
              
              UnrealizedValue
              
              
              Losses
              
              
              Value
              
              
              Losses
              
              
              Value
              
              
              LossesDecember
      31, 2009:U.S.
      Government agencies
              
              $
              4,420,862
              
              
              $
              14,139
              
              
              $
              -
              
              
              $
              -
              
              
              $
              4,420,862
              
              
              $
              14,139Mortgage-backed
      securities
              
              
              5,712,226
              
              
              
              40,158
              
              
              
              -
              
              
              
              -
              
              
              
              5,712,226
              
              
              
              40,158Municipal
      securities
              
              
              875,414
              
              
              
              5,235
              
              
              
              -
              
              
              
              -
              
              
              
              875,414
              
              
              
              5,235Corporate
      debt securities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Asset-backed
      securities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -$
              11,008,502
              
              
              $
              59,532
              
              
              $
              -
              
              
              $
              -
              
              
              $
              11,008,502
              
              
              $
              59,532December
      31, 2008:U.S.
      Government agencies
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -Mortgage-backed
      securities
              
              
              1,720,805
              
              
              
              24,700
              
              
              
              -
              
              
              
              -
              
              
              
              1,720,805
              
              
              
              24,700Municipal
      securities
              
              
              3,434,368
              
              
              
              146,784
              
              
              
              -
              
              
              
              -
              
              
              
              3,434,368
              
              
              
              146,784Asset-backed
      securities
              
              
              440,060
              
              
              
              6,439
              
              
              
              80,110
              
              
              
              11,397
              
              
              
              520,170
              
              
              
              17,836$
              5,595,233
              
              
              $
              177,923
              
              
              $
              80,110
              
              
              $
              11,397
              
              
              $
              5,675,343
              
              
              $
              189,320
 
 As of
December 31, 2009, ten securities have been in an unrealized loss position for
less than one year.  No securities have been in an unrealized loss
position for one year or longer as of December 31, 2009.  Other than
the one impaired asset-backed security footnoted above, none of the Bank’s
securities has exhibited a decline in value as a result of changes in credit
risk.
 
 Investments
securities carried at $5,133,000 and $5,121,000 as of December 31, 2009 and
2008, respectively, were pledged to secure public deposits as required by
law.  As of December 31, 2009, securities carried at $6,798,000 were
pledged to secure borrowings from the Federal Home Loan Bank of San Francisco,
as described in Note F.
 
  
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 Table of Contents
  
 NOTE
C - LOANS
 
 The
Bank’s loan portfolio consists primarily of loans to borrowers within the
Central Coast area of California.  Although the Bank seeks to avoid
concentrations of loans to a single industry or based upon a single class of
collateral, real estate and real estate associated businesses are among the
principal industries in the Bank’s market area and, as a result, the Bank’s loan
and collateral portfolios are concentrated in those industries and in that
geographic area.  As of December 31, 2009, 66% of the loan portfolio
was secured by commercial real estate (including construction and land
development loans as well as loans secured by non-farm, non-residential and
multi-family residential properties).  Under guidelines for commercial
real estate (“CRE”) lending issued by the bank regulatory agencies in 2006,
which generally excludes owner-occupied properties from the definition of
commercial real estate, CRE loans represented 38% of the loan portfolio as of
December 31, 2009.
 
 Included
in total loans are deferred loan fees (net of deferred loan origination costs)
of $21,000 and $67,000 at December 31, 2009 and 2008,
respectively.  As of December 31, 2009, loans totaling $114,308,000
were pledged to secure borrowings and potential borrowings from the Federal Home
Loan Bank of San Francisco and the Federal Reserve Bank of San Francisco, as
described in Note F.
 
 
 The
following is a summary of the investment in impaired loans as of December 31,
including the related allowance for loan losses and cash-basis income
recognized.  Also shown are loans on non-accrual and those that are
past due and still accruing interest:
 
 2009
              
              
              2008Impaired
      Loans:Impaired
      Loans With a Related Allowance for Loan Losses
              
              $
              672,355
              
              
              $
              4,513,760Impaired
      Loans With No Related Allowance for Loan Losses
              
              
              5,721,257
              
              
              
              3,970,355Total
      impaired loans
              
              $
              6,393,612
              
              
              $
              8,484,115Related
      Allowance for Loan Losses
              
              $
              66,821
              
              
              $
              1,342,312Average
      Recorded Investment in Impaired Loans
              
              
              6,312,843
              
              
              
              4,948,951Interest
      Income Recognized for Cash Payments While Impaired
              
              
              184,492
              
              
              
              243,479Total
      Loans on Non-accrual
              
              
              5,891,045
              
              
              
              3,556,660Total
      Loans Past Due 90 Days or More and Still Accruing
              
              
              -
              
              
              
              265,174
 
 
 The Bank
has no commitments to lend additional funds to customers with loans classified
as troubled debt restructurings.
 
 Following
is a summary of the changes in the allowance for possible loan and lease losses
for the years ended December 31:
 
 2009
              
              
              2008Balance
      at Beginning of Year
              
              $
              3,942,220
              
              
              $
              1,149,874Additions
      to the Allowance Charged to Expense
              
              
              5,055,722
              
              
              
              4,245,000Less
      Loans Charged Off
              
              
              (3,504,436
              )
              
              
              (1,478,652
              )Plus
      Recoveries on Loans Previously Charged Off
              
              
              43,423
              
              
              
              25,998Balance
      at End of Year
              
              $
              5,536,929
              
              
              $
              3,942,220
 
  -
65 -
 Table of Contents
  
 NOTE
C - LOANS - Continued
 
 The Bank
also originates SBA-guaranteed loans for sale to institutional
investors.  At December 31, 2009 and 2008 the Bank was servicing
$26,879,000 and $23,229,000, respectively, in loans previously sold or
participated.  The Bank has recorded servicing assets related to these
sold loans of approximately $197,000 and $187,000 at December 31, 2009 and 2008,
respectively.  In calculating the gain on sale of SBA loans and the
related servicing asset, the Bank used the following assumptions for sales
recorded in 2009:
 
 Range                                       Weighted
Average
 Discount
Rate                                                    5.75%
to
8.25%                                                        6.23%
 Estimated
Life                                                        48
months                                                48
months
 
 Management
performs an analysis each quarter to reassess these assumptions, which are
significant determinants on the value ascribed to the servicing
asset.  Following is a summary of the changes in the balance of the
SBA loan servicing asset for 2009 and 2008:
 
 2009
              
              
              2008Balance
      at Beginning of Year
              
              $
              187,388
              
              
              $
              252,572Additions
      to the Asset
              
              
              104,979
              
              
              
              71,425Less
      amortization
              
              
              (95,271
              )
              
              
              (136,609
              )Balance
      at End of Year
              
              $
              197,096
              
              
              $
              187,388
 
 The
estimated fair value of the servicing assets approximated the carrying amount at
December 31, 2009 and 2008.  These assets are included in accrued
interest and other assets in the consolidated balance
sheets.  Amortization of these assets is netted against loan servicing
fees in the consolidated statements of income.
 
 
 NOTE
D - PREMISES AND EQUIPMENT AND OTHER REAL ESTATE OWNED
 
 A summary
of premises and equipment as of December 31 follows:
 
 2009
              
              
              2008Land
              
              $
              976,498
              
              
              $
              976,498Buildings
              
              
              766,943
              
              
              
              796,633Leasehold
      Improvements
              
              
              1,312,691
              
              
              
              671,142Furniture,
      Fixtures, and Equipment
              
              
              2,942,724
              
              
              
              2,482,9045,998,856
              
              
              
              4,927,177Accumulated
      Depreciation and Amortization
              
              
              (2,744,345
              )
              
              
              (2,328,480
              )Net
      Premises and Equipment
              
              $
              3,254,511
              
              
              $
              2,598,697
 
 The Bank
has entered into operating leases for its branches and operating facilities,
which expire at various dates through 2024.  These leases include
provisions for periodic rent increases as well as payment by the lessee of
certain operating expenses.  Rental expense relating to these leases
was $676,000 in 2009 and $357,000 in 2008.
 
  -
66 -
 Table of Contents
  
 NOTE
D - PREMISES AND EQUIPMENT AND OTHER REAL ESTATE OWNED - continued
 
 At
December 31, 2009, the approximate future minimum annual payments under these
leases for the next five years are as follows:
 
 2010
              
              $
              687,0922011
              
              
              662,4242012
              
              
              681,5612013
              
              
              569,3092014
              
              
              519,634Later
      years
              
              
              5,844,755$
              8,964,775
 
 The
minimum rental payments shown above are given for the existing lease obligations
only and do not represent a forecast of future rents.  Future
increases in rent are not included unless the increases are scheduled and
currently determinable.
 
 Included
in the above table are obligations under a 15-year lease for an administrative
office in San Luis Obispo, California, in which the Bank also intends to open a
full-service branch at a future date.  Currently the lease provides
for rentals of $38,000 per month.
 
 In March
2008, the Bank entered into a 5-year lease for an office building in Santa
Maria, California, where the Bank opened a full-service branch office in
December 2008.  The current rental cost is $8,939 per
month.  The lease provides for two 5-year renewal options and an
option to purchase the property for a specified amount during the last two
months of 2010.
 
 Following
is a summary of the changes in the balance of other real estate owned for 2009
and 2008:
 
 2009
              
              
              2008Balance
      at Beginning of Year
              
              $
              83,100
              
              
              $
              -Real
      Estate Reclassified from Premises and Equipment
              
              
              -
              
              
              
              1,194,509Write-down
      of Real Estate Reclassified from Premises and Equipment
              
              
              (335,000
              )
              
              
              (294,509
              )Real
      Estate Acquired by Foreclosure
              
              
              1,694,802
              
              
              
              83,100Write-downs
      of Real Estate Acquired by Foreclosure
              
              
              (137,020
              )
              
              
              -Balance
      at End of Year
              
              $
              2,205,882
              
              
              $
              983,100
 
 
 NOTE
E - DEPOSITS
 
 At
December 31, 2009, the scheduled maturities of time deposits are as
follows:
 
 
 Due
      in One Year
              
              $
              74,777,265Due
      in One to Two Years
              
              
              9,723,216Due
      in Two to Three Years
              
              
              509,173$
              85,009,654
 
 Fifteen
customer relationships comprised $56.9 million, or 34.8%, of the Bank’s total
deposits as of December 31, 2009.
 
  -
67 -
 Table of Contents
  NOTE
F - OTHER BORROWINGS
 
 Other
borrowings at December 31, 2009, comprised of fixed rate advances from the
Federal Home Loan Bank of San Francisco, are scheduled to mature as
follows:
 
  
 Maturity
                Date
              
              Interest
                Rate
              
              
              AmountMay
      24, 2010
              
              
              5.13
              %
              
              $
              3,000,000November
      19, 2013
              
              
              4.82
              %
              
              
              1,000,000December
      11, 2013
              
              
              4.98
              %
              
              
              1,000,000December
      16, 2013
              
              
              4.88
              %
              
              
              1,000,000$
              6,000,000
 
 These
advances are secured by loans of approximately $86 million and securities of
approximately $7 million.  Utilizing that collateral, the Bank had the
capability to borrow an additional $32.6 million from the Federal Home Loan Bank
of San Francisco as of December 31, 2009.  That borrowing capacity
could be increased by another $15.1 million if additional securities were
pledged as collateral.
 
 As of
December 31, 2009, the Bank had access to the Federal Reserve Bank of San
Francisco’s (“FRB-SF”) “Discount Window” for additional secured borrowing should
the need arise.  As of that date, the Bank had pledged $29.4 million
of its loan portfolio to the FRB-SF, which provided the Bank with $10.8 million
in additional short-term borrowing capacity.  Effective January 15,
2010, this discount window facility became available only to the extent of
securities and/or loans which the Bank might place in safekeeping at
FRB-SF.  On that date, no securities or loans were held in safekeeping
at FRB-SF.
 
 The Bank
also has a $4.0 million unsecured borrowing line with a correspondent
bank.  As of December 31, 2009, there was no balance outstanding on
this line.
 
 
 NOTE
G - JUNIOR SUBORDINATED DEBT SECURITIES
 
 On
October 14, 2003, the Company issued $3,093,000 of junior subordinated debt
securities (the “debt securities”) to Mission Community Capital Trust, a
statutory trust created under the laws of the State of
Delaware.  These debt securities are subordinated to effectively all
borrowings of the Company and are due and payable on October 7,
2033.  Interest is payable quarterly on these debt securities at 3-mo.
LIBOR plus 2.95% for an effective rate of 3.23% as of December 31,
2009.  The debt securities can be redeemed at par.
 
 The
Company also purchased a 3% minority interest in Mission Community Capital
Trust. The balance of the equity of Mission Community Capital Trust is comprised
of mandatorilyredeemable preferred securities.Mission Community Capital Trust is not
consolidated into the Company’s financial statements.  The Federal
Reserve Board has ruled that subordinated notes payable to unconsolidated
special purpose entities (“SPE’s”) such as Mission Community Capital Trust, net
of the bank holding company’s investment in the SPE, qualify as Tier 1 Capital,
subject to certain limits.
 
  -
68 -
 Table of Contents
  NOTE
H - INCOME TAXES
 
 The
income tax expense (benefit) for the years ended December 31, 2009 and 2008 is
comprised of the following:
 
 
 2009
              
              
              2008Current
      Taxes:Federal
              
              $
              -
              
              
              $
              (436,253
              )State
              
              
              2,400
              
              
              
              2,4002,400
              
              
              
              (433,853
              )Deferred
              
              
              (2,615,033
              )
              
              
              (1,620,688
              )Change
      in Valuation Allowance
              
              
              3,447,584
              
              
              
              1,125,885Income
      Tax Expense(Benefit)
              
              $
              834,951
              
              
              $
              (928,656
              )
 
 
 A
comparison of the federal statutory income tax rates to the Company’s effective
income tax (benefit) follows:
 
 2009
              
              
              2008Amount
              
              
              Rate
              
              
              Amount
              
              
              RateFederal
      Tax Rate
              
              $
              (2,071,147
              )
              
              
              34.0
              %
              
              $
              (1,624,189
              )
              
              
              34.0
              %California
      Franchise Taxes, Netof
      Federal Tax Benefit
              
              
              (439,100
              )
              
              
              9.2
              %
              
              
              (344,040
              )
              
              
              7.2
              %Allowance
      for Deferred Tax Assets
              
              
              3,447,584
              
              
              
              (72.2
              )%
              
              
              1,125,885
              
              
              
              (23.6
              )%Interest
      on Municipal Securities and Loans
              
              
              (90,654
              )
              
              
              1.9
              %
              
              
              (90,220
              )
              
              
              1.9
              %Increase
      in Cash Surrender Valueof
      Company-Owned Life Insurance
              
              
              (32,740
              )
              
              
              0.7
              %
              
              
              (32,299
              )
              
              
              0.7
              %Other
      Items - Net
              
              
              21,008
              
              
              
              (0.4
              )%
              
              
              36,207
              
              
              
              (0.8
              )%Income
      Tax Expense(Benefit)
              
              $
              834,951
              
              
              
              (26.8
              )%
              
              $
              (928,656
              )
              
              
              19.4
              %
 
 Deferred
taxes are a result of differences between income tax accounting and generally
accepted accounting principles with respect to income and expense
recognition.
  -
69 -
 Table of Contents
  NOTE
H - INCOME TAXES - Continued
 
 The
following is a summary of the components of the net deferred tax asset
(liability) accounts recognized in the accompanying consolidated balance
sheets:
 
 2009
              
              
              2008Deferred
      Tax Assets:Allowance
      for Loan Losses Due to Tax Limitations
              
              $
              1,904,860
              
              
              $
              1,476,622Reserve
      for Impaired Security
              
              
              120,100
              
              
              
              113,815Other
      Real Estate Owned
              
              
              388,514
              
              
              
              121,203Interest
      on Non-Accrual Loans
              
              
              1,705
              
              
              
              26,417Net
      Operating Loss Carryforwards
              
              
              2,311,916
              
              
              
              525,724Charitable
      Contributions Carryforwards
              
              
              86,161
              
              
              
              80,700Other
              
              
              179,674
              
              
              
              79,249Total
      Deferred Tax Assets
              
              
              4,992,930
              
              
              
              2,423,730Deferred
      Tax Valuation Allowance
              
              
              (4,573,469
              )
              
              
              (1,125,885
              )Deferred
      Tax Liabilities:Deferred
      Loan Costs
              
              
              (210,697
              )
              
              
              (215,485
              )Depreciation
      Differences
              
              
              (125,645
              )
              
              
              (167,282
              )Other
              
              
              (83,119
              )
              
              
              (83,117
              )Total
      Deferred Tax Liabilities
              
              
              (419,461
              )
              
              
              (465,884
              )Net
      Deferred Tax Assets
              
              $
              -
              
              
              $
              831,961
 
 The
valuation allowance was established because the Company’s losses in 2008 and
2009 exceeded its ability to fully recognize deferred tax assets by carrying the
loss back to previous tax years.  The Company has net operating loss
carry forwards of approximately $5,514,000 for federal income and $6,112,000 for
California franchise tax purposes.  The federal and California net
operating loss carry forwards, to the extent not used, will expire in
2029.
 
 As of
December 31, 2009, tax years for 2006 through 2009 remain open to audit by the
Internal Revenue Service and by the California Franchise Tax
Board.  In the opinion of management, all significant tax positions
taken, or expected to be taken, by the Company in any open tax year would more
likely than not be sustained upon examination by the tax
authorities.
 
  -
70 -
 Table of Contents
  NOTE
I - STOCK OPTION PLANS
  The
Company adopted in 1998 a stock option plan under which 180,000 shares of the
Company’s common stock may be issued.  The 1998 Plan has been
terminated with respect to the granting of future options under the
Plan.  In 2008 the Company adopted and received shareholder approval
for the Mission Community Bancorp 2008 Stock Incentive Plan.  The 2008
Plan provides for the grant of various equity awards, including stock
options.  A total of 201,840 common shares may be issued under the
2008 Plan.  Options are granted at a price not less than 100% of the
fair value of the stock on the date of grant, generally for a term of ten years,
with vesting occurring ratably over five years.  The Plans provide for
acceleration of vesting of all options upon change in control of the
Bank.  The Bank recognized in 2009 and 2008 stock-based compensation
of $70 thousand and $64 thousand, respectively.  No income tax
benefits related to that stock-based compensation were recognized in 2009 or
2008.
   On May
27, 2008, the Company granted to the Bank’s two most senior officers options to
purchase a total of 41,064 shares of common stock at an exercise price of $18.00
per share.  These non-qualified stock options were granted under the
2008 Plan, vest over five years, and expire ten years after the date of
grant.  The fair value ascribed to those options, using the
Black-Scholes option pricing model, was $4.58 per share, or a total of
$188,073.  No options were granted in 2009.
  A summary
of the status of the Company’s fixed stock option plans as of December 31, 2009
and changes during the year is presented below:
 
 Weighted-
              
              AggregateWeighted-
              
              
              Average
              
              IntrinsicAverage
              
              
              Remaining
              
              Value
      ofExercise
              
              
              Contractual
              
              In-the-MoneyShares
              
              
              Price
              
              
              Term
              
              OptionsOutstanding
      at Beginning of Year
              
              
              89,564
              
              
              $
              16.24Granted
              
              
              -Exercised
              
              
              -Forfeited/Expired
              
              
              (2,000
              )Outstanding
      at End of Year
              
              
              87,564
              
              
              $
              16.44
              
              
              
              5.6
              
              Years
              
              $
              -Options
      Exercisable at Year-End
              
              
              51,413
              
              
              $
              14.86
              
              
              
              3.8
              
              Years
              
              $
              -
 
  The total
intrinsic value of options exercised during the year ended December 31, 2008 was
$110,000.  No options were exercised in 2009.
   As of
December 31, 2009, the Company has unvested options outstanding with
unrecognized compensation expense totaling $128 thousand, which is scheduled to
be recognized as follows (in thousands):
  2010                                                                   $  38
 2011                                                                       37
 2012                                                                       38
 2013                                                                   15
 Total
unrecognized compensation cost      $128
 
 
  -
71 -
 Table of Contents
  NOTE
J – DEFINED CONTRIBUTION PLAN
 
 The
Company has adopted a defined contribution plan, the Mission Community Bank 401k
Profit Sharing Plan (“the 401k Plan”), covering substantially all employees
fulfilling minimum age and service requirements.  Matching and
discretionary employer contributions to the 401k Plan are determined annually by
the Board of Directors.  The expense for the 401k Plan was
approximately $36,000 in 2009 and $90,000 in 2008.
 
 
 NOTE
K - PREFERRED AND COMMON STOCK
  Series A Preferred
Stock – the Series A Preferred Stock has a $5.00 stated value and is
non-voting, convertible and redeemable.  Each share is convertible
into one-half share of voting common stock of the Company.  Series A
shares are not entitled to any fixed rate of return, but do participate on the
same basis (as if converted on a two-for-one exchange) in any dividends declared
on the Company’s common stock.  Series A shares may be redeemed upon
request of the holder at their stated value if the Bank is found to be in
default under any Community Development Financial Institutions Program
Assistance Agreement for Equity Investments in Regulated Institutions, or any
successor agreement.  In the event of liquidation, the holders of
Series A shares will be entitled to a liquidation preference of $5.00 per share
before the holders of common stock receive any distributions and after the
holders of common stock receive distributions of $10.00 per share, all
distributions will be on the same basis (as if converted on a one-for-two
exchange).  These shares were issued for $392,194 (net of issuance
costs of $107,806) pursuant to an award from the Community Development Financial
Institutions Fund of the Department of the Treasury.
   Series B Preferred
Stock – the Series B Preferred Stock has a $10.00 stated value and is
non-voting, non-convertible and non-redeemable.  Series B shares are
not entitled to any fixed rate of return but do participate on the same basis in
any dividends declared on the Company’s common stock. In the event of
liquidation, the holders of Series B shares will be entitled to a liquidation
preference of $10.00 per share before the holders of common stock receive any
distributions.  Additionally, in the event of a specified “change in
control event” (including certain mergers or sales of assets), holders of the
Series B Preferred Stock shall be entitled to receive payment on the same basis
as the holders of the common stock of the Company.  These shares were
issued for $191,606 (net of issuance costs of $13,394) pursuant to an investment
from the National Community Investment Fund (“NCIF”).  In connection
with this investment, NCIF also purchased 29,500 shares of the Company’s common
stock for $10.00 per share.  As part of the investment agreement, the
Company by covenant agreed that so long as NCIF or any successor owns and holds
any of the Shares to remain a CDFI and to meet certain reporting
requirements.
   Series C Preferred
Stock – the Series C Preferred Stock has $10.00 stated value and is
non-voting, convertible and redeemable.  Each share is convertible
into one share of voting common stock of the Company.  Series C shares
are not entitled to any fixed rate of return, but do participate on the same
basis (as if converted on a one-to-one exchange) in any dividends declared on
the Company’s common stock.  Series C shares may be redeemed upon
request of the holder at their stated value if the Bank is found to be in
default under any Community Development Financial Institutions Program
Assistance Agreement for Equity Investments in Regulated Institutions, or any
successor agreement.  In the event of liquidation, the holders of
Series C shares will be entitled to a liquidation preference of $10.00 per share
(as adjusted for any stock dividends, combinations or splits with respect to
such shares) before the holders of common stock receive any
distributions.  These shares were issued for $500,000 pursuant to an
award from the Community Development Financial Institutions Fund of the
Department of the Treasury.
   -
72 -
 Table of Contents
  
 NOTE
K - PREFERRED AND COMMON STOCK (continued)
  Series D Preferred
Stock – On January 9, 2009, in exchange for aggregate consideration of
$5,116,000, Mission Community Bancorp issued to the United States Department of
the Treasury (“the Treasury”) a total of 5,116 shares of a new Series D Fixed
Rate Cumulative Perpetual Preferred Stock (the “Series D Preferred”) having a
liquidation preference of $1,000 per share.  This transaction was a
part of the Capital Purchase Program of the Treasury’s Troubled Asset Relief
Program (TARP).  The $5.1 million in new capital was subsequently
invested in Mission Community Bank as Tier 1 capital.  The Series D
Preferred pays cumulative dividends at a rate of 5% per annum for the first five
years and 9% per annum thereafter. The Series D Preferred may not be redeemed
during the first three years after issuance except from the proceeds of a
“Qualified Equity Offering.”  Thereafter, Mission Community Bancorp
may elect to redeem the Series D Preferred at the original purchase price plus
accrued but unpaid dividends, if any.
   Common Stock – As of
December 31, 2009 and 2008, the Company had 1,345,602 shares of common stock
outstanding.
   On
December 22, 2009, the Company entered into a Securities Purchase Agreement (the
“Agreement”) with Carpenter Fund Manager GP, LLC, (the “Manager”) on behalf of
and as General Partner of Carpenter Community BancFund, L.P., Carpenter
Community BancFund-A, L.P. and Carpenter Community BancFund—CA,
L.P.  (the “Investors”).  Pursuant to the Agreement the
Manager has agreed to cause the Investors to purchase an aggregate of 3,040,000
shares of the Company’s authorized but unissued common stock, with each share of
common stock paired with a warrant to purchase one additional share of common
stock.  Each “unit” of one common share and one warrant would be
purchased for $5.00.  The warrants are exercisable for a term of ten
years from issuance at an exercise price of $5.00 per share and contain
customary anti-dilution provisions.
   The
Agreement contemplates that the Units will be purchased in two separate
closings.  At the first closing the Investors will purchase an
aggregate of 2,000,000 shares of Common Stock, paired with warrants to purchase
2,000,000 shares of Common Stock, for an aggregate purchase price of $10
million.  At the second closing, the Investors will purchase an
aggregate of 1,040,000 shares of Common Stock, paired with warrants to purchase
1,040,000 shares of Common Stock, for an aggregate purchase price of
$5,200,000.  The Agreement further provides that the Company will
conduct a rights offering to its existing shareholders following the initial
closing, which is currently anticipated in the second quarter of 2010, pursuant
to which each shareholder will be offered the right to purchase additional
shares of common stock, paired with a warrant, at a price of $5.00 per unit of
common stock and warrant.  The warrants issuable in the rights
offering will also be for a term of 10 years and will be exercisable at a price
of $5.00 per share.
   The
sale of the units is subject to receipt of all required regulatory approvals and
the closings are subject to other customary conditions, such as satisfactory
completion of the Manager’s due diligence review.  In addition, the second
closing is contingent upon the approval of the Company and the Manager of the
Company’s redemption of the TARP Preferred Stock (Series D), as well as the
receipt of all regulatory and other approvals required with respect to a
redemption of the TARP Preferred Stock.
   -
73 -
 Table of Contents
   NOTE
L - RELATED PARTY TRANSACTIONS
   In the
ordinary course of business, the Bank has granted loans to certain directors and
the companies with which they are associated.  In the Bank’s opinion,
all loans and loan commitments to such parties are made on substantially the
same terms, including interest rate and collateral, as those prevailing at the
time for comparable transactions with other persons.
   The
following is a summary of the activity in these loans:
  
 2009
              
              
              2008Balance
      at the beginning of the year
              
              $
              4,986,295
              
              
              $
              2,498,900New
      loans and advances
              
              
              112,254
              
              
              
              3,187,523Repayments
              
              
              (1,938
              )
              
              
              (700,128
              )Reclassifications
      (persons no longer considered related parties)
              
              
              (4,891,364
              )
              
              
              -Balance
      at the end of the year
              
              $
              205,247
              
              
              $
              4,986,295
 
 Deposits
from related parties held by the Bank totaled approximately $1,714,000 at
December 31, 2009, and $4,761,000 at December 31, 2008.
 
 During
2003, Bancorp pledged a $250,000 certificate of deposit in an unaffiliated bank
as collateral for borrowings of MCSC under a line of credit.  The
certificate matured in 2008 and was replaced by a certificate for $75,000, which
has been pledged as collateral for the line of credit.  As of December
31, 2009, MCSC had borrowed $40,000 on the line.  No potential
liability was recognized by Bancorp as of December 31, 2009, because the
outstanding balance on the line is expected to be repaid with funds to be
received from other sources, including a grant program through the U.S. Small
Business Administration.  During 2009 Bancorp made cash contributions
to MCSC totaling $709.  No cash contributions were made to MCSC during
2008.
 
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 Table of Contents
  NOTE
M - COMMITMENTS AND CONTINGENCIES
 
 In the
normal course of business, the Bank enters into financial commitments to meet
the financing needs of its customers.  These financial commitments
include commitments to extend credit and standby letters of
credit.  Those instruments involve to varying degrees, elements of
credit and interest rate risk not recognized in the statement of financial
position.
 
 The
Bank’s exposure to credit loss in the event of nonperformance on commitments to
extend credit and standby letters of credit is represented by the contractual
amount of those instruments.  The Bank uses the same credit policies
in making commitments as it does for loans reflected in the financial
statements.
 
 As of
December 31, the Bank had the following outstanding financial commitments whose
contractual amount represents credit risk:
 
 2009
              
              
              2008Commitments
      to Extend Credit
              
              $
              18,219,000
              
              
              $
              28,427,000Standby
      Letters of Credit
              
              
              301,000
              
              
              
              304,000$
              18,520,000
              
              
              $
              28,731,000
 
 Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Standby
letters of credit are conditional commitments to guarantee the performance of a
Bank customer to a third party.  Since many of the commitments and
standby letters of credit are expected to expire without being drawn upon, the
total amounts do not necessarily represent future cash
requirements.  The Bank evaluates each customer's creditworthiness on
a case-by-case basis.  The amount of collateral obtained if deemed
necessary by the Bank is based on management's credit evaluation of the
customer.
 
 The Bank
has established an allowance for possible losses on unfunded loan commitments in
the amount of $105,000, which is included in other liabilities in the
consolidated balance sheets.  To date, no losses have been charged
against this allowance.
 
 In the
ordinary course of business, various claims and lawsuits are brought by and
against the Company and the Bank.  In the opinion of management, there
is no pending or threatened proceeding in which an adverse decision could result
in a material adverse change in the consolidated financial condition or results
of operations of the Company.
 
   -
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 Table of Contents
   NOTE
N - EARNINGS (LOSS) PER SHARE
  
 The
following is a reconciliation of net income (loss) and shares outstanding to the
income (loss) and number of shares used in the computation of earnings (loss)
per share:
 
 2009
              
              
              2008Average
      common shares outstandingduring
      the year (used for basic EPS)
              
              
              1,345,602
              
              
              
              1,090,569Dilutive
      effect of outstanding stock options
              
              
              -
              
              
              
              -Average
      common shares used for diluted EPS
              
              
              1,345,602
              
              
              
              1,090,569Net
      (loss)
              
              $
              (6,926,559
              )
              
              $
              (3,848,370
              )Less
      (loss) and dividends allocated to preferred stock:Convertible
      preferred (Series A and C)
              
              
              (487,278
              )
              
              
              (317,766
              )Non-convertible
      preferred (Series B)
              
              
              (99,892
              )
              
              
              (65,142
              )Non-convertible
      TARP preferred (Series D)
              
              
              217,430
              
              
              
              -Total
      loss allocated to preferred stock
              
              
              (369,740
              )
              
              
              (382,908
              )Net
      (loss) allocated to common stock
              
              $
              (6,556,819
              )
              
              $
              (3,465,462
              )Basic
      earnings (loss) per common share
              
              $
              (4.87
              )
              
              $
              (3.18
              )Diluted
      earnings (loss) per common share
              
              
              (4.87
              )
              
              
              (3.18
              )
 
 All stock
options were excluded from the diluted EPS computation in 2009 and 2008 because
any options would have an anti-dilutive effect on the net loss.
  -
76 -
 Table of Contents
  NOTE
O - REGULATORY MATTERS
 
 The Bank
is subject to various regulatory capital requirements administered by the
federal bank regulatory agencies.  Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Bank’s financial statements.  Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank’s
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices.  The Bank’s capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
 
 Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of Total
and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as
defined).  Management believes, as of December 31, 2009, that the Bank
meets all capital adequacy requirements to which it is subject.
 
 As of
December 31, 2009, the most recent notification from the Federal Reserve Board
categorized the Bank as well-capitalized under the regulatory framework for
prompt corrective action.  There are no conditions or events since
that notification that management believes have changed the Bank’s prompt
corrective action category.  To be categorized as well-capitalized,
the Bank must maintain minimum ratios as set forth in the table
below.  The following table also sets forth the Bank’s actual capital
amounts and ratios (dollar amounts in thousands):
 
 Amount
      of Capital RequiredTo
      Be
              
              
              To
      Be AdequatelyActual
              
              
              Well-Capitalized
              
              
              CapitalizedAmount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              RatioAs
      of December 31, 2009:Total
      Capital (to Risk-Weighted Assets)
              
              $
              22,053
              
              
              
              14.22
              %
              
              $
              15,509
              
              
              
              10.0
              %
              
              $
              12,407
              
              
              
              8.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              20,069
              
              
              
              12.94
              %
              
              $
              9,306
              
              
              
              6.0
              %
              
              $
              6,204
              
              
              
              4.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              20,069
              
              
              
              9.59
              %
              
              $
              10,462
              
              
              
              5.0
              %
              
              $
              8,369
              
              
              
              4.0
              %As
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
              
              $
              22,467
              
              
              
              13.27
              %
              
              $
              16,937
              
              
              
              10.0
              %
              
              $
              13,550
              
              
              
              8.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              20,326
              
              
              
              12.00
              %
              
              $
              10,162
              
              
              
              6.0
              %
              
              $
              6,775
              
              
              
              4.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              20,326
              
              
              
              9.47
              %
              
              $
              10,729
              
              
              
              5.0
              %
              
              $
              8,583
              
              
              
              4.0
              %
 
 
 The
Company is not subject to similar regulatory capital requirements because its
consolidated assets do not exceed $500 million, the minimum asset size criteria
for bank holding companies subject to those requirements.
 
 Banking
regulations limit the amount of cash dividends that may be paid without prior
approval of the Bank’s primary regulatory agency.  Cash dividends are
limited by the California Financial Code to the lesser of the Bank’s retained
earnings or its net income for the last three fiscal years, less any dividends
or other capital distributions made during those periods.  Under this
rule, due to the Bank’s 2008 and 2009 net losses, regulatory approval is
required as of December 31, 2009, for any dividend distributions from the Bank
to Bancorp.  However, dividend distributions from the Bank would not
downgrade the Bank’s prompt corrective action status from well-capitalized to
adequately-capitalized unless they exceeded $6,994,000.
 
  -
77 -
 Table of Contents
  
 NOTE
O - REGULATORY MATTERS – continued
 
 The
California Corporation Law provides that a corporation, such as Bancorp, may
make a distribution to its shareholders if the corporation’s retained earnings
equal at least the amount of the proposed distribution.  In the event
that sufficient retained earnings are not available for the proposed
distribution, under the law a corporation may nevertheless make a distribution
to its shareholders if it meets two conditions, which generally stated are as
follows: (i) the corporation’s assets equal at least 1.25 times its liabilities,
and (ii) the corporation’s current assets equal at least its current liabilities
or, if the average of the corporation’s earnings before taxes on income and
before interest expenses for the two preceding fiscal years was less than the
average of the corporation’s interest expenses for such fiscal years, then the
corporation’s current assets must equal at least 1.25 times its current
liabilities.
 
 
 NOTE
P - GRANTS AND AWARDS
 
 In 2009
the Bank received an $81 thousand grant from the Bank Enterprise Award program
of the Department of the Treasury, based on lending activity of the Bank in
2008.  That grant was recognized in non-interest income in
2009.
 
 Although
the Bank is a certified CDFI bank and expects to continue to apply for various
grants and awards, there can be no assurance that it will receive similar future
grants or awards.
 
  NOTE
Q - MISSION COMMUNITY BANCORP (Parent Company Only)
 
 On
December 15, 2000, Mission Community Bancorp acquired Mission Community Bank by
issuing 600,566 shares of common stock in exchange for all outstanding shares of
the Bank’s common stock.  There was no cash involved in this
transaction.
 
 Following
are the separate financial statements for Mission Community Bancorp (parent
company only):
 
 
 Mission
      Community Bancorp (Parent Company Only)CONDENSED
      BALANCE SHEETS2009
              
              
              2008ASSETSCash
              
              $
              842,766
              
              
              $
              1,468,589Deposits
      in other banks
              
              
              75,000
              
              
              
              75,000Investment
      in subsidiary bank
              
              
              20,570,694
              
              
              
              21,531,964Other
      real estate owned
              
              
              565,000
              
              
              
              -Other
      assets
              
              
              104,628
              
              
              
              645,066TOTAL
      ASSETS
              
              $
              22,158,088
              
              
              $
              23,720,619LIABILITIES
      AND SHAREHOLDERS' EQUITYJunior
      subordinated debentures
              
              $
              3,093,000
              
              
              $
              3,093,000Due
      to Mission Community Bank
              
              
              377,433
              
              
              
              26,889Other
      liabilities
              
              
              49,940
              
              
              
              83,907TOTAL
      LIABILITIES
              
              
              3,520,373
              
              
              
              3,203,796TOTAL
      SHAREHOLDERS' EQUITY
              
              
              18,637,715
              
              
              
              20,516,823$
              22,158,088
              
              
              $
              23,720,619
 
  -
78 -
 Table of Contents
  NOTE
Q - MISSION COMMUNITY BANCORP (Parent Company Only) – Continued
 
 
 CONDENSED
      STATEMENTS OF INCOME2009
              
              
              2008Interest
      income
              
              $
              22,604
              
              
              $
              26,668Interest
      expense
              
              
              116,092
              
              
              
              220,335Net
      interest (expense)
              
              
              (93,488
              )
              
              
              (193,667
              )Dividends
      received from subsidiary
              
              
              -
              
              
              
              -Less
      contributions to Mission Community Services Corp.
              
              
              709
              
              
              
              -Less
      other expenses
              
              
              557,933
              
              
              
              286,998(Loss)
      before taxes
              
              
              (652,130
              )
              
              
              (480,665
              )Income
      tax (benefit)
              
              
              -
              
              
              
              (92,080
              )(Loss)
      before equity in undistributed income of subsidiary
              
              
              (652,130
              )
              
              
              (388,585
              )Equity
      in undistributed (loss) of subsidiary
              
              
              (6,274,429
              )
              
              
              (3,459,785
              )Net
      (loss)
              
              $
              (6,926,559
              )
              
              $
              (3,848,370
              )
 
 
  CONDENSED
      STATEMENTS CASH FLOWS2009
              
              
              2008Operating
      activities:Net
      (loss)
              
              $
              (6,926,559
              )
              
              $
              (3,848,370
              )Adjustments
      to reconcile net (loss)to
      net cash provided by (used in) operating activities:Loss
      of subsidiary
              
              
              6,274,429
              
              
              
              3,459,785Amortization
      expense
              
              
              -
              
              
              
              12,925Write-downs
      on other real estate
              
              
              250,000
              
              
              
              -Income
      tax refunds received
              
              
              615,532
              
              
              
              -Other,
      net
              
              
              241,483
              
              
              
              122,923Net
      cash provided by (used in) operating activities
              
              
              454,885
              
              
              
              (252,737
              )Investing
      activities:Investment
      in certificate of deposit
              
              
              -
              
              
              
              (75,000
              )Maturity
      of certificate of deposit
              
              
              -
              
              
              
              250,000Purchase
      of other real estate from subsidiary
              
              
              (815,000
              )
              
              
              -Investment
      in subsidiary
              
              
              (5,116,000
              )
              
              
              (9,428,771
              )Net
      cash (used in) investing activities
              
              
              (5,931,000
              )
              
              
              (9,253,771
              )Financing
      activities:Proceeds
      from issuance of common stock
              
              
              -
              
              
              
              10,916,032Proceeds
      from issuance of preferred stock
              
              
              5,116,000
              
              
              
              -Preferred
      stock issuance costs
              
              
              (48,278
              )
              
              
              -Common
      stock repurchased
              
              
              -
              
              
              
              -Cash
      dividends paid
              
              
              (217,430
              )
              
              
              -Net
      cash provided by financing activities
              
              
              4,850,292
              
              
              
              10,916,032Net
      increase (decrease) in cash
              
              
              (625,823
              )
              
              
              1,409,524Cash
      at beginning of year
              
              
              1,468,589
              
              
              
              59,065Cash
      at end of year
              
              $
              842,766
              
              
              $
              1,468,589
 
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79 -
 Table of Contents
  NOTE
R - FAIR VALUE MEASUREMENT
  
 The
following is a description of valuation methodologies used for assets and
liabilities recorded at fair value:
 
 Securities: The fair
values of securities available for sale are determined by obtaining quoted
prices on nationally recognized securities exchanges (Level 1) or matrix
pricing, which is a mathematical technique used widely in the industry to value
debt securities without relying exclusively on quoted prices for specific
securities but rather by relying on the securities’ relationship to other
benchmark quoted securities (Level 2).
 
 In
certain cases where there is limited activity or less transparency for inputs to
the valuation, securities are classified in Level 3 of the valuation hierarchy.
For instance, the Bank has one security in its available-for-sale portfolio that
has been assessed as “impaired” since 2004.  Prior to 2008, the Bank
had used a pricing method for this security that would be considered Level 2
pricing.  Effective January 1, 2008, the Bank concluded that Level 3
pricing was more appropriate for this security, given the lack of observable
inputs to the estimation process.  Due to the illiquidity in the
secondary market for this security, this fair value estimate cannot be
corroborated by observable market data.  This change in estimate
resulted in a reduction in the fair value of this security by $168 thousand as
of January 1, 2008.  Because this security remains in the
available-for-sale portfolio, this change in estimate was included in other
comprehensive income (loss) but had no effect on reported net income
(loss).  With the exception of this one security, all of the Bank’s
securities were classified in Level 2.
 
 Loans Held for Sale:Loans held for sale are carried at the lower of cost or market
value.  The fair value of loans held for sale is determined using
quoted market prices for similar assets (Level 2).
 
 SBA Loan Servicing
Rights: SBA loan servicing rights are initially recorded at fair value in
accordance with FASB guidance regarding accounting for transfers of financial
assets.  Subsequent measurements of servicing assets use the
amortization method, which requires servicing rights to be amortized into
non-interest income in proportion to, and over the period of, the estimated
future net servicing income of the underlying loans.  Loan servicing
rights are evaluated for impairment subsequent to initial
recording.  Impairment is determined by stratifying rights into
groupings based on predominant risk characteristics, such as interest rate, risk
grade and loan type.  Impairment is recognized through a valuation
allowance for an individual grouping, to the extent that fair value is less than
the carrying amount.  SBA loan servicing rights do not trade in an
active market with readily observable prices. Accordingly, the Bank determines
the fair value of loan servicing rights by estimating the present value of the
future cash flows associated with the loans being serviced. Key economic
assumptions used in measuring the fair value of loan servicing rights include
prepayment speeds and discount rates. While market-based data is used to
determine the input assumptions, the Bank incorporates its own estimates of
assumptions market participants would use in determining the fair value of loan
servicing rights (Level 3).
 
 Collateral-Dependent
Impaired Loans:  The Bank does not record loans at fair value
on a recurring basis. However, from time to time, fair value adjustments are
recorded on these loans to reflect (1) partial write-downs, through charge-offs
or specific reserve allowances, that are based on the current appraised or
market-quoted value of the underlying collateral or (2) the full charge-off of
the loan carrying value. In some cases, the properties for which market quotes
or appraised values have been obtained are located in areas where comparable
sales data is limited, outdated, or unavailable. Fair value estimates for
collateral-dependent impaired loans are obtained from real estate brokers or
other third-party consultants (Level 3).
 
 Other Real Estate
Owned:  Nonrecurring adjustments to certain commercial and
residential real estate properties classified as other real estate owned (OREO)
are measured at the lower of carrying amount or fair value, less costs to
sell.  In cases where the carrying amount exceeds the fair value, less
costs to sell, an impairment loss is recognized.  Fair values are
generally based on third party appraisals of the property which are commonly
adjusted by management to reflect an expectation of the amount to be ultimately
collected (Level 3).
  -
80 -
 Table of Contents
  NOTE
R - FAIR VALUE MEASUREMENT – Continued
 The
following table provides the hierarchy and fair value for each major category of
assets and liabilities measured at fair value:
 
 As
      of December 31, 2009:
              
              Fair
      Value Measurements UsingLevel 1
              
              
              Level 2
              
              
              Level 3
              
              
              TotalAssets
      measured at fair value on a recurring basis:Securities
      Available for Sale
              
              $
              -
              
              
              $
              40,133,869
              
              
              $
              8,543
              
              
              $
              40,142,412Assets
      measured at fair value on a non-recurring basis:Collateral-Dependent
      Impaired Loans, Net of Specific Reserves
              
              $
              -
              
              
              $
              -
              
              
              $
              3,802,545
              
              
              $
              3,802,545Non-financial
      assets measured at fair value on a non-recurring basis:Other
      Real Estate Owned
              
              $
              -
              
              
              $
              -
              
              
              $
              2,205,882
              
              
              $
              2,205,882As
      of December 31, 2008:Assets
      measured at fair value on a recurring basis:Securities
      Available for Sale
              
              $
              -
              
              
              $
              24,813,494
              
              
              $
              32,345
              
              
              $
              24,845,839Assets
      measured at fair value on a non-recurring basis:Collateral-Dependent
      Impaired Loans, Net of Specific Reserves
              
              $
              -
              
              
              $
              -
              
              
              $
              4,723,314
              
              
              $
              4,723,314Non-financial
      assets measured at fair value on a non-recurring basis:Other
      Real Estate Owned
              
              $
              -
              
              
              $
              -
              
              
              $
              983,100
              
              
              $
              983,100
 
 
 SBA loan
servicing rights, which are carried at the lower of cost or fair value, have
resulted in no write-down or valuation allowance as of December 31,
2009.
 
 Collateral-dependent
impaired loans, which are measured for impairment using the fair value of the
collateral, had a carrying value of $5,332,921, with a specific reserve of
$36,934, as of December 31, 2009.  As of December 31, 2008,
collateral-dependent impaired loans had a carrying value of $8,484,115, with a
specific reserve of $1,342,312.
 
  -
81 -
 Table of Contents
  NOTE
R - FAIR VALUE MEASUREMENT – Continued
  For those
properties held in other real estate owned and carried at fair value,
write-downs of $472,019 and $0 were recorded as an adjustment to current
earnings through non-interest income in 2009 and 2008.
 
 The
following table presents a reconciliation of assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3):
 
 Available-For-Sale
      Securities2009
              2008Balance
      at beginning of year
              
              $
              32,345
              $               -Transfers
      into Level 3
              
              
              91,505
              226,899Total
      Gains (Losses):Included
      in Income (Loss)
              
              
              -
              -Unrealized
      Gains (Losses) Included in Other Comprehensive Income
    (Loss)
              
              
              -
              (168,493)Purchases
              
              
              -
              -Settlements
              
              
              -
              -Paydowns
      and maturities
              
              
              (115,307)
              (26,061)Ending
      at end of year
              
              $
              8,543
              $     32,345Total
      unrealized gains (losses) for the period relating to assets still held at
      the reporting date
              
              $
              -
              $(168,493)
 
 
  NOTE
S - FAIR VALUE OF FINANCIAL INSTRUMENTS
  The fair
value of a financial instrument is the amount at which the asset or obligation
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale.  Fair value estimates are made at a
specific point in time based on relevant market information and information
about the financial instrument.  These estimates do not reflect any
premium or discount that could result from offering for sale at one time the
entire holdings of a particular financial instrument.  Because no
market value exists for a significant portion of the financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors.  These estimates are
subjective in nature, involve uncertainties and matters of judgment and,
therefore, cannot be determined with precision.  Changes in
assumptions could significantly affect the estimates.
 
 Fair
value estimates are based on financial instruments both on and off the balance
sheet without attempting to estimate the value of anticipated future business
and the value of assets and liabilities that are not considered financial
instruments.  Additionally, tax consequences related to the
realization of the unrealized gains and losses can have a potential effect on
fair value estimates and have not been considered in many of the
estimates.
 
 The
following methods and assumptions were used to estimate the fair value of
significant financial instruments:
 
 Financial
      Assets
  The
carrying amounts of cash and short-term investments are considered to
approximate fair value.  Short-term investments include federal funds
sold and interest bearing deposits with banks.  The fair values of
investment securities, including available-for-sale, are generally based on
quoted matrix pricing.  The fair value of loans are estimated using a
combination of techniques, including discounting estimated future cash flows and
quoted market prices of similar instruments, where available.
 
  -
82 -
 Table of Contents
  NOTE
      S - FAIR VALUE OF FINANCIAL INSTRUMENTS -
  Continued
  Financial
      Liabilities
  The
carrying amounts of deposit liabilities payable on demand and short-term
borrowed funds are considered to approximate fair value.  For fixed
maturity deposits, fair value is estimated by discounting estimated future cash
flows using currently offered rates for deposits of similar remaining
maturities.  The fair value of long-term debt is based on rates
currently available to the Bank for debt with similar terms and remaining
maturities.
 
 Off-Balance Sheet
      Financial Instruments
  The fair
value of commitments to extend credit and standby letters of credit is estimated
using the fees currently charged to enter into similar
agreements.  The fair value of these financial instruments is not
material.
 
  The
estimated fair value of financial instruments is summarized as
follows:
 
  December
      31,2009
              
              
              2008Carrying
              
              
              Fair
              
              
              Carrying
              
              
              FairValue
              
              
              Value
              
              
              Value
              
              
              ValueFinancial
      Assets:Cash
      and due from banks
              
              $
              8,595,000
              
              
              $
              8,595,000
              
              
              $
              7,804,000
              
              
              $
              7,804,000Federal
      funds sold
              
              
              -
              
              
              
              -
              
              
              
              9,920,000
              
              
              
              9,920,000Interest-bearing
      deposits in other banks
              
              
              425,000
              
              
              
              425,000
              
              
              
              11,710,000
              
              
              
              11,710,000Investment
      securities
              
              
              40,142,000
              
              
              
              40,142,000
              
              
              
              24,846,000
              
              
              
              24,846,000Loans,
      net
              
              
              130,873,000
              
              
              
              132,763,000
              
              
              
              149,369,000
              
              
              
              150,476,000Federal
      Home Loan Bank and other stocks
              
              
              3,003,000
              
              
              
              3,003,000
              
              
              
              2,757,000
              
              
              
              2,757,000Company
      owned life insurance
              
              
              2,886,000
              
              
              
              2,886,000
              
              
              
              2,789,000
              
              
              
              2,789,000Accrued
      interest receivable
              
              
              730,000
              
              
              
              730,000
              
              
              
              824,000
              
              
              
              824,000Financial
      Liabilities:Deposits
              
              
              163,770,000
              
              
              
              164,174,000
              
              
              
              144,804,000
              
              
              
              145,206,000Other
      borrowings
              
              
              6,000,000
              
              
              
              6,259,000
              
              
              
              45,700,000
              
              
              
              46,484,000Junior
      subordinated debt securities
              
              
              3,093,000
              
              
              
              3,090,000
              
              
              
              3,093,000
              
              
              
              3,211,000Accrued
      interest and other liabilities
              
              
              1,605,000
              
              
              
              1,605,000
              
              
              
              1,376,000
              
              
              
              1,376,000
 
  
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 Item 9.  Changes In and Disagreements With Accountants
on Accounting and Financial Disclosure
 
 There
have been no disagreements with the Company’s accountants regarding accounting
and financial disclosure.
 
 
 Item
9AT.  Controls and Procedures
 
 Our Chief
Executive Officer and our Chief Financial Officer carried out an evaluation as
of December 31, 2009, of the effectiveness of the design and operation of our
disclosure controls and procedures as defined in Exchange Act Rule
15a-15.  Based upon that evaluation, the Chief Executive Officer and
the Chief Financial Officer concluded that current disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company and/or Bank that is required to be included in our
periodic filings with the Securities and Exchange Commission and also with bank
or bank holding company regulatory agencies.
 
 
 There
were no significant changes in the Company’s internal controls or in other
factors that could significantly affect the Company’s internal controls over
financial reporting in the fourth quarter of 2009.
 
 Management’s Annual Report on
Internal Control Over Financial Reporting
 
 
 The
following section of this Annual Report on Form 10-K will not be deemed
incorporated by reference by any general statement incorporating by reference
this Annual Report on Form 10-K into any filing under the Securities Act of 1933
or under the Securities Exchange Act of 1934, except to the extent that we
specifically incorporate this information by reference, and will not otherwise
be deemed filed under these Acts.
  Management
is responsible for establishing and maintaining adequate internal control over
financial reporting for the Company and the Bank, including periodic filings
with the Securities Exchange Commission, the Federal Deposit Insurance
Corporation (“FDIC”), the Federal Reserve Bank of San Francisco (“FRBSF”) and
the California Department of Financial Institutions (“DFI”).  Such
periodic financial reports are prepared internally and reviewed by management
prior to filing.  These financial reports are also reviewed for timely
filing, completeness and accuracy with possible civil monetary penalties for
late filing and intentional inaccurate reporting by the various agencies where
the reports are filed.
 
 The
Company’s internal control over financial reporting is a process designed under
the supervision of the Company’s management, including its Chief Executive
Officer and its Chief Financial Officer, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the
Company’s financial statements for external reporting purposes in accordance
with accounting principles that are generally accepted in the United States of
America.
 
 The
Company’s internal control over financial reporting includes policies and
procedures that pertain to the maintenance of records which, in reasonable
detail, accurately and fairly reflect transactions and dispositions of assets;
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures are being made only in
accordance with authorizations of management and the directors of the Company;
and provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company’s assets that could
have a material effect on the Company’s financial statements.
 
 Management
recognizes that there are inherent limitations in the effectiveness of any
system of internal control and, accordingly, even effective internal control can
provide only reasonable assurance with respect to financial statement
preparation and fair presentation. Further, because of changes in conditions,
the effectiveness of internal control may vary over time.
 
 Under the
supervision and with the participation of the Company’s management, including
the Company’s Chief Executive Officer and Chief Financial Officer, the Company
conducted an assessment of the effectiveness of the Company’s internal control
over financial reporting based on the framework established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission and interpretive guidance provided by the Securities
and Exchange Commission.  Based on this assessment, management has
determined that the Company’s internal control over financial reporting as of
December 31, 2009 is effective.
 
 Internal
controls over the Bank’s operational, lending procedures and underwriting,
financial systems and other systems are
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  reviewed
by internal auditors, holding company and/or bank examiners, and by registered
public accountants.  At present, Bancorp, based on its asset size and
lack of activity other than banking, is not independently examined by the
FRB.
 
 Bancorp
and the Bank have elected to outsource the internal audit function to firms who
specialize in performing such auditing functions for community
banks.  Internal audit engagements are in writing, including the
anticipated scope, and are generally for 12 to 24 months with interim auditing
during the term of the engagement.  Engagements are presented to and
approved by the Board’s Audit Committee.  Each of the internal audits,
along with management’s response to any observations, is completed in writing
and presented to the Audit Committee.  Management is then responsible
to take any corrective action required to modify procedures or policies to
improve internal controls and procedures. Based on internal audits performed in
2008 and 2009, neither management nor the Audit Committee has been informed of
any material weaknesses in internal controls over financial
reporting.
 
 Internal
controls, lending, and financial reporting are also periodically reviewed by
bank and bank holding company examiners.  As a state charted bank, the
Bank is examined by the FRBSF and the DFI.  Written reports of
examination by state or federal regulators are provided to the Bank, reviewed by
management and by the Board’s Audit Committee.  If an examination
revealed material issues, the Bank could be subject to regulatory action
including formal or informal agreements to take corrective
action.  Bank examination reports are confidential, and the results
are not disclosed unless there are material exceptions noted.  In the
event of material exceptions, a bank could be required to enter into a formal
agreement, which would document the specific weaknesses and corrective action
that must be taken.  These formal agreements are generally required to
be disclosed to the public.  As of December 2009, the Bank is not
operating under any formal agreement with the FRB or DFI.
 
 Finally,
internal controls and financial reporting are reviewed by independent registered
public accountants on an annual basis.  These audited reports,
including any recommendations for improvements in accounting or internal
controls, are presented to management and the Board’s Audit
Committee.  As of December 31, 2009, the Company’s independent
registered public accountants have certified the audited financial statements of
the Company, with no material weaknesses identified in internal controls or
financial reporting.
 This
Annual Report on Form 10-K does not include an attestation report of our
registered public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by our
registered pubic accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit us to provide only management’s report in
this Annual Report on Form 10-K.
 
 
 
 Item
9B.  Other Information
 
 None.
 
 
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  PART III
  
 Item
      10.  Directors, Executive Officers, and Corporate
      Governance.
 
 The
Company has adopted a Code of Conduct (Code of Ethics) that applies to all
employees, directors and officers, including the Company’s principal executive
officer, principal financial officer and principal accounting
officer.
 
 The
Company does not have a class of equity securities registered pursuant to
Section 12 of the Securities Exchange Act of 1934.  Therefore, the
Company’s officers and directors, and persons who own more than 10% of the
Company’s common stock, are not subject to the reporting requirements under
Section 16(a) of the Securities Exchange Act of 1934.  The remainder
of the information required under this Item is incorporated by reference to the
Company’s proxy statement for the annual meeting of shareholders.
 
 
 Item
11.  Executive Compensation
 
 The
information for this item is incorporated by reference to the Company’s proxy
statement for the annual meeting of shareholders.
 
 Item
      12.
              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Shareholder Matters
  The
information required by Item 11 with respect to securities authorized for
issuance under equity compensation plans is set forth under “Item 5—Market for
Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
Securities,” above.  The other information for this item is
incorporated by reference to the Company’s proxy statement for the annual
meeting of shareholders.
 
 Item
      13.  Certain Relationships and Related Transactions, and
      Director Independence
  The
information for this item is incorporated by reference to the Company’s proxy
statement for the annual meeting of shareholders.
 
 Item
14.  Principal Accountant Fees and Services
 
 The
information for this item is incorporated by reference to the Company’s proxy
statement for the annual meeting of shareholders.
 
 
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 Item
15.  Exhibits
  Exhibit
Index:
 Exhibit #2.1
              Plan
      of Reorganization and Agreement of Merger dated as of October 4, 2000
      (A)3.1
              Restated
      Articles of Incorporation (I)3.2
              Certificate
      of Amendment to Articles of Incorporation (L)3.3
              Bylaws
      (B)(S)4.1
              Certificate
      of Determination for Series A Non-Voting Preferred Stock
    (B)4.2
              Certificate
      of Determination for Series B Non-Voting Preferred Stock
    (B)4.3
              Certificate
      of Determination for Series C Non-Voting Preferred Stock
    (D)4.4
              Purchase
      Agreement dated October 10, 2003, by and among Registrant, Mission
      Community Capital Trust I, and Bear Stearns & Co., Inc.
      (E)4.5
              Indenture
      dated as of October 14, 2003 by and between Registrant and Wells Fargo
      Bank, National Association, as trustee (E)4.6
              Declaration
      of Trust Mission Community Capital Trust I dated  October 10,
      2003 (E)4.7
              Amended
      and Restated Declaration of Trust of Mission Community Capital Trust I
      dated October 14, 2003 by and among the Registrant, Wells Fargo Delaware
      Trust Company, as Trustee, and Anita M. Robinson and William C. Demmin, as
      Administrators (E)4.8
              Guarantee
      Agreement dated October 14, 2003 between Registrant, as Guarantor, and
      Wells Fargo Bank, National Association, as Guarantee Trustee
      (E)4.9
              Fee
      Agreement dated October 14, 2003 by and among the Registrant, Wells Fargo
      Delaware Trust Co., Bear Stearns & Co., Inc. and Mission Community
      Capital Trust I (E)4.10
              Certificate
      of Determination for Series D Preferred Stock (R)10.1
              Purchase
      and Sale Agreement and Lease dated January, 1997, as amended
      (B)10.2
              Intentionally
      omitted10.3
              Lease
      Agreement – Paso Robles (B)10.4
              Lease
      Agreement – San Luis Obispo (B)10.5
              Lease
      Agreement – Arroyo Grande (B)10.6
              1998
      Stock Option Plan, as amended (B)10.7
              Lease
      Agreement – 569 Higuera, San Luis Obispo (D)10.8
              Lease
      Agreement – 671 Tefft Street, Nipomo (C)10.9
              Intentionally
      omitted10.10
              Lease
      Agreement – 3480  S. Higuera, San Luis Obispo
(F)10.11
              Salary
      Protection Agreement — Mr. Pigeon (G)10.12
              Salary
      Protection Agreement — Mr. Judge (H)10.13
              Second
      Amended and Restated Employment Agreement dated August 28, 2006 between
      Anita M. Robinson and Mission Community Bank (J)10.14
              Employment
      Agreement dated June 3, 2007 between Brooks Wise and Mission Community
      Bank (J)10.15
              Financial
      Advisory Services Agreement dated January 4, 2007 between the Company and
      Seapower Carpenter Capital, Inc. (K)10.16
              Common
      Stock Repurchase Agreement dated August 10, 2007 between Fannie Mae and
      the Company (M)10.17
              Build-to-Suit
      Lease Agreement between Walter Bros. Construction Co., Inc. and Mission
      Community Bank for property at South Higuera Street and Prado Road in San
      Luis Obispo, California (N)10.18
              Lease
      Agreement – 1670 South Broadway, Santa Maria (O)10.19
              Mission
      Community Bancorp 2008 Stock Incentive Plan (P)10.20
              Amendment
      No. 1 to Second Amended and Restated Employment Agreement dated December
      29, 2008 by and among Mission Community Bancorp, Mission Community Bank,
      and Anita M. Robinson (Q)10.21
              Amendment
      No. 1 to Employment Agreement dated December 29, 2008 by and among Mission
      Community Bancorp, Mission Community Bank, and Brooks W. Wise
      (Q)10.22
              Amended
      and Restated Salary Protection Agreement dated December 29, 2008 by and
      between Mission Community Bank and Ronald B. Pigeon (Q)10.23
              Letter
      Agreement dated January 9, 2009 between Mission Community Bancorp and the
      United States Department of Treasury, which include the Securities
      Purchase Agreement—Standard Term attached thereto, with respect to the
      issuance and sale of the Series D. Preferred Stock (R)10.24
              Side
      Letter Agreement dated January 9, 2009 amendment the Stock Purchase
      Agreement between Mission Community Bancorp and the Department of the
      Treasury (R)10.25
              Side
      Letter Agreement dated January 9, 2009 between Mission Community Bancorp
      and The Department of the Treasury regarding maintenance of two open seats
      on the Board of Directors (R)10.26
              Side
      Letter Agreement dated January 9, 2009 between Mission Community Bancorp
      and The Department of the Treasury regarding CDFI status
    (R)10.27
              Securities
      Purchase Agreement dated December 22, 2009 between the Company and
      Carpenter Fund Manager GP, LLC (“Securities Purchase Agreement”)
      (U)10.28
              Form
      of Warrant to be issued in connection with the Securities Purchase
      Agreement (U)10.29
              Amendment
      No. 1 to Securities Purchase Agreement dated March 17, 2010
      (V)10.30
              Amendment
      No. 2 to Employment Agreement of Brooks Wise dated March 22, 2010
      (W)14
              Code
      of Ethics (T)21
              Subsidiaries of the registrant23.1
              Consent of Independent Registered Public Accounting
      Firm31.1
              Certification of CEO pursuant to Section 302 of
      Sarbanes Oxley Act31.2
              Certification of CFO pursuant to Section 302 of
      Sarbanes Oxley Act32.1
              Certification of CEO pursuant to Section 906 of
      Sarbanes Oxley Act32.2
              Certification of CFO pursuant to Section 906 of
      Sarbanes Oxley Act(A)Included
      in the Company’s Form 8-K filed on December 18, 2000
                (B)Included
      in the Company’s Form 10-KSB filed on April 2, 2001
                (C)Included
      in the Company’s Form 10-QSB filed August 12, 2002
                (D)Included
      in the Company’s Form 10-QSB filed on November 12, 2002
                (E)Included
      in the Company’s Form 8-K filed on October 21, 2003
                (F)Included
      in the Company’s Form 10-QSB filed on August 10, 2004
                (G)Included
      in the Company’s Form 8-K filed on January 19, 2005
                (H)Included
      in the Company’s Form 8-K filed on February 17, 2005
                (I)Included
      in the Company’s Form 10-QSB filed on August 14, 2006
                (J)Included
      in the Company’s Form 8-K filed on June 13, 2007
                (K)Included
      in the Company’s Form SB-2 Registration Statement filed on June 13,
      2007
                (L)Included
      in the Company’s Pre-Effective Amendment No. 1 to the Form SB-2
      Registration Statement filed on July 24, 2007
                (M)Included
      in the Company’s Form 8-K filed on August 14, 2007
                (N)Included
      in the Company’s Form 8-K filed on October 23, 2007
                (O)Included
      in the Company’s Form 10-KSB filed on March 28, 2008
                (P)Included
      in the Company’s Form 10-Q filed on May 15, 2008
                (Q)Included
      in the Company’s Form 8-K filed on December 30, 2008
                (R)Included
      in the Company’s Form 8-K filed on January 14, 2009
                (S)Included
      in the Company’s Form 10-Q filed on August 14, 2009
                (T)Included
      in the Company’s Form 10-K filed on March 16, 2009
                (U)Included
      in the Company’s From 8-K filed on December 24, 2009
                (V)Included
      in the Company’s Form 8-K filed on March 22, 2010
                (W)Included
      in the Company’s Form 8-K filed on March 26, 2010
 
 
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 Table of Contents
  SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED
PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED
SECURITIES PURSUANT TO SECTION 12 OF THE ACT
 As of the
date of the filing of this report, neither the Company’s proxy materials nor
annual report to shareholders has been sent to the Company’s
shareholders.  The Company will furnish copies of the Company’s proxy
materials and annual report to shareholders to the Commission on or prior to the
time it is sent to the Company’s shareholders.
 
 Signatures
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
 
 MISSION
COMMUNITY BANCORP
 
 
 
 By: /s/ Anita M.
Robinson
 ANITA M.
ROBINSON
 President
and Chief Executive Officer
 Dated:    April
14, 2010
 
 
 
 By: /s/ Ronald B.
Pigeon
 RONALD B.
PIGEON
 Executive
Vice President and Chief Financial Officer
 Dated:    April
14, 2010
 
 [Signatures
continue on next page]
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 Table of Contents
  Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
 
 /s/
      Bruce M. Breault
              Director
              April
      14, 2010BRUCE
      M. BREAULT/s/
      William B. Coy
              Chairman
      of the Board
              April
      14, 2010WILLIAM
      B. COYDirectorHOWARD
      N. GOULD/s/
      Richard Korsgaard
              Director
              April
      14, 2010RICHARD
      KORSGAARD/s/
      Ronald B. Pigeon
              Executive
      Vice President and Chief Financial Officer
                (Principal
      Financial and Accounting Officer)
              April
      14, 2010RONALD
      B. PIGEON/s/
      Anita M. Robinson
              Director,
      President and Chief Executive Officer (Principal Executive
      Officer)
              April
      14, 2010ANITA
      M. ROBINSON/s/
      Gary E. Stemper
              Director
              April
      14, 2010GARY
      E. STEMPER/s/
      Brooks W. Wise
              Director
              April
      14, 2010BROOKS
      W. WISE/s/
      Karl F. Wittstrom
              Director
              April
      14, 2010KARL
      F. WITTSTROM/s/
      Stephen P. Yost
              Director
              April
      14, 2010STEPHEN
      P. YOST
 
 
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