**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10-KSB**

 

ý**  ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the FiscalYear ended December 31, 2004**

 

**OR**

 

**o****  ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**Commissionfile number 333-12892**

 

**MISSION COMMUNITY BANCORP**

(Exact name ofregistrant as specified in its charter)

 
| **California**                                                 | ** ** | **77-0559736**                      |
|----------------------------------------------------------------|------------|-------------------------------------|
| State or other  jurisdiction of  incorporation or organization |       | I.R.S. Employer  Identification No. |
|                                                           |       |                                |
| **581  Higuera St., San Luis Obispo, California 93401**        | ** ** | **(805)  782-5000**                 |
| (Address of  principal executive offices)                      |       | Issuer’s  telephone number     |

 

Securities registeredpursuant to Section 12(b) of the Exchange Act: **None**

Securities registeredpursuant to Section 12(g) of the Exchange Act:  **None**

 

Check whether the issuer (1)has filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the preceding 12 months (or for such shorter period thatthe registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes ý****No **o**

 

Check if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-B is not contained inthis form, and no disclosure will be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB ý**.**

 

Registrant’srevenue for this year ended **December 31, 2004**was **$10,109,459.**

 

Statethe aggregate market value of the voting stock and non-voting common equityheld by non-affiliates computed by reference to the price at which the commonequity was sold, or the average bid and asked prices of such common equity; asof **March 1, 2005**such aggregatemarket value was **$12,774,506.**

 

As of **March 1, 2005**, the Registrant had 644,599 shares ofCommon Stock outstanding.

 

Transitional SmallBusiness Disclosure Format (check one) Yes **o**Noý

 

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Prior to December 18,2000, Mission Community Bancorp’s subsidiary, Mission Community Bank, N.A.,filed reports pursuant to Section 15(d) of the Securities Exchange Act of1934 with the Comptroller of the Currency.  On December 18, 2000,Mission Community Bancorp filed an 8-K Report with the Commission reportingthat it had acquired Mission Community Bank, N.A. in a holding companyformation transaction and that it would thereafter file reports with theCommission pursuant to Section 15(d) of the Securities Exchange Act of1934.

 

 

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**Forward Looking Statements**

 

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

 

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

 

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

 

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# **PART I**

# ** **

## **Item1.  Description of Business**

## ** **

**BUSINESS DEVELOPMENT**

 

**The Company**

 

Mission Community Bancorp (“Bancorp”)is a California corporation that was formed in September 2000. Bancorp’sprincipal business is to serve as a bank holding company for Mission CommunityBank (the “Bank”).  Bancorp and the Bankare collectively referred to herein as “the Company.”

 

As of December 31, 2004, theCompany had approximately $139 million in total assets and $10 million inshareholders’ equity.

 

On October 14, 2003, Bancorpformed Mission Community Capital Trust I in order to complete a trust preferredsecurity transaction and raised approximately $3,000,000 in net capital.  See *Market for Common Equityand Related Shareholder Matters*under Item 5 of Part II of thisreport.

 

The U.S. Department of the Treasury,Community Development Financial Institutions Fund, has certified Bancorp andthe Bank as Community Development Financial Institutions (“CDFI”).  This status also conveys possible CommunityReinvestment Act (CRA) credit to institutional depositors and investors in theBank and Bancorp.  It also opens to theBank and Bancorp various government sponsored programs, grants, and awards inwhich they may participate.

 

With its status as a CDFI, Bancorpcompleted the private placement of $500,000 in preferred stock during December 2000with the CDFI Fund.  Bancorp also wasawarded a second $500,000 Core Award in 2001 from the CDFI Fund, which wasfunded in December 2002 in the form of preferred stock.  This was matched with a combination ofpreferred and common shares through an investment of $500,000 from the NationalCommunity Investment Fund (“NCIF”).  NeitherBancorp nor the Bank received any grants or awards in 2003.  In 2004 the Bank received a $1,240,929 BankEnterprise Award (“BEA”) from the CDFI Fund.  The award was made under theFiscal Year 2004 BEA Program, which provides an incentive for any FDIC insuredbank to annually increase the levels of financial services provided toeconomically distressed communities.  This award was recognized as incomein 2004.  The Bank also received asimilar award in 2001 of $990,000.

 

**Mission Community Bank**

 

The Bank opened on December 18,1997, in San Luis Obispo, California, as a national bank chartered by theComptroller of the Currency and opened additional offices in San Luis Obispo Countyin the city of Paso Robles in 1998, Arroyo Grande and Nipomo in 2002.  The Bank is authorized to engage in thegeneral commercial banking business, and its deposits are insured by theFederal Deposit Insurance Corporation up to the applicable limits of the law.  At December 31, 2004, the Bank hadapproximately $139.2 million in assets, $103.4 million in loans, $112.8 millionin deposits, and $10.0 million in stockholders’ equity. The Bank does not offertrust services or international banking services and does not plan to do so inthe near future.

 

The Bank is also certified by the Stateof California Department of Insurance to accept deposits under the CaliforniaOrganized Investment Network (the “COIN”). The COIN program provides California tax credits and/or CRA credit toindividuals, corporations, or partnerships that invest in below market ratedeposits or specified term certificates of deposit.

 

On December 29, 2003, theCalifornia Department of Financial Institutions (the “DFI”) approved the Bank’sconversion application to be chartered in the State of California as a FederalReserve Member Bank and effective on this date, the Bank returned its nationalcharter from the Comptroller of the Currency. The

 

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change in charter was completedprimarily to allow the Bank to benefit from the larger secured legal lendinglimit for banks chartered in California, specifically, increasing its legallending limit from 15% to 25% for certain real estate secured loans.  Following the charter change, the Bank is nowsupervised by the Federal Reserve and the DFI. Other than the change in legal lending limit, no material changes areanticipated from the charter change.

 

**Mission Community DevelopmentCorporation (“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”), whichprovides financing for small businesses and low- to moderate-income areadevelopment and/or affordable housing projects.  Its purpose is to benefit small business andlow- to moderate-income areas/residents.  The board of directors of MCDC consists offour members of the Board of Directors of the Bank and three outside memberswho are actively involved in representing and supporting the low income community.

 

At December 31, 2004, MCDC hadapproximately $204,000 in net loans and $280,000 in shareholder’s equity, and providedloan accounting services for a very small pool of community development micro loanswhich were funded by a group of banks through the Economic Vitality Corporation,as well as management of an emergency assistance loan pool created after theSan Simeon earthquake of December 2003.

 

**Mission Community ServicesCorporation (“MCSC”)**

 

Bancorp and the Bank have anaffiliate relationship with, but no ownership of, MCSC, which was incorporated inAugust 1997 and which was established in September 2003 as a “not-for-profit”public charitable corporation under Internal Revenue Code Section 501(c)(3).  MCSC’s primary focus is to provide technicalsupport and training services to the community, including small business,minority and low-income entrepreneurs.  WhileMCSC has not engaged in any direct lending, it may provide some lending in thefuture.  The Board of Directors of MCSCincludes representatives from the Company, together with members representingthe low-income and business community. The accounts of MCSC are not included in the Company’s consolidatedfinancial statements or elsewhere in this Form 10-KSB.  See also Note L to the Consolidated FinancialStatements for additional information regarding MCSC.

 

**The “Mission” Group**

 

Bancorp, the Bank and itssubsidiary MCDC, and MCSC form an organizational structure intended to provide traditionalcommunity bank financial services and to foster economic revitalization andcommunity development to its market areas.

 

**Bankruptcy or Similar Proceedings**

 

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

 

**Material Reclassifications orOther Changes**

 

There have been no materialreclassifications, mergers, consolidations, or purchase or sale of asignificant amount of assets not in the ordinary course of business.

 

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**BUSINESS OF ISSUER**

 

**Principal Products, Services, andMarkets**

 

Other than holding theshares of the Bank, Bancorp conducts no significant activities. Bancorp isauthorized with the prior approval of the Board of Governors of the FederalReserve System (the “Federal Reserve Board”), its principal regulator, toengage in a variety of activities which are deemed closely related to thebusiness of banking.

 

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

 

The areas in which the Bank hasdirected virtually all of its lending activities are commercial loans(including government-guaranteed loans), agricultural loans, constructionloans, real estate loans, and consumer loans.  As of December 31, 2004, these fivecategories accounted for approximately 15.6%, 0.7%, 23.6%, 58.6%, and 1.5%respectively, of the Bank’s gross loan portfolio.  As of December 31, 2004, $84.8 million,or 82.2%, of the Bank’s loans consisted of interim construction and real estateloans, for single family residences or for commercial development.  The increase in construction and real estate loansis a material increase from the prior year’s combined 76.5%.  See *Concentrations*in Managements’ Discussion and Analysis under Item 6 of Part II of this report.

 

As of December 31, 2004, theBank had 4,112 deposit accounts, including 2,328 demand accounts totaling $24.6million; 1,216 savings accounts with balances totaling $42.9 million; and 568time certificates of deposit totaling $45.3 million.

 

The principal sources of the Bank’srevenues are interest and fees on loans, BEA awards, service charges on depositaccounts and other charges and fees, gain on sale of loans, interest oninvestments, and interest on other investments, including federal fundssold.  For the year ended December 31,2004, these sources comprised 65.7%, 13.1%, 7.4%, 6.5%, 6.4% and 0.9%,respectively, of the Bank’s total operating income.

 

**Distribution Methods of theProducts and Services**

 

The Bank’s primary service areaconsists of San Luis Obispo County and Northern Santa Barbara County, which liecentrally within the State of California along the Pacific Ocean.  Secondary market areas include cities andunincorporated areas in the neighboring counties, including Kern, Kings, andFresno.

 

The Bank operates out of four fullservice offices (in the cities of San Luis Obispo, Paso Robles, Arroyo Grandeand Nipomo) plus a loan production office and an administrative facility, whichare both located in the city of San Luis Obispo.  The Bank provides some financial services throughdirect contact by calling officers who travel into the neighboring counties.  Physical expansion into the neighboringcounties would most likely come from acquisitions or in the form of loanproduction offices although there are no immediate plans for acquisitions orloan production offices.

 

The Bank’s operating policy sinceits inception has emphasized community development through small business,commercial and retail banking.  Most ofthe Bank’s customers are retail customers, farmers and small to medium-sizedbusinesses.  As a CDFI, the Bank also emphasizesloans and financial services to low- to moderate-income communities within its marketarea.  Most of the Bank’s deposits areattracted by relationship banking, local activities, and advertising.

 

The business plan of the Bankemphasizes providing highly specialized financial services in a professionaland personalized manner to individuals and businesses in its service area.  Its key strengths are customer

 

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service and an experiencedmanagement team familiar with the community through the Bank’s involvement invarious community lending and development projects.

 

In 2003 and 2004, the Bank extendedits use of Internet technology as a distribution tool to improve its customerservice by use of email and Internet Banking, including bill pay and ACHorigination.  While the Bank continues tofocus on its local market areas, it has also been able to attract non-local (“brokered”)certificates of deposit at market rates. Management expects that brokered deposits will be used from time to timein the future as an alternative source of funding loan growth.

 

**Status of and Publicly AnnouncedNew Products or Services**

 

There has been no significantchange in the types of services offered by the Bank since its inception. The Companyhas no present plans to enter any material new line of business that wouldrequire the investment of a material amount of total assets.

 

The Bank participates in a 3-yearproject (2002 - 2005) sponsored by NCIF to explore and develop a profitable rangeof retail financial products and services to low income and unbanked customers(“low income customers”).  NCIF isunderwriting a majority of the costs associated with this project.  The project seeks to develop replicable andprofitable business models for both particular products and services targetedat low income customers, and coordinated suites of products that meet a rangeof needs.  Product and servicespecifications, target market, cross selling and profitability data is beingtracked over a two- to three-year time horizon with the goal to develop suitesof products that meet household financial and asset building needs while beingprofitable for financial institutions.  Expectedproducts include First Accounts, Individual Development Accounts, and access todebit cards and other electronic services.  The Bank expects to increase its focus onprofitable financial services for the un- and under-banked customers in itsmarket area, but does not expect these services will be a material percentageof its deposit activities.

 

The Company applied to the CDFI in2004 for a technical assistance grant to help offset any costs associated withproviding additional services to the un- and under-banked in its market area.  It was successful in this endeavor and wasawarded a grant of $134,935, which the Company expects to receive in 2005.

 

**Competition**

 

The banking and financial servicesbusiness in the Bank’s market area is highly competitive.  The increasingly competitive environment is aresult primarily of changes in regulation, and changes in technology andproduct delivery systems.  In order tocompete with other financial institutions in its service area, the Bank reliesupon local advertising programs; direct personal contact by officers, directors,employees, and shareholders; and specialized services such as courier pick-up.  The Bank emphasizes to its customers theadvantages of dealing with a locally owned and community development orientedinstitution. Larger banks may have a competitive advantage because of higherlending limits and major advertising and marketing campaigns in addition toexpanded products like trust services, international banking, discountbrokerage and insurance services that the Bank does not offer.  As a service to its customers, the Bank hasmade arrangements with other financial service providers to extend suchservices to its customers where possible.  For borrowers requiring loans in excess of theBank’s legal lending limits, the Bank makes use of loan participations with itscorrespondent banks and with other independent banks, retaining the portion ofsuch loans which is within its legal lending limits.  Commercial banks compete with savings and loanassociations, credit unions, other financial institutions, securities brokeragefirms, and other entities for funds.  Forinstance, yields on corporate and government debt securities and other commercialpaper affect the ability of commercial banks to attract and hold deposits.

 

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

 

**Sources and availability of RawMaterials and Principal Suppliers**

 

As a service organization, theCompany is not dependent on raw materials.

 

**No Dependence on One or a FewMajor Customers**

 

The Bank is limited in the size ofloans it can make to any one individual borrower (in the aggregate), and it hasapproximately 700 loan customers.  As of December 31,2004, the Bank’s legal lending limits to a single borrower, and such borrower’srelated parties, on a secured basis (first trust deed) were approximately $3.1million and $1.8 million for unsecured loans, based on regulatory capital plusreserves of approximately $12.3 million.

 

A material portion of the Bank’sdeposits have not been obtained from a single person or a few persons, the lossof any one or more of which would have a materially adverse effect on thebusiness of the Bank.  The Bank has ahigher than average dependence (as measured by peer group analysis) on largerdeposit balances (deposits of $100,000 or more) with a total of 307 depositorsholding $68.5 million in deposits as of December 31, 2004.  Included in those totals are 9 accounts of $1million or more totaling $16.0 million.  Thesedeposit balances have been reasonably stable during the past several years andare consistent with the Bank’s deposit/funding strategy.

 

The Bank’s business does not appearto be seasonal.

 

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

 

The Bank holds no special patents,licenses (other than licenses obtained from bank regulatory authorities),franchises or concessions.

 

**Effect of GovernmentPolicies and Regulations**

 

Banking is a business that dependson rate differentials.  In general, thedifference between the interest rate paid by the Bank on its deposits and itsother borrowings and the interest rate received by the Bank on loans extendedto its customers and securities held in the Bank’s portfolio comprise the majorportion of the Bank’s earnings.  Theserates are highly sensitive to many factors that are beyond the control of theBank. Accordingly, the earnings and growth of the Bank are subject to theinfluence of domestic and foreign economic conditions, including inflation, recessionand unemployment.

 

The commercial banking business isnot only affected by general economic conditions but is also influenced by themonetary and fiscal policies of the federal government and the policies ofregulatory agencies, particularly the Federal Reserve Board.  The Federal Reserve Board implements nationalmonetary policies (with objectives such as curbing inflation and combatingrecession) by its open-market operations in U.S. Government securities, byadjusting the required level of reserves for financial institutions subject toits reserve requirements and by varying the discount rates applicable toborrowings by depository institutions. The actions of the Federal Reserve Boardin these areas influence the growth of bank loans, investments and deposits andalso affect interest rates charged on loans and paid on deposits.  The nature and impact of any future changes inmonetary policies cannot be predicted.

 

From time to time, legislation isenacted which has the effect of increasing the cost of doing business, limitingor expanding permissible activities or affecting the competitive balancebetween banks and other financial institutions.  Proposals to change the laws and regulationsgoverning the operations and taxation of banks,

 

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bank holding companies and otherfinancial institutions are frequently made in Congress, in the California legislatureand before various bank regulatory and other professional agencies.

 

**Supervisionand Regulation**

 

The Company and the Bank areextensively regulated under both federal and state law.  Set forth below is a summary description ofcertain laws that relate to the regulation of Bancorp and the Bank. Thedescription does not purport to be complete and is qualified in its entirety byreference to the applicable laws and regulations.

 

**Bancorp**

 

Bancorp is a bank holding companywithin the meaning of the Bank Holding Company Act of 1956, as amended (the “BHCA”),and is registered as such with, and subject to the supervision of, the FederalReserve Board.  Bancorp is required tofile with the Federal Reserve Board quarterly and annual reports and such additionalinformation as the Federal Reserve Board may require pursuant to the BHCA.  The Federal Reserve Board may conductexaminations of bank holding companies and their subsidiaries.

 

Approval of the Federal ReserveBoard is required before Bancorp may acquire all or substantially all of theassets of any bank, or ownership or control of the voting shares of any bankif, after giving effect to such acquisition of shares, Bancorp would own or controlmore than 5% of the voting shares of such bank.  Prior approval of the Federal Reserve Board isalso required for the merger or consolidation of Bancorp and another bankholding company.

 

Bancorp is prohibited by the BHCA,except in certain statutorily prescribed instances, from acquiring direct orindirect ownership or control of more than 5% of the outstanding voting sharesof 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 orcontrolling banks or furnishing services to its subsidiaries.  However, Bancorp may, subject to the prior approvalof the Federal Reserve Board, engage in, or acquire shares of companies engagedin, any activities that are deemed by the Federal Reserve Board to be soclosely related to banking or managing or controlling banks as to be a properincident thereto.

 

The Federal Reserve Board mayrequire that Bancorp terminate an activity or terminate control of or liquidateor divest subsidiaries or affiliates when the Federal Reserve Board determinesthat the activity or the control of the subsidiary or affiliates constitutes asignificant risk to the financial safety, soundness or stability of any of itsbanking subsidiaries.  The FederalReserve Board also has the authority to regulate provisions of certain bankholding company debt, including authority to impose interest ceilings andreserve requirements on such debt.  Undercertain circumstances, Bancorp must file written notice and obtain approvalfrom the Federal Reserve Board prior to purchasing or redeeming its equitysecurities.

 

Under the Federal Reserve Board’sregulations, a bank holding company is required to serve as a source offinancial and managerial strength to its subsidiary banks and may not conductits operations in an unsafe and unsound manner.  In addition, it is the Federal Reserve Board’spolicy that in serving as a source of strength to its subsidiary banks, a bankholding company should stand ready to use available resources to provideadequate capital funds to its subsidiary banks during periods of financialstress or adversity and should maintain the financial flexibility andcapital-raising capacity to obtain additional resources for assisting itssubsidiary banks.  A bank holding company’sfailure to meet its obligations to serve as a source of strength to itssubsidiary banks will generally be considered by the Federal Reserve Board tobe an unsafe and unsound banking practice or a violation of the Federal ReserveBoard’s regulations or both.

 

Bancorp is subject to the periodicreporting requirements of Section 15(d) of the Securities Exchange Act of1934, as amended, and files reports pursuant to such Act with the Securitiesand Exchange Commission (“SEC”).

 

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**The Bank**

 

The Bank is chartered under thelaws of the state of California and its deposits are insured by the FDIC to theextent provided by law.  Prior to December 2003and its charter conversion, the Bank was supervised by the Comptroller of theCurrency.  Following the conversion, theBank is subject to the supervision of, and is regularly examined by, theFederal Reserve Bank of San Francisco (the “FRB”) and the DFI.  Such supervision and regulation includecomprehensive reviews of all major aspects of the Bank’s business andcondition.

 

Various requirements andrestrictions under the laws of the United States and of California affect theoperations of the Bank.  Federal statutesrelate to many aspects of the Bank’s operations, including reserves againstdeposits, interest rates payable on deposits, loans, investments, mergers andacquisitions, borrowings, dividends and locations of branch offices.  Further, the Bank is required to maintaincertain levels of capital.

 

If, as a result of an examinationof a bank, the FRB or DFI determines that the financial condition, capitalresources, asset quality, earnings prospects, management, liquidity, or otheraspects of the Bank’s operations are unsatisfactory or that the Bank or itsmanagement is violating or has violated any law or regulation, various remediesare available to such regulatory agency.  Such remedies include the power to enjoin “unsafeor unsound” practices, to require affirmative action to correct any conditionsresulting from any violation or practice, to issue an administrative order thatcan be judicially enforced, to direct an increase in capital, to restrict thegrowth of the Bank, to assess civil monetary penalties, to remove officers anddirectors, and ultimately to terminate the Bank’s deposit insurance, whichwould result in a revocation of the Bank’s charter.

 

**CapitalStandards**

 

The Federal Reserve Board hasadopted risk-based minimum capital guidelines intended to provide a measure ofcapital that reflects the degree of risk associated with a banking organization’soperations for both transactions reported on the balance sheet as assets andtransactions, such as letters of credit and recourse arrangements, which arerecorded as off-balance sheet items.  Underthese guidelines, nominal dollar amounts of assets and credit equivalentamounts of off-balance sheet items are multiplied by one of several riskadjustment percentages, which range from 0% for assets with low credit risk,such as certain U.S. Treasury securities, to 100% for assets with relatively highcredit risk, such as business loans.

 

A banking organization’s risk-basedcapital ratios are obtained by dividing its qualifying capital by its totalrisk adjusted assets.  The regulatorsmeasure risk-adjusted assets, which include off balance sheet items, againstboth Tier 1 capital and Total qualifying capital (the sum of Tier 1 capital andlimited amounts of Tier 2 capital).  Tier1 capital consists primarily of common stock, retained earnings, non-cumulativeperpetual preferred stock (cumulative perpetual preferred stock for bankholding companies) and minority interests in certain subsidiaries, less mostintangible assets.  Tier 2 capital mayconsist of a limited amount of the allowance for possible loan and leaselosses, cumulative preferred stock, long term preferred stock, eligible termsubordinated debt and certain other instruments with some characteristics ofequity.  The inclusion of elements ofTier 2 capital is subject to certain other requirements and limitations of thefederal banking agencies.  The federalbanking agencies require a minimum ratio of qualifying total capital torisk-adjusted assets of 8% and a minimum ratio of Tier 1 capital torisk-adjusted assets of 4%.

 

In addition to the risked-basedguidelines, federal banking regulators require banking organizations tomaintain a minimum amount of Tier 1 capital to total assets (not risk-adjusted),referred to as the leverage ratio.  For abanking organization rated in the highest of the five categories used byregulators to rate banking organizations, the minimum leverage ratio of Tier 1capital to total assets is 3%.  For allbanking organizations not rated in the highest category, including the Companyand the Bank, the minimum leverage ratio must be at least 4%.  In addition to these uniform risk-basedcapital guidelines and leverage ratios that apply across the industry, theregulators have the discretion to set individual minimum capital requirementsfor specific institutions at rates significantly above the minimum guidelinesand ratios.  Future changes in requiredcapital ratios or regulations or practices could further reduce the amount ofcapital recognized for purposes of capital adequacy.  Such a change could affect the ability of theBank to grow and could restrict the amount of profits, if any.

 

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The following table presents theamounts of regulatory capital and the capital ratios for the Bank compared toits minimum regulatory capital requirements as of December 31, 2004:

 

| ** **                       | ** ** | ** ** | ** ** | **Well-**        | ** ** | **Minimum**      | ** ** |
|----------------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                       | ** ** | **Bank**   | ** ** | **Capitalized**  | ** ** | **Capital**      | ** ** |
| ** **                       | ** ** | **Actual** | ** ** | **Requirements** | ** ** | **Requirements** | ** ** |
| Total Risk-Based  Capital Ratio  |       | 11.5%      |       | 10.0%            |       | 8.0%             |       |
| Tier 1  Risk-Based Capital Ratio |       | 10.6%      |       |  6.0%       |       | 4.0%             |       |
| Leverage Ratio                   |       |  9.1% |       |  5.0%       |       | 4.0%             |       |

 

Under applicable regulatoryguidelines, the Bank was considered “Well Capitalized” at December 31, 2004.

 

Under existing regulations of theFederal Reserve Board, the consolidated capital ratios of bank holding companieswith total assets of less than $150 million, such as the Company, are deemed tobe the same as those of the Bank.

 

**PromptCorrective Action and Other Enforcement Mechanisms**

 

Federal banking agencies possessbroad powers to take corrective and other supervisory action to resolve theproblems of insured depository institutions, including, but not limited to,those institutions that fall below one or more prescribed minimum capitalratios described above.  An institutionthat, based upon its capital levels, is classified as well capitalized,adequately capitalized, or undercapitalized may be treated as though it were inthe next lower capital category if the appropriate federal banking agency,after notice and opportunity for hearing, determines that an unsafe or unsoundcondition or an unsafe or unsound practice warrants such treatment.  At each successive lower capital category, aninsured depository institution is subject to more restrictions.  The federal banking agencies, however, may nottreat a significantly undercapitalized institution as critically undercapitalizedunless its capital ratio actually warrants such treatment.

 

In addition to measures taken underthe prompt corrective action provisions, commercial banking organizations maybe subject to potential enforcement actions by the federal regulators for unsafeor unsound practices in conducting their businesses or for violations of anylaw, rule, regulation, or any condition imposed in writing by the agency or anywritten agreement with the agency.

 

**Safety and Soundness Standards**

 

The federal banking agencies haveadopted guidelines designed to assist the federal banking agencies inidentifying and addressing potential safety and soundness concerns beforecapital becomes impaired.  The guidelinesset forth operational and managerial standards relating to internal controls,information systems and internal audit systems, loan documentation, creditunderwriting, asset growth, earnings, and compensation, fees and benefits.

 

In addition, the federal bankingagencies have also adopted safety and soundness guidelines with respect toasset quality and earnings standards.  Theseguidelines provide six standards for establishing and maintaining a system toidentify problem assets and prevent those assets from deteriorating.  Under these standards, an insured depositoryinstitution should:

 

•      conduct periodicasset-quality reviews to identify problem assets;

•      estimate theinherent losses in problem assets and establish reserves that are sufficient toabsorb estimated losses;

•      compare problemasset totals to capital;

•      take appropriatecorrective action to resolve problem assets;

•      consider thesize and potential risks of material asset concentrations; and

•      provide periodicasset quality reports with adequate information for management and the board ofdirectors to assess the level of asset risk.

 

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These guidelines also set forthstandards for evaluating and monitoring earnings and for ensuring that earningsare sufficient for the maintenance of adequate capital and reserves.

 

**Premiums forDeposit Insurance**

 

Through the Bank Insurance Fund (“BIF”),the FDIC insures the deposits of the Bank up to prescribed limits for eachdepositor.  The amount of FDIC assessmentspaid by each BIF member institution is based on its relative risk of default asmeasured by regulatory capital ratios and other factors.  Specifically, the assessment rate is based onthe institution’s capitalization risk category and supervisory subgroupcategory.  An institution’scapitalization risk category is based on the FDIC’s determination of whetherthe institution is well capitalized, adequately capitalized or less thanadequately capitalized.  An institution’ssupervisory subgroup category is based on the FDIC’s assessment of thefinancial condition of the institution and the probability that FDICintervention or other corrective action will be required.

 

The assessment rate currentlyranges from zero to 27 cents per $100 of domestic deposits.  The FDIC may increase or decrease theassessment rate schedule on a semi-annual basis.  An increase in the assessment rate could havea material adverse effect on the Bank’s earnings, depending on the amount ofthe increase.  The FDIC is authorized toterminate a depository institution’s deposit insurance upon a finding by theFDIC that the institution’s financial condition is unsafe or unsound or thatthe institution has engaged in unsafe or unsound practices or has violated anyapplicable rule, regulation, order or condition enacted or imposed by theinstitution’s regulatory agency.

 

All FDIC-insured depositoryinstitutions must pay an annual assessment to provide funds for the payment ofinterest on bonds issued by the Financing Corporation, a federal corporationchartered under the authority of the Federal Housing Finance Board.  The bonds, commonly referred to as FICO bonds,were issued to capitalize the Federal Savings and Loan Insurance Corporation.  The FICO assessments are adjusted quarterly toreflect changes in the assessment bases of the FDIC’s insurance funds and donot vary depending on a depository institution’s capitalization or supervisoryevaluations.

 

**CommunityReinvestment Act**

 

The Bank is subject to certain fairlending requirements and reporting obligations involving home mortgage lendingoperations and Community Reinvestment Act (“CRA”) activities. The CRA generallyrequires the federal banking agencies to evaluate the record of a financialinstitution in meeting the credit needs of their local communities, includinglow and moderate income neighborhoods.  In addition to substantial penalties andcorrective measures that may be required for a violation of certain fairlending laws, the federal banking agencies may take compliance with such lawsand CRA into account when regulating and supervising other activities.  In connection with its assessment of CRAperformance, the appropriate bank regulatory agency assigns a rating of “outstanding,”“satisfactory,” “needs to improve” or “substantial noncompliance.”

 

At its last examination, the Bankreceived a CRA rating of “Outstanding.”

 

**RecentLegislation**

 

**Financial Holding Companies**

 

A bank holding company that electsto become a financial holding company may affiliate with securities firms andinsurance companies and engage in other activities that are financial in natureor are incidental or complementary to activities that are financial in nature.  A bank holding company that is not also afinancial holding company is limited to engaging in banking and such otheractivities as determined by the Federal Reserve Board to be so closely relatedto banking or managing or controlling banks as to be a proper incident thereto. Bancorp has not elected to become afinancial holding company.

 

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**USA Patriot Act of 2001**

 

In October 2001, theUSA Patriot Act of 2001 was enacted in response to the terrorist attacks in NewYork, Pennsylvania and Washington, D.C., which occurred on September 11,2001.  The Patriot Act is intended tostrengthen U.S. law enforcement’s and the intelligence community’s abilities towork cohesively to combat terrorism on a variety of fronts.  The potential impact of the Patriot Act onfinancial institutions of all kinds is significant and wide ranging.  The Patriot Act contains sweeping anti-moneylaundering and financial transparency laws and imposes various regulations,including standards for verifying client identification at account opening, andrules to promote cooperation among financial institutions, regulators and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering.

 

**California Corporate DisclosureAct**

 

The California Corporate DisclosureAct, effective January 1, 2003, amends the Corporations Code by requiringadditional public disclosures by “publicly traded companies,” includingdomestic and foreign corporations, qualified to transact intrastate business inCalifornia.  The purpose of the newrequired disclosures is to help combat fraud and protect investors.  “Publicly traded company” means a companywith securities listed or admitted to trading on a national or foreignexchange, or which is the subject of two-way quotations that are regularlypublished.  Such companies must file withthe Secretary of State a statement, in the form prescribed, including thefollowing additional information:

 

•      Name ofindependent auditor, description of other services provided as specified, anddate of the last audit, including a copy of the report;

•      Annualcompensation paid to each director and executive officer;

•      Description ofany loans made to any director at a preferential loan rate;

•      Statementindicating whether any bankruptcy has been filed by corporation executiveofficers or directors during the past 10 years;

•      Statementindicating whether any member of the board of directors or executive officer ofthe corporation was convicted of fraud during the previous 10 years;

•      Statementindicating whether the corporation violated any federal security laws or anybanking or security provisions of California law during the previous 10 yearsfor which the corporation was found liable in an action before a federal orstate court or regulatory agency or a self-regulatory agency in which ajudgment over $10,000 was entered.

 

**Sarbanes-Oxley Act of 2002**

 

On July 30, 2002,President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “SOA”).  The stated goals of the SOA are to increasecorporate responsibility, to provide for enhanced penalties for accounting andauditing improprieties at publicly traded companies and to protect investors byimproving the accuracy and reliability of corporate disclosures pursuant to thesecurities laws.

 

The SOA is the mostfar-reaching U.S. securities legislation enacted in some time.  The SOA generally applies to all companies,both U.S. and non-U.S., that file or are required to file periodic reports withthe SEC under the Securities Exchange Act of 1934.  Given the extensive SEC role in implementingrules relating to many of the SOA’s new requirements, the final scope of theserequirements remains to be determined.

 

The SOA includes veryspecific additional disclosure requirements and new corporate governance rules,requires the SEC and securities exchanges to adopt extensive additionaldisclosure, corporate governance and other related rules and mandates furtherstudies of certain issues by the SEC. The SOA represents significant federal involvement in matterstraditionally left to state regulatory systems, such as the regulation of theaccounting profession, and to state corporate law, such as the relationshipbetween a board of directors and management and between a board of directorsand its committees.

 

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The SOA addresses, amongother matters:

 

•      the creation ofan independent accounting oversight board to oversee the audit of publiccompanies and auditors who perform such audits;

•      audit committeesfor all listed companies and expansion of the power of the audit committee,including the requirements that the audit committee: (i) have direct control ofthe outside auditor; (ii) be able to hire and fire the auditor; and (iii)approve all non-audit services;

•      auditorindependence provisions which restrict non-audit services that independentaccountants may provide to their audit clients;

•      certification offinancial statements by the chief executive officer and the chief financialofficer;

•      the forfeitureof bonuses or other incentive-based compensation and profits from the sale ofan issuer’s securities by directors and senior officers in the twelve monthperiod following initial publication of any financial statements that laterrequire restatement;

•      a prohibition oninsider trading during pension plan black out periods;

•      increasedprotection for whistleblowers and informants;

•      disclosure ofoff-balance sheet transactions;

•      expedited filingrequirements for ownership reports by officers and directors;

•      disclosure of acode of ethics and filing a Form 8-K for a change or waiver of such code;

•      “real time”filing of periodic reports; and

•      variousincreased criminal penalties for violations of securities laws.

 

The SOA contains provisionsthat became effective upon enactment on July 30, 2002, and provisions thatbecame effective within 30 days to one year from enactment.  The SEC has been delegated the task ofenacting rules to implement various provisions with respect to, among othermatters, disclosure in periodic filings pursuant to the Exchange Act.

 

On March 2, 2005, theSEC extended the compliance dates for non-accelerated filers, such as Bancorp,regarding rules pursuant to Section 404 of the Sarbanes-Oxley Act.  The rules relate to requirements thatcompanies include in annual reports a report by management on the company’sinternal control over financial reporting and an accompanying auditor’sreport.  Under the latest extension, acompany that is not required to file its annual and quarterly reports on anaccelerated basis (non-accelerated filer), must begin to comply with theinternal control over financial reporting requirements for its first fiscalyear ending on or after July 15, 2006. This is a one-year extension from the previously established July 15,2005, compliance date for non-accelerated filers.  The SEC also has extended the compliance datefor non-accelerated filers relating to requirements regarding evaluation ofinternal control over financial reporting and management certificationrequirements.

 

**Transactions Between Affiliates**

 

Transactions between a bankand its “affiliates” are quantitatively and qualitatively restricted under theFederal Reserve Act.  The FRB has alsoissued Regulation W, which codifies prior regulations under Sections 23A and23B of the Federal Reserve Act and interpretative guidance with respect toaffiliate transactions.  Regulation Wincorporates the exemption from the affiliate transaction rules but expands theexemption to cover the purchase of any type of loan or extension of credit froman affiliate.  Affiliates of a bankinclude, among other entities, companies that are under common control with thebank.  In general, subject to certainspecified exemptions, a bank or its subsidiaries are limited in their abilityto engage in “covered transactions” with affiliates:

 

•      to an amountequal to 10% of the bank’s capital and surplus, in the case of coveredtransactions with any one affiliate; and

•      to an amountequal to 20% of the bank’s capital and surplus, in the case of coveredtransactions with all affiliates.

 

In addition, a bank and itssubsidiaries may engage in covered transactions and other specifiedtransactions

 

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only on terms and undercircumstances that are substantially the same, or at least as favorable to thebank or its subsidiary, as those prevailing at the time for comparabletransactions with nonaffiliated companies. A “covered transaction” includes:

 

•      a loan orextension of credit to an affiliate;

•      a purchase of,or an investment in, securities issued by an affiliate;

•      a purchase ofassets from an affiliate, with some exceptions;

•      the acceptanceof securities issued by an affiliate as collateral for a loan or extension ofcredit to any party; and

•      the issuance ofa guarantee, acceptance or letter of credit on behalf of an affiliate.

 

In addition, under RegulationW:

 

•      a bank and itssubsidiaries may not purchase a low-quality asset from an affiliate;

•      coveredtransactions and other specified transactions between a bank or its subsidiariesand an affiliate must be on terms and conditions that are consistent with safeand sound banking practices; and

•      with someexceptions, each loan or extension of credit by a bank to an affiliate must besecured by collateral with a market value ranging from 100% to 130%, dependingon the type of collateral, of the amount of the loan or extension of credit.

 

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

 

**Environmental Regulations**

 

Management of the Bank is unawareof any material effect upon the Bank’s capital expenditures, earnings orcompetitive position as a result of federal, state or local environmentalregulation.

 

**Employees**

 

As of March 1, 2005the Bank had a total of 55 employees. The management of the Bank believes thatits employee relations are satisfactory.  Neither Bancorp nor MCDC have salariedemployees; 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; however,the time and services are not material at this time.

 

**Certain Business Risk**

 

In addition to the otherinformation contained in this Report, the following risks may affect theCompany.  If any of these risks occur, theCompany’s business, financial condition or operating results could be adverselyaffected.

 

**Dependence on Real Estate**

 

A significant portion of the loanportfolio of the Bank is dependent on real estate.  At December 31, 2004, real estate servedas the principal source of collateral with respect to approximately 82 percentof the Bank’s loan portfolio.  A declinein current economic conditions or rising interest rates could have an adverseeffect on the demand for new loans, the ability of borrowers to repayoutstanding loans, the value of real estate and other collateral securing loansand the value of real estate owned by the Bank, as well as the Company’sfinancial

 

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condition and results of operationsin general, and the market value of the Company’s common stock.  Acts of nature, including earthquakes andfloods, which may cause uninsured damage and other loss of value to real estatethat secures these loans, may also negatively impact the Company’s financial condition.  See *Concentrations*in Managements’ Discussion and Analysis under Item 6 of Part II of this report.

 

**Interest Rate Changes**

 

The earnings of the Company and theBank are substantially affected by changes in prevailing interest rates.Changes in interest rates affect the demand for new loans, the credit profileof existing loans, the rates received on loans and securities and the rates theBank must pay on deposits and borrowings.  The difference between the rates the Bankreceives on loans and securities and the rates it must pay on deposits andborrowings is known as the interest rate spread.  Given the Bank’s current volume and mix ofinterest-bearing liabilities and interest-earning assets, the Bank’s interestrate 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 “assetsensitive.”  Although the Bank believesits current level of interest rate sensitivity is reasonable, significantfluctuations in interest rates may have an adverse impact on the Company’s andthe Bank’s business, financial condition and results of operations.  See *Asset and LiabilityManagement* in Management’s Discussion and Analysis under Item 6 ofPart II of this report.

 

**Competition**

 

Competition may adversely affectthe Bank’s performance.  The financialservices business in the Bank’s market area is highly competitive and becomingmore so due to changes in regulation, technological advances and theaccelerating pace of consolidation among financial service providers.  The Bank faces competition both in attractingdeposits and in making loans.  Itcompetes for loans principally through the interest rates and loan fees itcharges and the efficiency and quality of the services it provides.  Increasing levels of competition in thebanking and financial services industry may reduce the Bank’s market share,cause the prices it charges for its services to fall, or cause the rates it mustpay to attract deposits to rise.  TheCompany’s results may differ in future periods depending on the nature or levelof competition by financial services providers.

 

**Regulation**

 

Bancorp and the Bank are subject togovernment regulation that could limit or restrict their activities, adverselyaffecting operations.  Federal and state bankingregulation is designed to protect the deposits of consumers, not to benefitshareholders.  The regulations imposesignificant limitations on operations, and may be changed at any time to imposesignificant new limitations, possibly causing the Company’s results to varysignificantly from past results.  Governmentpolicy and regulation, particularly as implemented through the Federal ReserveBoard, significantly affects credit conditions for the Bank.

 

**Borrowers’ Failure to Perform**

 

A significant number of the Bank’sborrowers and guarantors may fail to perform their obligations as required bythe terms of their loans, resulting in losses for the Bank.  The Bank has adopted underwriting and creditpolicies, and loan monitoring procedures, including the establishment andmonitoring of allowances for credit losses.  Management believes these provisions arereasonable and adequate, and should keep credit losses within expected limitsby assessing the likelihood of nonperformance, tracking loan performance anddiversifying the credit portfolio.  However, these policies and procedures may notbe adequate to prevent unexpected losses that could materially and adverselyaffect the Company’s results of operations.

 

**Limited Trading Market for theCompany’s Common Stock**

 

The Company’s common stock istraded over-the-counter and is not listed or quoted on any major exchange.Trading volume is modest and can cause fluctuations in the market value of theCompany’s stock.  These

 

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fluctuations can be exaggerated,leading to price volatility in excess of other stocks which are more activelytraded.  No assurances can be givenconcerning market value or the ability to sell shares of the Company’s commonstock.

 

**REPORTS TO SECURITY HOLDERS.**

 

**Annual Report**

 

An annual report to securityholders including audited financial statements is sent each year by theCompany.

 

Certain reports are filed by theCompany with the Securities Exchange Commission pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934.  The SEC maintains an Internetsite that contains reports and other information statements.  The Company files its reports electronicallyand they may be viewed from the SEC’s Internet site http://www.sec.gov.  The public may also read and copy anymaterials filed with the SEC at the SEC’s Public Reference Room at 450 FifthStreet, N.W., Washington, D.C. 20549.  Information regarding theoperation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0300.

 

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

 

## **Item2.  Description of Property**

## ** **

The Company occupies a propertyowned by the Bank at 581 Higuera Street, San Luis Obispo, California, where theBank’s main office is located.  For itsadministration offices, the Bank has been leasing approximately 2,950 squarefeet at 569 Higuera St. in San Luis Obispo at a cost of approximately $5,200per month.  The lease expires on June 30,2006, with an option to renew for one five-year period.  The administration office is located next tothe Bank’s main office.

 

The Bank also leases a branchoffice at 1226 Park Street, Paso Robles, California, at a cost of $1,855 permonth.  The lease expires on July 31,2008 and provides for one five-year option.

 

The Bank’s branch office at 154West Branch Street, Arroyo Grande, California, is leased at a cost of $3,052 permonth, plus common area operating expenses.  The lease expires in September 2005 andprovides for two five-year option periods.

 

In 2002, the Bank leased premisesat 671 Tefft Street, Nipomo, California, at a cost of $3,370 per month.  The lease expires May 31, 2007, and providesfor two five-year option periods.

 

In July 2004, the Bank enteredinto a five-year lease at a cost of $6,000 per month for office space at 3440and 3480 S. Higuera Street, San Luis Obispo, for its new Business BankingCenter.  One five-year option period is providedin the lease.

 

For the years ended December 31,2004 and 2003, the Bank’s total occupancy costs were approximately $442,000 and$394,000, respectively.  In the opinionof management, the premises are adequate for the Bank’s purposes and the Bank hassufficient insurance to cover its interest in the premises.  Note D to the Consolidated FinancialStatements contains additional information about properties.

 

Bancorp is restricted by the bankholding company regulations in its power to hold real estate property for investment. The Company does not currently invest in real estate, other than forpurposes of operations and

 

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mortgage interests in real estatesecuring loans made by the Bank in the ordinary course of business, and has noplans to do so in the future.

 

## **Item 3.  Legal Proceedings**

## ** **

The Company is, from time to time,subject to various pending and threatened legal actions which arise out of thenormal course of its business.  TheCompany is not a party to any pending legal or administrative proceedings(other than ordinary routine litigation incidental to the Company’s business)and no such proceedings are known to be contemplated.

 

There are no material proceedingsadverse to the Company to which any director, officer, affiliate of the Companyor 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 personshas a material interest adverse to the Company.

 

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

## ** **

No matters were submitted to a voteof security holders during the fourth quarter of 2004.

 

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# **PART II**

# ** **

## **Item5.  Market for Common Equity and RelatedShareholder Matters**

## ** **

**Market Information**

 

The Company’s common stock hastraded infrequently in the over-the-counter market under the symbol “MISS.”  The Company’s Common Stock is not listed onany exchange or market.  However, Hoefer& Arnett, the Seidler Companies, Wedbush Morgan Securities, UBS CapitalMarkets, Monroe Securities, Hill Thompson Magid & Co., Rbc Capital Markets,and Archipelago Trading Services make a market in the Company’s Common Stock.  Certain information concerning the CommonStock is reported on the Nasdaq OTC Bulletin Board (www.otcbb.com).

 

The information in the followingtable indicates the daily high and low bid prices of the Company’s Common Stockfor each quarterly period during the last two years based upon informationprovided by OTC Bulletin Board. These prices do not include retail mark-ups,mark-downs or commission.

 
| ** ** | ** **  | **Bid Prices** | ** ** |
|------------|-------------|----------------|------------|
| ** ** | ** **  | **Low**        | ** ** | **High** | ** ** |
| 2003       | 1st Quarter |           | $          | 12.05 |   | $ | 12.55 |   |
|       | 2nd Quarter |           | 12.65      |   | 12.80 |   |
|       | 3rd Quarter |           | 12.80      |   | 14.75 |   |
|       | 4th Quarter |           | 15.50      |   | 16.10 |   |
| 2004       | 1st Quarter |           | 16.10      |   | 20.00 |   |
|       | 2nd Quarter |           | 17.60      |   | 20.00 |   |
|       | 3rd Quarter |           | 17.55      |   | 18.30 |   |
|       | 4th Quarter |           | 18.35      |   | 23.00 |   |
|            |             |                |            |  |  |  |  |  |

 

**Holders**

 

As of March 1, 2005,there were 348 holders of record of Bancorp’s Common Stock.

 

**Preferred Stock**

 

**Series CNon-Voting Convertible Redeemable Preferred Stock**

 

On December 18,2002, Bancorp issued 50,000 shares of preferred stock to the CommunityDevelopment Financial Institutions Fund, for $500,000.  Such shares of preferred stock weredesignated as “Series C Non-Voting Convertible Redeemable Preferred Stock” andhave identical rights and privileges in every respect to Common Stock exceptthat they are non-voting.   The dividendrights attributed to Series C Preferred Stock are equal to the amount of thedividend that would be payable on the shares of Common Stock.  The Series C Preferred Stock shall not beentitled to any fixed rate of return. Each share of Series C Preferred Stock may converted, at the option ofthe holder thereof, at any time at or after the sale, transfer or other disposition(whether or not for value) by CDFI (other than to an affiliate of CDFI) of suchshares of Series C Preferred Stock into such number of fully paid andnonassessable shares of Common Stock of the Company as is determined bydividing $10.00 by the then effective Conversion Price. In the event of anyliquidation, dissolution or winding up of the Company, either voluntary orinvoluntary, the holders of the Series C Preferred Stock shall not be entitledto receive, from any of the assets or surplus funds of the Company legallyavailable for distribution, any payment or distribution until payment in fullof all preferential amounts provided for in Prior Stock of the Company. In theevent of any liquidation, dissolution or winding up of the Company, for anyreason, the holders of the Series C Preferred Stock shall be entitled toreceive, prior and in preference to any distribution of any of the assets orsurplus funds of the

 

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Company legally availablefor distribution to the holders of the Common Stock or any Junior Stock, theamount of $10.00 per share (as adjusted for any stock dividends, combinationsor splits with respect to such shares) plus all declared but unpaid dividendson such shares. If the assets and funds available for distribution to theholders of the Series C Preferred Stock and any Parity Stock shall beinsufficient to pay the stated preferential amounts in full, then the entireassets and funds of the Company legally available for distribution shall bedistributed to the holders of the Series C Preferred Stock and the Parity Stockin proportion to the preferential amount each such holders is otherwiseentitled to receive.  If the Common Stockis subdivided, combined or reclassified , the Series C Preferred Stock shall besubdivided, combined or reclassified on the same basis.

 

Subject to the receipt ofany required regulatory approval, the Series C Preferred Stock shall beautomatically redeemable, in whole or in part, at any time upon the request ofthe holder of the Series C Preferred Stock, in cash at the price of $10.00 pershare, without further action on the part of the Company, upon and after afinding by the Community Development Financial Institutions Fund, or itssuccessor agency or entity, that the Company is in default under any CommunityDevelopment Financial Institutions Program Assistance Agreement for EquityInvestments in Regulated Institutions, or any successor agreement, to which theCompany is a party or by which it is bound. No sinking fund will be established for the redemption of shares of theSeries C Preferred Stock.

 

The $500,000 proceeds from theSeries Preferred Stock were used to provide a $400,000 equity contribution tothe Bank with the remainder used to repay Bancorp borrowings and to provideBancorp with cash flow.

 

**Dividends**

 

The Company’s shareholders areentitled to receive dividends, when and as declared by its Board of Directors,out of funds legally available therefore, subject to the restrictions set forthin the in the California General Corporation Law (the “Corporation Law”).  The Corporation Law provides that acorporation may make a distribution to its shareholders if the corporation’sretained earnings equal at least the amount of the proposed distribution.  The Corporation Law also provides that, inthe event that sufficient retained earnings are not available for the proposeddistribution, a corporation may nevertheless make a distribution to itsshareholders if it meets two conditions, which generally stated are as follows:(i) the corporation’s assets equal at least 1.25 times its liabilities, and(ii) the corporation’s current assets equal at least its current liabilitiesor, if the average of the corporation’s earnings before taxes on income and beforeinterest expenses for the two preceding fiscal years was less than the averageof the corporation’s interest expenses for such fiscal years, then thecorporation’s current assets must equal at least 1.25 times its currentliabilities.  The Company was eligible topay dividends at the end of 2003 and 2004.

 

The availability of operating fundsfor the Company and the ability of the Company to pay a cash dividend dependslargely on the Bank’s ability to pay a cash dividend to Bancorp.  The payment of cash dividends by the Bank issubject to restrictions.  In general,dividends may not be paid from any of the Bank’s capital.  Dividends must be paid out of available netprofits, after deduction of all current operating expenses, actual losses,accrued dividends on preferred stock, if any, and all federal and statetaxes.  Additionally, a bank isprohibited from declaring a dividend on its shares of common stock until itssurplus fund equals its common capital, or, if its surplus fund does not equalits common capital, until at least one-tenth of the bank’s net profits, for thepreceding half year in the case of quarterly or semi-annual dividends, or thepreceding full year in the case of an annual dividend, are transferred to itssurplus fund each time dividends are declared. Regulatory approval is required if the total of all dividends declaredby a bank in any calendar year exceeds the total of its net profits for thatyear combined with its retained net profits of the two preceding years, lessany required transfers to surplus or a fund for the retirement of any preferredstock.  Furthermore, bank regulators alsohave authority to prohibit the payment of dividends by a bank when itdetermines such payment to be an unsafe and unsound banking practice.

 

Additionally, bank regulatoryagencies have authority to prohibit banks from engaging in activities that, intheir respective opinions, constitute unsafe and unsound practices inconducting its business.  It is possible,depending upon the financial condition of the bank in question and otherfactors, that the bank regulatory agencies could assert that the payment ofdividends or other payments might, under some circumstances, be

 

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an unsafe or unsound practice.  Further, the bank regulatory agencies haveestablished guidelines with respect to the maintenance of appropriate levels ofcapital by banks or bank holding companies under their jurisdiction.  Compliance with the standards set forth insuch guidelines and the restrictions that are or may be imposed under theprompt corrective action provisions of federal law could limit the amount ofdividends which the Bank may pay.

 

Under these provisions andconsidering minimum regulatory capital requirements, the Bank was eligible topay dividends in 2003 and 2004.

 

The Company paid a $0.10 per share cashdividend on December 23, 2002 on its Common Stock, $0.05 per share on its100,000 shares of Series A Preferred Stock outstanding, and $0.10 per share onits 20,500 shares of Series B Preferred Stock outstanding, comprising adistribution in the aggregate amount of approximately $70,068.

 

On December 22,2003, the Company paid a $0.10 per share cash dividend on its Common Stock,$0.05 per share on its 100,000 shares of Series A Preferred Stock, and $0.10pershare on its Series B and C Preferred Stock. The total amount paid was$75,067.

 

On November 22,2004, the Company declared a $0.12 per share cash dividend for holders of theCommon Stock of record on December 6, 2004.  The dividend was paid on December 20,2004.  Series A Preferred Stock receiveda $0.06 per share dividend and Series B and C Preferred Stock received a $0.12per share dividend. The total amount paid was $91,572.

 

The Bank paid a dividend in thetotal amount of $70,068 to Bancorp in December 2002.  No dividend was paid from the Bank to Bancorpin 2003 or 2004.

 

Prior to the December 2002dividends, no dividends had been paid by the Bank or the Company, and whetheror not stock or cash dividends will be paid in the future by the Company and/orthe Bank will be determined by the Board of Directors after consideration ofvarious factors including, but not limited to, profitability, regulatorycapital ratios, and financial condition. Additionally, certain provisions ofthe preferred stock issuances restrict the ability of the Company to pay cashdividends unless the required dividends on the preferred stock are also paid.

 

**Trust Preferred Securities**

 

On October 10, 2003, Bancorp formed awholly-owned business trust subsidiary, Mission Community Capital Trust I (the “Trust”),pursuant to the laws of the state of Delaware for the specific purpose of: (1)investing in Junior Subordinated Debentures (the “Debentures”) due October 7,2033; (2) selling Cumulative Capital Securities (the “Capital Securities”),representing a 97% beneficial interest in the Debentures owned by the Trust;and (3) issuing Common Securities (the “Common Securities”) to the Company,representing a 3% beneficial interest in the Debentures owned by the Trust.

 

On October 14, 2003, Bancorp issued $3.093million in Debentures to the Trust. Concurrently, the Trust issued $3.0 million of the Capital Securities toBear, Stearns & Co., Inc., the initial purchaser, and $93,000 of CommonSecurities to Bancorp.  The Debentureswere purchased by the Trust concurrently with the Trust’s issuance of theCapital Securities and Common Securities. The proceeds to the Company, net of the Initial Purchaser’s fees andother offering expenses, was approximately $2.924 million, which is treated asTier 1 capital for regulatory purposes.  The proceeds were used to increase the Bank’scapital by $2.0 million with the balance used for general corporate purposes.

 

The Debentures and Capital Securities mature in 2033and bear a floating interest rate equal to the London Inter-Bank Offered Rate (“LIBOR”)plus 2.95%.  The floating interest rate isadjustable quarterly with changes in LIBOR. The interest on the Debentures is tax deductible and paid by the Companyand represents the sole source of the Trust’s revenues available fordistributions to the holders of the Capital Securities.  The undertakings of the Company with regardto the issuance constitute the Company’s full and

 

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unconditional guarantee of the Trust’s obligations pursuant to the Amended and Restated Declaration of Trust.

 

The Company has the right, assuming that no default has occurred regarding the Debentures, to defer interest payments on the Debentures at any time and for a period of up to 20 consecutive calendar quarters. The Capital Securities will mature concurrently with the Debentures on October 7, 2033, but can be called after October 7, 2008 or earlier upon the occurrence of a “Special Event.”

 

**Equity Compensation Plans**

 

The following table shows, as of December 31, 2004, each category of equity compensation along with i) the number of securities to be issued upon the exercise of outstanding options, warrants and rights, ii) the weighted-average exercise price of the outstanding options, warrants and rights, and iii) the remaining number of securities available for future issuance under the plan, excluding stock options currently outstanding.

 

**Equity Compensation Plan Information**

 
| ** **                                                  | ** ** | **Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** | ** ** | **Weighted average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of  additional  securities available  for future grant  under the plan** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     |       | 138,933                                                                                               |       | $                                                                                   | 9.73       |                                                                              | 41,067     |   |
| Equity compensation plans not approved by  security holders |       | —                                                                                                |       | —                                                                              |       | —                                                                            |       |
|                                                        |       |                                                                                                  |       |                                                                                |       |                                                                              |       |
| Total                                                       |       | 138,933                                                                                               |       | $                                                                                   | 9.73       |                                                                              | 41,067     |   |

 

 

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

 

**Purchases of equity securities by Bancorp and affiliated purchasers**

 

Neither Bancorp nor any affiliate of Bancorp has repurchased any of its common or preferred stock during the period covered by this report, and no stock repurchase plan has been adopted.

 

 

21

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

 

**Executive Summary**

** **

At December 31, 2004, theCompany had total consolidated assets of $139.2 million, a 23% increase fromDecember 31, 2003.  Total net loansincreased 31%, to $102.3 million, over that same period.  Deposits and shareholders’ equity eachincreased 17%, to $112.8 million and $10.0 million, respectively, over the pastyear.

 

The Company’s net income was$1.49 million, or $1.84 per diluted share, for the year ended December 31,2004.  This compares with $716 thousand,or $0.91 per diluted share, in 2003.

 

The Company's results for 2004included $1.333 million ($792 thousand after taxes) in grants received from theBank Enterprise Award (“BEA”) program sponsored by the U.S. TreasuryDepartment, Community Development Financial Institutions Fund.  In 2003 the Company recognized $181 thousand($114 after taxes) in BEA awards.  Theseawards were received in recognition of the increased levels of financialservices the Bank has provided to economically distressed communities.

 

The net interest margin for2004 was 4.83%, up 30 basis points from 2003. Because the Bank is asset sensitive and most economists expect interestrates to rise during 2005, management does not expect the margin to contract in2005.

 

Negatively impacting earningsfor 2004 was a $254 thousand ($151 thousand after taxes) provision for losseson an impaired asset-backed security in the Bank’s held-to-maturityportfolio.  As of December 31, 2004, thefair value of that security was $21 thousand in excess of its written-down bookvalue.  Also negatively affecting 2004’searnings was a $250,000 cash grant to the non-profit affiliate MCSC, to furtherMCSC’s mission of providing Central Coast and Central California smallbusinesses with technical assistance, counseling and training in finance,management, marketing procurement and access to the U. S. Small BusinessAdministration’s programs and services.

 

Credit quality remained high in2004, with non-performing loans decreasing by $302 thousand, or 59%, fromyear-end 2003, and *negative* netcharge-offs (representing a small net recovery) for the year.

 

In 2005, management expects tocontinue to pursue the benefits related to CDFI products and services, althoughthere can be no assurance that any future BEA grants or awards will bereceived. In addition, appropriate opportunities for expansion will bedeveloped as they arise.

 

**Critical Accounting Policies**

** **

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires the Company’s management to make estimatesand assumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

A critical accounting policy isdefined as one that is both material to the presentation of the Company’sfinancial statements and requires management to make difficult, subjective orcomplex judgments that could have a material effect on the Company’s financialcondition and results of operations and may change in future periods.  Note A to the Consolidated FinancialStatements describes the significant accounting policies used in thepreparation of the Consolidated Financial Statements.  Not all of these accounting policies requiremanagement to make difficult, subjective or complex judgments orestimates.  However, management believesthat the following policies could be considered critical within the SEC’sdefinition.

 

22

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*Reservesand Contingencies*

 

In the normal course ofbusiness, the Company must manage and control certain risks inherent to thebusiness of banking.  These includecredit risk, interest rate risk, fraud risk, and operations and settlementrisk.  The Company has establishedreserves for risk of losses, including loan losses.  The allowance for loan losses representsmanagement’s estimate of the probable losses that have occurred as of the dateof the financial statements, as further described in Note A in the Notes to theConsolidated Financial Statements.

 

If the company prevails in amatter for which an accrual has been established or is required to pay anamount exceeding recorded reserves, the financial impact will be reflected inthe period in which the matter is resolved.

 

*Revenuerecognition*

 

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

 

The Company also records gainsin connection with the sale of the guaranteed portion of certain SBA-guaranteedloans for which the Bank retains the right to service the loans.  Recording of such gains involves the use ofestimates and assumptions related to the expected life of the loans and futurecash flows.  Notes A and C in the Notesto the Consolidated Financial Statements contain additional informationregarding the Company’s accounting policy for revenue recorded in connectionwith the sale of loans.  SBA loanservicing rights are based upon estimates and are subject to the risk of prepaymentsand market value fluctuation.

 

23

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**SelectedFinancial Data**

 

The following is selectedconsolidated financial data with respect to the Company’s consolidatedfinancial statements for the two years ended December 31, 2004 and 2003. Theinformation presented has been derived from the audited consolidated financialstatements included in Item 7 of Part II of this Form 10-KSB.  This information should be read in conjunctionwith such consolidated financial statements and the notes thereto.  

 
| ** **                                        | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|
| **In thousands, except share and per share data** | ** ** | **2004**                    | ** ** | **2003** | ** ** |
| Interest income                                   |       | $                           | 7,425      |   | $ | 5,544 |   |
| Interest expense                                  |       | 1,690                       |       | 1,268 |   |
| Net interest income                               |       | 5,735                       |       | 4,276 |   |
| Provision for loan losses                         |       | 280                         |       | 120 |   |
| Non-interest income                               |       | 2,684                       |       | 1,367 |   |
| Non-interest expense                              |       | 5,629                       |       | 4,390 |   |
| Income before income taxes                        |       | 2,510                       |       | 1,133 |   |
| Income taxes                                      |       | 1,018                       |       | 417 |   |
| Net income                                        |       | $                           | 1,492      |   | $ | 716 |   |
|                                              |       |                        |       |   |   |
| **Balance Sheet Data at End of Year**             |       |                        |       |   |   |
| Assets                                            |       | $                           | 139,249    |   | $ | 112,760 |   |
| Earning assets                                    |       | 131,164                     |       | 106,622 |   |
| Total loans                                       |       | 103,376                     |       | 78,758 |   |
| Deposits                                          |       | 112,836                     |       | 96,286 |   |
| Total shareholders’ equity                   |       | 10,027                      |       | 8,546 |   |
| Preferred equity                                  |       | 1,084                       |       | 1,084 |   |
| Common equity                                     |       | 8,943                       |       | 7,462 |   |
| Number of common shares outstanding               |       | 642,599                     |       | 630,166 |   |
| **Average Balance Sheet Data**                    |       |                        |       |   |   |
| Assets                                            |       | $                           | 129,022    |   | $ | 101,540 |   |
| Earning assets                                    |       | 118,814                     |       | 94,393 |   |
| Loans                                             |       | 95,205                      |       | 66,441 |   |
| Deposits                                          |       | 108,644                     |       | 89,889 |   |
| Shareholders’ equity                         |       | 9,240                       |       | 8,131 |   |
| **Per Share Data**                                |       |                        |       |   |   |
| Basic earnings per share                          |       | $                           | 1.97       |   | $ | 0.95 |   |
| Diluted earnings per share                        |       | 1.84                        |       | 0.91 |   |
| Average number of shares outstanding -  basic     |       | 759,250                     |       | 750,666 |   |
| Average number of shares outstanding -  diluted   |       | 812,979                     |       | 788,514 |   |
| Book value per common share                       |       | $                           | 13.92      |   | $ | 11.84 |   |
| Cash dividends declared                           |       | 0.12                        |       | 0.10 |   |
| **Performance Ratios**                            |       |                        |       |   |   |
| Return on average assets                          |       | 1.16                        | %          | 0.71 | % |
| Return on average shareholders’ equity       |       | 16.15                       | %          | 8.81 | % |
| Average equity to average assets                  |       | 7.16                        | %          | 8.01 | % |
| Efficiency ratio                                  |       | 66.30                       | %          | 77.80 | % |
| Leverage ratio                                    |       | 9.62                        | %          | 8.73 | % |
| Net interest margin                               |       | 4.83                        | %          | 4.53 | % |
| Non-interest revenue to total revenue             |       | 31.88                       | %          | 24.22 | % |
| **Asset Quality**                                 |       |                        |       |   |   |
| Non-performing assets                             |       | $                           | 206        |   | $ | 519 |   |
| Allowance for loan losses                         |       | 1,094                       |       | 812 |   |
| Net charge-offs (recoveries)                      |       | (2                          | )          | 52 |   |
| Non-performing assets to total assets             |       | 0.15                        | %          | 0.46 | % |
| Allowance for loan losses to loans                |       | 1.06                        | %          | 1.03 | % |
| Net charge-offs to average loans                  |       | 0.00                        | %          | 0.08 | % |

 

24

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#### **Basis of Presentation**

 

The following discussion andanalysis is intended to assist in an understanding of the significant factorsthat affected our consolidated financial condition and results of operationsfor the years ended December 31, 2004 and December 31, 2003.  This discussion, which refers to the Companyon a consolidated basis, should be read in conjunction with the Company’sconsolidated financial statements and corresponding notes.

 

Bancorp is inactive except forinterest expense associated with the junior subordinated debentures (related tothe trust preferred securities) and minimal other expenses.  Therefore, the financial information isprimarily reflective of the Bank.

 

The Bank operates as atraditional community bank, but has also used management’s expertise as a CDFIto provide a selection of financial services identified as “communitydevelopment” activities, with a focus on financial services to small businessesand business professionals.  Bancorp andthe Bank have received and used both grants and deposits under programsauthorized by CDFI and continuously review various options for both grants anddeposit programs from various government and public/private entities.  The CDFI status is dependent on management’sspecialized knowledge of working with various governmental programs andrequires a significant increase in reporting and documentation as compared withtraditional bank activities.

 

MCDC provides financing forsmall businesses and low- to moderate-income areas based on direct loans orfunding pools established in conjunction with others.  MCDC currently provides loan servicing forthe San Luis Obispo County Economic Vitality Corporation and has one smallcommunity development loan outstanding. MCDC also services the San Simeon Earthquake Recovery Loan Fund (the“Fund”), a loan pool funded by the Bank and other local banks.  This Fund is structured to provide low costfinancing to individuals and businesses in San Luis Obispo and Northern SantaBarbara counties which experienced severe damage in the December 22, 2003, SanSimeon Earthquake.  As of December 31,2004, the Fund had $183,000 in loans outstanding and $215,000 available tolend.  It is unclear how much of the Fundwill be used.  No loans have been fundedsince October 2004.  MCSC provides technicalassistance to applicants for the Fund.

 

MCSC provides technicalservices and training to the underserved segments of the community includingsmall businesses, minorities and low-income entrepreneurs.  As of December 31, 2004, the Bank has had limiteddirect benefit from its association with MCSC. However, MCSC has received grants and loan funds and has developed astrategic plan to achieve its objectives.

 

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

 

The principal component of earningsfor most banks is net interest income. Net interest income is the difference between the interest earned onloans and investments and the interest paid on deposits and otherinterest-bearing liabilities.

 

The banking industry uses twokey ratios to measure relative profitability of net interest income.  Thenet interest rate spread measures the difference between the average yield onearning assets and the average rate paid on interest bearing liabilities. The interest rate spread ignores the beneficial impact of non-interest bearingdeposits and capital, and provides a direct perspective on the effect of marketinterest rate movements.  The net interest margin is defined as netinterest income as a percentage of average interest-earning assets, whichincludes the positive impact of obtaining a portion of the funding for earningassets with non-interest bearing deposits and capital.

 

The following table presents,for the periods indicated, the total dollar amounts of interest income fromaverage interest-earning assets and the resultant yields. Also presented arethe dollar amounts of interest expense and average interest-bearingliabilities, expressed both in dollars and in rates.

 

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***Net Interest Analysis***

(dollarsin thousands)

 
| ** **                                                                             | ** ** | **For the Years Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                             | ** ** | **December 31, 2004**   | ** ** | **December 31, 2003** | ** ** |
| ** **                                                                             | ** ** | **Average  Balance**    | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** |
| **Assets:**                                                                            |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                                               |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income                                                          |       | $                       | 95,205     |   | $ | 6,685 |   | 7.02 | % | $ | 66,441 |   | $ | 4,717 |   | 7.10 | % |
| Investment securities                                                                  |       | 16,549                  |       | 618 |   | 3.73 | % | 16,385 |   | 634 |   | 3.87 | % |
| Federal funds sold                                                                     |       | 5,043                   |       | 71 |   | 1.41 | % | 8,561 |   | 90 |   | 1.05 | % |
| Interest-bearing deposits in banks                                                     |       | 2,017                   |       | 51 |   | 2.53 | % | 3,006 |   | 103 |   | 3.43 | % |
| **Total interest-earning assets / interest  income**                                   |       | $                       | 118,814    |   | 7,425 |   | 6.25 | % | $ | 94,393 |   | 5,544 |   | 5.87 | % |
| **Liabilities and Shareholders’ Equity**                                          |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                                          |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits:                                                             |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing demand accounts                                                       |       | $                       | 3,657      |   | 25 |   | 0.68 | % | $ | 2,682 |   | 10 |   | 0.37 | % |
| Savings deposits                                                                       |       | 42,162                  |       | 528 |   | 1.25 | % | 36,482 |   | 482 |   | 1.32 | % |
| Certificates of deposit                                                                |       | 41,101                  |       | 744 |   | 1.81 | % | 34,095 |   | 697 |   | 2.04 | % |
| Total interest-bearing deposits                                                        |       | 86,920                  |       | 1,297 |   | 1.49 | % | 73,259 |   | 1,189 |   | 1.62 | % |
| Federal funds purchased                                                                |       | 5                       |       | — |   | 0.00 | % | — |   |   |   | — |   |
| Federal Home Loan Bank advances                                                        |       | 7,390                   |       | 258 |   | 3.49 | % | 1,807 |   | 50 |   | 2.77 | % |
| Subordinated debt                                                                      |       | 3,093                   |       | 135 |   | 4.36 | % | 669 |   | 29 |   | 4.33 | % |
| Total borrowed funds                                                                   |       | 10,488                  |       | 393 |   | 3.75 | % | 2,476 |   | 79 |   | 3.19 | % |
| **Total interest-bearing liabilities / interest  expense**                             |       | $                       | 97,408     |   | 1,690 |   | 1.73 | % | $ | 75,735 |   | 1,268 |   | 1.67 | % |
| **Net interest-rate spread**                                                           |       |                    |       |   |   | 4.52 | % |   |   |   |   | 4.20 | % |
| Impact of non-interest-bearing sources and  other changes in balance sheet composition |       |                    |       |   |   | 0.31 | % |   |   |   |   | 0.33 | % |
| **Net interest income / margin on  interest-earning assets**                           |       |                    |       | $ | 5,735 |   | 4.83 | % |   |   | $ | 4,276 |   | 4.53 | % |

 

Nonaccrual loans are included in thecalculation of the average balances of loans; interest not accrued isexcluded.  Tax exempt income was notmaterial for 2004 or 2003.

 

Net interest income is affectedby changes in the amount and mix of our interest-earning assets andinterest-bearing liabilities, referred to as the change due to *volume*.  Averageinterest-earning assets grew by $24.4 million in 2004 over 2003, primarilydriven by loan volume—the most profitable component of interest-earningassets.  Interest-bearing liabilitiesincreased $21.7 million over the past year. Net interest income is also affected by changes in the yields we earn oninterest-earning assets and rates we pay on interest-bearing deposits and otherborrowed funds, referred to as the change due to *rate.*  The average yield oninterest-earning assets increased by 38 basis points (0.38%) in 2004, while theaverage rate paid on interest-bearing liabilities increased by only 6 basispoints.

 

The following table sets forthchanges in interest income and interest expense for each major category ofinterest-earning assets and interest-bearing liabilities, and the amount ofthose variances attributable to volume and rate changes for the yearsindicated.

 

26

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***Rate / Volume Variance Analysis***

(dollarsin thousands)

 
| ** **                                     | ** ** | **Year Ended December 31, 2004  Compared to 2003**                          | ** **  |
|------------------------------------------------|------------|-----------------------------------------------------------------------------|-------------|
| ** **                                     | ** ** | **Increase (Decrease)  in interest income and expense  due to changes in:** | ** **  |
| ** **                                     | ** ** | **Volume**                                                                  | ** **  | **Rate** | ** ** | **Total** | ** ** |
| Interest-earning assets:                       |       |                                                                        |        |   |   |   |   |
| Loans, net of unearned income                  |       | $                                                                           |  2,020 |   | $ |  (52 | ) | $ |  1,968 |   |
| Investment securities                          |       | 6                                                                           |        | (22 | ) | (16 | ) |
| Federal funds sold                             |       | (44                                                                         | )           | 25 |   | (19 | ) |
| Interest-bearing deposits in banks             |       | (29                                                                         | )           | (23 | ) | (52 | ) |
| Total increase (decrease) in interest  income  |       | 1,953                                                                       |        | (72 | ) | 1,881 |   |
|                                           |       |                                                                        |        |   |   |   |   |
| Interest-bearing liabilities:                  |       |                                                                        |        |   |   |   |   |
| Transaction accounts                           |       | 5                                                                           |        | 10 |   | 15 |   |
| Savings deposits                               |       | 72                                                                          |        | (26 | ) | 46 |   |
| Certificates of deposit                        |       | 133                                                                         |        | (86 | ) | 47 |   |
| Total interest-bearing deposits                |       | 210                                                                         |        | (102 | ) | 108 |   |
| Federal funds purchased                        |       | —                                                                      |        | — |   | — |   |
| FHLB advances                                  |       | 192                                                                         |        | 16 |   | 208 |   |
| Other borrowings                               |       | 106                                                                         |        | — |   | 106 |   |
| Total borrowed funds                           |       | 298                                                                         |        | 16 |   | 314 |   |
| Total increase (decrease) in interest  expense |       | 508                                                                         |        | (86 | ) | 422 |   |
| Increase (decrease) in net interest income     |       | $                                                                           | 1,445       |   | $ | 14 |   | $ | 1,459 |   |

 

Changes not solely attributable to rate orvolume have been allocated to volume and rate changes in proportion to therelationship of the absolute dollar amounts of the changes in each.

 

**Provisionfor Loan Losses**

 

The Bank makes provisions forloan losses when required to bring the total allowance for loan losses to a leveldeemed appropriate. The determination of the appropriate level for theallowance is based on such factors as historical experience, the volume andtype of lending conducted, the amount of nonperforming loans, regulatorypolicies, general economic conditions, and other factors related to thecollectibility of loans in the portfolio. The provision for loan losses is charged to earnings and totaled$280,000 for 2004, as compared to $120,000 for 2003.

 

See *Lending Activities*and *Asset Quality* below for additionalinformation on the provision and the allowance for loan losses.

 

#### **Non-interest Income**

#### ** **

Non-interest income increased$1.317 million in 2004 as compared to 2003, primarily due to a $1.241 millionBEA award received in the second half of 2004. The award was made in recognition of the Bank’s increased level oflending activity in economically distressed communities in the Bank’s marketarea.  Because this award was based on past lending activity, the entireaward was recognized in non-interest income in 2004.

 

In mid-2001, the Bank receiveda $990,000 cash award from the Bank Enterprise Award (BEA) Program

 

27

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thruthe CDFI.  The Bank was awarded this cashpayment for investing $3 million in deposits in 2001 to 14 other certifiedCommunity Development Financial Institutions. The deposits were for 3 years and were made at below market rates toassist the other CDFI’s to increase their financing activities.  The Bank recognized income of $537,750 in2001, $180,900 in 2002, and $180,800 in 2003 with the remaining approximately$91,000 taken into income in the first six months of 2004.

 

In 2004 the Company applied tothe CDFI for a technical assistance grant to help offset any costs associatedwith providing additional services to the un- andunder-banked in its market area.  It wasawarded a grant of $134,935, which the Company expects to receive in 2005.  No assurance can be given that the Companywill receive any future BEA grants or awards.

 

Gain on Sale of SBA loansincreased by $65,000 in 2004 compared to 2003 due to the growth in lendingactivity during 2004.

 

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

#### ** **

Non-interest expense increasedin 2004 by $1.240 million, or 28%.

 

Non-interest expenses that hadmaterial changes from 2003 to 2004 were:

 

•                  Salary andbenefits increased by $346 thousand or 15% due to a 4% increase in the numberof full-time-equivalent employees, normal salary increases during the year andincreased employee benefit costs, particularly health care and workers’compensation premiums.

•                  A $254 thousandprovision for losses on an impaired asset-backed security in the Bank’sheld-to-maturity portfolio.  As ofDecember31, 2004, the fair value of that security was $21 thousand in excess ofits written-down book value.  See Note Bto the consolidated financial statements for additional information regardinginvestment securities.

•                  Marketing andbusiness development increased by $286 thousand, or 251%.  Included in marketing and businessdevelopment for 2004 is a $250,000 grant to the non-profit affiliate MCSC, tofurther MCSC’s mission of providing Central Coast and Central California smallbusinesses with technical assistance, counseling and training in finance,management, marketing procurement and access to the U. S. Small BusinessAdministration’s programs and services.

•                  Professionalfees increased by $76 thousand, or 58%, due to increased expenses for auditingand the cost of filling the vacant chief financial position on an interim basisduring the second half of 2004.

 

#### **Income Taxes**

 

The Company’s combined federaland state effective income tax rate was 40.6% in 2004 and 36.8% in 2003.  In 2003 Bancorp and the Bank invested $550thousand in certificates of deposit with other COIN-certified financialinstitutions and received a California income tax credit of 20% for 2003.  The COIN certificates of deposit are at zerointerest for 60 months.  The COIN CDswill also provide the Bank with investment credit under the CommunityReinvestment Act (“CRA”).

 

See Note H to the consolidatedfinancial statements for more information on income taxes.

 

#### **Liquidity Management**

#### ** **

The objective of ourasset/liability strategy is to manage liquidity and interest rate risks toensure the safety and soundness of the Bank and its capital base, whilemaintaining an adequate net interest margin in order to provide an appropriatereturn to shareholders.

 

28

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The Bank’s liquidity, whichprimarily represents the ability to meet fluctuations in deposit levels andprovide for customers’ credit needs, is managed through various fundingstrategies that reflect the maturity structures of the sources of funds and theassets being funded.  The Bank’sliquidity is further augmented by payments of principal and interest on loansand increases in short-term liabilities such as demand deposits and short-termcertificates of deposit.  Short-terminvestments, primarily federal funds sold and federal funds lines of credit providedby our correspondent banks, are the primary means for providing immediateliquidity.  The Bank had $10.4 million infederal funds sold on December 31, 2004, and $5.5 million on December 31, 2003.

 

In order to meet the Bank’sliquidity requirements, the Bank endeavors to maintain an appropriate liquidityratio.  The liquidity ratio is the sum ofcash and deposits at other banks, federal funds sold, and unpledgedavailable-for-sale securities, divided by total deposits.  As of December 31, 2004 and 2003, the Bank’sliquidity ratios were 17.0% and 16.1%, respectively.

 

While the Bank primarily usesfederal funds sold as the immediate measure of cash liquidity, it also hasestablished short-term borrowing lines (federal funds purchased) for a total of$6.5 million from its correspondent banks. These lines are for short-term needs and are generally not used.

 

As of December 31, 2004, theBank had outstanding borrowings from the Federal Home Loan Bank of SanFrancisco (“FHLB”) of $12.5 million. Of the $12.5 million, $3 million wasborrowed for 10 years to offset a specific pool of the Bank’s fixed rate loansmaturing in 2013.  Another $2.5 millionwas borrowed for five years to “match-fund” a pool of fixed rate loans maturingin 2009.  Interest rates and terms forFHLB borrowings are generally more favorable than the rates for similar termcertificates of deposit.  The Bank hasthe potential (on a secured basis) to borrow up to 20 percent of its totalassets or approximately $25.4 million from the FHLB.  The Bank anticipates utilizing FHLB borrowingsin 2005 when needed as part of its normal liquidity management to fund assetgrowth on a cost-effective basis, and has more than adequate loans to pledge ascollateral should it need additional liquidity that cannot be funded bydeposits.

 

Following is a summary of theCompany’s contractual obligations extending beyond one year from December 31,2004:

 

**Long-Term Contractual Obligations**

 
| ** **                     | ** ** | **Less than  1 year**      | ** ** | **1 thru 3  years** | ** ** | **3 thru 5  years** | ** ** | **More than  5 years** | ** ** | **Total** | ** ** |
|--------------------------------|------------|----------------------------|------------|---------------------|------------|---------------------|------------|------------------------|------------|-----------|------------|
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Borrowed funds                 |       | $                          | 6,500      |                | $          | 500                 |       | $                      | 2,500      |      | $          | 3,000 |   | $ | 12,500 |   |
| Junior subordinated debentures |       | —                     |       | —              |       | —              |       | 3,093                  |       | 3,093     |       |
| Operating leases               |       | 229                        |       | 278                 |       | 121                 |       | —                 |       | 628       |       |
| Capital leases                 |       | —                     |       | —              |       | —              |       | —                 |       | —    |       |
| Purchase obligations           |       | —                     |       | —              |       | —              |       | —                 |       | —    |       |
| Other long-term liabilities    |       | —                     |       | —              |       | —              |       | —                 |       | —    |       |
| Total contractual obligations  |       | $                          | 6,729      |                | $          | 778                 |       | $                      | 2,621      |      | $          | 6,093 |   | $ | 16,221 |   |

 

While core, local depositsremain the primary source of deposits, the Bank continues to seek alternatesources for competitive rate deposits. The Bank also expects to continue to use its CDFI and COIN designationsto attract lower cost deposits.

 

Bancorp is a company separateand apart from the Bank.  It must providefor its own liquidity, which is provided, in part, by a line of credit fromPacific Coast Bankers’ Bank.  As ofDecember 31, 2004, Bancorp had no borrowings under its line of credit andapproximately $35,000 in available cash. See Note Q to the consolidated financial statements for additionalfinancial information for Bancorp.

 

29

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Substantially all of Bancorp’srevenues are obtained from dividends declared and paid by the Bank.  There are statutory and regulatory provisionsthat could limit the ability of the Bank to pay dividends to Bancorp.  Management believes that such restrictionswill not have an impact on the ability of Bancorp to meet its ongoing cashobligations.

 

**InvestmentActivities**

 

Banks are permitted to purchaseand own investment securities for yield, to provide liquidity and to balancethe overall interest-rate sensitivity of its assets and liabilities. The Bankdoes not maintain a trading account.

 

Investment policies and limitshave been established by the board of directors.  Investments can include investment gradecorporate securities, BBB-rated mortgage-backed securities, federally insuredcertificates of deposit, U.S. Treasury obligations and U.S. Governmentagency-backed securities.  Investments inU.S. Government and agency securities are generally limited to $500,000 to$1,000,000 per issue and no corporate or other investments equal or exceed tenpercent of shareholders’ equity.  The CFOreports investment activity to the Board on a monthly basis and quarterly tothe Investment Committee.

 

Investment goals are to obtainthe highest yield consistent with maintaining a stable overall asset andliability position while limiting economic risks.  In accordance with this policy, managementactively manages its investment portfolio between available for sale and heldto maturity investments, the composition of which may shift substantially overtime.

 

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

 

**Investmentsecurities composition**

 
| ** **                                         | ** ** | **December 31, 2004**      | ** ** | **December 31, 2003**      | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                         | ** ** | **Amortized  Cost**        | ** ** | **Approx.  Market  Value** | ** ** | **%  Yield** | ** ** | **Amortized  Cost** | ** ** | **Approx.  Market  Value** | ** ** | **%  Yield** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands)** | ** ** |
| U.S. Government agencies:                          |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Within one year                                    |       | $                          | —     |                       | $          | — |   |   |   | $ | — |   | $ | — |   |   |   |
| One to five years                                  |       | 4,000                      |       | 3,959                      |       | 3.24 | % | 7,999 |   | 8,010 |   | 3.21 | % |
| Five to ten years                                  |       | 1,500                      |       | 1,500                      |       | 4.15 | % | 3,000 |   | 2,993 |   | 4.19 | % |
| After 10 years                                     |       | 1,498                      |       | 1,460                      |       | 4.21 | % | 2,500 |   | 2,461 |   | 4.56 | % |
| Total U.S. Government agencies                     |       | 6,998                      |       | 6,919                      |       | 3.64 | % | 13,499 |   | 13,464 |   | 3.68 | % |
| Mortgage-backed and asset-backed  securities:      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Within one year                                    |       | —                     |       | —                     |       |   |   | — |   | — |   |   |   |
| One to five years                                  |       | 1,272                      |       | 1,265                      |       | 3.59 | % | 467 |   | 469 |   | 3.33 | % |
| Five to ten years                                  |       | 576                        |       | 582                        |       | 4.65 | % | 792 |   | 811 |   | 4.72 | % |
| After 10 years                                     |       | 6,950                      |       | 6,966                      |       | 3.76 | % | 3,464 |   | 3,282 |   | 4.37 | % |
| Total mortgage-backed and asset-backed  securities |       | 8,798                      |       | 8,813                      |       | 3.80 | % | 4,723 |   | 4,562 |   | 4.32 | % |
| Total investment securities                        |       | $                          | 15,796     |                       | $          | 15,732 |   | 3.73 | % | $ | 18,222 |   | $ | 18,026 |   | 3.85 | % |

 

The nonaccrual security is included in theamortized cost and market value of securities. Yields reflect no interest income on the nonaccrual security.  No tax equivalent adjustment has been made tothe weighted average yields in the above table because the Bank did not haveany tax-exempt investments and the end of 2003 or 2004.

 

One of the Bank’sheld-to-maturity asset-backed securities, which had a carrying value of$427,024 as of December 31, 2003, has been in an unrealized loss position forover twelve months.  During 2004,management concluded that the unrealized loss was not temporary and establisheda $253,598 loss reserve for this security through a charge to non-interestexpense.  The security was placed innonaccrual status,

 

30

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withany interest payments received being credited to the reserve.  As of December 31, 2004, the gross book valueof the security was $408,081 and the reserve was $259,375, for a net book value(amortized cost) of $148,706.  Theestimated fair value of the security as of December 31, 2004, was $169,992.

 

See Note B in the notes to theconsolidated financial statements for additional information on investmentsecurities.

 

 **Asset and LiabilityManagement**

 

The objectives of interest raterisk management are to control exposure of net interest income to risksassociated with interest rate movements in the market, to achieve consistentgrowth in net interest income and to profit from favorable market opportunities.  Even with perfectly matched repricing ofassets and liabilities, risks remain in the form of prepayment of assets, andtiming lags in adjusting certain assets and liabilities that have varyingsensitivities to market interest rates.

 

The table below sets forth theinterest rate sensitivity of interest-earning assets and interest-bearingliabilities as of December 31, 2004.  Forpurposes of the table, an asset or liability is considered rate-sensitivewithin a specified period when it can be repriced or matures within itscontractual terms.

 

**InterestSensitivity Gap**

*December 31, 2004*

 
| ** **                                  | ** ** | **Sensitive to Rate Changes Within** | ** ** | ** **          | ** ** | ** **        | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|---------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **3  Months**                        | ** ** | **4 to 12  Months** | ** ** | **1 to 5  Years** | ** ** | **Over 5  Years** | ** ** | **Non-Rate-  Sensitive** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)**           | ** ** |
| **Earning Assets:**                         | ** ** | ** **                           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loans                                   |       | $                                    | 78,044     |                | $          | 12,675            |       | $ | 13,311 |   | $ | 66 |   | $ | (720 | ) | $ | 103,376 |   |
| Investment securities                       |       | 1,024                                |       | 3,475               |       | 9,811             |       | 1,486 |   | (24 | ) | 15,772 |   |
| Other interest-earning assets               |       | 11,541                               |       | 225                 |       | 250               |       | — |   | — |   | 12,016 |   |
| Non-interest-earning assets                 |       | —                               |       | —              |       | —            |       | — |   | 8,085 |   | 8,085 |   |
| Total assets                                |       | 90,609                               |       | 16,375              |       | 23,372            |       | 1,552 |   | 7,341 |   | 139,249 |   |
|                                        |       |                                 |       |                |       |              |       |   |   |   |   |   |   |
| **Interest-Bearing Liabilities:**           |       |                                 |       |                |       |              |       |   |   |   |   |   |   |
| Interest-bearing deposits                   |       | 32,455                               |       | 46,736              |       | 11,180            |       | 1,872 |   | — |   | 92,243 |   |
| Borrowed funds                              |       | 5,500                                |       | 1,000               |       | 2,500             |       | 3,500 |   | — |   | 12,500 |   |
| Junior subrdinated debentures               |       | 3,093                                |       | —              |       | —            |       | — |   | — |   | 3,093 |   |
| Non-interest-bearing liabilities and equity |       | —                               |       | —              |       | —            |       | — |   | 31,413 |   | 31,413 |   |
| Total liabilities and equity                |       | 41,048                               |       | 47,736              |       | 13,680            |       | 5,372 |   | 31,413 |   | 139,249 |   |
|                                        |       |                                 |       |                |       |              |       |   |   |   |   |   |   |
| Interest rate sensitivity gap               |       | $                                    | 49,561     |                | $          | (31,361           | )          | $ | 9,692 |   | $ | (3,820 | ) | $ | (24,072 | ) | $ | — |   |
|                                        |       |                                 |       |                |       |              |       |   |   |   |   |   |   |
| Cumulative interest rate sensitivity gap    |       | $                                    | 49,561     |                | $          | 18,200            |       | $ | 27,892 |   | $ | 24,072 |   | $ | — |   |   |   |
|                                        |       |                                 |       |                |       |              |       |   |   |   |   |   |   |
| Cumulative gap to total earning assets      |       | 36                                   | %          | 13                  | %          | 20                | %          | 17 | % |   |   |   |   |

 

Gap analysis attempts tocapture interest rate risk, which is attributable to the mismatching ofinterest rate sensitive assets and liabilities. A positive cumulative gap, as shown in the table, means that over theperiods indicated our assets will reprice faster than our liabilities.  During the first year $107 million of the interestearning assets are expected to reprice, compared with $89 million of interestbearing liabilities—a slightly asset-sensitive structure.  However, during the first three months $91million of interest earning assets will reprice, but only $41 million of  interest-bearingliabilities—a higher degree of asset sensitivity in the first few months of aperiod of rate changes.  In general, thismeans that in a rising interest rate environment net interest income can beexpected to increase, and in a declining interest rate environment net interestincome can be expected to decrease.

 

Based on current economicforecasts, the Bank anticipates that interest rates will continue to rise in2005.

 

The actual impact of interestrate movements on net interest income may differ from that implied by any

 

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gapmeasurement, depending on the direction and magnitude of the interest ratemovements, the repricing characteristics of various on and off-balance sheetinstruments, as well as competitive pressures. Changes in the mix of earning assets or supporting liabilities caneither increase or decrease the net interest margin without affecting interestrate sensitivity.  In addition, varyinginterest rate environments can create unexpected changes in prepayment levelsof assets and liabilities that are not reflected in the interest ratesensitivity analysis.  Prepayments mayhave significant impact on our net interest margin.  These factors are not fully reflected in theforegoing gap analysis and, as a result, the gap report may not provide acomplete assessment of our interest rate risk.

 

#### **Lending Activities**

 

The Bank originates loans,participates in loans from other banks and structures loans for possible salein the secondary market.

 

The following table sets forththe composition of our loan portfolio by type of loan at the periods indicated:

 

**Loan Portfolio Composition**

 
| ** **                     | ** ** | **As of December 31,**     | ** ** |
|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| **Type of Loan**               | ** ** | **Amount**                 | ** ** | **Percentage** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Commercial                     |       | $                          | 16,178     |   | 15.65 | % | $ | 15,079 |   | 19.15 | % |
| Agricultural                   |       | 774                        |       | 0.75 | % | 1,526 |   | 1.94 | % |
| Real estate                    |       | 60,445                     |       | 58.47 | % | 55,840 |   | 70.89 | % |
| Construction                   |       | 24,394                     |       | 23.60 | % | 4,920 |   | 6.25 | % |
| Consumer                       |       | 1,585                      |       | 1.53 | % | 1,393 |   | 1.77 | % |
| Total loans                    |       | $                          | 103,376    |   | 100.00 | % | $ | 78,758 |   | 100.00 | % |
|                           |       |                       |       |   |   |   |   |   |   |
| Off-balance-sheet commitments: |       |                       |       |   |   |   |   |   |   |
| Undisbursed loan commitments   |       | $                          | 29,793     |   |   |   | $ | 27,578 |   |   |   |
| Standby letters of credit      |       | 123                        |       |   |   | 30 |   |   |   |

 

 

The following table sets forthas of December 31, 2004, the maturities and sensitivities of loans to interestrate changes:

 

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**Maturity and Rate Sensitivity of Loans**

*(Dollars in thousands)*

 
| ** **     | ** ** | **Maturity**          | ** ** | **Rate Structure for Loans  Maturing Beyond One Year** | ** ** |
|----------------|------------|-----------------------|------------|--------------------------------------------------------|------------|
| ** **     | ** ** | **One year  or less** | ** ** | **One through  five years**                            | ** ** | **Over five  years** | ** ** | **Total** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** |
| Commercial     |       | $                     | 11,198     |                                                   | $          | 3,466 |   | $ | 1,514 |   | $ | 16,178 |   | $ | 4,966 |   | $ | 14 |   |
| Agricultural   |       | 774                   |       | —                                                 |       | — |   | 774 |   | — |   | — |   |
| Real estate    |       | 22,601                |       | 6,562                                                  |       | 31,282 |   | 60,445 |   | 34,371 |   | 3,473 |   |
| Construction   |       | 22,985                |       | 853                                                    |       | 556 |   | 24,394 |   | 1,409 |   | — |   |
| Consumer Loans |       | 391                   |       | 633                                                    |       | 561 |   | 1,585 |   | 1,194 |   | — |   |
| Total Loans    |       | $                     | 57,949     |                                                   | $          | 11,514 |   | $ | 33,913 |   | $ | 103,376 |   | $ | 41,940 |   | $ | 3,487 |   |

 

The Bank funds commercial loansto provide working capital, to finance the purchase of equipment and for otherbusiness purposes.  These loans can be *short-term,* with maturities ranging from thirty days to oneyear, or *term loans,* with maturities normallyranging from one to twenty-five years. Short-term loans are generally intended to finance current transactionsand typically provide for periodic principal payments, with interest payablemonthly.  Term loans normally provide forfloating interest rates, with monthly payments of both principal and interest.

 

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

 

The Bank is active inconstruction lending for interim loans to finance the construction ofcommercial and single family residential property.  Construction loans totaled $24.4 million asof December 31, 2004, a $19.5 million increase from a year earlier.  These loans are typically extended for termsof no more than 12 to 18 months. Generally, the Bank does not provide loans for speculative purposesexcept to known builders who have a track record of successful projects and theexpertise and financial strength for the particular type of building.

 

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

 

Other real estate loans consistprimarily of commercial and industrial real estate loans.  These loans are made based on the incomegenerating capacity of the property or the cash flow of the borrower and aresecured by the property.  The Bank offersboth fixed and variable rate loans with maturities which generally do not exceed25 years.  Exceptions are made forSBA-guaranteed loans secured by real estate, or for other commercial realestate loans which can be readily sold in the secondary market.

 

The Bank makes SBA-guaranteedloans and sells the guaranteed portion of the SBA loans in the secondary marketbut retains the servicing rights for those loans.  At December 31, 2004 and 2003, the Bankserviced approximately $33.0 million and $19.7 million, respectively, in SBAloans.

 

#### **Asset Quality**

 

The risk of nonpayment of loansis inherent in the banking business. That risk varies with the type and purposeof the loan, the collateral which is utilized to secure payment and,ultimately, the creditworthiness of the borrower.  In order to minimize this credit risk, manyloans are reviewed and approved by the Loan Committee of the board ofdirectors.  The Loan Committee iscomprised of outside directors and the CEO.

 

Loan grades are assigned basedon a risk assessment of each loan.  Loanswith minimum risk are graded as “Pass,” with other classifications of “SpecialMention,” “Substandard,” “Doubtful” and “Loss,” depending on creditquality.  As these loans are identifiedin our review process, they are added to the internal watch

 

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listand a loss allowance is established for them as follows:  Special Mention – 5%, Substandard – 15%,Doubtful – 50%, and Loss – 100%. Additionally, loans are examined regularly by the Bank’s federal andstate regulators, and the Bank engages an outside firm to perform periodicreviews of the loan portfolio and to test the adequacy of the allowance forloan losses.

 

A loan is not returned toaccrual status until it is brought current with respect to both principal andinterest payments, the loan is performing to current terms and conditions, theinterest rate is commensurate with market interest rates and future principaland interest payments are no longer in doubt, at which time a further review ofthe loan is conducted.

 

The following table providesyear-end information with respect to the components of our impaired ornonperforming assets at the dates indicated:

 

**Non-Performing Assets**

 
| ** **                                               | ** ** | **As of December 31,**     | ** ** |
|----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                               | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| ** **                                               | ** ** | **(Dollars in thousands)** | ** ** |
| Loans on nonaccrual status                               |       | $                          | 206        |   | $ | 508 |   |
| Loans past due 90 days or more and accruing              |       | —                     |       | 11 |   |
| Restructured loans                                       |       | —                     |       | — |   |
| Total nonperforming loans                                |       | 206                        |       | 519 |   |
| Other real estate owned                                  |       | —                     |       | — |   |
| Total nonperforming assets                               |       | $                          | 206        |   | $ | 519 |   |
|                                                     |       |                       |       |   |   |
| Allowance for loan losses                                |       | $                          | 1,094      |   | $ | 812 |   |
|                                                     |       |                       |       |   |   |
| Asset quality ratios:                                    |       |                       |       |   |   |
| Non-performing assets to total assets                    |       | 0.15                       | %          | 0.46 | % |
| Non-performing loans to total loans                      |       | 0.20                       | %          | 0.66 | % |
| Allowance for loan losses to total loans                 |       | 1.06                       | %          | 1.03 | % |
| Allowance for loan losses to total  non-performing loans |       | 531                        | %          | 156 | % |

 

Restructured loans are thoseloans with concessions in interest rates or repayment terms due to a decline inthe financial condition of the borrower. Nonaccrual loans are loans which management believes may not be fullycollectible as to principal and interest. Generally, loans are placed in nonaccrual status when they are 90 daysor more past due.

 

As of December 31, 2004, 93% ofthe nonaccrual loans were SBA loans, with $159,000 of the total guaranteed by the SBA.  At December 31, 2003, all of the Bank’snonaccrual loans were SBA loans, and $436,000 of the total was guaranteed bythe SBA.

 

Other real estate owned isacquired in satisfaction of loans through foreclosure or other means and iscarried on an individual asset basis at the lower of the recorded investment inthe related loan or the estimated fair value of the property, less sellingexpenses.  The Bank had no other realestate owned as of December 31, 2004 and 2003.

 

The Bank has not identified anyloans that have deteriorated or where credit risk has increased following theDecember 22, 2003 San Simeon Earthquake which caused more than $200 million indamage in Paso Robles and surrounding areas. While most of the damage assessment has been completed, there can be noassurance that additional problems which could impact the Bank’s borrowers willnot arise.  A limited number of loans inthe Paso Robles area were placed on the internal watch list to allow managementto increase monitoring of these loans during the recovery period.

 

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The Bank has no foreign loans.

 

**Potential Problem Loans**

 

At December 31, 2004, the Companyhad approximately $714 thousand of loans that were not classified asnon-performing but for which known information about the borrower’s financialcondition caused management to have concern about the ability of the borrowersto comply with the repayment terms of the loans.  These loans were identified through the loanreview process described above.  Based onthe evaluation of current market conditions, loan collateral, other secondarysources of repayment and cash flow generation, management does not anticipateany significant losses related to these loans. These loans are subject to continuing management attention and areconsidered in the determination of the allowance for loan losses.

 

While credit quality, as measuredby loan delinquencies and by the Bank’s internal risk grading system, appearsto be satisfactory as of December 31, 2004, there can be no assurances that newproblem loans will not develop in future periods.  A decline in economic conditions in theBank’s market area or other factors could adversely impact individual borrowersor the loan portfolio in general.  TheBank has well defined underwriting standards and expects to continue withprompt collection efforts, but economic uncertainties or changes may cause oneor more borrowers to experience problems in the coming months.

 

**Loan Concentrations**

 

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

 

The following table reflectsthe major concentrations in the loan portfolio, by type of loan, as of December31, 2004:

 

**Loan Concentrations**

December 31, 2004

*(Dollars in thousands)*

 
| **Type of Loan**                                  | ** ** | **Amount** | ** ** | **Percent of  Total Loans** | ** ** |
|---------------------------------------------------|------------|------------|------------|-----------------------------|------------|
|                                              |       |       |       |                        |       |
| Construction and land development                 |       | $          | 24,394     |                        | 23.6       | % |
| Other real estate loans (by type of  collateral): |       |       |       |                        |       |
| Non-farm, non-residential property                |       | 47,266     |       | 45.7                        | %          |
| 1 to 4 family residential - 1st liens             |       | 1,363      |       | 1.3                         | %          |
| 1 to 4 family residential - Jr. liens             |       | 6,982      |       | 6.8                         | %          |
| Multi-family residential                          |       | 2,781      |       | 2.7                         | %          |
| Farmland                                          |       | 2,053      |       | 2.0                         | %          |
| Total real estate-secured loans                   |       | 84,839     |       | 82.1                        | %          |
| Commercial loans and leases                       |       | 16,178     |       | 15.7                        | %          |
| Agricultural loans                                |       | 774        |       | 0.7                         | %          |
| Consumer loans                                    |       | 1,585      |       | 1.5                         | %          |
| Total loans                                       |       | $          | 103,376    |                        | 100.0      | % |

 

The table shows a concentrationin commercial real estate loans (loans secured by non-farm, non-residential andmulti-family residential properties). However, these loans are well secured, seasoned loans with no classifiedloans or loss experience.

 

35

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The Bank’s analysis of loanconcentrations compared to a California peer group of 50 banks suggests thatthe Bank does not have an unusually high real estate concentration compared to othersimilar sized banks in California.  Banksin California typically are more prone than banks in other states to use realestate collateral for many commercial loans for business purposes wherecollateral is taken as an abundance of caution. In its analysis of real estate concentrations, the Bank carefullyconsiders economic trends and real estate values.  The commercial real estate market in San LuisObispo County remains very strong, with good demand, limited vacancies andrising rents.

 

#### **Allowance for LoanLosses**

#### ** **

The following table summarizes,for each reported period, changes in the allowance for loan losses arising fromloans charged off, recoveries on loans previously charged off, additions to theallowance which have been charged to operating expenses, and certain ratiosrelating to the allowance for loan losses:

 

**Summary of Loan Loss Experience**

*(Dollars in thousands)*

 
| ** **                                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |
| Balance at beginning of year              |       | $        | 812        |     | $          | 744 |   |
| Loans charged off:                        |       |     |       |     |       |
| Real Estate                               |       | —   |       | —   |       |
| Commercial                                |       | (1       | )          | (110     | )          |
| Consumer                                  |       | —   |       | —   |       |
| Other                                     |       | —   |       | —   |       |
| Total loans charged off                   |       | (1       | )          | (110     | )          |
| Recoveries:                               |       |     |       |     |       |
| Real Estate                               |       | —   |       | —   |       |
| Commercial                                |       | 3        |       | 57       |       |
| Consumer                                  |       | —   |       | 1        |       |
| Other                                     |       | —   |       | —   |       |
| Total recoveries                          |       | 3        |       | 58       |       |
| Net recoveries (charge-offs)              |       | 2        |       | (52      | )          |
| Provision charged to operations           |       | 280      |       | 120      |       |
| Balance at end of year                    |       | $        | 1,094      |     | $          | 812 |   |
|                                      |       |     |       |     |       |
| Ratio of net charge-offs to average loans |       | 0.00     | %          | 0.08     | %          |
| Ratio of provision to average loans       |       | 0.29     | %          | 0.18     | %          |

 

The Bank performs a quarterlydetailed review to identify the risks inherent in the loan portfolio, to assessthe overall quality of the loan portfolio and to determine the adequacy of theallowance for loan losses and the related provision for loan losses to becharged to expense.  Systematic reviewsfollow the methodology set forth by various regulatory policy statements on theallowance for loan losses.

 

A key element of the Bank’smethodology is the previously discussed credit classification process.  As of December 31, 2004, the Bank did notestablish special reserves for individual loans based on specific anticipationof loss to the portfolio.  The inherentrisk present in the “acceptable” portion of the loan portfolio is taken intoconsideration and adjustments made for trends, changes in economic conditionsand other relevant factors that may affect repayment of the loans.

 

Management and the boardconsider the allowance for loan losses to be adequate to provide for lossesinherent in the loan portfolio. Although management usesavailable information to recognize losses on loans and leases, future additionsto the allowance may be necessary based on changes in economic conditions.  In addition, federal regulators periodicallyreview our allowance for loan losses and may

 

36

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recommendadditions based upon their evaluation of the portfolio at the time of theirexamination.  Accordingly, there can beno assurance that our allowance for loan losses will be adequate to coverfuture loan losses or that significant additions to the allowance for loanlosses will not be required in the future. Material additions to the allowance for loan losses would decreaseearnings and capital and would thereby reduce the Bank’s ability to paydividends, among other adverse consequences.

 

The ratio of allowance for loanlosses to total loans as of December 31, 2004 was 1.06%.  Management and the board consider this to beadequate based on their analysis and reviews of the portfolio.  The analysis assumes that there will be nomaterial asset quality problems following the recent recession and a continuedresumption of economic growth in the Central Coast of California.

 

As part of the analysis of theallowance, the Bank also assigns certain risk factors to the entire loan portfolioin addition to the specific percentages used for classified loans. Thefollowing table summarizes the allocation of the allowance for loan losses bygeneral loan types based on collateral or security type as used internally bythe Bank as of December 31, 2004.

 

 
| ** **                 | ** ** | **December 31, 2004** | ** ** | **December 31, 2003**        | ** ** |
|----------------------------|------------|-----------------------|------------|------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Loans**             | ** ** | **Percent  of Total  Loans** | ** ** | **Allowance  Allocation** | ** ** | **% of Total  Allowance** | ** ** | **Loans** | ** ** | **Percent  of Total  Loans** | ** ** | **Allowance  Allocation** | ** ** | **% of Total  Allowance** | ** ** |
| Unclassified loans:        |       |                  |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate                |       | $                     | 76,939     |                         | 74.1       | % | $ | 309 |   | 28.2 | % | $ | 51,643 |   | 65.0 | % | $ | 206 |   | 25.4 | % |
| Other secured loans        |       | 24,415                |       | 23.5                         | %          | 338 |   | 30.9 | % | 23,760 |   | 29.9 | % | 296 |   | 36.4 | % |
| Unsecured loans            |       | 1,277                 |       | 1.2                          | %          | 14 |   | 1.3 | % | 2,852 |   | 3.6 | % | 22 |   | 2.7 | % |
| Total unclassified loans   |       | 102,631               |       | 98.8                         | %          | 661 |   | 60.4 | % | 78,255 |   | 98.5 | % | 524 |   | 64.5 | % |
| Classified loans           |       | 1,195                 |       | 1.2                          | %          | 155 |   | 14.2 | % | 1,208 |   | 1.5 | % | 156 |   | 19.2 | % |
| Other economic factors     |       |                  |       |                         |       | 278 |   | 25.4 | % |   |   |   |   | 132 |   | 16.3 | % |
| Totals                     |       | $                     | 103,826    |                         | 100.0      | % | $ | 1,094 |   | 100.0 | % | $ | 79,463 |   | 100.0 | % | $ | 812 |   | 100.0 | % |

 

 

**Deposits**

 

Deposits are the primary sourceof funding for lending and investing needs. Total deposits were $112.8 million as of December 31, 2004, and $96.3million at December 31, 2003.  Depositsincreased by $16.5 million, or 17%, following an $8.8 million, or 10%, increasein 2003.

 

The Bank generally pricesdeposits at or above the median rate by classification based on periodicinterest rate surveys in the local market. Deposit rates are then adjusted to balance the cost of funds versusfunding needs and asset and liability considerations.  The Bank has used and expects to continue touse an Investor Savings product that pays higher rates than normal savings,similar to money market accounts, as a special product unique in the Bank’smarket, but management also expects to see the relative percentage of InvestorSavings to total deposits to continue to decline.  The *Net Interest Analysis*and *Rate/Volume Analysis* earlier in thisDiscussion contains information regarding the averagerates paid on deposits for 2004 and 2003.

 

The following table reflectsthe maturity distribution of certificates of deposit in the amounts of $100,000

 

37

----

 

ormore as of December 31, 2004:

 

**Maturities of Time Deposits of $100,000 orMore**

*(Dollars in thousands)*

 
| Three months or less                    |   | $      | 11,351 |   |
|-----------------------------------------|--------|--------|--------|--------|
| Three months to six months              |   | 12,143 |   |
| Six months to one year                  |   | 4,885  |   |
| Over one year                           |   | 2,128  |   |
| Total time deposits of $100,000 or more |   | $      | 30,507 |   |

 

#### **Short Term and OtherBorrowings**

 

As of December 31, 2004, theBank had $12.5 million in outstanding borrowings from the Federal Home LoanBank of San Francisco, $6.5 million of which matures during 2005, and thebalance matures on various dates from June 2006 through December 2013.  Note F to the consolidated financialstatements contains additional information regarding these borrowings.

 

#### **Effects of Inflation andEconomic Issues**

 

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

 

San Luis Obispo Countycontinues to have one of the lowest unemployment rates in California and realestate values continue to show increases, with steady demand for bothresidential and commercial properties. There can be no assurance that the economy will improve in the shortterm, and the Bank has adopted a cautiously optimistic outlook with closeattention to credit quality, interest rate risk, and control of operationalexpenses.

 

On December 22, 2003, the SanSimeon Earthquake hit the Paso Robles area the hardest, but was felt throughoutthe county.  Estimates suggest damages inexcess of $200 million.  There was nomaterial damage to the Bank’s leased office in Paso Robles and there has beenno reported major increase in credit risk for the Bank’s loans in the PasoRobles area or in other parts of the county. The County was declared a Federal Disaster Area and residents andbusinesses were eligible for FEMA & SBA assistance until March 15, 2004.

 

**Return onEquity and Assets**

 

The following table shows theCompany’s return on average assets and return on average equity for past twoyears:

 
| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Return on Average Assets |       | 1.16     | %          | 0.71     | %          |
| Return on Average Equity |       | 16.15    | %          | 8.81     | %          |

 

38

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## **Item7.**  FinancialStatements

 

 

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATED FINANCIAL STATEMENTS**

**WITH**

**INDEPENDENT AUDITORS’ REPORT**

 

**December 31, 2004 and 2003**

 

39

----

 

**CONTENTS**

 
| **REPORT OF INDEPENDENT REGISTERED  PUBLIC ACCOUNTING FIRM ON THE CONSOLIDATED FINANCIAL STATEMENTS** | 41             |
|-------------------------------------------------------------------------------------------------------|----------------|
|                                                                                                  |           |
| **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                |           |
|                                                                                                  |           |
| **Consolidated Balance Sheets**                                                                       | 42 and 43      |
| **Consolidated Statements of Income**                                                                 | 44             |
| **Consolidated Statement of Changes  in Shareholders’ Equity**                                   | 45             |
| **Consolidated Statements of Cash Flows**                                                             | 46             |
| **Notes to Consolidated Financial Statements**                                                        | 47 through  74 |

 

40

----

 

 

#### **REPORTOF INDEPENDENT** REGISTERED PUBLIC ACCOUNTING FRIM

 

Board of Directors andShareholders ofMission Community Bancorp and Subsidiary

 

We have audited theaccompanying consolidated balance sheets of Mission Community Bancorp andSubsidiary as of December 31, 2004 and 2003 and the related consolidatedstatements of income, changes in shareholders’ equity, and cash flows of theyears then ended.  These consolidatedfinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

We conducted our audits inaccordance with the standards of the public company accounting oversight board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the consolidated financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Mission Community Bancorp and Subsidiary as of December 31, 2004and December 31, 2003, and the results of its operations and its cash flows forthe years then ended, in conformity with accounting principles generallyaccepted in the United States of America.

 

 
| /s/ Vavrinek,  Trine, Day & Co., LLP |
|------------------------------------------|
|                                     |
| Laguna  Hills, California                |
| January 25,  2005                        |

 

41

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**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

**December 31, 2004 and 2003**

 
| ** **                                             | ** ** | **2004**    | ** **  | **2003**   | ** ** |
|--------------------------------------------------------|------------|-------------|-------------|------------|------------|
| **ASSETS**                                             |       |        |        |       |       |
|                                                   |       |        |        |       |       |
| Cash and Due from Banks                                |       | $           | 2,587,235   |       | $          | 2,798,175 |   |
| Federal Funds Sold                                     |       | 10,385,000  |        | 5,495,000  |       |
| **TOTAL  CASH AND CASH EQUIVALENTS**                   |       | 12,972,235  |        | 8,293,175  |       |
|                                                   |       |        |        |       |       |
| Interest-Bearing Deposits in Other Banks               |       | 550,000     |        | 3,550,000  |       |
|                                                   |       |        |        |       |       |
| Investment Securities:                                 |       |        |        |       |       |
| Investment Securities Available for Sale               |       | 6,727,055   |        | 6,951,780  |       |
| Investment Securities Held to Maturity                 |       | 9,044,846   |        | 11,300,627 |       |
| **TOTAL  INVESTMENT SECURITIES**                       |       | 15,771,901  |        | 18,252,407 |       |
|                                                   |       |        |        |       |       |
| Loans:                                                 |       |        |        |       |       |
| Commercial                                             |       | 16,178,184  |        | 15,078,689 |       |
| Agricultural                                           |       | 773,726     |        | 1,526,632  |       |
| Construction                                           |       | 24,394,027  |        | 4,919,585  |       |
| Real Estate                                            |       | 60,445,553  |        | 55,839,615 |       |
| Consumer                                               |       | 1,584,730   |        | 1,393,407  |       |
| **TOTAL  LOANS**                                       |       | 103,376,220 |        | 78,757,928 |       |
|                                                   |       |        |        |       |       |
| Allowance for Loan Losses                              |       | (1,093,838  | )           | (811,925   | )          |
| **NET  LOANS**                                         |       | 102,282,382 |        | 77,946,003 |       |
|                                                   |       |        |        |       |       |
| Federal Home Loan Bank Stock and Other  Stock, at Cost |       | 1,080,925   |        | 566,609    |       |
| Premises and Equipment                                 |       | 2,479,880   |        | 2,429,851  |       |
| Cash Surrender Value of Life Insurance                 |       | 2,059,805   |        | —     |       |
| Accrued Interest and Other Assets                      |       | 2,052,093   |        | 1,722,007  |       |
|                                                   |       | $           | 139,249,221 |       | $          | 112,760,052 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

42

----

 

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

**December 31, 2004 and 2003**

 
| ** **                                                                                               | ** ** | **2004**    | ** **  | **2003**    | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                           |       |        |        |        |       |
|                                                                                                     |       |        |        |        |       |
| Deposits:                                                                                                |       |        |        |        |       |
| Noninterest-Bearing Demand                                                                               |       | $           | 20,593,303  |        | $          | 20,195,209 |   |
| Money Market, NOW and Savings                                                                            |       | 46,972,959  |        | 41,106,568  |       |
| Time Deposits Under $100,000                                                                             |       | 14,762,438  |        | 10,174,539  |       |
| Time Deposits $100,000 and Over                                                                          |       | 30,507,350  |        | 24,809,222  |       |
| **TOTAL  DEPOSITS**                                                                                      |       | 112,836,050 |        | 96,285,538  |       |
|                                                                                                     |       |        |        |        |       |
| Other Borrowings                                                                                         |       | 12,500,000  |        | 4,500,000   |       |
| Junior Subordinated Debt Securities                                                                      |       | 3,093,000   |        | 3,093,000   |       |
| Accrued Interest and Other Liabilities                                                                   |       | 792,855     |        | 335,988     |       |
| **TOTAL  LIABILITIES**                                                                                   |       | 129,221,905 |        | 104,214,526 |       |
|                                                                                                     |       |        |        |        |       |
| Commitments and Contingencies - Notes D and  M                                                           |       | —      |        | —      |       |
|                                                                                                     |       |        |        |        |       |
| Shareholders’ Equity:                                                                               |       |        |        |        |       |
| Preferred Stock - Authorized 1,000,000  Shares:                                                          |       |        |        |        |       |
| Series A - $5 Stated Value; Issued and  Outstanding, 100,000  Liquidation Value of $500,000              |       | 392,194     |        | 392,194     |       |
| Series B - $10 Stated Value; Issued and  Outstanding, 20,500  Liquidation Value of $205,000              |       | 191,606     |        | 191,606     |       |
| Series C - $10 Stated Value; Issued and  Outstanding, 50,000  Liquidation Value of $500,000              |       | 500,000     |        | 500,000     |       |
| Common Stock - Authorized 1,000,000 Shares;  Issued and Outstanding, 642,599 in 2004 and 630,166 in 2003 |       | 6,387,326   |        | 6,273,101   |       |
| Retained Earnings                                                                                        |       | 2,570,697   |        | 1,170,337   |       |
| Accumulated Other Comprehensive Income -  Unrealized                                                     |       |        |        |        |       |
| Appreciation(Depreciation) on  Available-for-Sale Securities, net of tax                                 |       | (14,507     | )           | 18,288      |       |
| **TOTAL  SHAREHOLDERS’ EQUITY**                                                                     |       | 10,027,316  |        | 8,545,526   |       |
|                                                                                                     |       | $           | 139,249,221 |        | $          | 112,760,052 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

43

----

 

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF INCOME**

**Years Ended December 31, 2004 and 2003**

** **
| ** **                                                | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-----------------------------------------------------------|------------|-----------|------------|-----------|------------|
| **INTEREST INCOME**                                       |       |      |       |      |       |
| Interest and Fees on Loans                                |       | $         | 6,684,695  |      | $          | 4,716,796 |   |
| Interest on Investment Securities                         |       | 648,004   |       | 614,221   |       |
| Other Interest Income                                     |       | 92,191    |       | 213,295   |       |
| **TOTAL  INTEREST INCOME**                                |       | 7,424,890 |       | 5,544,312 |       |
| **INTEREST EXPENSE**                                      |       |      |       |      |       |
| Interest on Money Market, NOW and Savings  Deposits       |       | 552,232   |       | 492,121   |       |
| Interest on Time Deposits                                 |       | 744,624   |       | 697,557   |       |
| Other Interest Expense                                    |       | 393,467   |       | 79,037    |       |
| **TOTAL  INTEREST EXPENSE**                               |       | 1,690,323 |       | 1,268,715 |       |
| **NET  INTEREST INCOME**                                  |       | 5,734,567 |       | 4,275,597 |       |
| Provision for Loan Losses                                 |       | 280,000   |       | 120,000   |       |
| **NET  INTEREST INCOME AFTER  PROVISION FOR LOAN LOSSES** |       | 5,454,567 |       | 4,155,597 |       |
| **NON-INTEREST INCOME**                                   |       |      |       |      |       |
| Service charges on deposit accounts                       |       | 249,321   |       | 197,781   |       |
| Gain on sale of loans                                     |       | 665,047   |       | 600,015   |       |
| Loan servicing fees                                       |       | 283,806   |       | 204,266   |       |
| Bank Enterprise Awards                                    |       | 1,332,756 |       | 180,900   |       |
| Loss on sale of available-for-sale  securities            |       | (71,281   | )          | —    |       |
| Other income and fees                                     |       | 224,920   |       | 184,208   |       |
| **TOTAL  NON-INTEREST INCOME**                            |       | 2,684,569 |       | 1,367,170 |       |
| **NON-INTEREST EXPENSE**                                  |       |      |       |      |       |
| Salaries and employee benefits                            |       | 2,726,944 |       | 2,381,261 |       |
| Occupancy expenses                                        |       | 441,600   |       | 393,789   |       |
| Furniture and equipment                                   |       | 150,861   |       | 154,725   |       |
| Data processing                                           |       | 370,328   |       | 371,863   |       |
| Professional fees                                         |       | 208,470   |       | 132,190   |       |
| Marketing and business development                        |       | 400,706   |       | 114,216   |       |
| Office supplies and expenses                              |       | 232,042   |       | 236,967   |       |
| Insurance and regulatory assessments                      |       | 86,705    |       | 93,127    |       |
| Loan and lease expenses                                   |       | 218,419   |       | 150,398   |       |
| Provision for securities losses                           |       | 253,598   |       | —    |       |
| Other expenses                                            |       | 539,766   |       | 360,943   |       |
| **TOTAL  NON-INTEREST EXPENSE**                           |       | 5,629,439 |       | 4,389,479 |       |
| **INCOME  BEFORE INCOME TAXES**                           |       | 2,509,697 |       | 1,133,288 |       |
| Income Tax Expense                                        |       | 1,017,766 |       | 416,774   |       |
| **NET  INCOME**                                           |       | $         | 1,491,931  |      | $          | 716,514 |   |
|                                                      |       |      |       |      |       |
| Per Share Data (Notes A and N):                           |       |      |       |      |       |
| Net Income - Basic                                        |       | $         | 1.97       |      | $          | 0.95 |   |
| Net Income - Diluted                                      |       | $         | 1.84       |      | $          | 0.91 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

44

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**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY**

**Years Ended December 31, 2004 and 2003**

 
| ** **                                                                                               | ** ** | **Preferred** | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------------|------------|-------------------|------------|--------------|------------|---------------------------------------|------------|------------|------------|
| ** **                                                                                               | ** ** | **Stock**     | ** ** | **Shares**       | ** ** | **Amount**        | ** ** | **Income**   | ** ** | **Earnings**                          | ** ** | **Income** | ** ** | **Total** | ** ** |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Balance at January 1, 2003**                                                                           |       | $             | 1,083,800  |             | 630,166    |              | $          | 6,273,101    |       |                                  |       | $          | 528,890    |   | $ | 63,697 |   | $ | 7,949,488 |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Dividends paid                                                                                           |       |          |       |             |       |              |       |         |       | (75,067                               | )          |       |       | (75,067 | ) |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Comprehensive Income:**                                                                                |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Net income                                                                                               |       |          |       |             |       |              |       | $            | 716,514    |                                  | 716,514    |       |       |   | 716,514 |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Net unrealized loss on available-for-sale  securities, net of taxes of $34,433                           |       |          |       |             |       |              |       | (45,409      | )          |                                  |       | (45,409    | )          | (45,409 | ) |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Total Comprehensive Income**                                                                           |       |          |       |             |       |              |       | $            | 671,105    |                                  |       |       |       |   |   |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Balance at December 31, 2003**                                                                         |       | $             | 1,083,800  |             | 630,166    |              | $          | 6,273,101    |       |                                  |       | $          | 1,170,337  |   | $ | 18,288 |   | $ | 8,545,526 |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Dividends paid                                                                                           |       |          |       |             |       |              |       |         |       | (91,571                               | )          |       |       | (91,571 | ) |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Exercise of stock options                                                                                |       |          |       | 12,433           |       | 114,225           |       |         |       |                                  |       |       |       | 114,225 |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Comprehensive Income:**                                                                                |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Net income                                                                                               |       |          |       |             |       |              |       | $            | 1,491,931  |                                  | 1,491,931  |       |       |   | 1,491,931 |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| Net unrealized loss on available-for-sale  securities, net of taxes of $52,015                           |       |          |       |             |       |              |       | (74,851      | )          |                                  |       | (74,851    | )          | (74,851 | ) |
| Less reclassification adjustment for loss  on securities included in net income, net of taxes of $29,225 |       |          |       |             |       |              |       | 42,056       |       |                                  |       | 42,056     |       | 42,056 |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Total Comprehensive Income**                                                                           |       |          |       |             |       |              |       | $            | 1,459,136  |                                  |       |       |       |   |   |   |
|                                                                                                     |       |          |       |             |       |              |       |         |       |                                  |       |       |       |   |   |
| **Balance at December 31, 2004**                                                                         |       | $             | 1,083,800  |             | 642,599    |              | $          | 6,387,326    |       |                                  |       | $          | 2,570,697  |   | $ | (14,507 | ) | $ | 10,027,316 |   |

 

45

----

 

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Years Ended December 31, 2004 and 2003**

 
| ** **                                                                         | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **OPERATING ACTIVITIES**                                                           |       |        |       |        |       |
| Net income                                                                         |       | $           | 1,491,931  |        | $          | 716,514 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |        |       |        |       |
| Depreciation and amortization                                                      |       | 233,124     |       | 202,623     |       |
| Provision for credit losses                                                        |       | 280,000     |       | 120,000     |       |
| Provision for losses on unfunded loan  commitments                                 |       | 50,000      |       | —      |       |
| Provision for securities losses                                                    |       | 253,598     |       | —      |       |
| Loss on sale of securities                                                         |       | 71,281      |       | —      |       |
| Gain on loan sales                                                                 |       | (665,047    | )          | (600,015    | )          |
| Increase in cash surrender value of life  insusance                                |       | (59,805     | )          | —      |       |
| Other, net                                                                         |       | 117,287     |       | (261,358    | )          |
| **NET CASH  PROVIDED BY OPERATING ACTIVITIES**                                     |       | 1,772,369   |       | 177,764     |       |
|                                                                               |       |        |       |        |       |
| **INVESTING ACTIVITIES**                                                           |       |        |       |        |       |
| Purchases of Federal Home Loan Bank and  other stock                               |       | (522,550    | )          | (135,625    | )          |
| Net maturities (purchases) of deposits in  other banks                             |       | 3,000,000   |       | (550,000    | )          |
| Purchase of available-for-sale securities                                          |       | (10,514,498 | )          | (10,567,042 | )          |
| Purchase of held-to-maturity securities                                            |       | (500,000    | )          | (10,512,031 | )          |
| Proceeds from maturities of  available-for-sale securities                         |       | 4,169,460   |       | 8,772,080   |       |
| Proceeds from maturities of  held-to-maturity securities                           |       | 2,481,076   |       | 5,932,807   |       |
| Proceeds from sales of available-for-sale  securities                              |       | 6,428,719   |       | —      |       |
| Proceeds from loan sales                                                           |       | 6,320,343   |       | 6,701,730   |       |
| Net increase in loans                                                              |       | (30,263,629 | )          | (20,499,616 | )          |
| Purchase of bank-owned life insurance                                              |       | (2,000,000  | )          | —      |       |
| Purchases of premises and equipment                                                |       | (265,396    | )          | (144,413    | )          |
| **NET CASH  USED IN INVESTING ACTIVITIES**                                         |       | (21,666,475 | )          | (21,002,110 | )          |
|                                                                               |       |        |       |        |       |
| **FINANCING ACTIVITIES**                                                           |       |        |       |        |       |
| Net increase in demand deposits and savings  accounts                              |       | 6,264,485   |       | 7,516,672   |       |
| Net increase in time deposits                                                      |       | 10,286,027  |       | 1,263,865   |       |
| Net increase in other borrowings                                                   |       | 8,000,000   |       | 2,000,000   |       |
| Proceeds from issuance of junior  subordinated debt securities                     |       | —      |       | 3,093,000   |       |
| Payment of dividends                                                               |       | (91,571     | )          | (75,067     | )          |
| Proceeds from exercise of stock options                                            |       | 114,225     |       | —      |       |
| **NET CASH  PROVIDED BY FINANCING ACTIVITIES**                                     |       | 24,573,166  |       | 13,798,470  |       |
|                                                                               |       |        |       |        |       |
| **NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS**                          |       | 4,679,060   |       | (7,025,876  | )          |
| Cash and cash equivalents at beginning of  year                                    |       | 8,293,175   |       | 15,319,051  |       |
| **CASH AND  CASH EQUIVALENTS AT END OF YEAR**                                      |       | $           | 12,972,235 |        | $          | 8,293,175 |   |
|                                                                               |       |        |       |        |       |
| **Supplemental Disclosures of Cash Flow  Information:**                            |       |        |       |        |       |
| Interest paid                                                                      |       | $           | 1,654,913  |        | $          | 1,297,991 |   |
| Taxes paid                                                                         |       | 1,341,834   |       | 359,823     |       |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

46

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**NOTE A****- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Principles ofConsolidation

 

The financial statementsinclude the accounts of Mission Community Bancorp (“Bancorp”) and its subsidiary,Mission Community Bank (“the Bank”), and the Bank’s subsidiary, MissionCommunity Development Corporation, collectively referred to herein as the “Company.”

 

Nature ofOperations

 

The Bank has been organized asa single reporting segment and operates four branches in the Central Coast areaof California.  The Bank’s primary sourceof revenue is providing Small Business Administration (“SBA”) guaranteed loans,real estate, commercial and consumer loans to customers, who are predominatelysmall and middle-market businesses and individuals.  The Company and the Bank are certified by theDepartment of Treasury as Community Development Financial Institution(s) (CDFI)with a commitment to focus on providing financial services to low and moderateincome communities.

 

MissionCommunity Development Corporation

 

Mission Community Development Corporation is a communitydevelopment corporation, which provides financing for small businesses andprojects in low- to moderate-income areas. The Board of Directors of Mission Community Development Corporationconsists of four members of the Board of Directors of the Company and threeoutside members who are actively involved in supporting community affairs andactivities. Community development investment is limited to 5% of the Bank’scapital and up to 10% with prior approval by the Federal Reserve Board.  Operations of Mission Community DevelopmentCorporation were not material as of December 31, 2004.

 

###### *MissionCommunity Services Corporation*

###### * *

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

 

47

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Use ofEstimates in the Preparation of Financial Statements

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

Cash and CashEquivalents

 

For purposes of reporting cashflows, cash and cash equivalents include cash, due from banks and federal fundssold.  Generally, federal funds are soldfor one-day periods.

 

Cash and DueFrom Banks

 

Banking regulations requirethat all banks maintain a percentage of their deposits as reserves in cash oron deposit with the Federal Reserve Bank. The Bank was in compliance with this requirement, which was $447,000 asof December 31, 2004.

 

The Company maintains amountsdue from banks, which exceed federally insured limits.  The Company has not experienced any losses insuch accounts.

 

InvestmentSecurities

 

Bonds, notes, and debenturesfor which the Company has the positive intent and ability to hold to maturityare reported at cost, adjusted for premiums and discounts that are recognizedin interest income using the interest method over the period to maturity.

 

Investments not classified astrading securities nor as held-to-maturity securities are classified asavailable-for-sale securities and recorded at fair value.  Unrealized gains or losses onavailable-for-sale securities are excluded from net income and reported as anamount net of taxes as a separate component of comprehensive income included inshareholders’ equity.  Premiums ordiscounts are amortized or accreted into income using the interest method.  Realized gains or losses on sales ofsecurities are recorded using the specific identification method.

 

Loans

 

Loans are reported at theprincipal amount outstanding, net of any deferred loan origination fee incomeand deferred direct loan origination costs, and net of any unearned interest ondiscounted loans.  Deferred loanorigination fee income and direct loan origination costs are amortized tointerest income over the life of the loan using the interest method.  Interest on loans is accrued to income dailybased upon the outstanding principal balances.

 

48

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

 

For impairment recognized inaccordance with Financial Accounting Standards Board (“FASB”) Statement ofFinancial Accounting Standards (“SFAS”) No. 114, *“Accountingby Creditors for Impairment of a Loan”,* as amended by SFAS No. 118,the entire change in the present value of expected cash flows is reported aseither provision for credit losses in the same manner in which impairmentinitially was recognized, or as a reduction in the amount of provision forcredit losses that otherwise would be reported.

 

The Bank has adopted SFAS No.140, *“Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.”*  The Statement provides accounting andreporting standards for transfers and servicing of financial assets andextinguishments of liabilities.  Underthis Statement, after a transfer of financial assets, an entity recognizes thefinancial and servicing assets it controls and liabilities it has incurred,derecognizes financial assets when control has been surrendered, andderecognizes liabilities when extinguished.

 

To calculate the gain (loss) onsale of loans, the Bank’s investment in the loan is allocated among theretained portion of the loan, the servicing retained, the interest-only stripand the sold portion of the loan, based on the relative fair market value ofeach portion.  The gain (loss) on thesold portion of the loan is recognized at the time of sale based on thedifference between the sale proceeds and the allocated investment.  As a result of the relative fair value allocation,the carrying value of the retained portion is discounted, with the discountaccreted to interest income over the life of the loan.  That portion of the excess servicing feesthat represent contractually specified servicing fees (contractual servicing)are reflected as a servicing asset which is amortized over an estimated lifeusing a method approximating the level yield method; in the event futureprepayments exceed Management’s estimates and future expected cash flows areinadequate to cover the unamortized servicing asset, additional amortizationwould be recognized.  The portion ofexcess servicing fees in excess of the contractual servicing fees is reflectedas interest-only (I/O) strips receivable, which are classified as interest-onlystrips receivable available for sale and are carried at fair value.

 

Allowance forLoan Losses

 

The allowance for loan lossesis increased by charges to income and decreased by charge-offs (net ofrecoveries).  Management performs, atleast quarterly, an analysis of the allowance for loan losses to determine itsadequacy.  In this analysis, allnon-classified loans are segmented into components by loans type and internalrisk ratings.  Estimated loss factors areapplied to each loan pool based on historical losses as well as management’sassessment of current factors that may impact these historical factors, such aschanges in the local economy, changes in underwriting standards, changes inloans concentrations and changes in past due and non-

 

49

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performing trends.  Significant loans classified as less thanacceptable by management, the Bank’s regulators or external credit reviewconsultants are evaluated separately in the process.  In this evaluation, management reviews theborrower’s ability to repay as well as the estimated value of any underlyingcollateral.

 

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Premises andEquipment

 

###### *Land is carried at cost.  Premises and equipment are carried at costless accumulated depreciation and amortization. Depreciation is computed using the straight-line method over theestimated useful lives, which range from three to ten years for furniture andfixtures and forty years for buildings. Leasehold improvements are amortized using the straight-line method overthe estimated useful lives of the improvements or the remaining lease term,whichever is shorter.  Expenditures forbetterments or major repairs are capitalized and those for ordinary repairs andmaintenance are charged to operations as incurred.*

###### * *

###### *Advertising Costs*

###### * *

The Bank expenses the costs of advertising in the periodincurred.

 

Income Taxes

 

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

 

ComprehensiveIncome

 

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

 

FinancialInstruments

 

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

 

Earnings PerShare (EPS)

 

Basic EPS excludes dilution andis computed by dividing income available to common stockholders by theweighted-average number of common shares outstanding for the period.  Diluted EPS reflects the potential dilutionthat could occur if options or other contracts to issue common stock wereexercised or converted into common stock or resulted in the issuance of commonstock that then shared in the earnings of the Company.

 

51

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Stock-BasedCompensation

 

SFAS No. 123*, “Accounting for Stock-Based Compensation,”* encourages, butdoes not require, companies to record compensation cost for stock-basedemployee compensation plans at fair value. The Company accounts for stock-based compensation using the intrinsicvalue method prescribed in Accounting Principles Board (APB) Opinion No. 25, *“Accounting for Stock Issued to Employees,”*and related Interpretations.

 

Accordingly, compensation costfor stock options will be measured as the excess, if any, of the quoted marketprice of the Company’s stock at the date of the grant over the amount anemployee must pay to acquire the stock.

 

Had compensation cost for theCompany’s stock option plans been determined based on the fair value at thegrant dates for awards under those plans consistent with the method of SFAS No.123, the Company’s net income and income per share would have been reduced tothe pro forma amounts indicated below:

 
| ** **                                                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net Income:                                                                                     |       |     |       |     |       |
| As Reported                                                                                     |       | $        | 1,491,931  |     | $          | 716,514 |   |
| Stock-Based Compensation using the  Intrinsic Value Method                                      |       | —   |       | —   |       |
| Stock-Based Compensation that would have  been reported using the Fair Value Method of SFAS 123 |       | (14,769  | )          | (43,776  | )          |
| Pro Forma                                                                                       |       | $        | 1,477,162  |     | $          | 672,738 |   |
|                                                                                            |       |     |       |     |       |
| Basic Income Per Share:                                                                         |       |     |       |     |       |
| As Reported                                                                                     |       | $        | 1.97       |     | $          | 0.95 |   |
| Pro Forma                                                                                       |       | 1.95     |       | 0.90     |       |
|                                                                                            |       |     |       |     |       |
| Diluted Income Per Share:                                                                       |       |     |       |     |       |
| As Reported                                                                                     |       | 1.84     |       | 0.91     |       |
| Pro Forma                                                                                       |       | 1.82     |       | 0.85     |       |

 

52

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Recent****Accounting Announcements

 

In December 2004, FASB revisedSFAS 123 and issued it under its new name, *“Share-BasedPayment.” *This statementeliminates the alternative to use APB Opinion 25’s intrinsic value method ofaccounting discussed in the previous paragraph. Instead, this Statement generally requires entities to recognize thecost of employee services received in exchange for awards of stock options, orother equity instruments, based on the grant-date fair value of thoseawards.  This cost will be recognizedover the period during which an employee is required to provide service inexchange for the award, generally the vesting period.

 

The Company must adopt thisStatement in 2006 for all new stock option awards as well as any existingawards that are modified, repurchased or cancelled.  In addition, the unvested portion ofpreviously awarded options will also be recognized as expense.  The Company is unable to estimate the impactof this Statement on its financial condition and results of operations as thedecision to grant option awards is made annually on a case-by-case basis and,accordingly, the Company cannot estimate the amount of stock awards that willbe made in 2006.

 

Reclassifications

 

Certain reclassifications weremade to prior years’ presentations to conform to the current year.  These reclassifications had no effect on netincome or earnings per share.

 

53

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**NOTE B -INVESTMENT SECURITIES**

 

Investment securities have beenclassified in the consolidated balance sheets according to management’sintent.  The amortized cost of securitiesand their approximate fair values at December 31 were as follows:

 
| ** **                         | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Market  Value** | ** ** |
|------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|------------------------------|------------|
| **Available-for-Sale Securities:** |       |                |       |                         |       |                          |       |                         |       |
| **December 31, 2004:**             |       |                |       |                         |       |                          |       |                         |       |
| U.S. Government agencies           |       | $                   | —     |                         | $          | —                        |       | $                            | —     |   | $ | — |   |
| Mortgage-backed securities         |       | 6,695,720           |       | 3,480                        |       | (29,270                       | )          | 6,669,930                    |       |
| Asset-backed securities            |       | 55,924              |       | 1,201                        |       | —                        |       | 57,125                       |       |
|                               |       | $                   | 6,751,644  |                         | $          | 4,681                         |       | $                            | (29,270    | ) | $ | 6,727,055 |   |
|                               |       |                |       |                         |       |                          |       |                         |       |
| **December 31, 2003:**             |       |                |       |                         |       |                          |       |                         |       |
| U.S. Government agencies           |       | $                   | 5,501,031  |                         | $          | 36,381                        |       | $                            | (10,470    | ) | $ | 5,526,942 |   |
| Mortgage-backed securities         |       | 1,288,305           |       | 3,524                        |       | (3,305                        | )          | 1,288,524                    |       |
| Asset-backed securities            |       | 131,448             |       | 4,866                        |       | —                        |       | 136,314                      |       |
|                               |       | $                   | 6,920,784  |                         | $          | 44,771                        |       | $                            | (13,775    | ) | $ | 6,951,780 |   |
|                               |       |                |       |                         |       |                          |       |                         |       |
| **Held-to-Maturity Securities:**   |       |                |       |                         |       |                          |       |                         |       |
| **December 31, 2004:**             |       |                |       |                         |       |                          |       |                         |       |
| U.S. Government agencies           |       | $                   | 6,998,038  |                         | $          | 6,875                         |       | $                            | (86,028    | ) | $ | 6,918,885 |   |
| Mortgage-backed securities         |       | 1,600,881           |       | 22,207                       |       | (6,512                        | )          | 1,616,576                    |       |
| Asset-backed securities            |       | 445,927             |       | 23,132                       |       | —                        |       | 469,059                      |       |
|                               |       | $                   | 9,044,846  |                         | $          | 52,214                        |       | $                            | (92,540    | ) | $ | 9,004,520 |   |
|                               |       |                |       |                         |       |                          |       |                         |       |
| **December 31, 2003:**             |       |                |       |                         |       |                          |       |                         |       |
| U.S. Government agencies           |       | $                   | 7,997,592  |                         | $          | 21,852                        |       | $                            | (82,463    | ) | $ | 7,936,981 |   |
| Mortgage-backed securities         |       | 2,474,491           |       | 31,096                       |       | (9,930                        | )          | 2,495,657                    |       |
| Asset-backed securities            |       | 828,544             |       | 22,325                       |       | (209,525                      | )          | 641,344                      |       |
|                               |       | $                   | 11,300,627 |                         | $          | 75,273                        |       | $                            | (301,918   | ) | $ | 11,073,982 |   |

 

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The scheduled maturities ofinvestment securities at December 31, 2004, were as follows.  Actual maturities may differ from contractualmaturities because some investment securities may allow the right to call orprepay the obligation with or without call or prepayment penalties.

 
| ** **                     | ** ** | **Available-for-Sale Securities** | ** ** | **Held-to-Maturity Securities** | ** ** |
|--------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **Amortized  Cost**               | ** ** | **Fair  Value**                 | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|                           |       |                              |       |                            |       |   |   |   |   |
| Within one year                |       | $                                 | —     |                            | $          | — |   | $ | — |   | $ | — |   |
| Due in one year to five years  |       | 1,257,154                         |       | 1,250,858                       |       | 4,014,591 |   | 3,973,070 |   |
| Due in five years to ten years |       | —                            |       | —                          |       | 2,075,903 |   | 2,082,487 |   |
| Due in greater than ten years  |       | 5,494,490                         |       | 5,476,197                       |       | 2,954,352 |   | 2,948,963 |   |
|                           |       | $                                 | 6,751,644  |                            | $          | 6,727,055 |   | $ | 9,044,846 |   | $ | 9,004,520 |   |

 

### **Includedin accumulated other comprehensive income at December 31, 2004 were netunrealized gains on investment securities available for sale of $24,589 lessapplicable income taxes of $10,082.  AtDecember 31, 2003, accumulated other comprehensive income included netunrealized gains on available-for-sale securities of $30,996 less applicableincome taxes of $12,708.  During 2004,the Bank realized $76,437 in losses and $5,156 in gains on sales of securitiesavailable for sale.**

 

Investment securities in atemporary unrealized loss position as of December 31, 2004 are shown in thefollowing table, based on the length of time they have been continuously in anunrealized loss position:

 
| ** **                         | ** ** | **Less than 12 Months** | ** ** | **12 Months or Longer** | ** ** | **Total**       | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                         | ** ** | **Fair  Value**         | ** ** | **Unrealized  Losses**  | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| **Available-for-Sale Securities:** |       |                    |       |                    |       |            |       |   |   |   |   |   |   |
| U.S. Government agencies           |       | $                       | —     |                    | $          | —          |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Mortgage-backed securities         |       | 5,635,592               |       | 29,270                  |       | —          |       | — |   | 5,635,592 |   | 29,270 |   |
|                               |       | $                       | 5,635,592  |                    | $          | 29,270          |       | $ | — |   | $ | — |   | $ | 5,635,592 |   | $ | 29,270 |   |
|                               |       |                    |       |                    |       |            |       |   |   |   |   |   |   |
| **Held-to-Maturity Securities:**   |       |                    |       |                    |       |            |       |   |   |   |   |   |   |
| U.S. Government agencies           |       | $                       | 3,466,540  |                    | $          | 33,460          |       | $ | 1,445,470 |   | $ | 52,568 |   | $ | 4,912,010 |   | $ | 86,028 |   |
| Mortgage-backed securities         |       | 602,471                 |       | 5,256                   |       | 201,018         |       | 1,256 |   | 803,489 |   | 6,512 |   |
|                               |       | $                       | 4,069,011  |                    | $          | 38,716          |       | $ | 1,646,488 |   | $ | 53,824 |   | $ | 5,715,499 |   | $ | 92,540 |   |

 

 

One of the Bank’sheld-to-maturity asset-backed securities, which had a carrying value of$427,024 as of December 31, 2003, has been in an unrealized loss position forover twelve months.  During 2004,management concluded that the unrealized loss was not temporary and establisheda $253,598 loss reserve for this security through a charge to non-interestexpense.  The security was placed innonaccrual status, with any interest payments received being credited to the reserve.  As of December 31, 2004, the gross book valueof the security was $408,081 and the reserve was $259,375, for a net book valueof $148,706.

 

55

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The unrealized losses oninvestments in U.S. Government agency and mortgage-backed securities which havebeen in an unrealized loss position for one year or longer were caused byinterest rate increases subsequent to the purchase of the security.  Other than the one asset-backed securityfootnoted above, none of these securities has exhibited a decline in value as aresult of changes in credit risk. Because the Bank has the ability and intent to hold all theseinvestments until maturity, the unrealized losses on these investments are notconsidered to be other-than-temporarily impaired.

 

Investments securities carriedat $8,226,000 and $5,500,000 as of December 31, 2004 and 2003, respectively,were pledged to secure short-term borrowings and public deposits as required bylaw.

 

### **NOTE C - LOANS**

 

The Bank’s loan portfolioconsists primarily of loans to borrowers within the Central Coast Area of California.  Although the Bank seeks to avoidconcentrations of loans to a single industry or based upon a single class ofcollateral, real estate and real estate associated businesses are among theprincipal industries in the Bank’s market area and, as a result, the Bank’sloan and collateral portfolios are concentrated in those industries and in thatgeographic area.  As of December 31,2004, 72% of the loan portfolio was secured by commercial real estate(including construction and land development loans as well as loans secured bynon-farm, non-residential and multi-family residential properties).

 

The Bank also originatesSBA-guaranteed loans for sale to institutional investors.  At December 31, 2004 and 2003 the Bank wasservicing $33,030,000 and $19,707,000, respectively, in loans previously soldor participated. The Bank has recorded servicing assets related to these loanstotaling $636,000 and $607,000 at December 31, 2004 and 2003, respectively. Theestimated fair value of the servicing assets approximated the carrying amountat December 31, 2004 and 2003.

 

Included in total loans are netdeferred loan fees of $70,000 and discounts related to the unguaranteed portionof SBA loans of $720,000 at December 31, 2004. At December 31, 2003, the Bank had net deferred loan fees of $78,000 anddiscounts of $628,000 related to the unguaranteed portion of SBA loans.

 

A summary of the changes in theallowance for possible loan losses as of December 31 follows:

 
| ** **                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Balance at Beginning of Year                     |       | $        | 811,925    |     | $          | 744,248 |   |
| Additions to the Allowance Charged to  Expense   |       | 280,000  |       | 120,000  |       |
| Less Loans Charged Off                           |       | (1,230   | )          | (110,285 | )          |
| Plus Recoveries on Loans Previously Charged  Off |       | 3,143    |       | 57,962   |       |
| Balance at End of Year                           |       | $        | 1,093,838  |     | $          | 811,925 |   |

 

56

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The following is a summary ofthe investment in impaired loans as of December 31, including the relatedallowance for loan losses and cash-basis income recognized.  Also shown are loans on nonaccrual and thosepast due loans and still accruing interest:

 
| ** **                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                     |       |     |       |     |       |
| Recorded Investment in Impaired Loans                    |       | $        | 206,000    |     | $          | 508,000 |   |
| Related Allowance for Loan Losses                        |       | 17,000   |       | 36,000   |       |
| Average Recorded Investment in Impaired  Loans           |       | 333,000  |       | 127,000  |       |
| Interest Income Recognized for Cash Payments             |       | —   |       | 2,666    |       |
| Total Loans on Nonaccrual                                |       | 206,000  |       | 508,000  |       |
| Total Loans Past Due 90 Days or More and  Still Accruing |       | —   |       | 11,000   |       |
|                                                          |            |          |            |          |            |  |  |

 

**NOTE D -PREMISES AND EQUIPMENT**

 

A summary of premises andequipment as of December 31 follows:

 
| ** **                                | ** ** | **2004**   | ** ** | **2003**  | ** ** |
|-------------------------------------------|------------|------------|------------|-----------|------------|
|                                      |       |       |       |      |       |
| Land                                      |       | $          | 976,498    |      | $          | 976,498 |   |
| Buildings                                 |       | 722,333    |       | 722,333   |       |
| Leasehold improvements                    |       | 346,788    |       | 341,519   |       |
| Furniture, fixtures, and equipment        |       | 1,612,965  |       | 1,385,139 |       |
|                                      |       | 3,658,584  |       | 3,425,489 |       |
| Accumulated depreciation and amortization |       | (1,178,704 | )          | (995,638  | )          |
| Net premises and equipment                |       | $          | 2,479,880  |      | $          | 2,429,851 |   |

 

The Bank has entered intooperating leases for its branches and operating facilities, which expire atvarious dates through 2009.  These leasesinclude provisions for periodic rent increases as well as payment by the lesseeof certain operating expenses.  Rentalexpense relating to these leases was $170,000 in 2004 and $155,000 in 2003.

 

At December 31, 2004, the approximate future minimum annualpayments under these leases are as follows:

 

| 2005   |   | $       | 228,884 |   |
|--------|--------|---------|---------|--------|
| 2006   |   | 167,459 |    |
| 2007   |   | 111,119 |    |
| 2008   |   | 84,990  |    |
| 2009   |   | 36,000  |    |
|   |   | $       | 628,452 |   |

 

The minimum rental paymentsshown above are given for the existing lease obligations and do not reflect anyincreases in rent unless the increases are scheduled and currentlydeterminable.  It is not a forecast ofrental expenses.

 

57

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**NOTE E -DEPOSITS**

 

At December 31, 2004, thescheduled maturities of time deposits are as follows:

 

| Due in one year          |   | $         | 42,472,226 |   |
|--------------------------|--------|-----------|------------|--------|
| Due in one to five years |   | 2,797,562 |       |
|                     |   | $         | 45,269,788 |   |

 

**NOTE F -OTHER BORROWINGS**

 

Other borrowings at December 31, 2004 are comprised of thefollowing advances from the Federal Home Loan Bank of San Francisco:

 

 

| **Maturity  Date** | ** ** | **Interest  Rate** | ** ** | **Amount** | ** ** |
|--------------------|------------|--------------------|------------|------------|------------|
| 1/3/2005           |       | 2.17               | %          | $          | 1,000,000  |   |
| 1/6/2005           |       | 2.39               | %          | 3,000,000  |       |
| 1/31/2005          |       | 1.98               | %          | 1,500,000  |       |
| 8/31/2005          |       | 2.21               | %          | 1,000,000  |       |
| 6/5/2006           |       | 1.76               | %          | 500,000    |       |
| 3/30/2009          |       | 3.19               | %          | 2,000,000  |       |
| 5/13/2009          |       | 4.48               | %          | 500,000    |       |
| 11/19/2013         |       | 4.82               | %          | 1,000,000  |       |
| 12/11/2013         |       | 4.98               | %          | 1,000,000  |       |
| 12/16/2013         |       | 4.88               | %          | 1,000,000  |       |
|               |       |               |       | $          | 12,500,000 |   |

 

These advances are secured by loans of approximately $46million.  As of December 31, 2004, theBank had a borrowing capacity of approximately $12.9 million with the FederalHome Loan Bank of San Francisco in addition to the borrowings listed above.

 

The Bank also has unsecured borrowing lines withcorrespondent banks totaling $6,500,000 and Bancorp had one borrowing linetotaling $200,000.  As of December 31,2004, there were no balances outstanding on these lines.

 

58

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**NOTE G -JUNIOR SUBORDINATED DEBT SECURITIES**

 

On October 14, 2003, theCompany issued $3,093,000 of junior subordinated debt securities (the “debtsecurities”) to Mission Community Capital Trust, a statutory trust createdunder the laws of the State of Delaware. These debt securities are subordinated to effectively all borrowings ofthe Company and are due and payable on October 7, 2033.  Interest is payable quarterly on these debtsecurities at LIBOR plus 2.95% for an effective rate of 5.61% as of December 31,2004.  The debt securities can beredeemed for 105% of the principal balance through October 7, 2008 and at parthereafter; they can also be redeemed at par if certain events occur thatimpact the tax treatment or the capital treatment of the issuance.

 

The Company also purchased a 3%minority interest in Mission Community Capital Trust. The balance of the equityof Mission Community Capital Trust is comprised of mandatorily redeemablepreferred securities.  Under FASBInterpretation No. 46 (FIN 46), “*Consolidationof Variable Interest Entities, an interpretation of ARB No. 51,”*theCompany is not allowed to consolidate Mission Community Capital Trust into theCompany financial statements.  Prior tothe issuance of FIN 46, bank holding companies typically consolidated theseentities.  The Federal Reserve Board hasruled that subordinated notes payable to unconsolidated special purposeentities (“SPE’s”) such as Mission Community Capital Trust, net of the bankholding company’s investment in the SPE, qualify as Tier 1 Capital, subject tocertain limits.

 

**NOTE H -INCOME TAXES**

 

The income tax expense for theyears ended December 31, 2004 and 2003 is comprised of the following:

 

 

| ** **     | ** ** | **2004**  | ** ** | **2003** | ** ** |
|----------------|------------|-----------|------------|----------|------------|
| Current Taxes: |       |      |       |     |       |
| Federal        |       | $         | 825,390    |     | $          | 330,643 |   |
| State          |       | 231,914   |       | 105,097  |       |
|           |       | 1,057,304 |       | 435,740  |       |
| Deferred       |       | (39,538   | )          | (18,966  | )          |
|           |       | $         | 1,017,766  |     | $          | 416,774 |   |

 

59

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A comparison of the federalstatutory income tax rates to the Company’s effective income tax follows:

 
| ** **                                                     | ** ** | **2004**   | ** ** | **2003** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|----------|------------|
| ** **                                                     | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
|                                                           |       |       |       |     |       |   |   |   |   |
| Federal tax rate                                               |       | $          | 853,297    |     | 34.0       | % | $ | 385,318 |   | 34.0 | % |
| California franchise taxes, net of federal tax  benefit        |       | 175,726    |       | 7.0      | %          | 81,651 |   | 7.2 | % |
| Increase in cash surrender value of  bank-owned life insurance |       | (20,334    | )          | (0.8     | )%         | — |   | — |   |
| Other items - net                                              |       | 9,077      |       | 0.4      | %          | (50,195 | ) | (4.4 | )% |
|                                                           |       | $          | 1,017,766  |     | 40.6       | % | $ | 416,774 |   | 36.8 | % |

 

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

 

The following is a summary ofthe components of the net deferred tax asset accounts recognized in theaccompanying consolidated balance sheets:

 
| ** **                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred Tax Assets:                              |       |     |       |     |       |
| Allowance for Loan Losses Due to Tax  Limitations |       | $        | 410,075    |     | $          | 296,027 |   |
| Bank Enterprise Award Deferral                    |       | —   |       | 37,791   |       |
| Unrealized Loss on Available-for-Sale  Securities |       | 10,082   |       | —   |       |
| Other                                             |       | 149,512  |       | 185,824  |       |
|                                              |       | 569,669  |       | 519,642  |       |
| Deferred Tax Liabilities:                         |       |     |       |     |       |
| Cash Basis of Tax Reporting                       |       | (47,784  | )          | (95,567  | )          |
| Depreciation Differences                          |       | (113,757 | )          | (76,709  | )          |
| Unrealized Gain on Available-for-Sale  Securities |       | —   |       | (12,708  | )          |
| Other                                             |       | (16,542  | )          | (5,400   | )          |
|                                              |       | (178,083 | )          | (190,384 | )          |
| Net Deferred Tax Assets                           |       | $        | 391,586    |     | $          | 329,258 |   |

 

60

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**NOTE I -STOCK OPTION PLAN**

 

During 1998, the Board ofDirectors adopted a stock option plan, which was approved by the shareholders,under which 180,000 shares of the Company’s common stock may be issued.  The Company applies APB Opinion No. 25 andrelated interpretations in accounting for its plan.  Accordingly, no compensation cost has beenrecognized for its fixed stock option plan.

 

The fair value of each option granted in 2002 was estimatedon the date of grant using the Black-Scholes option pricing model with thefollowing assumptions:  risk-free rate of3.75%, expected lives of five years, no dividend payments and disregarding anystock price volatility.  No options weregranted in 2003 or 2004.

 

A summary of the status of theCompany’s fixed stock option plan as of December 31, 2004 and 2003 and changesduring the years is presented below:

 
| ** **                                                      | ** ** | **2004**   | ** ** | **2003**                                | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|
| ** **                                                      | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding at Beginning of Year                                |       | 154,966    |       | $                                       | 9.66       |   | 158,666 |   | $ | 9.69 |   |
| Granted                                                         |       | —     |       | —                                  |       | — |   | — |   |
| Exercised                                                       |       | (12,433    | )          | 9.19                                    |       | — |   | — |   |
| Forfeited                                                       |       | (3,600     | )          | 9.47                                    |       | (3,700 | ) | 10.88 |   |
| Outstanding at End of Year                                      |       | 138,933    |       | $                                       | 9.73       |   | 154,966 |   | $ | 9.66 |   |
|                                                            |       |       |       |                                    |       |   |   |   |   |
| Options Exercisable at Year-End                                 |       | 118,733    |       | $                                       | 9.76       |   | 119,966 |   | $ | 9.71 |   |
|                                                            |       |       |       |                                    |       |   |   |   |   |
| Weighted-Average Fair Value of  Options Granted During the Year |       |       |       | N/A                                     |       |   |   | N/A |   |

 

61

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The following table summarizesinformation about fixed options outstanding at December 31, 2004:

 
| ** **          | ** **       | **Options Outstanding** | ** ** | ** **                              | ** ** | ** **                                | ** ** |
|---------------------|------------------|-------------------------|------------|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **          | ** **       | ** **              | ** ** | ** **                              | ** ** | **Weighted-**                             | ** ** | **Options Exercisable** | ** ** |
| **Exercise  Price** | ** **       | **Number  Outstanding** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual  Life** | ** ** | **Number  Exercisable** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $                   | 10.00            |                    | 94,433     |                                    | $          | 10.00                                     |       | 3.1 Years |   | 94,433 |   | $ | 10.00 |   |
| $                   |   7.88 |                    | 2,500      |                                    | 7.88       |                                      | 5.9 Years  |   | 2,000 |   | 7.88 |   |
| $                   |   7.50 |                    | 14,000     |                                    | 7.50       |                                      | 6.6 Years  |   | 8,400 |   | 7.50 |   |
| $                   |   8.19 |                    | 2,500      |                                    | 8.19       |                                      | 5.6 Years  |   | 2,000 |   | 8.19 |   |
| $                   |   8.25 |                    | 8,500      |                                    | 8.25       |                                      | 6.2 Years  |   | 5,100 |   | 8.25 |   |
| $                   | 11.30            |                    | 17,000     |                                    | 11.30      |                                      | 7.7 Years  |   | 6,800 |   | 11.30 |   |
| Total/Wgtd.  Ave.   |             | 138,933                 |       | $                                       | 9.73       |                                      | 4.3 Years  |   | 118,733 |   | $ | 9.76 |   |

 

**NOTE J –DEFINED CONTRIBUTION PLAN**

 

The Company has adopted adefined contribution plan, the Mission Community Bank 401k Profit Sharing Plan(“the 401k Plan”), covering substantially all employees fulfilling minimum ageand service requirements.  Matching anddiscretionary employer contributions to the 401k Plan are determined annuallyby the Board of Directors.  The expensefor the 401k Plan was approximately $123,000 in 2004 and $31,000 in 2003.

 

**NOTE K -PREFERRED STOCK**

 

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

 

62

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Series B – the Series BPreferred Stock has a $10.00 stated value and is non-voting, non-convertibleand non-redeemable.  Series B shares arenot entitled to any fixed rate of return but do participate on the same basisin any dividends declared on the Company’s common stock. In the event ofliquidation, the holders of Series B shares will be entitled to a liquidationpreference of $10.00 per share before the holders of common stock receive anydistributions.  Additionally, in theevent of a specified “change in control event” (including certain mergers orsales of assets), holders of the Series B Preferred Stock shall be entitled toreceive payment on the same basis as the holders of the common stock of theCompany.  These shares were issued for$191,606 (net of issuance costs of $13,394) pursuant to an investment from theNational Community Investment Fund (“NCIF”). In connection with this investment, NCIF also purchased 29,500 shares ofthe Company’s common stock for $10.00 per share.  As part of the investment agreement, theCompany by covenant agreed that so long as NCIF or any successor owns and holdsany of the Shares to remain a CDFI and to meet certain reporting requirements.

 

Series C – the Series CPreferred Stock has $10.00 stated value and is non-voting, convertible andredeemable.  Each share is convertibleinto one share of voting common stock of the Company.  Series C shares are not entitled to any fixedrate of return, but do participate on the same basis (as if converted on aone-to-one exchange) in any dividends declared on the Company’s commonstock.  Series C shares may be redeemedupon request of the holder at their stated value if the Bank is found to be indefault under any Community Development Financial Institutions Program AssistanceAgreement for Equity Investments in Regulated Institutions, or any successoragreement.  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 splitswith respect to such shares) before the holders of common stock receive anydistributions.  These shares were issuedfor $500,000 pursuant to an award from the Community Development FinancialInstitutions Fund of the Department of the Treasury.

 

63

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### **NOTE L - RELATED PARTY TRANSACTIONS**

### ** **

In the ordinary course of business, the Bank has grantedloans to certain directors and the companies with which they areassociated.  In the Bank’s opinion, allloans and loan commitments to such parties are made on substantially the sameterms, including interest rate and collateral, as those prevailing at the timefor comparable transactions with other persons.

 

The following is a summary of the activity in these loans:

 
| ** **                           | ** ** | **2004**  | ** ** | **2003**   | ** ** |
|--------------------------------------|------------|-----------|------------|------------|------------|
|                                 |       |      |       |       |       |
| Balance at the beginning of the year |       | $         | 2,124,738  |       | $          | 2,656,000 |   |
| New loans and renewals               |       | 1,983,301 |       | 1,300,000  |       |
| Repayments and renewals              |       | (690,087  | )          | (1,831,262 | )          |
| Balance at the end of the year       |       | $         | 3,417,952  |       | $          | 2,124,738 |   |

 

Deposits from related parties heldby the Bank totaled approximately $2,894,000 at December 31, 2004, and$1,115,000 at December 31, 2003.

 

During 2003, Bancorp pledged a$250,000 interest-bearing deposit as collateral for borrowings of MissionCommunity Services Corp., and in 2004 Bancorp granted $250,000 to MCSC tocontinue providing Central Coast and Central California small businesses withtechnical assistance, counseling and training in finance, management, marketingprocurement and access to the U. S. Small Business Administration’s programsand services.  This grant is included inmarketing and business development expenses in the consolidated statements ofincome.

 

**NOTE M -COMMITMENTS AND CONTINGENCIES**

 

In the normal course ofbusiness, the Bank enters into financial commitments to meet the financingneeds of its customers.  These financialcommitments include commitments to extend credit and standby letters ofcredit.  Those instruments involve tovarying degrees, elements of credit and interest rate risk not recognized inthe statement of financial position.

 

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

 

As of December 31, the Bank hadthe following outstanding financial commitments whose contractual amountrepresents credit risk:

 

64

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| ** **                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Commitments to Extend Credit |       | $        | 29,793,000 |     | $          | 27,578,000 |   |
| Standby Letters of Credit    |       | 123,000  |       | 30,000   |       |
|                         |       | $        | 29,916,000 |     | $          | 27,608,000 |   |

 

65

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Commitments to extend creditare agreements to lend to a customer as long as there is no violation of anycondition established in the contract. Standby letters of credit are conditional commitments to guarantee theperformance of a Bank customer to a third party.  Since many of the commitments and standbyletters of credit are expected to expire without being drawn upon, the totalamounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Bank isbased on management’s credit evaluation of the customer.

 

During 2004, the Bankestablished an allowance for possible losses on unfunded loan commitments inthe amount of $50,000, through a charge to non-interest expense.  No losses were charged against this allowancein 2004. The balance of the allowance, which is included in other liabilities,was $50,000 as of December 31, 2004.

 

In the ordinary course of business, various claims andlawsuits are brought by and against the Company and the Bank.  In the opinion of management, there is nopending or threatened proceeding in which an adverse decision could result in amaterial adverse change in the consolidated financial condition or results ofoperations of the Company.

 

NOTEN - EARNINGS PER SHARE

 

The following is a reconciliation of net income and sharesoutstanding to the income and number of shares used in the computation ofearnings per share:

 
| ** **                                                                       | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                       | ** ** | **Income** | ** ** | **Shares** | ** ** | **Income** | ** ** | **Shares** | ** ** |
|                                                                             |       |       |       |       |       |   |   |   |   |
| Net Income                                                                       |       | $          | 1,491,931  |       |       |   | $ | 716,514 |   |   |   |
| Average Common Shares  Outstanding During the Year                               |       |       |       | 638,750    |       |   |   | 630,166 |   |
| Preferred Shares Participating in Net  Income With Common Shareholders - Average |       |       |       | 120,500    |       |   |   | 120,500 |   |
| Used in  Basic EPS                                                               |       | $          | 1,491,931  |       | 759,250    |   | $ | 716,514 |   | 750,666 |   |
| Dilutive Effect of Outstanding Stock  Options                                    |       |       |       | 53,729     |       |   |   | 37,848 |   |
| Used in  Dilutive EPS                                                            |       | $          | 1,491,931  |       | 812,979    |   | $ | 716,514 |   | 788,514 |   |

 

Preferred shares are included in the computation of basicearnings per share because they share equally with common shares in thedistribution of net income and they do not have a stated dividend rate.

 

66

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**NOTE O -REGULATORY MATTERS**

 

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

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the table below) of Total andTier 1 capital (as defined in the regulations) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to average assets (asdefined).  Management believes, as ofDecember 31, 2004, that the Bank meets all capital adequacy requirements towhich it is subject.

 

As of December 31, 2004 and2003, the most recent notification from the Federal Reserve Board categorizedthe Bank as well-capitalized under the regulatory framework for prompt correctiveaction.  There are no conditions orevents since that notification that management believes have changed the Bank’scategory.  To be categorized aswell-capitalized, the Bank must maintain minimum ratios as set forth in thetable below.  The following table alsosets forth the Bank’s actual capital amounts and ratios (dollar amounts inthousands):

 

 
| ** **                               | ** ** | ** ** | ** ** | ** **                  | ** ** | **Amount of Capital Required**    | ** ** |
|------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | **Actual** | ** ** | **To Be  Well-Capitalized** | ** ** | **To Be Adequately  Capitalized** | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**                   | ** ** | **Amount**                        | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of December 31, 2004:**             |       |       |       |                        |       |                              |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 13,461     |                        | 11.5       | %                                 | $          | 11,667 |   | 10.0 | % | $ | 9,333 |   | 8.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 12,317     |                        | 10.6       | %                                 | $          | 7,000 |   | 6.0 | % | $ | 4,667 |   | 4.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $          | 12,317     |                        | 9.1        | %                                 | $          | 6,802 |   | 5.0 | % | $ | 5,442 |   | 4.0 | % |
|                                     |       |       |       |                        |       |                              |       |   |   |   |   |   |   |
| **As of December 31, 2003:**             |       |       |       |                        |       |                              |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 11,444     |                        | 12.4       | %                                 | $          | 9,238 |   | 10.0 | % | $ | 7,390 |   | 8.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 10,633     |                        | 11.5       | %                                 | $          | 5,543 |   | 6.0 | % | $ | 3,695 |   | 4.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $          | 10,633     |                        | 9.7        | %                                 | $          | 5,494 |   | 5.0 | % | $ | 4,395 |   | 4.0 | % |

 

The Company will be subject tosimilar requirements when its consolidated assets exceed $150 million.  For capital adequacy purposes, the Companymust then maintain total capital to risk-weighted assets, Tier 1 capital torisk-weighted assets and Tier 1 capital to average assets of 8.0%, 4.0% and4.0%, respectively.  The Company’s totalcapital to risk-weighted assets, Tier 1 capital to risk-weighted assets andTier 1 capital to average assets were 12.0%, 11.1% and 9.5%, respectively, atDecember 31, 2004, and 13.4%, 12.3% and 10.4%, respectively, at December 31,2003.

 

Banking regulations limit theamount of cash dividends that may be paid without prior approval of the Bank’sprimary regulatory agency.  Cashdividends are limited by the California Financial Code to the lesser of theBank’s retained earnings, if any, or its net income for the last three fiscalyears, net of the amount of any dividends or other capital distributions madeduring those periods.

 

67

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As of December 31, 2004,$3,127,000 was available for cash dividend distributions from the Bank toBancorp without prior regulatory approval.

 

68

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### **NOTE P - BANK ENTERPRISE AWARDS**

 

During 2001, the Bank received a $990,000 award under theFiscal Year 2001 Bank Enterprise Award Program. The program is sponsored by the Department of Treasury, CommunityDevelopment Financial Institutions (CDFI) Fund. The Bank received the award for making a total of $3,000,000 in depositswith certified Community Development Financial Institutions.

 

The Bank deferred approximately $452,000 of the award toincrease the future earnings on the deposits to market rates, recognizing$181,000 of this deferred amount in 2003, and the balance of $92,000 wasrecognized in 2004.

 

The Bank received a $1,240,929 Bank Enterprise Award fromthe CDFI Fund in 2004.  The award was made under the Fiscal Year 2004 BankEnterprise Award (BEA) Program, which provides an incentive for any FDICinsured bank to annually increase the levels of financial services provided toeconomically distressed communities.  Because this award was based on pastlending activity, the entire award was recognized in non-interest income in2004.

 

Although the Bank is a certified CDFI bank and expects tocontinue to apply for various grants and awards, there can be no assurance thatit will receive similar future grants or awards.

 

69

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**NOTE Q -MISSION COMMUNITY BANCORP (Parent Company Only)**

 

On December 15, 2000, MissionCommunity Bancorp acquired Mission Community Bank by issuing 600,566 shares ofcommon stock in exchange for all outstanding shares of the Bank’s commonstock.  There was no cash involved inthis transaction.

 

Following are the separatefinancial statements for Mission Community Bancorp (parent company only):

 

**Mission Community Bancorp (Parent Company Only)**

 

**CONDENSED BALANCE SHEETS**

 
| ** **                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                    |       |       |       |       |       |
| Cash                                          |       | $          | 35,479     |       | $          | 571,596 |   |
| Interest-Bearing Deposits in Other Banks      |       | 250,000    |       | 250,000    |       |
| Investment in Subsidiary Bank                 |       | 12,366,327 |       | 10,651,319 |       |
| Loans Receivable                              |       | 150,000    |       | —     |       |
| Other Assets                                  |       | 356,996    |       | 194,653    |       |
| **TOTAL  ASSETS**                             |       | $          | 13,158,802 |       | $          | 11,667,568 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY** |       |       |       |       |       |
| Junior Subordinated Debentures                |       | $          | 3,093,000  |       | $          | 3,093,000 |   |
| Other Liabilities                             |       | 38,486     |       | 29,042     |       |
| **TOTAL  LIABILITIES**                        |       | 3,131,486  |       | 3,122,042  |       |
| **TOTAL  SHAREHOLDERS’ EQUITY**          |       | 10,027,316 |       | 8,545,526  |       |
|                                          |       | $          | 13,158,802 |       | $          | 11,667,568 |   |

 

**CONDENSED STATEMENTS OF INCOME**

 
| ** **                                                         | ** ** | **2004**  | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| Interest income                                                    |       | $         | 6,155      |     | $          | 291 |   |
| Interest expense                                                   |       | 135,250   |       | 29,366   |       |
| Net interest (expense)                                             |       | (129,095  | )          | (29,075  | )          |
| Contribution to Mission Community Services  Corp.                  |       | 250,000   |       | —   |       |
| Other expenses                                                     |       | 63,725    |       | 26,754   |       |
| Income (loss) before taxes                                         |       | (442,820  | )          | (55,829  | )          |
| Income taxes expense (benefit)                                     |       | (178,712  | )          | (19,800  | )          |
| Income (loss) before equity in  undistributed income of subsidiary |       | (264,108  | )          | (36,029  | )          |
| Equity in undistributed income of  subsidiary                      |       | 1,756,039 |       | 752,543  |       |
| Net Income                                                         |       | $         | 1,491,931  |     | $          | 716,514 |   |

 

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**CONDENSED STATEMENTS CASH FLOWS**

 
| ** **                                                     | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Operating activities:**                                      |       |       |       |       |       |
| Net Income                                                     |       | $          | 1,491,931  |       | $          | 716,514 |   |
| Adjustments to Reconcile Net Income to Net                     |       |       |       |       |       |
| Cash Provided by Operating Activities:                         |       |       |       |       |       |
| Equity in undistributed income of  subsidiary                  |       | (1,756,039 | )          | (752,543   | )          |
| Amortization expense                                           |       | 17,232     |       | 4,308      |       |
| Other, net                                                     |       | (161,894   | )          | 9,243      |       |
| Net cash (used in) operating activities                        |       | (408,770   | )          | (22,478    | )          |
| **Investing activities:**                                      |       |       |       |       |       |
| Investment in certificate of deposit                           |       | —     |       | (250,000   | )          |
| Loans advanced                                                 |       | (150,000   | )          | —     |       |
| Investment in subsidiary                                       |       | —     |       | (2,000,000 | )          |
| Net cash (used in) investing activities                        |       | (150,000   | )          | (2,250,000 | )          |
| **Financing activities:**                                      |       |       |       |       |       |
| Proceeds from issuance of junior subordinated  debentures, net |       | —     |       | 2,913,838  |       |
| Proceeds from issuance of common stock                         |       | 114,225    |       | —     |       |
| Cash dividends paid                                            |       | (91,572    | )          | (75,067    | )          |
| Net cash provided by financing activities                      |       | 22,653     |       | 2,838,771  |       |
| Net increase (decrease) in cash                                |       | (536,117   | )          | 566,293    |       |
| Cash at beginning of year                                      |       | 571,596    |       | 5,303      |       |
| Cash at end of year                                            |       | $          | 35,479     |       | $          | 571,596 |   |

 

 

**NOTE R - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The fair value of a financialinstrument is the amount at which the asset or obligation could be exchanged ina current transaction between willing parties, other than in a forced orliquidation sale.  Fair value estimatesare made at a specific point in time based on relevant market information andinformation about the financial instrument. These estimates do not reflect any premium or discount that could resultfrom offering for sale at one time the entire holdings of a particularfinancial instrument.  Because no marketvalue exists for a significant portion of the financial instruments, fair valueestimates are based on judgments regarding future expected loss experience,current economic conditions, risk characteristics of various financialinstruments, and other factors.  Theseestimates are subjective in nature, involve uncertainties and matters ofjudgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantlyaffect the estimates.

 

Fair value estimates are basedon financial instruments both on and off the balance sheet without attemptingto estimate the value of anticipated future business and the value of assetsand

 

71

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liabilities that are notconsidered financial instruments. Additionally, tax consequences related to the realization of theunrealized gains and losses can have a potential effect on fair value estimatesand have not been considered in many of the estimates.

 

72

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The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

 

## **FinancialAssets**

## ** **

The carrying amounts of cash andshort-term investments are considered to approximate fair value.  Short-term investments include federal fundssold and interest bearing deposits with Banks. The fair values of investment securities, including available-for-sale,are generally based on quoted market prices. The fair value of loans are estimated using a combination of techniques,including discounting estimated future cash flows and quoted market prices ofsimilar instruments, where available.

 

## **FinancialLiabilities**

## ** **

The carrying amounts of depositliabilities payable on demand, and short-term borrowed funds are considered toapproximate fair value.  For fixedmaturity deposits, fair value is estimated by discounting estimated future cashflows using currently offered rates for deposits of similar remaining maturities.  The fair value of long-term debt is based onrates currently available to the Bank for debt with similar terms and remainingmaturities.

 

## **Off-BalanceSheet Financial Instruments**

## ** **

The fair value of commitmentsto extend credit and standby letters of credit is estimated using the feescurrently charged to enter into similar agreements.  The fair value of these financial instrumentsis not material.

 

The estimated fair value offinancial instruments is summarized as follows:

 

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| ** **                               | ** ** | **December 31,**    | ** ** |
|------------------------------------------|------------|---------------------|------------|
| ** **                               | ** ** | **2004**            | ** ** | **2003** | ** ** |
| ** **                               | ** ** | **Carrying  Value** | ** ** | **Fair  Value** | ** ** | **Carrying  Value** | ** ** | **Fair  Value** | ** ** |
| **Financial Assets:**                    |       |                |       |   |   |   |   |   |   |
| Cash and due from banks                  |       | $                   | 2,587,000  |   | $ | 2,587,000 |   | $ | 2,798,000 |   | $ | 2,798,000 |   |
| Federal funds sold                       |       | 10,385,000          |       | 10,385,000 |   | 5,495,000 |   | 5,495,000 |   |
| Interest-Bearing Deposits in Other Banks |       | 550,000             |       | 550,000 |   | 3,550,000 |   | 3,550,000 |   |
| Investment securities                    |       | 15,772,000          |       | 15,732,000 |   | 18,252,000 |   | 18,026,000 |   |
| Loans, net                               |       | 102,282,000         |       | 102,224,000 |   | 77,946,000 |   | 77,878,000 |   |
| Federal Reserve Bank and other Stocks    |       | 1,081,000           |       | 1,081,000 |   | 474,000 |   | 474,000 |   |
| Accrued interest receivable              |       | 431,000             |       | 431,000 |   | 400,000 |   | 400,000 |   |
|                                     |       |                |       |   |   |   |   |   |   |
| **Financial Liabilities:**               |       |                |       |   |   |   |   |   |   |
| Deposits                                 |       | 112,836,000         |       | 112,653,000 |   | 96,286,000 |   | 96,360,000 |   |
| Other borrowings                         |       | 15,593,000          |       | 15,553,000 |   | 7,593,000 |   | 7,593,000 |   |
| Accrued interest and other liabilities   |       | 793,000             |       | 793,000 |   | 336,000 |   | 336,000 |   |
|                                          |            |                     |            |  |  |  |  |  |  |  |  |  |  |

 

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**Item8.  Changes In and Disagreements WithAccountants on Accounting and Financial Disclosure**

 

There have been no changes inor disagreements with the Company’s accountants.

 

**Item8A.  Controls and Procedures**

 

Within the 90 days prior to the date of thisreport, our Chief Executive Officer and our Chief Financial Officer carried outan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures pursuant to Exchange Act Rule 15a-15.  Based upon that evaluation, the ChiefExecutive Officer and the Chief Financial Officer concluded that currentdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to the Company and/or Bank that is required to beincluded in our periodic filings with the Securities and Exchange Commissionand also with bank or bank holding company regulatory agencies.

 

Management is responsible for establishingand maintaining adequate internal control over financial reporting for theCompany and the Bank including periodic filings with the Securities ExchangeCommission, the Federal Deposit Insurance Corporation (FDIC), the FederalReserve Bank of San Francisco (FRBSF) and the California Department ofFinancial Institutions (DFI).  Suchperiodic financial reports are prepared internally and reviewed by managementprior to filing.  These financial reportsare also reviewed for timely filing, completeness and accuracy with possiblecivil monetary penalties for late filing and intentional inaccurate reportingby the various agencies where the reports are filed.

 

Internal controls over the Bank’soperational, lending procedures and underwriting, financial systems and othersystems are reviewed by internal auditors, holding company and/or bankexaminers, and by registered public accountants.  At present, Bancorp, based on its asset sizeand lack of activity other than banking, is not independently examined by theFRB.

 

Bancorp and the Bank have elected tooutsource the internal audit function to firms who specialize in performingsuch auditing functions for community banks. During 2004, the Bank had internal audits or reviews performed for operations,finance, and compliance.  Additionalinternal audits were conducted of the Bank’s computers and informationmanagement systems including information security, and the Bank has contractedfor several years for an independent loan review function which reviews loansand lending activity once every two months. Each of the internal audits alongwith management’s response to any observations are completed in writing andpresented to the Board Audit Committee. Management is then responsible to take any corrective action required tomodify procedures or policies to improve internal controls and procedures.Internal audit engagements are in writing, including the anticipated scope, andare generally for 18 to 24 months with interim auditing during the term of theengagement.  Engagements are presented toand approved by the Board Audit Committee. Based on internal audits performed in 2004, neither management nor theBoard Audit Committee have been informed of any material weaknesses in internalcontrols over financial reporting.

 

Internal controls, lending, and financialreporting are also periodically reviewed by bank and bank holding companyexaminers.  As a state charted bank, theBank is examined by the FRBSF and the DFI. Prior to the December 2003 charter conversion, the Bank was periodicallyexamined by the Comptroller of the Currency (OCC) as required by law, includingexaminations for safety and soundness, lending, compliance, CommunityReinvestment Act, and information technology. Written reports of examination by state or federal regulators areprovided to the Bank, reviewed by management and by the Board AuditCommittee.  If an examination revealedmaterial issues, the Bank could be subject to regulatory action including formalor informal agreements to take corrective action.  Bank examination reports are confidential,and the results are not disclosed unless there are material exceptionsnoted.  In the event of materialexceptions, a bank could be required to enter into a formal agreement (such asa Memorandum of Understanding or Cease and Desist Order) which would documentthe specific weaknesses and corrective action that must be taken.  These formal agreements are generally requiredto be disclosed to the public.  As ofDecember 2004, the Bank is not operating under any formal or informal agreementwith the FRB, DFI or OCC nor is any such

 

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agreement pending or anticipated.

 

Finally, internal controls and financialreporting is reviewed by independent registered public accountants on an annualbasis.  These audited reports, includingany recommendations for improvements in accounting or internal controls, arepresented to management and the Board’s Audit Committee.  As of December 31, 2004, the auditedfinancial statements of the Company have been certified by the Company’sindependent registered public accountants with no material weaknessesidentified in internal controls or financial reporting.  Beginning in 2006, the Company will berequired to have its registered public accountants provide an attestation ofmanagement’s assessment of internal controls over financial reporting.

 

No material changes have been made ininternal controls during the past year. However, the Bank did increase its budget and expenses for internalcontrol reviews and internal auditing in 2003 and 2004. It also engaged a firmto perform a specific internal audit of the Bank’s information technology andinformation reporting systems including information security beginning in 2003and completed in 2004.  It has made minorstaffing changes to improve internal controls based on recommendations madeduring the internal auditing process.

 

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# ** **

# **PART III**

# ** **

**Item 9. Directors and Executive Officers of the Registrant.**

 

Thefollowing table lists the names and certain information as of December 31,2004, concerning all directors and executive officers of the Company and theBank.  The Company and the Bank have no “significantemployees” (as defined) except its executive officers.

 
| **Name and Title**                                                  | ** ** | **Age** | ** ** | **Business Experience for the Past Five Years**                                                                                                                                                                                                               | ** ** | **Year First Elected or  Appointed Director*** |
|---------------------------------------------------------------------|------------|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|
|                                                                |       |    |       |                                                                                                                                                                                                                                                          |       |                                           |
| Bruce M. Breault  Founding Chairman  of the Board (Emeritus)        |       | 62      |       | Partner and  Owner, F. McLintocks, Inc. (restaurants) (1973-)                                                                                                                                                                                                 |       | 1996                                           |
| Roxanne M. Carr  Vice Chairman of the Board                         |       | 67      |       | Division  President and Corporate Senior Vice President, The Mortgage House, Inc. (1995-);  Regional Vice President, ARCS Mortgage, Inc. (1973-1995)                                                                                                          |       | 1997                                           |
| Karla S. Cool  Director                                             |       | 62      |       | President  and Owner, Central California Investments (1998-); Broker and Owner, Karla  Cool Realty (1987-1998)                                                                                                                                                |       | 1998                                           |
| William B. Coy  Chairman of the Board                               |       | 67      |       | Owner and  Manager, Rancho Rio Conejo (citrus and avocados) (1979-); Corporate Marketing  Manager, San Luis Obispo County Farm Supply Company (1991-2001)                                                                                                     |       | 1996                                           |
| Richard Korsgaard  Executive Vice President/  Chief Credit Officer  |       | 63      |       | Banker (1)                                                                                                                                                                                                                                                    |       | 2005                                           |
| Anita M. Robinson  Director, President and  Chief Executive Officer |       | 52      |       | President  and Chief Executive Officer of the Bank and the Company  (2)                                                                                                                                                                                  |       | 1996                                           |
| Robin L. Rossi  Director                                            |       | 57      |       | President,  Rossi Enterprises (property management) (1991-); President, Infinite  Horizons, Inc. (Manager of Avila Beach Resort and Blacklake Resort - Real  estate investments) (1979-)                                                                      |       | 1996                                           |
| Gary E. Stemper  Immediate Past Chairman  of the Board              |       | 62      |       | Manager,  Eagle Castle Winery, LLC, (2000-); Sales Consultant and Technical Analyst,  Artesia Ready Mix, Inc. (1996-2000); Partner, Eberle Winery of Paso Robles  (1982-); Owner, Gary Stemper Construction Co. (1967-); Partner, Mill Road  Vineyard (1994-) |       | 1996                                           |
| Karl F. Wittstrom  Secretary                                        |       | 51      |       | Self-employed-real  estate development, construction, vineyards, ranching and investments, (1996-)                                                                                                                                                            |       | 1997                                           |

 

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* Refers toyear first elected or appointed to Board of the Bank

 

 (1)       Mr. Korsgaard joined theBank on July 22, 2002 as the Executive Vice President and Chief CreditOfficer.  He was appointed to the Boardof Directors effective January 1, 2005, is retiring as Chief Credit Officereffective March 31, 2005, and will continue to serve as a Director followinghis retirement.  Mr. Korsgaard has 39years of banking experience.  For theperiod of March 2001 to March 2002 he held the position of Senior VicePresident with California Bank and Trust, San Diego, California. From 1995 to2001 he served as an Executive Vice President with Eldorado Bank, Laguna Hills,California, which was acquired by California Bank and Trust in March 2001.

 

(2)          Ms. Robinson has been the Bank’s Presidentand Chief Executive Officer since its formation in 1996.  She has over 33 years of banking experience.

 

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On January 18, 2005, Ronald B.Pigeon joined the Bank as its Executive Vice President and Chief FinancialOfficer, replacing William Demmin, who left the Bank on July 29, 2004, toaccept a position with another firm.  Mr. Pigeon was also appointed by theCompany’s  Board of Directors to serve as Chief Financial Officer forBancorp.  During the past five years, Mr.Pigeon held the positions of Senior Vice President and Controller with HumboldtBancorp located in Roseville, California (2003 to 2004); and Controller andChief Financial Officer for 722 Redemption Funding, Inc. located in Cincinnati,Ohio (1999 to 2003).  He also served as the Controller for TransFinancial, Inc., located in Bowling Green, Kentucky, from 1993 to 1998.

 

The terms of Mr. Pigeon’semployment are an annual base salary of $120,000 per year, plus discretionarybonuses, a $400 per month automobile allowance, a life insurance policy at aspecified amount, moving expense reimbursement of up to $5,000, and all othercustomary employee benefits.

 

On February 16, 2005, James M.Judge joined the Bank as its Executive Vice President/Chief Credit Officer,replacing Richard Korsgaard, who is retiring effective March 31, 2005.  Mr. Judge has over 42 years of banking andfinance experience, recently serving as Executive Vice President/Chief CreditOfficer for Cerritos Valley Bank in Artesia, California (2001-2002).

 

The terms of Mr. Judge’semployment are an annual base salary of $115,000 per year, plus discretionarybonuses, a $400 per month automobile allowance, a life insurance policy at aspecified amount, moving expense reimbursement of up to $5,000 and all othercustomary employee benefits.

 

In addition, separate SalaryProtection Agreements (“the Agreements”) have been entered into by the Bankwith Mr. Pigeon and Mr. Judge, which will provide for salary continuationbenefits for a period of six months in the event of applicable occurrences asspecified within the Agreements.

 

None of the Bank’sdirectors or executive officers was selected pursuant to any arrangement orunderstanding, other than with the directors and executive officers of theBank, acting within their capacities as such. There are no family relationships between the directors or executiveofficers of the Bank and none serve as directors of any other company which hasa class of securities registered under, or which is subject to the periodicreporting requirements of, the Securities Exchange Act of 1934 or anyinvestment company registered under the Investment Company Act of 1940.

 

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

 

The Company does not have a class of equity securities registeredpursuant to Section 12 of the Securities Exchange Act of 1934 (the “ExchangeAct”).  Therefore, the Company’s officersand 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 theExchange Act.

 

**The Board of Directors and Committees**

 

During2004, the Board of Directors held 12 regular meetings.  In addition to attending Board meetings,certain of the directors serve on committees of the Board, with the Chairmanand Vice Chairman being an Ex officio member of all of the committees.

 

TheExecutive Committee, which currently consists of Directors William B. Coy(Chairman), Bruce M. Breault, Roxanne Carr, Anita M. Robinson, Gary E. Stemper,and Karl F. Wittstrom, did not meet in 2004.

 

TheAudit Committee, which currently consists of Directors Karl F. Wittstrom(Chairman), Bruce M. Breault, Roxanne Carr, William B. Coy and Gary E. Stemper,reviews all internal and external examination reports and selects the Company’s/Bank’sindependent accountants.  The AuditCommittee met 4 times in 2004.

 

TheLoan Committee, which currently consists of Directors Bruce M. Breault(Chairman), William B. Coy, Anita Robinson, Gary E. Stemper and Karl F.Wittstrom, as well as Mr. Richard Korsgaard (non-voting), establishes the Bank’sloan policy, reviews loans made by Management, and approves loans in excess of 

 

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Management’slending authority.  The Loan Committeemet 44 times in 2004.

 

TheBank’s Investment Committee, which currently consists of Directors Robin L.Rossi (Chairman), Bruce M. Breault, Roxanne Carr, Karla S. Cool, Anita M. Robinsonand Karl F. Wittstrom, as well as the Bank’s Chief Financial Officer(non-voting), sets policies and oversees the Bank’s investments. There were 4meetings of the Investment Committee during 2004.

 

ThePersonnel and Compensation Committee, which currently consists of DirectorsKarla S. Cool (Chairman), Bruce M. Breault, William B. Coy, Anita M. Robinson(non-voting member) and Karl F. Wittstrom, reviews and approves the Bank’soverall compensation and benefit programs and administers the compensation forthe Bank’s executive and senior officers. There were 5 meetings of thePersonnel and Compensation Committee during 2004.

 

TheTechnology Committee, which currently consists of Directors Karla S. Cool(Chairman), Bruce M. Breault, William B. Coy, Anita M. Robinson and Gary E.Stemper, is responsible for overseeing the Bank’s electronic banking andinformation systems and assisting management with technological changes in thebanking and business environment.  Therewere 2 meetings of the Technology Committee in 2004.

 

TheBank does not have a standing Nominating Committee.  In connection with selecting candidates fornomination to the Board of Directors, including any nominees recommended bysecurity holders, the Board of Directors (i) review compliance by the securityholders with the Bank’s nominating procedures contained in the Bylaws andsummarized in the Notice of Annual Meeting; (ii) review information assembledfor the purpose of selecting candidates for nomination to membership on theBoard of Directors;  and (iii) followingappropriate investigation, ascertains the willingness of selected candidates toserve and extends on behalf of the Board of Directors, invitations to becomecandidates.

 

During2004, except for Roxanne Carr, all Directors attended at least 75% of the Boardand Committee meetings.

 

**Item10.  Executive Compensation**

 

**SummaryCompensation Table**

 

The following table setsforth a summary of annual and long-term compensation for services in allcapacities to the Company for the Company’s executive officers who were paidmore than $100,000 during 2004.

 

*** ***
| ** **               | ** ** | **Annual Compensation** | ** ** | **Long-Term  Compensation  Awards** | ** ** | ** ** | ** ** |
|--------------------------|------------|-------------------------|------------|-------------------------------------|------------|------------|------------|
| **Name and Position**    | ** ** | **Year**                | ** ** | **Salary/  Benefits**               | ** ** | **Bonus**  | ** ** | **Other Annual  Compensation (1)** | ** ** | **Securities  Underlying Options** | ** ** | **All Other Compensation** | ** ** |
|                     |       |                    |       |                                |       |       |       |   |   |   |   |   |   |
| **Anita M. Robinson**    |       |                    |       |                                |       |       |       |   |   |   |   |   |   |
| President and Chief      |       | 2004                    |       | $                                   | 140,400    |       | —     |   | $ | 7,800 |   |   |   | — |   |
| Executive Officer        |       | 2003                    |       | $                                   | 140,400    |       | —     |   | $ | 7,800 |   | — |   | — |   |
|                     |       | 2002                    |       | $                                   | 130,000    |       | $          | 10,000 |   | $ | 7,800 |   | — |   | — |   |
|                     |       |                    |       |                                |       |       |       |   |   |   |   |   |   |   |   |   |
| **Richard Korsgaard**    | ** ** | ** **              | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Executive Vice President |       | 2004                    |       | $                                   | 110,000    |       | —     |   | $ | 4,800 |   |   |   | — |   |
| and Chief  Credit        |       | 2003                    |       | $                                   | 105,000    |       | —     |   | $ | 4,800 |   | — |   | — |   |
| Officer (2)              |       | 2002                    |       | —                              |       | —     |       | — |   | — |   | — |   |
|                          |            |                         |            |                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

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(1) “Other Annual Compensation”represents automobile allowance paid during the year.

(2)Mr. Korsgaard, who was hired July 22, 2002, did not receive annual compensationof $100,000 or more in 2002.

 

Noother officer received annual compensation of $100,000 or more in 2004.  The Company currently pays no salaries to itsdirectors who are not officers.

 

In 2004 the Bank initiated anincentive compensation plan covering the above two executive officers andeighteen other bank officers.  Nopayments were made under this plan in 2004. Total incentive compensation payments in 2005 to all participants, basedon 2004 results, totaled approximately $57,000.

 

**Option/SARGrants**

 

On January 20, 1998 the Bank’sBoard of Directors adopted the 1998 Stock Option Plan, pursuant to approval bythe Bank’s shareholders prior to January 20, 1999.

 

In 2004, no stock options weregranted, 3,600 incentive stock options were retired, and 12,433 stock optionswere exercised.

 

See Note I - Stock Option Planin the consolidated financial statements for outstanding options previouslyissued.

 

**Long TermIncentive Plan Awards**

 

There were no long-termincentive plan awards in 2003 or 2004.

 

**EmploymentContracts**

 

On February 25, 2002, the Boardof Directors approved a new employment contract for Ms. Robinson, effective fora five year term beginning on January 1, 2002, which provides for a base salaryof $10,833 per month, an automobile allowance of $650 per month, expensereimbursement, $250,000 of life insurance, standard and customary medical anddental insurance benefits, and a non-recurring bonus of $10,000.  The five year agreement provides for anannual review by the Board of Directors of the base salary provided to Ms.Robinson, which shall not be less than $10,833 per month during the life of theagreement.  Effective January 1, 2003,the Board of Directors approved an increase to Ms. Robinson’s annual basesalary to $11,700 per month. Ms. Robinson's base salary was increasedeffective January 1, 2005, to $13,750 per month, along with an increase inlife insurance coverage to $500,000, and continued participation in theofficers' Incentive Compensation Plan at the same level as in 2004. Thecontract provides for severance benefits of six months base salary fortermination without cause, and severance benefits of sixty months base salary,from the date of event, for termination after a merger, change in control, orother defined corporation reorganizations.

 

In 2001 and 2002, the Bankentered into Change in Control Employment agreements with Executive OfficerKorsgaard and four of the Bank’s Senior Vice Presidents, in 2003 with two ofthe Bank’s Senior Vice Presidents, and in 2004 with one of the Bank’s SeniorVice Presidents, that will provide for severance benefits for termination aftera merger, change in control, or other defined corporate reorganizations equalto six months salary.

 

In 2005, the Bank entered intoSalary Protection agreements with newly-appointed Executive Officers Pigeon andJudge that will provide for severance benefits for termination after a merger,change in control, or other defined corporate reorganizations equal to sixmonths salary.

 

**Directors’Compensation**

 

Prior to 2002 the Bank’sdirectors were not paid for attending meetings of the Board or the committeeson which they served.  On April 22, 2002the bank’s Board of Directors approved a Director Compensation Program, whichbecame effective on July 1, 2002, providing for outside directors to receive amonthly retainer of $500 for each Board Meeting attended and a fee of $100 foreach Director Committee meeting attended. In 2004, the Board received, on a cumulative basis, $58,700 in directorfees for meetings attended in 2004.

 

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There were no Stock Optiongrants to Directors during the year ended December 31, 2004.

 

**Item 11.****   ****SecurityOwnership of Certain Beneficial Owners and Management and Related ShareholderMatters**

 

The following table setsforth certain information as of December 31, 2004, concerning the beneficialownership of the Company’s outstanding Common Stock: (i) by each of thedirectors and executive officers; and (ii) by all directors and executiveofficers of the Company as a group. Management is not aware of any change in control of the Company whichhas occurred since January 1, 2005 or of any arrangement which may, at asubsequent date, result in such a change in control.

 
| **Name and Position Held**                                                | ** ** | **Common  Stock  Beneficially  Owned (1)** | ** ** | **Shares  Subject  to  Exercise** | ** ** | **Total Shares  Beneficially  Owned** | ** ** | **Percent  of Class** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|-----------------------|------------|
|                                                                      |       |                                       |       |                              |       |                                  |       |                  |       |
| Bruce M. Breault   Founding Chairman of the Board (Emeritus)              |       | 21,250                                     |       | 15,133                            |       | 36,383                                |       | 5.5                   | %          |
| Roxanne M. Carr   Vice Chairman of the Board                              |       | 10,000                                     |       | 9,000                             |       | 19,000                                |       | 2.9                   | %          |
| Karla S. Cool   Director                                                  |       | 4,837                                      |       | 3,200                             |       | 8,037                                 |       | 1.2                   | %          |
| William B. Coy   Chairman of the Board                                    |       | 7,750                                      |       | 9,000                             |       | 16,750                                |       | 2.6                   | %          |
| Richard Korsgaard                                                         |       | —                                     |       | 2,000                             | (2)        | 2,000                                 |       | 0.3                   | %          |
|                                                                      |       |                                       |       |                              |       |                                  |       |                  |       |
| Anita M. Robinson  Director, President and Chief Executive Officer        |       | 18,609                                     |       | 24,000                            |       | 42,609                                |       | 6.4                   | %          |
| Robin L. Rossi   Director                                                 |       | 13,707                                     | (3)        | 13,000                            |       | 26,707                                |       | 4.1                   | %          |
| Gary E. Stemper   Immediate Past Chairman of the Board                    |       | 7,500                                      |       | 11,400                            |       | 18,900                                |       | 2.9                   | %          |
| Karl F. Wittstrom   Secretary                                             |       | 15,350                                     |       | 10,600                            |       | 25,950                                |       | 4.0                   | %          |
|                                                                      |       |                                       |       |                              |       |                                  |       |                  |       |
| All Directors and Executive Officers as a  Group, consisting of 9 persons |       | 99,003                                     |       | 97,333                            | (2)        | 196,336                               |       | 26.5                  | %          |

 

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(1)          Includes shares beneficially owned, directly orindirectly, together with associates. Also includes shares held as trustee andheld by or as custodian for minor children, by a closely held business or otherassociate. Unless otherwise indicated, all shares are held as communityproperty under California law or with sole voting and investment power.

(2)          Includes 2,000 shares subject to option held byRichand Korsgaard which are exercisable within 60 days.  Shares subject to options exercisable within60 days of December 31, 2004 are treated as issued and outstanding for thepurpose of computing the percent of class owned by such person but not for thepurpose of computing the percent of class owned by any other person.

(3)          Mr. Rossi’s beneficially-owned shares include 457shares held in the name of The Rossi Foundation, with no voting rights beingheld by Mr. Rossi.

 

Management of the Companyis aware of one person who owns, beneficially or of record, more than 5% of theCompany’s outstanding Common Stock:

The Patrick W.Hopper Trust beneficially owns 41,634 shares of common stock, or 6.5% of totalshares outstanding.

 

The U.S. Department ofTreasury, Community Development Financial Institutions Fund, holds theequivalent of 100,000 shares Common Stock under its combined ownership ofSeries A and Series C Convertible Preferred Stock.

 

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**Item 12.  Certain Relationshipsand Related Transactions**

 

**CertainTransactions**

 

There are no material existingor proposed transactions between Bancorp or the Bank and any of its executiveofficers, directors, or beneficial owners of 5% or more of the Common Stock, orthe immediate family or associates of any of the foregoing persons, except asindicated below.

 

Some of the Bank’s directorsand executive officers and their immediate families, as well as the companieswith which such directors and executive officers are associated, are customersof, and have had banking transactions with the Bank in the ordinary course ofbusiness and anticipate having such banking transactions with such persons inthe future.  In the opinion ofManagement, all loans and commitments to lend included in such transactionswere made in compliance with applicable laws on substantially the same terms,including interest rates and collateral, as those prevailing at the time forcomparable transactions with other persons of similar creditworthiness and didnot involve more than a normal risk of collectibility or present otherunfavorable features.  As ofDecember 31, 2004, loans outstanding to the Bank’s directors and executiveofficers (including associated companies) totaled approximately $3,418,000.

 

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## **Item13.  Exhibits and Reports on Form 8-K**

## ** **

**Exhibit Index:**

 
| **Exhibit #** | ** ** | ** **                                                                                                                                                                                                                                               |
|---------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1           |       | Plan of Reorganization and  Agreement of Merger dated as of October 4, 2000 (A)                                                                                                                                                                          |
| 3.1           |       | Articles of Incorporation  (B)(G)                                                                                                                                                                                                                        |
| 3.2           |       | Bylaws (B)                                                                                                                                                                                                                                               |
| 4.1           |       | Certificate of  Determination for Series A Non-Voting Preferred Stock (B)                                                                                                                                                                                |
| 4.2           |       | Certificate of  Determination for Series B Non-Voting Preferred Stock (B)                                                                                                                                                                                |
| 4.3           |       | Certificate of  Determination for Series C Non-Voting Preferred Stock (D)                                                                                                                                                                                |
| 4.4           |       | Purchase Agreement dated  October 10, 2003, by and among Registrant, Mission Community Capital Trust I,  and Bear Stearns & Co., Inc. (F)                                                                                                            |
| 4.5           |       | Indenture dated as of  October 14, 2003 by and between Registrant and Wells Fargo Bank, National  Association, as trustee (F)                                                                                                                            |
| 4.6           |       | Declaration of Trust  Mission Community Capital Trust I dated October 10, 2003 (F)                                                                                                                                                                       |
| 4.7           |       | Amended and Restated  Declaration of Trust of Mission Community Capital Trust I dated October 14,  2003 by and among the Registrant, Wells Fargo Delaware Trust Company, as  Trustee, and Anita M. Robinson and William C. Demmin, as Administrators (F) |
| 4.8           |       | Guarantee Agreement dated  October 14, 2003 between Registrant, as Guarantor, and Wells Fargo Bank,  National Association, as Guarantee Trustee (F)                                                                                                      |
| 4.9           |       | Fee Agreement dated October  14, 2003 by and among the Registrant, Wells Fargo Delaware Trust Co., Bear  Stearns & Co., Inc. and Mission Community Capital Trust I (F)                                                                               |
| 10.1          |       | Purchase and Sale Agreement  and Lease dated January, 1997, as amended (B)                                                                                                                                                                               |
| 10.2          |       | Employment Contract – Ms.  Robinson (B)                                                                                                                                                                                                             |
| 10.3          |       | Lease Agreement – Paso  Robles (B)                                                                                                                                                                                                                  |
| 10.4          |       | Lease Agreement – San Luis  Obispo (B)                                                                                                                                                                                                              |
| 10.5          |       | Lease Agreement – Arroyo  Grande (B)                                                                                                                                                                                                                |
| 10.6          |       | 1998 Stock Option Plan, as  amended (B)                                                                                                                                                                                                                  |
| 10.7          |       | Lease Agreement – 569  Higuera, San Luis Obispo (D)                                                                                                                                                                                                 |
| 10.8          |       | Lease Agreement – 671 Tefft  Street Nipomo CA (C)                                                                                                                                                                                                   |
| 10.9          |       | Employment Agreement – Ms.  Robinson (E)                                                                                                                                                                                                            |
| 10.10         |       | Lease Agreement – 3480 S.  Higuera, San Luis Obispo (G)                                                                                                                                                                                             |
| 10.11         |       | Salary Protection Agreement  — Mr. Pigeon (H)                                                                                                                                                                                                       |
| 10.12         |       | Salary Protection Agreement  — Mr. Judge (I)                                                                                                                                                                                                        |
| 21            |       | Subsidiaries of the  registrant                                                                                                                                                                                                                          |
| 23.1          |       | Independent Auditors’  Consent                                                                                                                                                                                                                      |
| 31.1          |       | Certification of CEO  pursuant to Section 302 of Sarbanes Oxley Act                                                                                                                                                                                      |
| 31.2          |       | Certification of CFO  pursuant to Section 302 of Sarbanes Oxley Act                                                                                                                                                                                      |
| 32.1          |       | Certification of CEO  pursuant to Section 906 of Sarbanes Oxley Act                                                                                                                                                                                      |
| 32.2          |       | Certification of CFO  pursuant to Section 906 of Sarbanes Oxley Act                                                                                                                                                                                      |

 

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|   | (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 10-QSB filed on August 13, 2003           |
|   | (F) |   | Included in the Company’s  Form 8-K filed on October 21, 2003             |
|   | (G) |   | Amendment included in the  Company’s Form 10-QSB filed on August 10, 2004 |
|   | (H) |   | Included in the Company’s  Form 8-K filed on January 19, 2005             |
|   | (I) |   | Included in the Company’s  Form 8-K filed on February 17, 2005            |

 

83

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**Reports on Form 8-K:**

#### **1.**               On October 8, 2004, the Company filed a Form 8-K announcing that itwould be receiving an award of $134,935 from the Community DevelopmentFinancial Institutions Fund of the U.S. Treasury.

#### ** **

#### **2.**               On October 15, 2004, the Company filed a Form 8-K announcing that theCompany had granted to Mission Community Services Corp., an affiliate, $250,000to continue providing small businesses with technical assistance, counselingand training in finance, management and marketing, and access to SBA programsand services.

#### ** **

#### **3.**               On November 23, 2004, the Company filed a Form 8-K announcing thedeclaration of a $0.12 per share cash dividend to be paid December 20, 2004, toshareholders of record on December 6, 2004.

 

#### **4.**               On January 19, 2005, the Company filed a Form 8-K announcingthe appointment of Ronald B. Pigeon as Executive Vice President and ChiefFinancial Officer of the Bank and Bancorp.

 

#### **5.**               On February 17, 2005, the Company filed a Form 8-K announcingthe appointment of James M. Judge as Executive Vice President and ChiefCredit Officer of the Bank.

 

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

 

The following table presents fees forprofessional audit services rendered by Vavrinek, Trine, Day & Co., LLP forthe audit of the Company’s annual financial statements for the years endedDecember 31, 2004, and December 31, 2003, and fees billed for the otherservices rendered by Vavrinek, Trine, Day & Co., LLP during those periods.

 

| **(Amounts in dollars)** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Audit Fees               |       | $        | 37,000     |     | $          | 35,500 |   |
| Tax Fees                 |       | 4,000    |       | 3,500    |       |
|                          |            |          |            |          |            |  |  |

 

Audit Fees consist of amounts billed forprofessional services rendered by Vavrinek, Trine, Day & Co., LLP for theaudit of the Company’s annual financial statements and the reviews of thefinancials statements included in the Company’s Forms 10-QSB for the applicablefiscal year.  Tax Fees consist of theaggregate fees billed for professional services rendered by Vavrinek, Trine,Day & Co., LLP for tax compliance, tax advice, and tax planning.  Before Vavrinek, Trine, Day & Co., LLPwas engaged by the Bank to render audit or non-audit services associated withthe fees discussed above, the engagement was approved by the Audit Committee ofthe Board of Directors.  The Board ofDirectors is of the opinion that all service fees charged by Vavrinek, Trine,Day & Co., LLP are consistent with Vavrinek, Trine, Day & Co., LLPmaintaining its independence from the Company.

 

84

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**Signatures**

 

Pursuant to the requirements ofSection 13 of the Securities Exchange Act of 1934, the Company has duly causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| **MISSION  COMMUNITY BANCORP**                        |                   |
|-------------------------------------------------------|------------------------|
|                                                  |                   |
|                                                  |                   |
| By:                                                   | /s/ Anita M.  Robinson |   |   |
| ANITA M.  ROBINSON                                    |                   |
| President  and Chief Executive Officer                |                   |
| Dated:                                                | March 30,  2005        |   |
|                                                  |                   |
|                                                  |                   |
| By:                                                   | /s/ Ronald  B. Pigeon  |   |   |
| RONALD B.  PIGEON                                     |                   |
| Executive  Vice President and Chief Financial Officer |                   |
| Dated:                                                | March 30,  2005        |   |
|                                                  |                   |
| [Signatures continue on next page]                    |                   |
|                                                       |                        |  |  |  |  |

 

85

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Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.

 

** **
| **/s/ Bruce M. Breault** | ** ** | ** **                                                                            | ** **          |
|--------------------------|------------|---------------------------------------------------------------------------------------|---------------------|
| BRUCE M. BREAULT         |       | Founding Chairman of the Board (Emeritus)                                             | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Roxanne M. Carr      |       |                                                                                  |                |
| ROXANNE M. CARR          |       | Vice Chairman of the Board                                                            | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Karla S. Cool        |       |                                                                                  |                |
| KARLA S. COOL            |       | Director                                                                              | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ William B. Coy       |       |                                                                                  |                |
| WILLIAM B. COY           |       | Chairman of the Board                                                                 | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Richard Korsgaard    |       |                                                                                  |                |
| RICHARD KORSGAARD        |       | Director                                                                              | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Ronald B. Pigeon     |       |                                                                                  |                |
| RONALD B. PIGEON         |       | Executive Vice President and Chief  Financial Officer  (Principal Accounting Officer) | March 28, 2005 |
|                     |       |                                                                                  |                |
| /s/ Anita M. Robinson    |       |                                                                                  |                |
| ANITA M. ROBINSON        |       | Director, President and Chief Executive  Officer                                      | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Robin L. Rossi       |       |                                                                                  |                |
| ROBIN L. ROSSI           |       | Director                                                                              | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Gary E. Stemper      |       |                                                                                  |                |
| GARY E. STEMPER          |       | Immediate Past Chairman of the Board                                                  | March 28, 2005      |
|                     |       |                                                                                  |                |
| /s/ Karl F. Wittstrom    |       |                                                                                  |                |
| KARL F. WITTSTROM        |       | Director and Secretary                                                                | March 28, 2005      |

 

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