**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-KSB**

 
| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|
|       |                                                                                      |
|       | **For  the Year ended December 31, 2002**                                                 |

 

**OR**

 
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                |
|--------|------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                         |
|   | **For  the transition period from          to       ** |

 

**Commission file number 333-12892**

 

**MISSIONCOMMUNITY BANCORP**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

 

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

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý No o(1)

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Bis not contained herein, and will not be contained, to the best of theregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB ý.

 

Registrant’s revenue for this year ended December 31, 2002 was$6,933,496. The aggregate market value of the voting stock held bynon-affiliates of the Registrant at March 1, 2003 was $6,687,796.  As of March 7, 2003, the Registrant had630,166 shares of Common Stock outstanding.

 

Transitional SmallBusiness Disclosure Format (check one) Yes oNoý

 

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(1) Prior toDecember 18, 2000, Mission Community Bancorp’s subsidiary, Mission CommunityBank, N.A., filed reports pursuant to Section 15(d) of the Securities ExchangeAct of 1934 with the Comptroller of the Currency.  On December 18, 2000, Mission Community Bancorp filed an 8-KReport with the Commission reporting that it had acquired Mission CommunityBank, N.A. in a holding company formation transaction and that it wouldthereafter file reports with the Commission pursuant to Section 15(d) of theSecurities Exchange Act of 1934.

 

 

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**TABLE OF CONTENTS**

 
| PART I                                                                    |           |
|---------------------------------------------------------------------------|----------------|
|                                                                      |           |
|                                                                      | **ITEM 1.**    | **DESCRIPTION OF  BUSINESS** |
|                                                                      |           |   |
|                                                                      | **ITEM 2.**    | **DESCRIPTION OF PROPERTIES** |
|                                                                      |           |   |
|                                                                      | **ITEM 3.**    | **LEGAL PROCEEDINGS** |
|                                                                      |           |   |
|                                                                      | **ITEM  4.**   | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS** |
|                                                                      |           |   |
| PART  II                                                                  |           |
|                                                                      |           |
|                                                                      | **ITEM  5.**   | **MARKET  FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS** |
|                                                                      |           |   |
|                                                                      | **ITEM  6.**   | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION** |
|                                                                      |           |   |
|                                                                      | **Item 7**     | **FINANCIAL STATEMENTS** |
|                                                                      |           |   |
|                                                                      | **ITEM  8.**   | **CHANGES  WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL** |
|                                                                      |           |   |
| **PART III**                                                              |           |
|                                                                      |           |
|                                                                      | **ITEM 9.**    | **DIRECTORS, EXECUTIVE OFFICERS,  PROMOTERS AND CONTROL PERSONS;   COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT** |
|                                                                      |           |   |
|                                                                      | **ITEM 10.**   | **EXECUTIVE COMPENSATION** |
|                                                                      |           |   |
|                                                                      | **ITEM  11**   | **SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND** |
|                                                                      |           |   |
|                                                                      | **ITEM  12.**  | **CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS** |
|                                                                      |           |   |
|                                                                      | **ITEM 13.**   | **EXHIBITS AND  REPORTS ON FORM 8-K** |
|                                                                      |           |   |
|                                                                      | **ITEM 14.**   | **CONTROLS AND  PROCEDURES** |
|                                                                      |           |   |
|                                                                      | **Signatures** |   |
|                                                                      |           |   |
| SARBANES-OXLEY  ACT SECTION 302 CERTIFICATION                             |
|                                                                      |
| SARBANES-OXLEY ACT SECTION 302  CERTIFICATION                             |
|                                                                      |
| **SARBANES-OXLEY ACT SECTION 906  CERTIFICATION CHIEF EXECUTIVE OFFICER** |
|                                                                      |
| **SARBANES-OXLEY ACT SECTION 906  CERTIFICATION CHIEF FINANCIAL OFFICER** |

 

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**Forward Looking Statements**

 

This Annual Report on Form 10-KSB includes forward-looking information,which is subject to the “safe harbor” created by Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act ant thePrivate Securities Litigation Reform Act of 1995.  When the Company uses or incorporates by reference in this AnnualReport on Form 10-KSB the words “anticipate,” “estimate,” “expect,” “project,”“intend,” “commit,” “believe” and similar expressions, the Company intends toidentify forward-looking statements. Such statements are subject to certain risks, uncertainties andassumptions, including those described in this Annual Report on Form 10-KSB.  Should one or more of these risks oruncertainties materialize, or should underlying assumptions prove incorrect,actual results may vary materially from those anticipated, estimated, expected,projected, intended, committed or believed. Such risks and uncertainties include, but are not limited to, thefollowing factors: (i) general economic conditions, whether national orregional, that could affect the demand for loans and other banking services orlead to increased loan losses; (ii) competitive factors, including increasedcompetition with community, regional and national financial institutions thatmay lead to pricing pressures on rates the Bank charges on loans and pays ondeposits or reduce the value of real estate collateral securing the Bank’sloans; (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 volatility of rate sensitive loans anddeposits; (v) changing business conditions in the banking industry; (vi)changes in the regulatory environment or new legislation; (vi) changes intechnology or required investments in technology; (vii) credit qualitydeterioration which could cause an increase in the provision for loan losses;(viii) dividend restrictions; (ix) the effects of the September 11, 2001terrorist attacks and their aftermath; (x) increased political tensions in Iraqand elsewhere in the Middle East; and (xi) increased regulation of thesecurities markets, whether pursuant to the Sarbanes-Oxley Act of 2002 orotherwise. Investors and other readers are cautioned not to place unduereliance on forward-looking statements, which reflect management’s analysisonly as of the date of the statement. The Company undertakes no obligation to revise any forward-lookingstatement to reflect later events or circumstances.

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# **PARTI**

 

## **ITEM 1.**              DESCRIPTIONOF BUSINESS

 

**General**

 

Mission Community Bancorp(the “Company”) is a California corporation organized in September 2000 to actas the bank holding company for Mission Community Bank (the “Bank”). InDecember 2000, the Company acquired all of the outstanding common stock of theBank in a holding company formation transaction.  Shareholders of the Bank received one share of the common stockof the Company for each share of Bank common stock.  The transaction was accounted for on a basis similar to thepooling of interest method and was structured to be tax free to theshareholders. Other than holding the shares of the Bank, the Company conductsno significant activities, although it is authorized, with the prior approvalof the Board of Governors of the Federal Reserve System (the “Federal ReserveBoard”), the Company’s principal regulator, to engage in a variety ofactivities which are deemed closely related to the business of banking.

 

**The Bank**

 

The Bank, a nationalbanking association, opened its Main Office and commenced operations onDecember 18, 1997 at 581 Higuera Street, San Luis Obispo, California 93401. TheBank is authorized to engage in the general commercial banking business and itsdeposits are insured by the Federal Deposit Insurance Corporation up to theapplicable limits of the law. At December 31, 2002, the Company hadapproximately $99.0 million in assets, $64.4 million in net loans, $87.5million in deposits, and $7.9 million in stockholders’ equity. The Bank doesnot offer trust services or international banking services and does not plan todo so in the near future.

 

The Bank established awholly-owned subsidiary community development corporation, Mission CommunityDevelopment Corporation (“MCDC”), and has a close relationship with, but noownership of, Mission Community Services Corporation (“MCSC”).

 

Mission CommunityDevelopment Corporation is a “for-profit” community development corporationCDC, which provides financing for small businesses and low- and moderate-incomearea development and/or affordable housing projects. Its purpose is to benefitsmall business and low- and moderate-income areas/residents. The board ofdirectors of MCDC consists of four members of the Board of Directors of theBank and three outside members who are actively involved in supportingcommunity affairs and activities.

 

Mission CommunityServices Corporation is a “not-for-profit” public charitable corporation and isin the process of filing under IRS Section Code 501(c )(3). This company’sprimary focus is to provide technical support, training services to thecommunity including small business, minorities and low-income entrepreneurs.  The Board of Directors of MCSC includes somerepresentatives from the Bank’s Board together with members representing thecommunity at large.

 

The Company, MissionCommunity Bank and its subsidiary Mission Community Development Corporation andMission Community Services Corporation, form an organizational structureintended to provide economic revitalization and community development to theCentral Coast of California.

 

The Bank’s MissionStatement commits to:

 

*“Ourmission is to be the leading financial institution in our community providingfinancial support and services by promoting community development and economicvitality.*

 

*Thiswill be accomplished through the development of high quality, community*

 

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*directedbanking services and through the fostering and nurturing of small businessgrowth.*

 

*Wewill be innovative in the development and creation of jobs and individualwealth within our community, and be a partner and facilitator in creatingopportunities in our marketplace.*

 

*Allof this will be accomplished while providing strong value to our shareholdersand a meaningful financial investment to our investors”.*

 

The Department ofTreasury, Community Development Institution Fund, has certified the Company andthe Bank as Community Development Financial Institutions (CDFI). This statusalso conveys possible Community Reinvestment Act (CRA) credit to institutionaldepositors and investors in the Bank and Company.  It also opens various government sponsored programs, grants, andawards in which the Bank and Company may participate.

 

With its status as a CDFIthe Company completed the private placement of $1,000,000 in common andpreferred stock during December 2000 to two institutional investors.  The Company also was awarded a $500,000 CoreAward in 2001 from the CDFI Fund which was funded in December 2002 in the formof preferred stock.   See “Item 5.Market for Common Equity and Related Stockholder Matters – Issuance ofPreferred Stock.”

 

**Banking Services**

 

The Bank offers a widevariety of deposit, loan and other financial services to small businesses,entrepreneurs and their employees and families.  Its key strengths are customer service, an experienced managementteam familiar with the community through the Bank’s involvement in variouscommunity lending and development projects. 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.

 

The Bank operates out offour branches plus an administrative facility all of which are located in SanLuis Obispo County as follows:

 

1.               MainOffice/Branch in the city of San Luis Obispo,

 

2.               Branchin Paso Robles,

 

3.               Branchin Arroyo Grande,

 

4.               Branchin Nipomo, and

 

5.               Administrativeoffice in San Luis Obispo.

 

The Bank’s branchesenable it offer products and services throughout its primary market area whichis defined as:

 

1.               Thecity of San Luis Obispo which is located in the central west portion of thisservice area.

 

2.               TheSouth County includes the cities of Pismo Beach, Arroyo Grande, Grover Beach,and unincorporated areas of Oceano and Nipomo and is often referred to as the“Five Cities” area.

 

3.               The“North County” includes the cities of Paso Robles, Atascadero, Templeton andSanta Margarita.

 

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4.               “The Coast” includes Los Osos, Morro Bay, Cayucos, Cambria and San Simeon.

 

5.               NorthernSanta Barbara County includes the cities of Santa Maria, Guadalupe, and Lompoc.

 

6.               TheBank also offers services to companies and individuals located in its marketarea through the use of ATMs and courier services.

 

The Bank offers checkingand savings accounts, money market accounts and time certificates of deposits;offers commercial, agribusiness, government guaranteed, real estate, automobileand other installment and term loans and leases; issues drafts, sellstravelers’ checks and provides other customary banking services. Although theBank does not operate a trust department or provide international services, itmakes trust services or international services available through correspondentinstitutions. The business plan of the Bank emphasizes providing highlyspecialized financial services in a professional and personalized manner toindividuals and businesses in its service area.

 

The Bank’s operatingpolicy since its inception has emphasized community development through smallbusiness, commercial and retail banking. Most of the Bank’s customers areretail customers, farmers and small to medium-sized businesses.  As a CDFI, the Bank also emphasizes loansand financial services to low to moderate income communities within its marketarea. The Bank accepts real estate, listed and unlisted securities, savings andtime deposits, automobiles, machinery and equipment as collateral for loans.The areas in which the Bank has directed virtually all of its lendingactivities are (i) commercial loans, (ii) agricultural loans (iii) constructionloans, (iv) real estate loans, and (v) consumer loans. As of December 31, 2002,these five categories accounted for approximately 25.7%, 3.6%, 10.0%, 57.8%,and 2.9% respectively, of the Bank’s gross loan portfolio. As of December 31,2002, $44.2 million or 67.8­% of the Bank’s net loans consisted of interimconstruction and real estate loans, primarily for single family residences orfor commercial development.  Theincrease in construction and real estate in a material increase from the prioryear’s combined 54.5%.  SeeConcentrations in Managements’ Discussion and Analysis of Financial Conditionand Results of Operations.

 

Most of the Bank’sdeposits are attracted by local promotional activities and advertising. Amaterial portion of the Bank’s deposits have not been obtained from a singleperson or a few persons, the loss of any one or more of which would have amaterially adverse effect on the business of the Bank. As of December 31, 2002,the Bank had approximately 3,469 deposit accounts consisting of non-interestbearing (demand) of $15.0 million with 1,788 accounts with average balances ofapproximately $8,400; 95 interest-bearing demand and money market accounts withbalances totaling $2.8 million with an average balance per account ofapproximately $29,000;  1,037 savingsaccounts with balances totaling $36.0 million with an average balance peraccount of approximately $34,800; and 549 time certificate of deposit accountswith balances totaling $33.7 million and an average balance per account ofapproximately $61,000.

 

The principal sources of the Bank’s revenues are (i) interest andfees on loans, (ii) interest on investments, (iii) service charges ondeposit accounts and other charges and fees, (iv) BEA award, (v) gain onsale of loans, and (vi) interest on other investments including federal fundssold.  For the year ended December 31,2002, these sources comprised 68.2%, 9.4%, 7.8%, 2.6%, 9.1% and 2.9%,respectively, of the Bank’s total operating income.

 

There has been no significant change in the types of services offeredby the Bank since its inception, except in connection with new types ofaccounts allowed by statute or regulation in recent years. The Bank has nopresent plans to enter any new line of business that would require theinvestment of a material amount of total assets.  The Bank does intend to add a mortgage lending product under anarrangement with another financial organization that specializes in providingdocumentation, underwriting, and takeout financing for mortgage loans. The Bankalso is developing a relationship with another financial institution to providedocumentation, joint underwriting, and takeout financing for larger fixed ratelong term loans on a broker fee basis.

 

The Bank is participating in a 3-year project (2002 - 2005) sponsoredby the National Community Investment Fund (NCIF) to explore and develop aprofitable range of retail financial products and services to low income andunbanked customers (“low income customers”). NCIF is underwriting a majority of the costs associated

 

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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 range ofneeds. Product and service specifications, target market, cross selling andprofitability data would be tracked over a two- to three-year time horizon withthe goal to develop suites of products that meet household financial and assetbuilding needs while being profitable for financial institutions to offer.Expected products include First Accounts, Individual Development Accounts, andaccess to debit cards and other electronic services.

 

Most of the Bank’s business originates from San Luis Obispo County withsome activity in Northern Santa Barbara County. The Bank’s business, based uponperformance to date, does not appear to be seasonal. A material portion of theBank’s loans is not concentrated within a single industry or group of relatedindustries, nor is the Bank dependent upon a single customer or group ofrelated customers for a material portion of its deposits.

 

Management of the Bank is unaware of any material effect upon theBank’s capital expenditures, earnings or competitive position as a result offederal, state or local environmental regulation.

 

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

 

**Employees**

 

As of March 1, 2003 theBank had a total of 47 employees. The management of the Bank believes that itsemployee relations are satisfactory. Neither the Company nor MCDC have salariedemployees; the Company’s officers all hold similar positions at the Bank.  The Bank under intercompany arrangements maycharge the Company and/or MCDC for management, staff, and services; however,the time and services are not material at this time.

 

**Competition**

 

The banking and financialservices business in the Bank’s market area is highly competitive. Theincreasingly competitive environment is a result primarily of changes inregulation, and changes in technology and product 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 courierpick-up. The Bank emphasizes to its customers the advantages of dealing with alocally owned and community development oriented institution. Larger banks mayhave a competitive advantage because of higher lending limits and majoradvertising and marketing campaigns in addition to expanded products like trustservices, international banking, discount brokerage and insurance services thatthe Bank does not offer. As a service to its customers, the Bank has madearrangements with other financial service providers to extend such services forits 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. As of December 31, 2002,the Bank’s legal lending limits to a single borrower and such borrower’srelated parties was $1,303,350 based on regulatory capital plus reserves of$8,689,000.

 

Commercial banks competewith savings and loan associations, credit unions, other financialinstitutions, securities brokerage firms, 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.Commercial banks also compete for loans with savings and loan associations,credit unions, consumer finance companies, mortgage companies and other lendinginstitutions.

 

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**Effect of Government Policies**

 

Banking is a businessthat depends on rate differentials. In general, the difference between theinterest rate paid by the Bank on its deposits and its other borrowings and theinterest rate received by the Bank on loans extended to its customers andsecurities held in the Bank’s portfolio comprise the major portion of theBank’s earnings. These rates are highly sensitive to many factors that arebeyond the control of the Bank. Accordingly, the earnings and growth of theBank are subject to the influence of domestic and foreign economic conditions,including inflation, recession and unemployment.

 

The commercial bankingbusiness is not only affected by general economic conditions but is alsoinfluenced by the monetary and fiscal policies of the federal government andthe policies of regulatory agencies, particularly the Federal Reserve Board.The Federal Reserve Board implements national monetary policies (withobjectives such as curbing inflation and combating recession) by itsopen-market operations in United States Government securities, by adjusting therequired level of reserves for financial institutions subject to its reserverequirements and by varying the discount rates applicable to borrowings by depositoryinstitutions. The actions of the Federal Reserve Board in these areas influencethe growth of bank loans, investments and deposits and also affect interestrates charged on loans and paid on deposits. The nature and impact of anyfuture changes in monetary policies cannot be predicted.

 

From time to time,legislation is enacted which has the effect of increasing the cost of doingbusiness, limiting or expanding permissible activities or affecting thecompetitive balance between banks and other financial institutions. Proposalsto change the laws and regulations governing the operations and taxation ofbanks, bank holding companies and other financial institutions are frequentlymade in Congress, in the California legislature and before various bankregulatory and other professional agencies. See “Recent Legislation.”

 

**Supervision and Regulation**

 

**General**

 

The Company and the Bankare extensively regulated under both federal and state law. Set forth below isa summary description of certain laws that relate to the regulation of theCompany and the Bank. The description does not purport to be complete and isqualified in its entirety by reference to the applicable laws and regulations.

 

**The Company**

 

The Company is a bankholding company within the meaning of the Bank Holding Company Act of 1956, asamended (the “BHCA”), and is registered as such with, and subject to the supervisionof, the Federal Reserve Board. The Company is required to file with the FederalReserve Board quarterly and annual reports and such additional information asthe Federal Reserve Board may require pursuant to the BHCA. The Federal ReserveBoard may conduct examinations of bank holding companies and theirsubsidiaries.

 

The Company is requiredto obtain the approval of the Federal Reserve Board before it may acquire allor substantially all of the assets of any bank, or ownership or control of thevoting shares of any bank if, after giving effect to such acquisition ofshares, the Company would own or control more than 5% of the voting shares ofsuch bank. Prior approval of the Federal Reserve Board is also required for themerger or consolidation of the Company and another bank holding company.

 

The Company is prohibitedby the BHCA, except in certain statutorily prescribed instances, from acquiringdirect or indirect ownership or control of more than 5% of the outstandingvoting shares of any company that is not a bank or bank holding company andfrom engaging, directly or indirectly, in activities other than those ofbanking, managing or controlling banks or furnishing services to itssubsidiaries. However, the Company may, subject to the prior approval of theFederal Reserve Board, engage in any, or acquire shares of companies engagedin, activities that are deemed by the Federal Reserve Board to be so closelyrelated to

 

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banking or managing orcontrolling banks as to be a proper incident thereto. See discussion under“Financial Modernization Act” below for additional information.

 

The Federal Reserve Boardmay require that the Company terminate an activity or terminate control of orliquidate or divest subsidiaries or affiliates when the Federal Reserve Boarddetermines that the activity or the control or the subsidiary or affiliatesconstitutes a significant risk to the financial safety, soundness or stabilityof any of its banking subsidiaries. The Federal Reserve Board also has the authorityto regulate provisions of certain bank holding company debt, includingauthority to impose interest ceilings and reserve requirements on such debt.Under certain circumstances, the Company must file written notice and obtain approvalfrom the Federal Reserve Board prior to purchasing or redeeming its equitysecurities.

 

Under the Federal ReserveBoard’s regulations, a bank holding company is required to serve as a source offinancial and managerial strength to its subsidiary banks and may not conduct itsoperations in an unsafe and unsound manner. In addition, it is the Federal ReserveBoard’s policy that in serving as a source of strength to its subsidiary banks,a bank holding 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’s failure to meet its obligations toserve as a source of strength to its subsidiary banks will generally be consideredby the Federal Reserve Board to be an unsafe and unsound banking practice or aviolation of the Federal Reserve Board’s regulations or both.

 

The Company is subject tothe periodic reporting requirements of Section 15(d) of the Securities ExchangeAct of 1934, as amended, and files reports pursuant to such Act with theSecurities and Exchange Commission.

 

**The Bank**

 

The Bank is charteredunder the laws of the United States and its deposits are insured by the FDIC tothe extent provided by law. The Bank is subject to the supervision of, and isregularly examined by, the Office of the Comptroller of Currency (“OCC”). Suchsupervision and regulation include comprehensive reviews of all major aspectsof the Bank’s business and condition.

 

Various requirements andrestrictions under the laws of the United States and of California affect theoperations of the Bank. Federal statutes relate to many aspects of the Bank’soperations, including reserves against deposits, interest rates payable ondeposits, loans, investments, mergers and acquisitions, borrowings, dividendsand locations of branch offices. Further, the Bank is required to maintain certain levels of capital.

 

If, as a result of anexamination of a bank, the OCC should determine that the financial condition,capital resources, asset quality, earnings prospects, management, liquidity, orother aspects of the Bank’s operations are unsatisfactory or that the Bank orits management is violating or has violated any law or regulation, variousremedies are available to such regulatory agency. Such remedies include thepower to enjoin “unsafe or unsound” practices, to require affirmative action tocorrect any conditions resulting from any violation or practice, to issue anadministrative order that can be judicially enforced, to direct an increase incapital, to restrict the growth of the Bank, to assess civil monetarypenalties, to remove officers and directors, and ultimately to terminate theBank’s deposit insurance, which would result in a revocation of the Bank’scharter.

 

**Capital Standards**

 

The Federal Reserve Boardand the OCC have adopted risk-based minimum capital guidelines intended toprovide a measure of capital that reflects the degree of risk associated with abanking organization’s operations for both transactions reported on the balancesheet as assets and transactions, such as letters of credit and recoursearrangements, which are recorded as off balance sheet items. Under theseguidelines, nominal dollar amounts of assets and credit equivalent amounts ofoff balance sheet items are multiplied by one of several risk adjustment percentages,which range from 0% for assets with low credit risk, such as certain U.S.Treasury securities, to 100% for assets with relatively high credit risk, suchas business loans.

 

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A banking organization’srisk-based capital ratios are obtained by dividing its qualifying capital byits total risk adjusted assets. The regulators measure risk-adjusted assets,which includes off balance sheet items, against both total qualifying capital(the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1capital. Tier 1 capital consists primarily of common stock, retained earnings,non-cumulative perpetual preferred stock (cumulative perpetual preferred stockfor bank holding companies) and minority interests in certain subsidiaries,less most intangible assets. Tier 2 capital may consist of a limited amount ofthe allowance for possible loan and lease losses, cumulative preferred stock,long term preferred stock, eligible term subordinated debt and certain otherinstruments with some characteristics of equity. The inclusion of elements ofTier 2 capital is subject to certain other requirements and limitations of thefederal banking agencies. The federal banking agencies require a minimum ratioof qualifying total capital to risk-adjusted assets of 8% and a minimum ratioof Tier 1 capital to risk-adjusted assets of 4%.

 

In addition to therisked-based guidelines, federal banking regulators require bankingorganizations to maintain a minimum amount of Tier 1 capital to total assets,referred to as the leverage ratio. For a banking organization rated in the highestof the five categories used by regulators to rate banking organizations, theminimum leverage ratio of Tier 1 capital to total assets is 3%. For all bankingorganizations not rated in the highest category, the minimum leverage ratiomust be at least 4%. In addition to these uniform risk-based capital guidelinesand leverage ratios that apply across the industry, the regulators have thediscretion to set individual minimum capital requirements for specific institutionsat rates significantly above the minimum guidelines and ratios. Future changesin regulations or practices could further reduce the amount of capitalrecognized for purposes of capital adequacy. Such a change could affect theability of the Bank to grow and could restrict the amount of profits, if any.

 

The following tablepresents the amounts of regulatory capital and the capital ratios for the Bankcompared to its minimum regulatory capital requirements as of December 31,2002:

 

|                    |   | **Bank   Actual** |   | **Minimum Capital  Requirements** |   |
|-------------------------|--------|-------------------|--------|-----------------------------------|--------|
| LEVERAGE RATIO          |   | 7.9               | %      | 4                                 | %      |
| TIER 1 RISK-BASED RATIO |   | 10.7              | %      | 4                                 | %      |
| TOTAL RISK-BASED RATIO  |   | 11.7              | %      | 8                                 | %      |

 

Under applicable regulatory guidelines, the Bank was considered “WellCapitalized” at December 31, 2002. Under existing regulations of the FederalReserve Board, the capital ratios of the bank holding company with total assetsof less than $150 million, such as the Company, are deemed to be the same asthose of the Bank.

 

**Prompt Corrective Action and OtherEnforcement Mechanisms**

 

Federal banking agenciespossess broad powers to take corrective and other supervisory action to resolvethe problems of insured depository institutions, including but not limited tothose institutions that fall below one or more prescribed minimum capitalratios described above. An institution that, based upon its capital levels, isclassified as well capitalized, adequately capitalized, or undercapitalized maybe treated as though it were in the next lower capital category if theappropriate federal banking agency, after notice and opportunity for hearing,determines that an unsafe or unsound condition or an unsafe or unsound practicewarrants such treatment. At each successive lower capital category, an insureddepository institution is subject to more restrictions. The federal bankingagencies, however, may not treat a significantly undercapitalized institutionas critically undercapitalized unless its capital ratio actually warrants suchtreatment.

 

In addition to measurestaken under the prompt corrective action provisions, commercial bankingorganizations may be subject to potential enforcement actions by the federalregulators for unsafe or unsound practices in conducting their businesses orfor violations of any law, rule, regulation, or any condition imposed inwriting by the agency or any written agreement with the agency.

 

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**Safety and Soundness Standards**

 

The federal bankingagencies have adopted guidelines designed to assist the federal bankingagencies in identifying and addressing potential safety and soundness concernsbefore capital becomes impaired. The guidelines set forth operational andmanagerial standards relating to internal controls, information systems andinternal audit systems; loan documentation; credit underwriting; asset growth;earnings; and compensation, fees and benefits.

 

In addition, the federalbanking agencies have also adopted safety and soundness guidelines with respectto asset quality and earnings standards. These guidelines provide six standardsfor establishing and maintaining a system to identify problem assets andprevent those assets from deteriorating. Under these standards, an insureddepository institution should:

 

•    conduct periodic asset-quality reviews to identifyproblem assets;

 

•    estimate the inherent losses in problemassets and establish reserves that are sufficient to absorb estimated losses;

 

•    compare problem asset totals to capital;

 

•    take appropriate corrective action toresolve problem assets;

 

•    consider the size and potential risks ofmaterial asset concentrations; and

 

•             provide periodic asset quality reportswith adequate information for management and the board of directors to assessthe level of asset risk.

 

These guidelines also setforth standards for evaluating and monitoring earnings and for ensuring thatearnings are sufficient for the maintenance of adequate capital and reserves.

 

**Premiums for Deposit Insurance**

 

Through the BankInsurance Fund (“BIF”), the FDIC insures the deposits of the Bank up toprescribed limits for each depositor. The amount of FDIC assessments paid byeach BIF member institution is based on its relative risk of default asmeasured by regulatory capital ratios and other factors. Specifically, theassessment rate is based on the institution’s capitalization risk category andsupervisory subgroup category. An institution’s capitalization risk category isbased on the FDIC’s determination of whether the institution is wellcapitalized, adequately capitalized or less than adequately capitalized. Aninstitution’s supervisory subgroup category is based on the FDIC’s assessmentof the financial condition of the institution and the probability that FDICintervention or other corrective action will be required.

 

The assessment ratecurrently ranges from zero to 27 cents per $100 of domestic deposits. The FDICmay increase or decrease the assessment rate schedule on a semi-annual basis.An increase in the assessment rate could have a material adverse effect on theBank’s earnings, depending on the amount of the increase. The FDIC isauthorized to terminate a depository institution’s deposit insurance upon afinding by the FDIC that the institution’s financial condition is unsafe orunsound or that the institution has engaged in unsafe or unsound practices orhas violated any applicable rule, regulation, order or condition enacted orimposed by the institution’s regulatory agency.

 

All FDIC-insureddepository institutions must pay an annual assessment to provide funds for thepayment of interest on bonds issued by the Financing Corporation, a federalcorporation chartered under the authority of the Federal Housing Finance Board.The bonds, commonly referred to as FICO bonds, were issued to capitalize theFederal Savings and Loan Insurance Corporation. The FDIC established the FICOassessment rates effective for the fourth quarter of 2001 at approximately$.0168 per $100 annually for assessable deposits. The FICO assessments areadjusted quarterly to reflect changes in the assessment bases of the

 

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FDIC’s insurance fundsand do not vary depending on a depository institution’s capitalization orsupervisory evaluations.

 

**Community Reinvestment Act**

 

The Bank is subject tocertain fair lending requirements and reporting obligations involving homemortgage lending operations and Community Reinvestment Act (“CRA”) activities.The CRA generally requires the federal banking agencies to evaluate the recordof a financial institution in meeting the credit needs of their localcommunities, including low and moderate income neighborhoods. In addition to substantialpenalties and corrective measures that may be required for a violation ofcertain fair lending laws, the federal banking agencies may take compliancewith such laws and CRA into account when regulating and supervising otheractivities. In connection with its assessment of CRA performance, the appropriatebank regulatory agency assigns a rating of “outstanding.” “satisfactory,”“needs to improve” or “substantial noncompliance.”

 

At its last examinationby the OCC, the Bank received a CRA rating of “Satisfactory.”

 

**Recent Legislation**

 

**Financial Services ModernizationLegislation**

 

On November 12, 1999,President Clinton signed into law the Gramm- Leach-Bliley Act of 1999 (the“Financial Services Modernization Act”). The Financial Services ModernizationAct repeals the two affiliation provisions of the Glass-Steagall Act: Section20, which restricted the affiliation of Federal Reserve Member Banks with firms“engaged principally” in specified securities activities; and Section 32, whichrestricts officer, director, or employee interlocks between a member bank andany company or person “primarily engaged” in specified securities activities.In addition, the Financial Services Modernization Act also contains provisionsthat expressly preempt any state law restricting the establishment of financialaffiliations, primarily related to insurance. The general effect of the law isto establish a comprehensive framework to permit affiliations among commercialbanks, insurance companies, securities firms, and other financial serviceproviders by revising and expanding the BHCA framework to permit a holdingcompany system to engage in a full range of financial activities through a newentity known as a Financial Holding Company.

 

The law also:

 

•             broadens the activities that may beconducted by national banks, banking subsidiaries of bank holding companies,and their financial subsidiaries;

 

•             provides an enhanced framework forprotecting the privacy of consumer information;

 

•             adopts a number of provisions related tothe capitalization, membership, corporate governance, and other measuresdesigned to modernize the Federal Home Loan Bank system;

 

•             modifies the laws governing theimplementation of the Community Reinvestment Act; and

 

•             addresses a variety of other legal andregulatory issues affecting both day-to-day operations and long-term activitiesof financial institutions.

 

The Financial ServicesModernization Act has not had a material adverse effect on the operations ofthe Bank. However, to the extent that it permits banks, securities firms, andinsurance companies to affiliate, the financial services industry mayexperience further consolidation. The Financial Services Modernization Act isintended to grant to community banks certain powers as a matter of right thatlarger institutions have accumulated on an ad hoc basis. Nevertheless, this actmay have the result of increasing the amount of competition that the Companyand the Bank face from larger institutions and other types of companies

 

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offering financialproducts, many of which may have substantially more financial resources thanthe Company and the Bank.

 

***Financial Holding Companies —*** Bankholding companies that elect to become a financial holding company mayaffiliate with securities firms and insurance companies and engage in otheractivities that are financial in nature or are incidental or complementary toactivities that are financial in nature. A bank holding company that is notalso a financial holding company is limited to engaging in banking and suchother activities as determined by the Federal Reserve Board to be so closelyrelated to banking or managing or controlling banks as to be a proper incidentthereto. The Company has not elected to become a financial holding company.

 

***Privacy —*** Under the Financial ServicesModernization Act, federal banking regulators are required to adopt rules thatwill limit the ability of banks and other financial institutions to disclosenon-public information about consumers to nonaffiliated third parties. Theselimitations will require disclosure of privacy policies to consumers and, insome circumstances, will allow consumers to prevent disclosure of certainpersonal information to a nonaffiliated third party. Federal banking regulatorsissued final rules on May 10, 2000. Pursuant to the rules, financial institutionsmust provide:

 

•             initial notices to customers about theirprivacy policies, describing the conditions under which they may disclosenonpublic personal information to nonaffiliated third parties and affiliates;

 

•             annual notices of their privacy policiesto current customers; and

 

•             a reasonable method for customers to “optout” of disclosures to nonaffiliated third parties.

 

The rules were effectiveNovember 13, 2000 with compliance optional until July 1, 2001. These privacyprovisions affect how consumer information is transmitted through diversifiedfinancial companies and conveyed to outside vendors.

 

The Bank has had someincreases in costs to provide notices and for periodic reporting, but has notexperienced any material costs or changes in business operations in meetingthese privacy requirements.  The Bankhas provided the required notices and disclosures and has implementedprocedures for ongoing compliance with rules relating to privacy and there hasbeen no measurable impact on Bank activities due to privacy issues.

 

***Consumer Protection Rules—Sale of Insurance —***In December 2000, pursuant to the requirements of the Financial ServicesModernization Act, the federal bank and thrift regulatory agencies adoptedconsumer protection rules for the sale of insurance products by depository institutions.The rule became effective on October 1, 2001 and applies to any depositoryinstitution or any person selling, soliciting, advertising, or offeringinsurance products or annuities to a consumer at an office of the institutionor on behalf of the institution. The regulation requires oral and written disclosure,before the completion of the sale of an insurance product or annuity, that suchproduct:

 

•             is not a deposit or other obligation of,or guaranteed by, the depository institution or its affiliate;

 

•             is not insured by the FDIC or any otheragency of the United States, the depository institution or its affiliates; and

 

•             has certain risks of investment, includingthe possible loss of value.

 

The depositoryinstitution may not condition an extension of credit on the consumer’s purchaseof an insurance product or annuity from the depository institution or from anyof its affiliates, or on the consumer’s agreement not to obtain, or aprohibition on the consumer from obtaining, an insurance product or annuityfrom an unaffiliated entity. Furthermore, to the extent practicable, adepository institution must keep insurance and annuity sales activitiesphysically segregated from the areas where retail deposits are routinelyaccepted from the general public. Finally, the rule addresses cross marketingand referral fees.

 

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Neither the Company northe Bank have seen any change in operation since they do not offer insuranceproducts nor does the Bank or Company have any immediate plans to offer suchproducts.

 

***Safeguarding Confidential Customer Information —***In January 2000, the banking agencies adopted guidelines requiring financialinstitutions to establish an information security program to:

 

•             identify and assess the risks that maythreaten customer information;

 

•             develop a written plan containing policiesand procedures to manage and control these risks;

 

•             implement and test the plan; and

 

•             adjust the plan on a continuing basis toaccount for changes in technology, the sensitivity of customer information andinternal or external threats to information security.

 

Each institution mayimplement a security program appropriate to its size and complexity and thenature and scope of its operations. The guidelines became effective July 1,2001, and the Bank has implemented an Information Security Policy and procedureto control, to the best of the Bank’s ability and consistent with regulatoryguidelines, the risk of internal or external threats to information security.

 

**USA Patriot Act of 2001**

 

On October 26, 2001, President Bush signed the USA Patriot Act of2001.  Enacted in response to theSeptember 11, 2001 terrorist attacks, the Patriot Act (“Act”) is intended tostrengthen the ability of various agencies of the United States to workcohesively to combat terrorism on a variety of fronts.  The potential impact of the Act on financialinstitutions of all kinds is significant and wide ranging.  The Act contains sweeping antimoney-laundering and financial transparency laws and requires variousregulations, including:

 

•             due diligence requirements for financialinstitutions that administer, maintain, or manage private bank accounts orcorrespondent accounts for non-U.S. persons;

 

•             standards for verifying client identificationat account opening;

 

•             rules to promote cooperation amongfinancial institutions, regulators, law-enforcement entities in identifyingparties that may be involved in terrorism or money-laundering;

 

•             reports by non-financial trades and businessfiled by the Treasury Department’s Financial Crimes Enforcement Network fortransactions exceeding $10,000; and;

 

•             filing a suspicious activities reportssecurities by banks, brokers and dealers if they believe a client may beviolating U.S. laws and regulations.

 

The Bank is unable to predict the impact of such law on its financialcondition and results of operations at this time and does not expect theadditional reporting and record keeping to add a material burden in terms ofdirect expense or in staff/officer time for monitoring account activity.

 

**California Corporate Disclosure Act**

 

The California Corporate Disclosure Act, effective January 1, 2003,amends the Corporations Code by requiring additional public disclosures by“publicly traded companies,” including domestic and foreign corporations,qualified to transact intrastate business in California. 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 filewith the Secretary of State a statement, in the form prescribed, including thefollowing additional information:

 

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•             Name of independent auditor, descriptionof other services provided as specified, and date of the last audit, includinga copy of the report;

 

•             Annual compensation paid to each directorand executive officer;

 

•             Description of any loans made to anydirector at a preferential loan rate;

 

•             Statement indicating whether anybankruptcy has been filed by corporation executive officers or directors duringthe past 10 years;

 

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

 

•             Statement indicating whether thecorporation violated any federal security laws or any banking or security provisions of California law during theprevious 10 years for which the corporation was found liable in an actionbefore a federal or state court or regulatory agency or a self-regulatoryagency in which a judgment over $10,000 was entered.

 

**Sarbanes-Oxley Act of 2002**

 

The provisions of the Act became effective on July 30, 2002.  The purpose of this legislation includesprotection of investors by improving the accuracy and reliability of corporatedisclosures made pursuant to the securities laws.

 

The Act applies to issuers,****asdefined in the Act, which includes all SEC-Reporting companies, domestic orforeign.  Such public companies includebanks and bank holding companies but exclude banks which are wholly-ownedsubsidiaries of bank holding companies, or other wholly-owned affiliates ofbanks or bank holding companies.  TheAct also amended Section 12(i) of the Exchange Act to make it clear that thefederal banking agencies have the authority to administer and enforce variousprovisions of the Act applicable to banks which are public companies.  The FDIC Regulations incorporates throughthe regulations of the Securities and Exchange Commission (“SEC”) issued underspecified sections of the Exchange Act.  Some of the provisions of the Act are effective immediately, but mostprovisions require rulemaking by the SEC. The SEC must propose and adopt final rules for implementation of variousprovisions of the Act by the deadlines specified in the Act. The Act seeks toreform the accounting profession by establishing the Public Company OversightBoard, a self-regulatory, nonprofit corporation subject to SEC oversight(“Board”).  The Board is responsible foroverseeing the audits and auditors of public companies and participates in theestablishment of auditing standards relating to the preparation of auditreports for issuers.  The Board is to befully organized by April 26, 2003.

 

Each board of an insured bank (or its holding company) which is apublic company must comply with the additional requirements of the Act, as wellas continue to comply with the existing financial management requirements ofthe Federal Deposit Insurance Act.  TheSEC must adopt rules directing the national security exchanges and the NationalAssociation of Securities Dealers to prohibit listing any company that does notsatisfy the audit committee requirements. The audit committee must be composed of entirely “independent” directorsas defined in the Act.  “Independence”is defined to prohibit the director’s acceptance of any consulting, advisory orother compensatory fees from the issuer and being an affiliate of the issuer,or any subsidiary, thereof, subject to the exemption authority of the SEC andfederal banking agencies.  The auditcommittee is directly responsible for the appointment, compensation, andoversight of any registered public accounting firm engaged by the issuer.  Each audit committee has the authority toengage independent counsel and other advisors. This new authority under the Act is similar to the existing authority of“large bank” audit committees, as defined by the FDIC, to have access to itsown outside counsel.

 

The bank on loans to executive officers and directors does not apply toan issuer that is an insured depository institution, as defined in the FederalDeposit Insurance Act, if the loan is subject to the requirements of the

 

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insider lending restrictions of Section 22(h) of the Federal ReserveAct and the Federal Reserve Board’s Regulation O.

 

The SEC has required a “one time”certification from the 947 largest public companies, compelling the CEOs andCFOs to certify to the accuracy of disclosures when the next quarterly reportwas required to be filed.  There are alsotwo apparently divergent certification requirements, each requiring the CEOsand CFOs of public companies to certify that the financial statements containedin the company’s periodic reports fairly present in all material respects thefinancial condition and results of operations of the company, as well ascertification of other matters as required by each section.  A“knowing” and “willful” failure to comport with the requirements of Section 906results in criminal penalties.  Section906 is effective immediately.  The Act****alsorequires a company’s****CEO and CFO to certify that theperiodic report(s) do not contain any untrue statement of a material fact ormaterial omission, as well as other matters.

 

The Act makes it illegal for a company’s directors or officers to“fraudulently influence, coerce, manipulate, or mislead” an accountant for thepurpose of rendering the company’s audit report materially misleading. The SECmust adopt final rules by April 26, 2003.

 

The Act requires CEOs and CFOs to disgorge bonuses, other incentive- orequity-based compensation and profits where an accounting restatement isrequired due to material noncompliance of the issuer with any financialreporting requirement under the securities laws as a result of misconduct. Thisrequirement is subject to the exemption authority of the SEC.

 

This section prohibits executiveofficers and directors from acquiring or transferring company equity securitiesduring pension fund “black out” periods. “Blackout period” means a period ofmore than three business days during which trading in a company retirement planis suspended.

 

The SEC must issue rules requiring each issuer to disclose in periodicreports, whether or not it has adopted a code of ethics for senior financialofficers.

 

The Act gives the SEC the authority to bar an individual from servingas an officer or director of a public company upon a finding that theindividual is “unfit” to serve. Section 1105 gives the SEC authority in anadministrative cease and desist proceeding to bar an individual who has violatedthe anti-fraud provisions of the Securities Act and/or the Exchange Act fromacting as a director or officer of any public company, if the individual’sconduct demonstrates unfitness to serve.

 

Public companies must provide in periodic reports and other reportsfiled with the SEC enhanced disclosures in pro forma financial statements andof off balance sheet transactions, include an internal control report in theannual report, provide accelerated reporting of certain management purchasesand sales of securities, and disclose material changes in financial conditionor operations on a rapid and currentbasis.

 

The Act creates a new federal felony with a 25 year maximum penalty fordefrauding shareholders of publicly traded companies.

 

The Company and Bank are unable to predict the impact of such law onits financial condition and results of operations at this time.

 

**Factors That May Affect Future Results of Operations**

 

In addition to the other information contained in this Report, thefollowing risks may affect the Company or Bank.  If any of these risks occur, the Company’s or Bank’s business,financial condition or operating results could be adversely affected.

 

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**Dependence on Real Estate**

 

A significant portion ofthe loan portfolio of the Bank is dependent on real estate. At December 31,2002, real estate served as the principal source of collateral with respect toapproximately 68 percent of the Bank’s loan portfolio. A decline in currenteconomic conditions or rising interest rates could have an adverse effect onthe demand for new loans, the ability of borrowers to repay outstanding loans,the value of real estate and other collateral securing loans and the value ofreal estate owned by the Bank, as well as the Company’s financial condition andresults of operations in general and the market value of the Company’s commonstock. Acts of nature, including earthquakes and floods, which may cause uninsureddamage and other loss of value to real estate that secures these loans, mayalso negatively impact the Company’s financial condition.  See Concentrations in Managements’Discussion and Analysis of Financial Condition and Results of Operations

 

**Interest Rate Changes**

 

The earnings of theCompany and the Bank are substantially affected by changes in prevailinginterest rates. Changes in interest rates affect the demand for new loans, thecredit profile of existing loans, the rates received on loans and securitiesand the rates the Bank must pay on deposits and borrowings. The differencebetween the rates the Bank receives on loans and securities and the rates itmust pay on deposits and borrowings is known as the interest rate spread. Giventhe Bank’s current volume and mix of interest-bearing liabilities and interest-earningassets, the Bank’s interest rate spread can be expected to increase when marketinterest rates are rising, and to decline when market interest rates aredeclining. Although the Bank believes its current level of interest ratesensitivity is reasonable, significant fluctuations in interest rates may havean adverse impact on the Company’s and the Bank’s business, financial conditionand results of operations.

 

**Competition**

 

Competition may adverselyaffect the Bank’s performance. The financial services business in the Bank’smarket area is highly competitive and becoming more so due to changes inregulation, technological advances and the accelerating pace of consolidationamong financial service providers. The Bank faces competition both in attractingdeposits and in making loans. It competes for loans principally through theinterest rates and loan fees it charges and the efficiency and quality of theservices it provides. Increasing levels of competition in the banking andfinancial services businesses may reduce the Bank’s market share or cause theprices it charges for its services to fall. The Company’s results may differ infuture periods depending on the nature or level of competition by financialservices providers.

 

**Regulation**

 

The Company and the Bankare subject to government regulation that could limit or restrict theiractivities, adversely affecting operations. The financial services industry isheavily regulated. Federal and state regulation is designed to protect thedeposits of consumers, not to benefit shareholders. 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. Government policy and regulation, particularlyas implemented through the Federal Reserve Board, significantly affects creditconditions for the Bank.

 

**Borrowers’ Failure to Perform**

 

A significant number ofthe Bank’s borrowers and guarantors may fail to perform their obligations asrequired by the terms of their loans, resulting in losses for the Bank. TheBank has adopted underwriting and credit policies, and loan monitoringprocedures, including the establishment and monitoring of allowances for creditlosses. Management believes these provisions are reasonable and adequate, andshould keep credit losses within expected limits by assessing the likelihood ofnonperformance, tracking loan performance and diversifying the creditportfolio. However, these policies and procedures may not be adequate toprevent unexpected losses that could materially and adversely affect theCompany’s results of operations.

## ** **

## **17**

## ****

##  

## **ITEM 2.**                 DESCRIPTION OF PROPERTIES

## ** **

## **The Bank and the Company occupy aproperty owned by the Bank at 581 Higuera Street, San Luis Obispo, California93401, where the Bank’s main office is located. The property, consisting ofapproximately 21,850 sq. ft., was purchased from an unaffiliated third partyfor $976,449. The Bank purchased and installed the modular facility beingutilized as the banking facility for a total of $250,846, plus improvements of$466,209.**

 

On August 8, 1998, theBank opened a loan production office at 1226 Park Street, Paso Robles,California 93446. This office became a full service branch in April, 1999. TheBank leases approximately 3,000 sq. ft. at $1,925 per month. The term of thelease is five years, and the Bank has an option to renew the lease for twoadditional five-year periods.

 

The Bank moved itsadministrative office from 570 Higuera Street to 569 Higuera in June 2001. Thenew offices have approximately 1,950 square feet with five year lease at a costof $3,315 per month. There are two additional option periods of five yearseach.  The administration office islocated immediately next to the Bank’s main office.

 

On December 15, 2000, theBank opened a loan production office at 154 West Branch Street, Arroyo Grande,California 93420. This office was converted to a full service branch in mid2002.  The lease is for approximately2,000 sq. ft. at $2,392 per month, plus common area operating expenses. Theterm of the lease is five years, and the Bank has an option to renew the leasefor two additional sixty-month periods.

 

In June 2002, the Bankleased premises at 671 Tefft Street, Nipomo under a five year lease at a costof $3,125 per month with approximately 2,500 square feet.  This lease has one five year option period.

 

For the years endedDecember 31, 2002 and 2001, the Bank’s total occupancy costs were $279,070 and$244,163, respectively. In the opinion of management, the premises are adequatefor the Bank’s purposes and the Bank has sufficient insurance to cover itsinterest in the premises.  With recentstaffing increases, the Bank is seeking some additional space foradministrative staff.

## ** **

## **ITEM 3.      LEGALPROCEEDINGS**

 

The Company and the Bankare, from time to time, subject to various pending and threatened legal actionswhich arise out of the normal course of its business. Neither the Company northe Bank is a party to any pending legal or administrative proceedings (otherthan ordinary routine litigation incidental to the Company’s or the Bank’sbusiness) and no such proceedings are known to be contemplated.

 

There are no materialproceedings adverse to the Company or the Bank to which any director, officer,affiliate of the Company or 5 % shareholder of the Company or the Bank, or anyassociate of any such director, officer, affiliate or 5% shareholder of theCompany or Bank is a party, and none of the above persons has a materialinterest adverse to the Company or the Bank.

 

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## **ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

No matters were submittedto a vote of security holders during the fourth quarter of 2002.

 

# **PARTII**

 

## **ITEM 5.            MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

**Market Information**

 

The Company’s commonstock has traded infrequently in the over-the-counter market under the symbol“MISS.” The Company’s Common Stock is not listed on any exchange or market.However, Hoefer & Arnett, Brookstreet Securities, Seideler Companies andWedbush Morgan Securities make a market in the Company’s Common Stock. Certaininformation concerning the Common Stock is reported on the NASDAQ electronicbulletin board.

 

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

 

|               |   | **Bid Prices** |   |
|--------------------|--------|----------------|--------|
| **Quarter  Ended** |   | **Low**        |   | **High** |   |
|               |   |           |   |   |   |
| 2001               |   |           |   |   |   |
| March  31          |   | $              | 7.89   |   | $ | 9.25 |   |
| June  30           |   | 7.50           |   | 9.25 |   |
| September  30      |   | 8.10           |   | 12.00 |   |
| December  31       |   | 8.55           |   | 12.00 |   |
|               |   |           |   |   |   |
| 2002               |   |           |   |   |   |
| March  31          |   | 6.75           |   | 10.00 |   |
| June  30           |   | 7.06           |   | 10.30 |   |
| September  30      |   | 8.00           |   | 11.30 |   |
| December  31       |   | 10.30          |   | 12.00 |   |
|                    |        |                |        |  |  |  |  |

 

**Holders**

 

As of March 1, 2003, there were approximately 363 holders of theCompany’s Common Stock.

 

**Dividends**

 

The Company is a legal entity separate and distinct from the Bank.  The Company’s shareholders are entitled toreceive dividends when and as declared by its Board of Directors, out of fundslegally available therefore, subject to the restrictions set forth in the inthe 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,

 

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a corporation may nevertheless make a distribution to its shareholdersif it meets two conditions, which generally stated are as follows: (i) thecorporation’s assets equal at least 1-1/4 times its liabilities, and (ii) thecorporation’s current assets equal at least its current liabilities or, if theaverage 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 1-1/4 times its currentliabilities.  The Company was eligibleto pay dividends at the end of 2002.

 

The availability of operating funds for the Company and the ability ofthe Company to pay a cash dividend depends largely on the Bank’s ability to paya cash dividend to the Company.  The paymentof cash dividends by the Bank is subject to restrictions set forth in theNational Bank Act.  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 national 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 such bank’s net profits, forthe preceding half year in the case of quarterly or semi-annual dividends, orthe preceding two half-years in the case of an annual dividend, are transferredto its surplus fund each time dividends are declared.  The approval of the OCC is required if the total of all dividendsdeclared by a national bank in any calendar year exceeds the total of its netprofits for that year combined with its retained net profits of the twopreceding years, less any required transfers to surplus or a fund for theretirement of any preferred stock. Furthermore, the OCC also has authority to prohibit the payment ofdividends by a national bank when it determines such payment to be an unsafeand unsound banking practice..

 

Additionally, bank regulatory agencies have authority to prohibit banksfrom engaging in activities that, in their respective opinions, constituteunsafe and unsound practices in conducting its business.  It is possible, depending upon the financialcondition of the bank in question and other factors, that the bank regulatoryagencies could assert that the payment of dividends or other payments might,under some circumstances, be an unsafe or unsound practice.  Further, the bank regulatory agencies 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 and considering minimum regulatory capitalrequirements, the bank was eligible to pay dividends in 2002

 

Acknowledging its fifth year of successful operation, the Companydeclared and paid a cash dividend on December 23, 2002 to shareholders ofrecord on December 9, 2002, in the amount of $0.10 per share on its 630,166shares of Common Stock outstanding, $0.05 per share on its 100,000 shares ofSeries A Preferred Stock outstanding, and $0.10 per share on its 20,500 sharesof Series B Preferred Stock outstanding, comprising a distribution in the aggregateamount of approximately $70,068.

 

The Bank paid a corresponding dividend in the total amount of $70,068to the Company in December 2002.

 

Prior to the December 2002 dividend, no dividends have been paid by theBank or Company and whether or not stock or cash dividends will be paid in thefuture by the Company and/or the Bank will be determined by the Board ofDirectors after consideration of various factors including but not limited toprofitability, regulatory capital ratios, and other financial conditions.Additionally, certain provisions of the preferred stock restrict the ability ofthe Company to pay cash dividends unless the required dividends on thepreferred stock are also paid.

 

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**Issuanceof Preferred Stock**

 

**Series A Non-Voting Convertible Redeemable Preferred Stock**

 

On December 29, 2000, the Company issued 100,000 shares of preferredstock to the Community Development Financial Institutions Fund, a division ofthe U.S. Treasury Department (“CDFI”), for $500,000.  Such shares of preferred stock were designated as “Series ANon-Voting Convertible Redeemable Preferred Stock” and have identical rightsand privileges in every respect to Common Stock except that they arenon-voting.  The dividend rightsattributable to the holders of “Non-Voting Convertible Redeemable PreferredStock” are proportioned to those of the holders of the Common Stock based upontwo for one conversion ratio set forth below; that is, the Non-VotingConvertible Redeemable Preferred Stock participates on a per share basis in anydividend declared on Common Stock at the rate of one-half of the per sharecommon dividend, but are not entitled to any fixed rate of return (zero percentcumulative).  This Non-VotingConvertible Redeemable Preferred Stock may be converted into Common Stock ofthe Company on a two-for-one exchange (and 50,000 shares if Common Stock shallbe set aside and reserved by the Company for such purpose) at any time upon therequest of a holder of such Non-Voting Convertible Redeemable Preferred Stockupon or after the transfer of Non-Voting Convertible Redeemable Preferred Stockby the initial holder thereof.  In theevent the Company is liquidated, for any reason, the holders of Non-VotingConvertible Redeemable Preferred Stock shall be entitled to a liquidationpreference of Five Dollars ($5.00) per share before holders of Common Stockreceive any distribution and after the holders of Common Stock receive TenDollars ($10.00) per share, any further distributions on Non-Voting ConvertibleRedeemable Preferred Stock and Common Stock shall be at the ratio of One Dollar($1.00) per share on the Non-Voting Convertible Redeemable Preferred Stock toTwo Dollars ($2.00) per share for Common Stock.  If the Common Stock is subdivided, combined or reclassified, theNon-Voting Convertible Redeemable Preferred Stock****shall be subdivided,combined or reclassified on the same basis. The holders of the Non-Voting Convertible Redeemable Preferred Stockshall have no right to vote any such shares except as may be required byapplicable law.

 

The Non-Voting Convertible Redeemable Preferred Stock shall beautomatically redeemable, in whole or in part, at any time upon the request ofthe holder of such Non-Voting Convertible Redeemable Preferred Stock, in cashat the price of Five Dollars ($5.00) per share, without further action on thepart of the Company, upon and after a finding by the CDFI or its successor thatthe Company is in default under any Community Development Financial InstitutionsProgram Assistance Agreement****for Technical Assistance Grants to andEquity Investments in Regulated Institutions, or any successor agreement, towhich the Company is a party or by which it is bound.

 

The $500,000 in proceeds from the CDFI investments was included in theaudited financial statement of the Bank for the year-ended December 31, 1999because the CDFI award had occurred during such year.  When the proceeds from the sale of Non-Voting ConvertibleRedeemable Preferred Stock were received, $401,675 was invested as a capitalcontribution to the Bank with the remaining $98,325 used for expenses relatedto the transaction.

 

**Series B Non-Voting Preferred Stock**

 

On December 29 2000, the Company issued 29,500 shares of Common Stockand 20,500 shares of preferred stock to National Community Investment Fund(NCIF), a private sector community development investment trust for thedistribution of community development funds at $10.00 per share for anaggregate of $500,000.  Such shares ofpreferred stock were designated as “Series B Non-Voting Preferred Stock” andhave rights and privileges similar to Common Stock except that they arenon-voting.  The dividend rightsattributable to the holders of the Series B Non-Voting Preferred Stock areproportioned to those of the holders of the Common Stock; that is, the Series BStock participates on a per share basis in any dividend declared on CommonStock, but such Stock is not entitled to any fixed rate of return (zero percentcumulative).  The Series B Non-VotingPreferred Stock is not convertible or redeemable.  ** **If the Common Stock issubdivided, combined or reclassified, the Series B Non-Voting Preferred Stock****shallbe subdivided, combined or reclassified on the same basis.

 

21

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In the event the Company is liquidated, for any reason, the holders ofSeries B Non-Voting Preferred Stock shall be entitled to a liquidationpreference of Ten Dollars ($10.00) per share before holders of Common Stockreceive any distribution but such liquidation preference is junior in right ofpayment to the liquidation preference for the Series A Non-Voting ConvertibleRedeemable Preferred Stock discussed above. Additionally, in the event of a so-called “change in control event” (includingcertain mergers, sales of assets or tender offers), holders of the Series BNon-Voting Preferred Stock shall be entitled to receive a payment in the sameform of consideration and in the same amount as the per share price received,or deemed to be received, by the holders of the common stock of the Company inor as a result of the “change in control event.”

 

When the proceeds from the sale of Series B Non-Voting Preferred Stockwere received, $475,000 was invested as a capital contribution to the Bank withthe remaining $25,000 used for expenses related to the transaction.

 

The sales of the Non-Voting Convertible Redeemable Preferred Stock andthe Series B Non-Voting Preferred Stock were made in reliance on the exemptionprovided in Section 4(2) of the Securities Act of 1933.

 

**Series C Non-voting Convertible Redeemable Preferred Stock**

 

On December 18, 2002, the Company issued 50,000 shares of preferredstock to the Community Development Financial Institutions Fund, for$500,000.  Such shares of preferredstock were designated as “Series C Non-Voting Convertible Redeemable PreferredStock” and have identical rights and privileges in every respect to CommonStock except that they are non-voting.  The dividend rights attributed to Series C Preferred Stock are equal tothe amount of the dividend that would be payable on the shares of Common Stock.The Series C Preferred Stock shall not be entitled to any fixed rate ofreturn.  Each share of Series CPreferred Stock may converted, at the option of the holder thereof, at any timeat or after the sale, transfer or other disposition (whether or not for value)by CDFI (other than to an affiliate of CDFI) of such shares of Series CPreferred Stock into such number of fully paid and nonassessable shares of CommonStock of the Company as is determined by dividing $10.00 by the then effectiveConversion Price. In the event of any liquidation, dissolution or winding up ofthe Company, either voluntary or involuntary, the holders of the Series CPreferred Stock shall not be entitled to receive, from any of the assets orsurplus funds of the Company legally available for distribution, any payment ordistribution until payment in full of all preferential amounts provided for inPrior Stock of the Company. In the event of any liquidation, dissolution orwinding up of the Company, for any reason, the holders of the Series CPreferred Stock shall be entitled to receive, prior and in preference to anydistribution of any of the assets or surplus funds of the 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 CommonStock is subdivided, combined or reclassified , the Series C Preferred Stockshall be subdivided, combined or reclassified on the same basis.

 

Subject to the receipt of any required regulatory approval, the SeriesC Preferred Stock shall be automatically redeemable, in whole or in part, atany time upon the request of the holder of the Series C Preferred Stock, incash at the price of $10.00 per share, without further action on the part ofthe Company, upon and after a finding by the Community Development FinancialInstitutions Fund, or its successor agency or entity, that the Company is indefault under any Community Development Financial Institutions ProgramAssistance Agreement for Equity Investments in Regulated Institutions, or anysuccessor agreement, to which the Company is a party or by which it isbound.   No sinking fund will beestablished for the redemption of shares of the Series C Preferred Stock.

 

22

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The $500,000 proceeds from the Series Preferred Stock were used toprovide a $400,000 equity contribution to the Bank with the remainder used torepay Company borrowings and to provide the Company with cash flow.

 

**NewMarkets Tax Credits**

 

On August 27, 2002, Mission Community Bancorp and Mission CommunityBank announced the filing of an application for an allocation of $10 million inNew Markets Tax Credits.  The NewMarkets Tax Credit Program is designed to encourage investments in low-incomecommunities by offering tax credits to investors who bring new capital tospecially accredited community development entities, or CDEs, such as the Bankand the Company.  The CDEs, in turn,must use the new capital to provide investment capital or loans for qualifiedactive low-income community businesses. The New Markets Tax Credit Program is being administered by theCommunity Development Financial Institutions Fund, a branch of the TreasuryDepartment.  Up to $2.5 billion in newmarkets tax credits will be made available, on a competitive basis, for theyear 2002.  The program providesinvestors 39% in tax credits over a seven-year period.  On March 13, 2002, the Company was advisedthat it would not receive an allocation under the NMTC program.

 

The Company and the Bank anticipate that they will continue during 2003and in subsequent years to seek investments from CDFI, NCIF and otherinstitutions which invest in community development financial institutions inorder to support the capital for community development investmentpurposes.  Such investment may be in theform of common and/or preferred stock. The Company is authorized to issue an additional 369,824 shares ofCommon Stock and up to 829,500 shares of preferred stock without shareholderapproval.

 

On March 13, 2003, the Company was advised that it was a successfulawardee in the 2002 WMTC allocation awards. The Company is eligible to continue to apply in future rounds ofallocations.

 

 

23

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| **ITEM 6.** |   | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS  OF OPERATION** |
|-------------|--------|------------------------------------------------------------------------------------------------|

 

**Significant Critical AccountingPolicies**

 

Following is a summary of the Bank’s significant accounting policies,which are described more fully in the financial statements:

 

**Use of Estimates in the Preparation of Financial Statements**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requires theBank’s management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Note A to the Financial Statements describesthe significant accounting policies used in the preparation of the FinancialStatements.

 

A critical accounting policy is defined as one that is both material tothe presentation of the Company’s financial statements and requires managementto make difficult, subjective or complex judgments that could have a materialeffect on the Company’s financial condition and results of operations.  Management believes that the following arecritical accounting policies.

 

**Allowance for Loan Losses**

 

The allowance for possible loan losses is increased by charges toincome and decreased by charge-offs (net of recoveries).  Monthly detailed reviews are performed toidentify the risks inherent in the loan portfolio, assess the overall qualityof the loan portfolio and to determine the adequacy of the allowance for loanlosses and the related provision for loan losses to be charged to expense.  Loans identified as less than “acceptable”are reviewed individually to estimate the amount of probable losses that needto be included in the allowance.  Thesereviews include analysis of financial information as well as evaluation ofcollateral securing the credit. Additionally, management considers the inherent risk present in the“acceptable” portion of the loan portfolio taking into consideration historicallosses on pools of similar loans, adjusted for trends, conditions and otherrelevant factors that may affect repayment of the loans in these pools.

 

**Stock-Based Compensation**

 

SFAS No. 123*, “Accounting for Stock-Based Compensation”,*encourages, but does not require, companies to record compensation cost forstock-based employee compensation plans at fair value.  The Company has chosen to continue toaccount for stock-based compensation using the intrinsic value methodprescribed in APB Opinion No. 25, “*Accounting for Stock Issued to Employees”,*and related Interpretations. Accordingly, compensation cost for stock options is measured as theexcess, if any, of the quoted market price of the Company’s stock at the dateof the grant over the amount an employee must pay to acquire the stock.

 

24

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**SelectedFinancial Data**

 

The following is selected consolidated financial data with respect tothe Company’s statement of financial position for the three years ended December31, 2002 and 2001. The information presented has been derived from the auditedconsolidated financial statements included in Item 7 of this Form 10-KSB.  This information should be read inconjunction with such consolidated financial statements and the notes thereto.

 
|                                                |   | **Year ended  December 31,** |   |
|-----------------------------------------------------|--------|------------------------------|--------|
| **(Dollars in thousands)**                          |   | **2002**                     |   | **2001** |   |
| Summary of  Operations                              |   |                         |   |   |   |
| Interest Income                                     |   | 5,575                        |   | 5,360 |   |
| Interest Expense                                    |   | 1,730                        |   | 2,143 |   |
| Net Interest  Income                                |   | 3,845                        |   | 3,217 |   |
| Provision for  Loan Losses                          |   | 132                          |   | 280 |   |
| Net Interest  Income After Provision                |   | 3,713                        |   | 2,937 |   |
| Noninterest  Income                                 |   | 1,359                        |   | 1,514 |   |
| Noninterest  expense                                |   | 3,805                        |   | 3,431 |   |
| Income Before  Taxes                                |   | 1,267                        |   | 1,020 |   |
| Income Tax                                          |   | 515                          |   | — |   |
| Net Income                                          |   | 752                          |   | 1,020 |   |
| Per Share Data                                      |   |                         |   |   |   |
| Net Income –  Basic                            |   | $                            | 1.07   |   | $ | 1.46 |   |
| Net Income -  Diluted                               |   | $                            | 1.05   |   | $ | 1.46 |   |
| Number of Shares  Basic                             |   | 701,671                      |   | 700,506 |   |
| Number of Shares  Diluted                           |   | 716,261                      |   | 700,506 |   |
| Balance Sheet  Data – At Period End            |   |                         |   |   |   |
| Total Assets                                        |   | 99,008                       |   | 79,891 |   |
| Total Loans                                         |   | 65,187                       |   | 60,462 |   |
| Allowance for  Loan Losses                          |   | 744                          |   | 635 |   |
| Investment  Securities                              |   | 11,891                       |   | 10,835 |   |
| Total Deposits                                      |   | 87,505                       |   | 71,684 |   |
| Total  Shareholders’ Equity                    |   | 7,949                        |   | 6,774 |   |
| Operating Ratios  and Other Selected Data           |   |                         |   |   |   |
| Return on  Average Assets                           |   | 0.8                          | %      | 1.4 | % |
| Return on  Average Equity                           |   | 10.6                         | %      | 17.4 | % |
| Dividend Payout  Ratio                              |   | 9.0                          | %      | 0.0 | % |
| Operating  Efficiency Ratio                         |   | 73.1                         | %      | 72.5 | % |
| Net Interest  Margin                                |   | 4.6                          | %      | 4.8 | % |
| Average Equity  to Average Assets                   |   | 7.9                          | %      | 8.1 | % |
| Selected Asset  Quality Ratios – At Period End |   |                         |   |   |   |
| Nonperforming  Loans to Total Loans                 |   | 0.0                          | %      | 1.5 | % |
| Nonperforming  Assets to Total Assets               |   | 0.0                          | %      | 1.1 | % |
| ALL as a  Percentage of Nonperforming Loans         |   | na                           |   | 70.2 | % |
| ALL as a  Percentage of Total Loans                 |   | 1.14                         | %      | 1.05 | % |

 

25

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**History**

 

The Bank commenced operations in December 1997 as a full servicecommunity bank. The Bank also concurrently established Mission CommunityDevelopment Corporation (MCDC), a wholly-owned community developmentcorporation subsidiary.

 

The intent of the MCDC is to provide financing for small businesses andlow- to moderate-income area development based on funding pools from otherbanks.  MCDC currently provides loanservicing for the San Luis Obispo County Economic Vitality Corporation and hasone community development loan outstanding; however, as of December 31, 2002,the activities of MCDC are not material. Management has investigated providing loan processing for others andexpects to increase the number of loans serviced if and when it completesagreements for its services.

 

The Bank also has a close association with Mission Community ServicesCorporation (MCSC) which is a non-profit company, which until late 2002 wasinactive.  MCSC is expected to provideservices to Bank and non-Bank customers in the form of technical services andtraining services to the underserved segments of the community including smallbusinesses, minorities and low-income entrepreneurs.  As of December 31, 2002, the Bank has had no direct benefit fromits association with MCSC.  It isanticipated that MCSC will offer training and other support service for Bankcustomers, potential customers, and to the community at large beginning in2003.

 

The Bank operates as a traditional community bank, but has also used management’sexpertise to provide a selection of financial services identified as “communitydevelopment” activities with a focus on financial services to small businessesand business professionals.  TheDepartment of Treasury’s Community Development Institution Fund (CDFI) hascertified the Bank and the Company as a “community development financialinstitution(s)” (CDFI).  The Company andBank have received and used both grants and deposits under programs authorizedby CDFI and consistently review various options for both grants and depositprograms from various government and public/private entities.  See Item 5. - Market for Common Stock andRelated Stockholder Matters. The CDFI status is dependent on managements’ specializedknowledge of working with various governmental programs and requires a materialincrease in reporting and documentation.

 

In mid-2001, the Bank received a $990,000 cash award from the BankEnterprise Award (BEA) Program through the CDFI.  The Bank was awarded this cash payment for investing $3 millionin deposits in 2001 to 14 other certified Community Development FinancialInstitutions.  The deposits were for 3years and were made at below market rates to assist the other CDFI’s toincrease their financing activities. The Bank recognized income of $537,750 in2001 and deferred the remaining $452,250 over the next 30 months to approximatethe future earnings on the deposits compared to market rates.

 

The Company was organized in December 2000 to provide a vehicle tofacilitate raising capital from various organizations wishing to benefit fromthe Bank’s community development status.

 

#### **Basis of Presentation**

 

The following discussion and analysis is intended to assist in anunderstanding of the significant factors that influenced our consolidatedfinancial condition at December 31, 2002 and December 31, 2001. The followingdiscussion and analysis, which refers to the company on a consolidated basis,should be read in conjunction with the Company’s financial statements andcorresponding notes.  The Company isinactive except of minimal expenses and the financial information is primarilyreflective of the Bank.

 

26

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####  

**Assets**

 

The following table presents average balance sheet information for thetwo year ended December 31, 2002 and 2001:

 

**Distribution of Assets, Liabilities,and Stockholder’s Equity**

 
|                                                |   | **31-Dec-02**        |   | **31-Dec-01**     |   |
|-----------------------------------------------------|--------|----------------------|--------|-------------------|--------|
| **(dollars in thousands)**                          |   | **Average  Balance** |   | **%****of Total** |   | **Average  Balance** |   | **%****of Total** |   |
| Cash and Due From Banks                             |   | 2,623                |   | 2.9               | %      | 2,250 |   | 3.1 | % |
| Interest - Bearing  Deposits Other Banks            |   | 3,000                |   | 3.3               | %      | 1,706 |   | 2.4 | % |
| Investment securities                               |   | 12,105               |   | 13.5              | %      | 11,202 |   | 15.5 | % |
| Federal funds sold                                  |   | 5,568                |   | 6.2               | %      | 2,543 |   | 3.5 | % |
| Loans                                               |   | 63,229               |   | 70.5              | %      | 51,180 |   | 70.6 | % |
| Allowance for loan loss                             |   | (685                 | )      | -0.8              | %      | (466 | ) | -0.6 | % |
| Property, Premises, and  Equipment                  |   | 2,422                |   | 2.7               | %      | 2,455 |   | 3.4 | % |
| Other Investments                                   |   | 306                  |   | 0.3               | %      | 181 |   | 0.2 | % |
| Other Assets                                        |   | 1,178                |   | 1.3               | %      | 1,419 |   | 2.0 | % |
| Total Assets                                        |   | 89,747               |   | 100.0             | %      | 72,469 |   | 100 | % |
| Deposits:                                           |   |                 |   |              |   |   |   |   |   |
| Demand, non-interest-bearing                        |   | 13,851               |   | 15.4              | %      | 11,157 |   | 15.4 | % |
| Demand,  interest-bearing                           |   | 3,277                |   | 3.7               | %      | 2,987 |   | 4.1 | % |
| Savings                                             |   | 30,494               |   | 34.0              | %      | 27,965 |   | 38.6 | % |
| Time                                                |   | 32,153               |   | 35.8              | %      | 23,333 |   | 32.2 | % |
| Total deposits                                      |   | 79,776               |   | 88.9              | %      | 65,443 |   | 90.3 | % |
| Short-term Borrowings                               |   | 1,595                |   | 1.8               | %      | 157 |   | 0.2 | % |
| Other liabilities                                   |   | 1,262                |   | 1.4               | %      | 1,006 |   | 1.4 | % |
| Total  Liabilities                                  |   | 82,632               |   | 92.1              | %      | 66,606 |   | 91.9 | % |
| Common stock                                        |   | 6,855                |   | 7.6               | %      | 6,854 |   | 9.5 | % |
| Unrecognized gain on  Available-for-sale Securities |   | 58                   |   | 0.1               | %      | 52 |   | 0.1 | % |
| Accumulated deficit                                 |   | 201                  |   | 0.2               | %      | (1,043 | ) | -1.4 | % |
| Total  stockholders’ equity                    |   | 7,115                |   | 7.9               | %      | 5,863 |   | 8.1 | % |
| Total  liabilities and stockholders’ equity    |   | 89,747               |   | 100.0             | %      | 72,469 |   | 100.0 | % |

 

During 2002, total assets increased $19.0 million to $99.0 million atDecember 31, 2002 from $79.9 million at December 31, 2001 representing annualasset growth of 24%. This increase in assets was consistent with budgeted plansto continue to increase the volume of business in the Bank’s market area bycontinued business development in existing branches in San Luis Obispo and PasoRobles, from upgrading the Loan Production Office in Arroyo Grande in mid 2002,and by opening a new full service branch in July 2002 in Nipomo. The Bank isvery active in the local communities that it serves and its officers and staffmembers participate in a wide-range of business and community group activitiesas a means of both providing community support and to expand its businessdevelopment contacts.

 

**Analysisof Net Interest Income**

 

The following table presents, for the periods indicated, the totaldollar amounts of interest income from

 

27

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average interest-earning assets and the resultant yields. Alsopresented are the dollar amounts of interest expense and averageinterest-bearing liabilities, expressed both in dollars and in rates.Nonaccrual loans are included in the calculation of the average balances ofloans, and interest not accrued is excluded.

 
|                                  |   | **12/31/02**         |   | **31-Dec-01**        |   |
|---------------------------------------|--------|----------------------|--------|----------------------|--------|
| **(dollars in thousands)**            |   | **Average  Balance** |   | **Income/  Expense** |   | **Average  Yield or  Rate Paid** |   | **Average  Balance** |   | **Income/  Expense** |   | **Average  Yield or  Rate Paid** |   |
|                                  |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:             |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits in banks   |   | 3,000                |   | 103                  |   | 3.43 | % | 1,706 |   | 60 |   | 3.52 | % |
| Investment  securities                |   | 12,105               |   | 667                  |   | 5.51 | % | 11,202 |   | 684 |   | 6.11 | % |
| Federal funds  sold                   |   | 5,568                |   | 84                   |   | 1.51 | % | 2,543 |   | 96 |   | 3.78 | % |
| Loans                                 |   | 63,229               |   | 4,721                |   | 7.47 | % | 51,180 |   | 4,520 |   | 8.83 | % |
| Total  Interest-earning assets        |   | 83,903               |   | 5,575                |   | 6.64 | % | 66,631 |   | 5,360 |   | 8.04 | % |
|                                  |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:        |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Deposits:                             |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Demand,  interest-bearing             |   | 3,277                |   | 35                   |   | 1.07 | % | 2,987 |   | 63 |   | 2.11 | % |
| Savings                               |   | 30,494               |   | 690                  |   | 2.26 | % | 27,965 |   | 944 |   | 3.38 | % |
| Time                                  |   | 32,153               |   | 960                  |   | 2.99 | % | 23,333 |   | 1,125 |   | 4.82 | % |
| Borrowings                            |   | 1,595                |   | 45                   |   | 2.82 | % | 157 |   | 11 |   | 7.01 | % |
| Total  interest-bearing liabilities   |   | 67,519               |   | 1,730                |   | 2.56 | % | 54,442 |   | 2,143 |   | 3.94 | % |
|                                  |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Net interest  income and yield:       |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Net Interest  income                  |   |                 |   | 3,845                |   |   |   |   |   | 3,217 |   |   |   |
| Net yield on  interest-earning assets |   |                 |   |                 |   | 4.58 | % |   |   |   |   | 4.83 | % |

 

#### **Net Interest Income**

 

The principal component of earnings is net interest income.  Net interest income is the differencebetween the interest earned on loans and investments and the interest paid ondeposits and other interest-bearing liabilities.

 

Net interest income is affected by changes in the amount and mix of ourinterest-earning assets and interest-bearing liabilities, referred to as a“volume change”.  It is also affected bychanges in the yields we earn on interest-earning assets and rates we pay oninterest-bearing deposits and other borrowed funds, referred to as a “ratechange”.

 

The following table sets forth changes in interest income and interestexpense for each major category of interest-earning assets and interest-bearingliabilities, and the amount of change attributable to volume and rate changesfor the years indicated. Changes not solely attributable to rate or volume havebeen allocated to volume and rate changes in proportion to the relationship ofthe absolute dollar amounts of the changes in each.

 

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|                           |   | **Year Ended  December 31, 2002  over  Year Ended December 31, 2001** |   |
|--------------------------------|--------|-----------------------------------------------------------------------|--------|
|                           |   | **Increase (Decrease)  Due to Change**                                |   |
| **(dollars in thousands)**     |   | **Volume**                                                            |   | **Rate** |   | **Change** |   |
| Interest-Bearing  Assets:      |   |                                                                  |   |   |   |   |   |
| IBA other Banks                |   | 47                                                                    |   | (4 | ) | 43 |   |
| Investments                    |   | 53                                                                    |   | (70 | ) | (17 | ) |
| Federal funds  sold            |   | 160                                                                   |   | (172 | ) | (12 | ) |
| Loans                          |   | 1,163                                                                 |   | (962 | ) | 201 |   |
| Total Interest  Income         |   | 1,423                                                                 |   | (1,208 | ) | 215 |   |
|                           |   |                                                                  |   |   |   |   |   |
| Interest-Bearing  Liabilities: |   |                                                                  |   |   |   |   |   |
| Demand,  interest-bearing      |   | 7                                                                     |   | (35 | ) | (28 | ) |
| Savings                        |   | 91                                                                    |   | (345 | ) | (254 | ) |
| Time                           |   | 506                                                                   |   | (671 | ) | (165 | ) |
| Borrowings                     |   | 157                                                                   |   | (123 | ) | 34 |   |
| Total Interest  Expense        |   | 761                                                                   |   | (1,174 | ) | (413 | ) |
|                           |   |                                                                  |   |   |   |   |   |
| Increase in                    |   |                                                                  |   |   |   |   |   |
| Net Interest  Income           |   | 662                                                                   |   | (34 | ) | 628 |   |

 

#### **Year Ended December 31,2002 Compared to December 31, 2001**

 

For the year ended 2002, net interest income increased by approximately$628,000 or 20% compared to the year ended 2001.  This increase was almost evenly split by increases between totalincreases in interest income of $215,000 and decreases in interest expenses of$413,000.  Changes in interest ratesplayed a very important role in 2002 as rates dropped from low levels in 2001to a forty plus year record low by the end of 2002.  Given the deposit composition of the Bank which tends to rely onsavings accounts which are more responsive to rate changes than time deposits,increased focus on loan pricing, and volume increases, the Bank was able tominimize much of the rate shock.

 

Three trends in 2002 are of note when considering average balances andnet interest income.  First, loanvolumes continued to increase as the Bank continued its expansion – averageloans volume increased by $12 million or 23.5%.  However, this trend based on averages tends to overstate loangrowth with a substantial slowing in loan demand and a high volume of ratebased refinancing at the end of the year. Second, while Federal Funds Sold (FFS) increased on average by $3million or 119.0%, FFS at the end of the year totaled $12 million compared toborrowing of FFS at the end of 2001. This shift in earning assets from loans to FFS at the end of the year isexpected to increase the pressure on net interest income in 2003.  Third, the Bank implemented a strategicchange in deposit pricing in 2002 and increased CDs by $8.8 million or 37.8%.Average savings accounts only increased by $2 million or 9.0%.  This deposit trend change continued as ofthe end of 2002 with savings accounts as a percent of total deposits droppingfrom 65% in 2000, to 44% in 2001 and to 41% at the end of 2002.  The Bank expects to continue to see growthin CDs in preparation for future rate increase in late 2003 or 2004 but willcontinue to use its savings products more aggressively than most other banks.

 

The Bank continues to use its status as a CDFI to attract lower costdeposits from investors who recognize the Bank’s contribution to communitydevelopment.  Deposits included theState of California and a number of insurance companies who operate inCalifornia.  CDFI related CDs totalapproximately $6.5 

 

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million as of December 31, 2002 with the largest concentration of $4.5million from the State of California.

 

**Provisionfor Loan Losses**

 

The Bank makes provisions for loan losses when required to bring thetotal allowance for loan losses to a level deemed appropriate. Thedetermination 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 amount provided for loan losses is charged to earnings. Theprovision for loan losses was $132,000 for 2002 compared to $280,000 for 2001.

 

The decrease in the provision in 2002 is consistent with slower loangrowth and improved credit quality (loans increased by just $4.8 million or7.9% in 2002 compared to $17.3 million or 40.1% in 2001).  The Bank also noted a material improvementin credit quality and credit administration in 2002.  See — Asset Quality.

 

#### **Noninterest Income**

 

Noninterest Income decreased in 2002 from $1,514,000 to $1,359,000 or adecrease of $155,000 (10.2%) with two specific items accounting for thedecrease.  The Bank outsourced itsmerchant credit card processing in 2002 and accounted for merchant card incomeon a net basis in 2002 while using gross income in 2001.  The change in processing and accountingresulted in a comparative decrease in income in 2002 of $265,000 (net income in2002 of $43,000 versus gross income in 2001 of $308,000).  The Bank recorded $537,750 in non-interestincome for 2001 based on a $990,000 award from the Banker Enterprise Awardprogram under the Department of Treasury’s CDFI program.  This income/award was based on the Bankmeeting its investment goals by investing $3 million in other CDFIs at belowmarket rates.  The balance of the awardfunds are being accrued to income based on a yield formula with income in 2002of $183,000. The change in BEA income on a comparative basis is a decrease of$354,000 in 2002.  Income from the BEAaward will accrue until June 2004 at the rate of approximately $15,000 permonth.

 

Discounting the change in accounting for merchant card and cardprocessing, other service charges and fees increased in 2002 by approximately$171,000.  Approximately $100,000 ofthis increase was from brokering loans to another financial institution and theremainder was from normal increase in fee income.  The Bank expects to continue to work with other financialinstitutions to broker loans that do not fit within the Bank’s portfolio.

 

SBA lending remains the Bank’s most active lending area and sales ofSBA loans generated $632,000 in fee income in 2002 compared to $338,000 theprior year.  The Bank has been andexpects to be a major SBA lender in the San Luis Obispo market area.

 

Fee and service charge income decreased by $94,000 or from $638,000 in2001 to $544,000 in 2002 primarily due to the change in merchant cardaccounting.

 

#### **Non interest Expense**

 

Non interest expense increased in 2002 by $374,000 or 10.9% compared tothe prior year or from $3,431,000 in 2001 to $3,805,000 in 2002.  This increase was due to increased staff andopening a new branch in Nipomo in the middle of 2002.  Salary expenses increased by $359,000 as the staff increased to47 as of December 2002 compared to 33 for the prior year.

 

Specific operating expenses that were new or reflective of a materialchange in 2002 included: lease expense which increased by $33,000 or 38% in2002; marketing, advertising, sponsorships, etc. which increased by $29,000 or25%;  office supplies and expensesincreased by $78,000 or 67% due to the new branches and general cost increases;director fees and expenses increased by $36,000 with the Bank paying directorfees for the first time; and loan processing fees increased by $57,000 as theBank outsourced loan documentation.

 

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Two areas showed material decreases in 2002: professional fees whichdecreased by $77,000 or 28% and merchant credit card processing which decreasedby $266,000 with processing expenses netted from card income.

 

#### **Income Taxes**

 

See Note G to the consolidated financial statements for moreinformation on income taxes.

#### ** **

#### **Liquidity Management**

 

The objective of our asset/liability strategy is to manage liquidityand interest rate risks to ensure the safety and soundness of the Bank and itscapital base, while maintaining adequate net interest margins and spreads toprovide an appropriate return to shareholders.

 

The Bank’s liquidity, which primarily represents the ability to meetfluctuations in deposit levels and provide for customers’ credit needs, ismanaged through various funding strategies that reflect the maturity structuresof the sources of funds being gathered and the assets being funded.  The Bank’s liquidity is further augmented bypayments of principal and interest on loans and increases in short-termliabilities such as demand deposits, short-term certificates of deposit, andovernight purchases of federal funds. Short-term investments, primarily federal funds sold and federal fundlines of credit provided by our correspondent banks, are the primary means forproviding immediate liquidity.  In orderto meet the Bank’s liquidity requirements, the Bank endeavors to maintain anappropriate liquidity ratio.  Theliquidity ratio is equivalent to the sum of cash and deposits at other banks,interest-earning deposits at other banks, federal funds sold, and availableinvestment securities, divided by deposits.

 

As of December 31, 2002 and 2001, the Bank’s liquidity ratios were23.6% and 16.6%, respectively.  The Bankhad $12 million in Federal Funds Sold (immediate liquidly) on December 31, 2002but was in a net borrowing position on December 31, 2001 with zero FFS.  This material increase in liquidity wasconsistent with funding a large volume of loans at the end of 2001 while loanactivity was slow at the end of 2002.

 

As part of liquidity management, the Bank has $4 million in short-termfunding lines from correspondent banks. The lines are for short term needs and are generally not actively used.As of December 31, 2002, the Bank had outstanding borrowings from the FederalHome Loan Bank of San Francisco of $2,500,000. This was reduced to $1.5 million in January 2003 with the outstandingloans used to fund short and mid-term assets. The Bank has the potential on asecured basis to borrow up to 20 percent of its total assets or approximately$19.8 million from the FHLB.  The Bankanticipates utilizing FHLB borrowings in 2003 when needed as part of its normalliquidity management to cost effectively fund asset growth.

 

The Company’s liquidity is provided by a line of credits from PacificCoast Bankers’ Bank, from cash retained from stock offerings for expenses andworking capital, and from dividends from the Bank.  As of December 31, 2002, the Company had no borrowings under itsline of credit and received a cash dividend of $70,000 from the Bank.  The Company issued $500,000 in PreferredStock in December 2002 from a CDFI core award and proceeds for the stock wereused to contribute $400,000 to the Bank’s capital, to repay outstanding loans,and for short term cash needs and working capital.

 

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**InvestmentActivities**

 

Banks are permitted to purchase and own investment securities for bothyield and to balance the overall interest-rate sensitivities of its assets andliabilities. The Bank does not maintain a trading account.

 

Investment decisions are primarily made by the Bank’s Chief FinancialOfficer within policies limits established by the board of directors. The CFOreports investment activity on a monthly basis to the Board and on a quarterlybasis to the Investment Committee. Investments can include investment grade corporate securities, BBB-ratedmortgage-backed securities, federally insured certificates of deposit, U.S.treasury obligations and U.S. Government agency-backed securities.  Investment goals are to obtain the highestyield consistent with maintaining a stable overall asset and liability positionwhile 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. See Item 7 Note B — Investment Securities notes to consolidated financialstatements.

 

As of December 31, 2002, the book value of the Bank’s investmentsincluding stock ownership in the Federal Reserve Bank of San Francisco and theFederal Home Loan Bank, which totaled $338,000, was $12,229,000.  The following table presents the distributionof investments by sector (dollars in thousands), the stated due dates of theinvestments, and the weighted yield of the investments:

 
| **(dollars in thousands)**                        |   | **1 year or  less** |   | **1 - 5  years** |   | **5 - 10  years** |   | **after 10  years** |   | **Total** |   |
|---------------------------------------------------|--------|---------------------|--------|------------------|--------|-------------------|--------|---------------------|--------|-----------|--------|
| Investment  Portfolio Book Value:                 |   |                |   |             |   |              |   |                |   |      |   |
| US Treasury and  other U.S. Government agencies   |   | —              |   | 3,480            |   | 1,000             |   | 113                 |   | 4,593     |   |
| Mortgage Backed  Securities                       |   |                |   |             |   | 767               |   | 6,482               |   | 7,249     |   |
| Other Securities  including stock in FRB and FHLB |   |                |   |             |   |              |   | 387                 |   | 387       |   |
| Total                                             |   | —              |   | 3,480            |   | 1,767             |   | 6,982               |   | 12,229    |   |
|                                              |   |                |   |             |   |              |   |                |   |      |   |
| Weigted Average  Yield:                           |   |                |   |             |   |              |   |                |   |      |   |
| US Treasury and  other U.S. Government agencies   |   |                |   | 4.04             | %      | 5.44              | %      | 7.50                | %      | 4.67      | %      |
| Mortgage Backed  Securities                       |   |                |   |             |   | 5.90              | %      | 4.49                | %      | 4.63      | %      |
| Other Securities  including stock in FRB and FHLB |   |                |   |             |   |              |   | 5.00                | %      | 5.00      | %      |
|                                              |   |                |   |             |   |              |   |                |   |      |   |
| Weighted Average  Total                           |   |                |   | 4.04             | %      | 5.64              | %      | 4.57                | %      | 4.66      | %      |

 

Weighted average yields are stated on fully taxable basis, and the Bankdoes not have any tax-exempt investments. Investments in US Government and agency securities are generally limitedto $500,000 to $1,000,000 per issue and no corporate or other investments equalor exceed ten percent of the shareholders’ equity.

 

The Bank has structured the investment portfolio primarily withmortgage backed securities and callable agencies which provide monthly cashflows of approximately $300,000 to $500,000. Projected cash flows and expected call dates are included in thefollowing section on Asset Liability Management.

 

Management expects to maintain short term or floating rate investmentsin 2003 as a hedge against increasing interest rates once the economy begins toimprove with the expectation of increasing rates in late 2003 or 2004.

 

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**AssetLiability Management**

 

The objectives of interest rate risk management are to control exposureof net interest income to risks associated with interest rate movements in themarket, to achieve consistent growth in net interest income and to profit fromfavorable market opportunities.  Evenwith perfectly matched repricing of assets and liabilities, risks remain in theform of prepayment of assets, timing lags in adjusting certain assets andliabilities that have varying sensitivities to market interest rates and basisrisk.

 

The table below sets forth the interest rate sensitivity ofinterest-earning assets and interest-bearing liabilities as of December 31,2002, using the interest rate sensitivity gap ratio.  For purposes of the table, an asset or liability is consideredrate-sensitive within a specified period when it can be repriced or matureswithin its contractual terms.

 
| **(dollars in thousands)**             |   | **Up to 3  Months** |   | **>3  Months  < 1 Year** |   | **1 year to  5 Years** |   | **over  5 Years** |   | **Total** |   |
|----------------------------------------|--------|---------------------|--------|--------------------------------|--------|------------------------|--------|-------------------|--------|-----------|--------|
| Interest-Earning  Assets:              |   |                |   |                           |   |                   |   |              |   |      |   |
| Investments and  Stock in FHLB and FRB |   | 1,991               |   | 5,262                          |   | 3,838                  |   | 1,138             |   | 12,229    |   |
| CD’s other Banks                  |   | —              |   | —                         |   | 3,000                  |   | —            |   | 3,000     |   |
| FFS                                    |   | 12,295              |   | —                         |   | —                 |   | —            |   | 12,295    |   |
| Loans                                  |   | 55,218              |   | 6,401                          |   | 3,192                  |   | 376               |   | 65,187    |   |
| Total                                  |   | 69,504              |   | 11,663                         |   | 10,030                 |   | 1,514             |   | 92,711    |   |
| Interest-Bearing  Liabilities:         |   |                |   |                           |   |                   |   |              |   |      |   |
| Money Market and  Now Accounts         |   | 2,716               |   | —                         |   | —                 |   | —            |   | 2,716     |   |
| Savings                                |   | 36,065              |   | —                         |   | —                 |   | —            |   | 36,065    |   |
| Time Deposits                          |   | 12,209              |   | 18,559                         |   | 2,943                  |   | 9                 |   | 33,720    |   |
| Other Borrowings  (FHLB)               |   | 1,000               |   | 1,000                          |   | 500                    |   | —            |   | 2,500     |   |
| Total                                  |   | 51,990              |   | 19,559                         |   | 3,443                  |   | 9                 |   | 75,001    |   |
|                                   |   |                |   |                           |   |                   |   |              |   |      |   |
| Interest Rate  Sensitive Gap           |   | 17,514              |   | (7,896                         | )      | 6,587                  |   | 1,505             |   | 17,710    |   |
|                                   |   |                |   |                           |   |                   |   |              |   |      |   |
| Cumulative Gap  Sensitivity            |   | 17,514              |   | 9,618                          |   | (1,309                 | )      | 8,092             |   | 19,215    |   |
|                                   |   |                |   |                           |   |                   |   |              |   |      |   |
| Cumulative Gap  Ratio                  |   | 133.7               | %      | 113.4                          | %      | 28.9                   | %      | 15.4              | %      | 123.6     | %      |
|                                   |   |                |   |                           |   |                   |   |              |   |      |   |
| Cumulative Gap  to Total Assets        |   | 17.7                | %      | 9.7                            | %      | -1.3                   | %      | 8.2               | %      | 19.4      | %      |

 

Gap analysis attempts to capture interest rate risk, which isattributable to the mismatching of interest rate sensitive assets andliabilities.  The actual impact ofinterest rate movements on net interest income may differ from that implied byany gap measurement, depending on the direction and magnitude of the interestrate movements, the repricing characteristics of various on and off-balancesheet instruments, as well as competitive pressures.  These factors are not fully reflected in the foregoing gapanalysis and, as a result, the gap report may not provide a complete assessmentof our interest rate risk.

 

A negative cumulative gap value means that over the periods indicatedour liabilities will reprice slightly faster than our assets.  This means generally that, in a risinginterest rate environment, net interest income can be expected to decrease andthat, in a declining interest rate environment, net interest income can beexpected to increase. In actual practice, there is not a 100% correlationbetween the time the Federal Reserve changes rates and the time or amount of adeposit rate change by the Bank. This allows the bank to balance deposit ratesbased on funding needs rather than immediate changes in the market rates.

 

Based on current economic uncertainties with record low interest rates,discussion of possible further rate cuts, an economic “crisis” in California,and the geopolitical issues in the Middle East, the Bank expects to

 

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continue to position itself with short term assets andliabilities.  Strategies that are beingused include but are not limited to maintaining a majority of its loans on afloating basic, selling or brokering fixed rate long term loans, maintainingshort terms and adjustable rates for investments and closely monitoring depositrates and trends.  The Bank expects tosee a continued slowing in its growth in 2003 with higher liquidity andincreased pressures net income.

 

#### **Lending Activities**

 

The Bank originates purchases, sells loans, and participates in loansfrom other banks and structures loans for possible sale in the secondary market.

 

The following table sets forth the composition of our loan portfolio bytype of loan at the periods indicated:

 
|                          |   | **31-Dec-02** |   | **31-Dec-01** |   |
|-------------------------------|--------|---------------|--------|---------------|--------|
| **(dollars in thousands)**    |   | **Amount**    |   | **Percent**   |   | **Amount** |   | **Percent** |   |
| Loan Category:                |   |          |   |          |   |   |   |   |   |
| Commercial                    |   | 15,220        |   | 23.35         | %      | 19,781 |   | 32.72 | % |
| Agricultural                  |   | 2,324         |   | 3.57          | %      | 2,833 |   | 4.69 | % |
| Real Estate                   |   | 37,662        |   | 57.78         | %      | 22,797 |   | 37.70 | % |
| Construction                  |   | 6,539         |   | 2.90          | %      | 10,159 |   | 16.80 | % |
| Consumer Loans                |   | 1,891         |   | 2.90          | %      | 3,520 |   | 5.82 | % |
| Leases                        |   | 1,551         |   | 2.38          | %      | 1,371 |   | 2.27 | % |
| Total Loans                   |   | 65,187        |   | 100           | %      | 60,462 |   | 100.00 | % |
|                          |   |          |   |          |   |   |   |   |   |
| Standby Letters  of Credit    |   | 64            |   |          |   | 268 |   |   |   |
|                          |   |          |   |          |   |   |   |   |   |
| Undisbursed Loan  Commitments |   | 18,079        |   |          |   | 13,444 |   |   |   |

 

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The following table sets forth as of December 31, 2002 the maturitiesand sensitivities of loans to interest rate changes:

 
| **(dollars  in thousands)**     |   | **1 Year  or Less** |   | **1 - 5  Years** |   | **Due after  5 Years** |   | **Total** |   |
|---------------------------------|--------|---------------------|--------|------------------|--------|------------------------|--------|-----------|--------|
| Loan Category:                  |   |                |   |             |   |                   |   |      |   |
| Commercial                      |   | 15,067              |   | 140              |   | 13                     |   | 15,220    |   |
| Agricultural                    |   | 2,217               |   | 93               |   | 14                     |   | 2,324     |   |
| Real Estate                     |   | 35,055              |   | 2,317            |   | 290                    |   | 37,662    |   |
| Construction                    |   | 6,387               |   | 130              |   | 22                     |   | 6,539     |   |
| Consumer Loans                  |   | 1,626               |   | 244              |   | 21                     |   | 1,891     |   |
| Leases                          |   | 1,266               |   | 269              |   | 16                     |   | 1,551     |   |
| Total Loans                     |   | 61,618              |   | 3,193            |   | 376                    |   | 65,187    |   |
|                            |   |                |   |             |   |                   |   |      |   |
| Fixed and  Variable Rate Loans: |   |                |   |             |   |                   |   |      |   |
| Fixed Rate                      |   | 12,075              |   | 3,011            |   | 356                    |   | 15,442    |   |
| Variable Rate                   |   | 49,543              |   | 182              |   | 20                     |   | 49,745    |   |
| Nonaccrual Loans                |   |                |   |             |   |                   |   | 0         |   |
| Total Loans                     |   |                |   |             |   |                   |   | 65,187    |   |

 

The Bank makes commercial loans to provide working capital, finance thepurchase of equipment and for other business purposes. These loans can be“short-term”, with maturities ranging from thirty days to one year, or “termloans” with maturities normally ranging from one to twenty-five years.  Short-term loans are generally intended tofinance current transactions and typically provide for periodic principalpayments, with interest payable monthly. Term loans normally provide for floating interest rates, with monthlypayments of both principal and interest.

 

Consumer loans are used to finance automobiles, various types ofconsumer goods, and other personal purposes. Consumer loans generally provide for the monthly payment of principaland interest.  Most consumer loans aresecured by the personal property being purchased.

 

The Bank is active in construction lending for interim loans to financethe construction of commercial and single family residential property.  While the construction loan totals are downas of December 31, 2002, there are a number of new construction loans and loancommitments that have not as yet been funded. These loans are typically short term of 12 to 18 months.  As a rule, the Bank does not provide loansfor speculative purposes except to known builders who have a track record ofsuccessful projects and the expertise and financial strength for this kind ofbuilding.

 

Residential real estate loans are generally limited to home equityloans and home equity lines of credit. The Bank has not been active in residential real estate lending and refersloan requests for residential mortgages to other permanent mortgagelenders.  As of January 2003, the Bankhas contracted with another intermediary lender to provide residential lendingservices utilizing systems and support from the other intermediary.  This new and more defined service isexpected to result in a higher volume of residential loans and improved lendingservices for the Bank’s customers.  Thisnew program is being specifically designed to meet the needs of low to moderateincome residents in the Bank’s market area.

 

Other real estate loans consist primarily of commercial and industrialreal estate loans. These loans are made based on the income generating capacityof the property or the cash flow of the borrower.  These loans are secured by the property. The Bank offers bothfixed and variable rate loans with maturities, which generally do not exceed 15years, unless the loans are U.S. Small Business Administration (“SBA”) loanssecured by real estate or other commercial real estate loans easily sold in thesecondary market.

 

The Bank makes SBA-guaranteed loans and sells the guaranteed portion ofour SBA loans in the secondary market but retains the servicing rights for suchSBA loans. At December 31, 2002 and 2001, the Bank

 

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serviced approximately $17.3 million and $12.3 million, respectively,in SBA loans. SBA loans are categorized as Commercial or Real Estate dependingon the underlying collateral.

 

#### **Asset Quality**

 

The risk of nonpayment of loans is an inherent feature of the bankingbusiness. That risk varies with the type and purpose of the loan, thecollateral which is utilized to secure payment, and ultimately, the creditworthiness of the borrower.  In order tominimize this credit risk, many loans are approved and/or reviewed by the LoanCommittee of the board of directors. The Loan Committee is comprised of outside directors and the CEO.

 

Loan grades are based on a risk assessment with loans with minimum riskgraded as “Pass” with other classifications of “Special Mention”,“Substandard”, “Doubtful” and “Loss”, depending on credit quality.  As these loans are identified in our reviewprocess, they are added to the internal watch list and a loss allowance isestablished for them as follows: Special Mention – 5%, Substandard – 15%, Doubtful – 50%, and Loss –100%.  Additionally, loans are examinedregularly by the OCC, and the Bank engages an outside firm to perform periodicreviews of the loan portfolio and to test the adequacy of the Allowance forLoan Losses.

 

Loans are not returned to accrual status until it is brought currentwith respect to both principal and interest payments, the loan is performing tocurrent terms and conditions, the interest rate is commensurate with market interestrates and future principal and interest payments are no longer in doubt atwhich time a further review of loans is conducted.

 

The following table provides year end information with respect to thecomponents of our impaired or nonperforming assets at the dates indicated:

 
| **(dollars  in thousands)**                       |   | **31-Dec-02** |   | **31-Dec-01** |   |
|---------------------------------------------------|--------|---------------|--------|---------------|--------|
| Loans on Nonaccrual Basis                         |   | 0             |   | 889           |   |
| Loans Past Due  90 Day or more                    |   | 0             |   | 15            |   |
| Restructured  Loans                               |   | 0             |   | 0             |   |
| Total  Nonperforming Loans                        |   | 0             |   | 904           |   |
| Other Real  Estate Owned                          |   | 0             |   |          |   |
| Total Nonperforming  Assets                       |   | 0             |   | 904           |   |
|                                              |   |          |   |          |   |
| Nonaccrual Loans  to Total Loans                  |   | 0.00          | %      | 1.47          | %      |
| Past Due 90 Days  or More to Total Loans          |   | 0.00          | %      | 0.02          | %      |
| Restructured  Loans to Total Loans                |   | 0.00          | %      | 0.00          | %      |
| Nonperforming  Loans to Total Loans               |   | 0.00          | %      | 1.50          | %      |
|                                              |   |          |   |          |   |
| Allowance for  Loan Losses to Nonperforming Loans |   | na            |   | 70.24         | %      |
|                                              |   |          |   |          |   |
| Nonperforming  Assets to Total Assets             |   | 0.00          | %      | 1.13          | %      |

 

Restructured loans are those loans with concessions in interest ratesor repayment terms to assist the borrower. Non-accrual loans are generallyloans which are past due 90 days or are loans that management believes theinterest upon which may not be collectible. At December 31, 2002 the Bank had no loans on nonaccrual or past due 90days or more and still accruing.

 

Other real estate owned is acquired in satisfaction of loan receivablesthrough foreclosure or other means and is carried on an individual asset basisat the estimated fair value less selling expenses. The Bank had no other realestate owned as of December 31, 2002 and 2001

 

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During 2002, the Bankemployed a new Chief Credit Officer and implemented improved systems fortracking and follow up on delinquent and/or problem loans.  As a result of these efforts and new systems,the Bank has consistently shown the results of these efforts with fewerdelinquencies and improved credit quality. As of December 31, 2002, the Bankhad just $49,000 in loans past due 30 through 89 days.

 

While credit quality asmeasured by loan delinquencies appears to be satisfactory as of December 31,2002, there can be no assurances that new problem loans will not develop infuture periods.  The Bank has tightenedits underwriting standards and expects to continue with prompt collectionefforts, but economic uncertainties and the economic challenges that San LuisObispo and the State of California face could cause one or more borrowers toexperience problems in the coming months.

 

The Bank has no foreignloans.

** **

**Potential Problem Loans**

 

As of March 19, 2003,there has been no material change in asset quality except for on smaller loanthat has been placed on nonaccrual status.

 

**Loan Concentrations**

 

The Board of Directors has approved concentrations (of capital) levelsfor various loan types based on the Bank’s business plan and historic lossexperience. On a quarterly basis, management provides a loan concentrationreport to the board in writing with information relating toconcentrations.  As of December 31, 2002,the Bank has identified certain loan types or groups of loans relating to realestate in its analysis of concentrations. These groups or types include a pool of approximately $6 million in loanparticipations purchased that represent a well-secured, seasoned portfolio ofcommercial and multi-family real estate loans that are geographically diversefrom the Bank’s target market area. Commercial Real Estate loans represent approximately 107% of capital andare well within policy limits.  Loanssecured by other first trust deeds represent a concentration of approximately127% of capital, but these loans also represent a variety of borrowers andtypes of loans that do not represent a concentration to any one borrower orbusiness segment.

 

Using FDIC Call Report Data, the Bank has reviewed a California peergroup analysis of commercial bank with assets of $100 million to $300 millionas of December 31, 2002 and found the follow comparisons:

 
| **Real  Estate Loans as a percent of Total Assets** |   | **Mission  Community  Bank** |   | **Peer Group  of 93 banks** |   |
|-----------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
| Real estate  loans in domestic offices:             |   | 44.64                        | %      | 49.41                       | %      |
| Construction and  land development                  |   | 6.60                         | %      | 7.64                        | %      |
| Commercial real  estate                             |   | 30.62                        | %      | 31.32                       | %      |
| Multifamily  residential real estate                |   | 0.66                         | %      | 3.61                        | %      |
| 1-4 family  residential                             |   | 6.51                         | %      | 6.26                        | %      |
| Farmland                                            |   | 0.24                         | %      | 0.59                        | %      |

 

The Bank’s analysis of loan concentrations plus the peer group analysissuggest that the bank does not have an unusually high real estate concentrationcompared to other similar sized banks in California.  Banks in California traditionally are more prone than banks inother states to use real estate collateral for many commercial loans forbusiness purposes where collateral is taken as an abundance of caution.  In its analysis of real estateconcentrations, the Bank does consider economic trends and real estate values.

 

37

----

 

#### **Allowance for LoanLosses**

 

The following table summarizes, for each reported period, changes inthe allowance for loan losses arising from loans charged off, recoveries onloans previously charged off, additions to the allowance which have beencharged to operating expenses and certain ratios relating to the allowance forloan losses:

 
|                                      |   | **31-Dec-02** |   | **31-Dec-01** |   |
|-------------------------------------------|--------|---------------|--------|---------------|--------|
| Allowance For  Loan Losses:               |   |          |   |          |   |
| Balance at  Beginning of Period           |   | 635           |   | 512           |   |
| Actual  Charge-offs:                      |   |          |   |          |   |
| Commercial                                |   | 49            |   | 150           |   |
| Consumer                                  |   | 6             |   | 14            |   |
| Real Estate                               |   |          |   |          |   |
| Total  Charge-Offs                        |   | 55            |   | 164           |   |
| Less Recoveries:                          |   |          |   |          |   |
| Commercial                                |   | 32            |   | 6             |   |
| Consumer                                  |   | —        |   | 1             |   |
| Real Estate                               |   | —        |   | —        |   |
| Total Recoveries                          |   | 32            |   | 7             |   |
|                                      |   |          |   |          |   |
| Net Loans Charged  Off                    |   | 23            |   | 157           |   |
| Provision for  Loan Losses                |   | 132           |   | 280           |   |
| Balance at End  of Period                 |   | 744           |   | 635           |   |
|                                      |   |          |   |          |   |
| Ratios:                                   |   |          |   |          |   |
| Net Loans  Charged Off to Average Loans   |   | 0.04          | %      | 0.31          | %      |
| Allowance for  Loan Losses to Total Loans |   | 1.14          | %      | 1.05          | %      |

 

The Bank performs a quarterly detailed review to identify the risksinherent in the loan portfolio, to assess the overall quality of the loanportfolio and to determine the adequacy of the allowance for loan losses andthe related provision for loan losses to be charged to expense.  Systematic reviews follow the methodologyset forth by the OCC in its 1993 policy statement on the allowance for loanlosses.

 

A key element of the Bank’s methodology is the previously discussedcredit classification process.  As ofDecember 31, 2002, the Bank did not establish special reserves for individualloans based on specific anticipation of loss to the portfolio.  The inherent risk present in the“acceptable” portion of the loan portfolio is taken into consideration andadjustments made for trends, changes in economic conditions and other relevantfactors that may affect repayment of the loans.  As of December 31, 2002, the Bank allocated $156,000 as anadditional portion of the Allowance for unknown factors.

 

Management and the board consider the allowance for loan losses to beadequate to provide for losses inherent in the loan portfolio. While managementuses available information to recognize losses on loans and leases, futureadditions to the allowance may be necessary based on changes in economicconditions. In addition, federal regulators, as an integral part of theirexamination process, periodically review our allowance for loan losses and mayrecommend additions based upon their evaluation of the portfolio at the time oftheir examination.  Accordingly, therecan be no assurance that our allowance for loan losses will be adequate tocover future loan losses or that significant additions to the allowance forloan losses will not be required in the future.  Material additions to the allowance for loan losses woulddecrease our earnings and capital and would thereby reduce the ability to paydistributions among other adverse consequences.

 

38

----

 

The ratio of allowance for loan losses to total loans as of December31, 2002 was 1.14%, and management and the board feel this is adequate based onits analysis and reviews of the portfolio. The analysis assumes that there will be no material asset quality problemsfollowing the “recession” and a future resumption of economic growth in theCentral Coast.  On a peer basis (UniformBank Performance Report), the ratio of the allowance for loan losses to totalloans was 1.27% as of December 31, 2002.

 

As part of the analysis of the allowance, the Bank also assigns certainrisk factors to the entire loan portfolio in addition to the specificpercentages used for classified loans. The following table summarizes theallocation of the allowance for loan losses by general loan types based oncollateral or security type as used internally by the Bank as of December 31,2002.

 
| **(dollars  in thousands)**      |   | **Loans** |   | **Percent** |   | **Factor** |   | **Reserve  Amt.** |   |
|----------------------------------|--------|-----------|--------|-------------|--------|------------|--------|-------------------|--------|
| Total Loans:                     |   |      |   |        |   |       |   |              |   |
| Real Estate                      |   | 37,477    |   | 58          | %      | 0.40       | %      | 150               |   |
| Other Security                   |   | 24,394    |   | 37          | %      | 1.13       | %      | 275               |   |
| Unsecured                        |   | 3,316     |   | 5           | %      | 0.75       | %      | 25                |   |
| Total Loans                      |   | 65,187    |   | 100         | %      | 0.59       | %      | 450               |   |
| Other Factors:                   |   |      |   |        |   |       |   |              |   |
| Letters of  Credit               |   | 64        |   |        |   | 0.00       | %      | —            |   |
| Unspecified and  other factors   |   | 18,079    |   |        |   | 0.97       | %      | 176               |   |
| Total of Other  Factors          |   | 18,143    |   |        |   |       |   | 176               |   |
|                             |   |      |   |        |   |       |   |              |   |
| Classified Loans                 |   | 875       |   |        |   | 13.49      | %      | 118               |   |
| Total Allowance  for Loan Losses |   |      |   |        |   |       |   | 744               |   |

 

39

----

 

#### **Deposits**

 

Deposits are the primary source of funding for lending and investingneeds. Total deposits were $87.5 million at December 31, 2002 and $71.7 millionat the end of 2001.  Deposits increasedby $15.8 million or 22% in 2002 following a 32% or $17.5 million increase in2001.

 

The following table reflects the average amount and average rate paidon each of the following deposit classifications for the reported periods:

 
|                           |   | **31-Dec-02**        |   | **31-Dec-01**          |   |
|--------------------------------|--------|----------------------|--------|------------------------|--------|
| **(dollars  in thousands)**    |   | **Average  Balance** |   | **Average  Rate Paid** |   | **Average  Balance** |   | **Average  Rate Paid** |   |
| Deposits in  Domestic Offices: |   |                 |   |                   |   |   |   |   |   |
| Noninterest  bearing demand    |   | 13,851               |   | 0.00                   | %      | 11,157 |   | 0.00 | % |
| Demand,  interest-bearing      |   | 3,277                |   | 1.07                   | %      | 2,987 |   | 2.12 | % |
| Savings                        |   | 30,494               |   | 2.26                   | %      | 27,965 |   | 3.38 | % |
| Time                           |   | 32,153               |   | 2.99                   | %      | 23,333 |   | 4.82 | % |
| Total Deposits                 |   | 79,776               |   | 2.11                   | %      | 65,443 |   | 3.26 | % |

 

The Bank generally prices deposits at or above the median rate byclassification based on periodic interest rate surveys in the localmarket.  Deposits rates are thenadjusted to balance the cost of funds versus funding needs and asset liabilityconsiderations.  In the past year, theBank increased the percentage for certificates of deposit and decreased thepercentage of savings deposits. Savings accounts represent 38% of averagedeposits in 2002 compared to 43% in 2001. The Bank has used and expects tocontinue to use an Investor Savings product that pays higher rates than normalsavings and similar rates to money market accounts as a special product uniqueto the Bank, but management also expect to see the relative percentage ofInvestor Savings to total deposit to continue to decline.

 

The change in deposit rates in 2002 was material and consistent withchanges in overall rates and yields on deposits and investment securities.  The Bank anticipates that interest rateswill begin to increase in late 2003 or 2004 as the current economic andgeopolitical issues are resolved and when the economy begins to shift back intoconsistent growth.

 

The following table reflects the maturity distribution of certificatesof deposit in the amounts of $100,000 or more as of December 31, 2002:

 
| **(dollars  in thousands)**       |   | **3 months  or  less** |   | **3 - 6  months** |   | **6 - 12  months** |   | **over 12  months** |   | **Total** |   |
|-----------------------------------|--------|------------------------|--------|-------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|
| Deposit  Maturities:              |   |                   |   |              |   |               |   |                |   |      |   |
| Certificates of  $100,000 or more |   | 8,325                  |   | 4,210             |   | 8,420              |   | 2,434               |   | 23,389    |   |

 

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

 

As of December 31, 2002, the Bank had $2.5 million in outstanding loansto the Federal Home Loan Bank of San Francisco. The Bank repaid $1 million inadvances in January 2003.

 

As of December 31, 2001, the Company also had a $50,000 outstandingunder a $200,000 line of credit with Pacific Coast Bankers’ Bank. The Companyfully repaid its loans from PCBB as of December 31, 2002.

 

40

----

 

See Note F of the notes to consolidated financial statements.

 

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

 

The impact of inflation on a financial institution can differsignificantly from that exerted on other companies.  Banks, as financial intermediaries, have many assets andliabilities, which may move in concert with inflation both as to interest ratesand value.  This is especially true forbanks with a high percentage of interest rate-sensitive assets andliabilities.  A bank can reduce theimpact of inflation if it can manage its interest rate sensitivity gap.Management has attempted to structure the mix of financial instruments andmanage interest rate sensitivity gap 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 County continues to have one of the lowest unemploymentrates in California and real estate values continue to show increases withsteady demand; however, management is seeing a slowing in loan demand anddeposits activity as borrowers wait for signs of improvements in the economyand higher deposit rates.  There can beno assurance that the economy will improve in the short term and the Bank hasadopted a cautiously optimistic outlook with close attention to credit quality,to interest rate risk, and control of operational expenses.

 

No assurance can be give as to the outcome of the situation in theMiddle East and any possible impact it will have on the short and mid termeconomy and bank earnings.

 

41

----

 

**Item7     FINANCIAL STATEMENTS**

 

**CONTENTS**

 
| **INDEPENDENT AUDITORS’  REPORT ON THE FINANCIAL STATEMENTS** |
|--------------------------------------------------------------------|
|                                                               |
| **FINANCIAL  STATEMENTS**                                          |
|                                                               |   |
|                                                               | **Balance Sheets** |
|                                                               | **Statements  of Income** |
|                                                               | **Statement  of Changes in Shareholders’ Equity** |
|                                                               | **Statements  of Cash Flows** |
|                                                               | **Notes to Financial  Statements** |

 

42

----

 

**INDEPENDENT AUDITORS’ REPORT**

 

Board of Directors and Shareholders of

Mission Community Bancorp and Subsidiary

 

We have audited the accompanying Balance Sheets of Mission CommunityBancorp and Subsidiary as of December 31, 2002 and 2001 and the relatedStatements of Income, changes in shareholders’ equity, and cash flows of theyears then ended.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of Mission CommunityBancorp and Subsidiary as of December 31, 2002 and December 31, 2001, and theresults of its operations and its cash flows for the years then ended, inconformity with accounting principles generally accepted in the United Statesof America.

 
| VAVRINEK, TRINE, DAY & CO., LLP |
|-------------------------------------|
|                                |
| Laguna Hills, California            |
| February 6, 2003                    |

 

F-1

----

 

**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

 

**BALANCESHEETS**

**December 31, 2002 and 2001**

 
|                                                |   | **2002**   |       | **2001**   |       |
|-----------------------------------------------------|--------|------------|------------|------------|------------|
| **ASSETS**                                          |   |       |       |       |       |
|                                                |   |       |       |       |       |
| Cash and Due from Banks                             |   | $          | 3,024,051  |       | $          | 2,526,189 |   |
| Federal Funds Sold                                  |   | 12,295,000 |       | —     |       |
| **TOTAL  CASH AND CASH EQUIVALENTS**                |   |       | 15,319,051 |       | 2,526,189  |   |
|                                                |   |       |       |       |       |
| Interest-Bearing Deposits in Other Banks            |   | 3,000,000  |       | 3,009,345  |       |
|                                                |   |       |       |       |       |
| Investment Securities:                              |   |       |       |       |       |
| Investment Securities Available for Sale            |   | 5,260,475  |       | 6,331,381  |       |
| Investment Securities Held to Maturity              |   | 6,630,449  |       | 4,503,944  |       |
| **TOTAL INVESTMENT  SECURITIES**                    |   |       | 11,890,924 |       | 10,835,325 |   |
|                                                |   |       |       |       |       |
| Loans:                                              |   |       |       |       |       |
| Commercial                                          |   | 16,770,152 |       | 21,152,236 |       |
| Agricultural                                        |   | 2,324,468  |       | 2,833,275  |       |
| Construction                                        |   | 6,539,327  |       | 10,159,461 |       |
| Real Estate                                         |   | 37,662,315 |       | 22,796,843 |       |
| Consumer                                            |   | 1,891,124  |       | 3,520,079  |       |
| **TOTAL  LOANS**                                    |   |       | 65,187,386 |       | 60,461,894 |   |
|                                                |   |       |       |       |       |
| Allowance for Loan Losses                           |   | (744,248   | )          | (635,468   | )          |
| **NET LOANS**                                       |   |       | 64,443,138 |       | 59,826,426 |   |
|                                                |   |       |       |       |       |
| Federal Reserve Bank Stock and Other Stock, at Cost |   | 337,984    |       | 222,475    |       |
| Premises and Equipment                              |   | 2,488,061  |       | 2,389,031  |       |
| Accrued Interest and Other Assets                   |   | 1,529,071  |       | 1,082,139  |       |
|                                                |   |       |       |       |       |
|                                                |   | $          | 99,008,229 |       | $          | 79,890,930 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

F-2

----

 

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

 

**BALANCESHEETS**

**December 31, 2002 and 2001**

 
|                                                                                                           |   | **2002**   |       | **2001**   |       |
|----------------------------------------------------------------------------------------------------------------|--------|------------|------------|------------|------------|
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                  |   |       |       |       |       |
|                                                                                                           |   |       |       |       |       |
| Deposits:                                                                                                      |   |       |       |       |       |
| Noninterest-Bearing Demand                                                                                     |   | $          | 15,005,159 |       | $          | 13,030,253 |   |
| Money Market, NOW and Savings                                                                                  |   | 38,779,946 |       | 29,740,916 |       |
| Time Deposits Under $100,000                                                                                   |   | 10,331,312 |       | 11,038,762 |       |
| Time Deposits $100,000 and Over                                                                                |   | 23,388,584 |       | 17,874,419 |       |
| **TOTAL  DEPOSITS**                                                                                            |   |       | 87,505,001 |       | 71,684,350 |   |
|                                                                                                           |   |       |       |       |       |
| Short-Term Borrowings                                                                                          |   | 2,500,000  |       | 420,000    |       |
| Accrued Interest and Other Liabilities                                                                         |   | 1,053,740  |       | 1,012,687  |       |
| **TOTAL  LIABILITIES**                                                                                         |   |       | 91,058,741 |       | 73,117,037 |   |
|                                                                                                           |   |       |       |       |       |
| Commitments and Contingencies - Notes D and L                                                                  |   | —     |       | —     |       |
|                                                                                                           |   |       |       |       |       |
| 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    |       | —     |       |
| Common Stock - Authorized 1,000,000 Shares; Issued and Outstanding,  630,166 in 2002 and 630,066 in 2001       |   | 6,273,101  |       | 6,272,276  |       |
| Retained Earnings (Accumulated Deficit)                                                                        |   | 528,890    |       | (153,185   | )          |
| Accumulated Other Comprehensive Income - Unrealized Appreciation on  Available-for-Sale Securities, net of tax |   | 63,697     |       | 71,002     |       |
| **TOTAL  SHAREHOLDERS’ EQUITY**                                                                           |   |       | 7,949,488  |       | 6,773,893  |   |
|                                                                                                           |   |       |       |       |       |
|                                                                                                           |   | $          | 99,008,229 |       | $          | 79,890,930 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

F-3

----

 

**MISSION COMMUNITY BANCORP ANDSUBSIDIARY**

 

**STATEMENTS OF INCOME**

**Years Ended December 31, 2002 and2001**

 
|                                                     |   | **2002**  |      | **2001**  |      |
|----------------------------------------------------------|--------|-----------|-----------|-----------|-----------|
| **INTEREST INCOME**                                      |   |      |      |      |      |
| Interest and Fees on Loans                               |   | $         | 4,721,149 |      | $         | 4,424,831 |   |
| Interest on Investment Securities                        |   | 649,398   |      | 769,476   |      |
| Other Interest Income                                    |   | 204,320   |      | 165,725   |      |
| **TOTAL  INTEREST INCOME**                               |   |      | 5,574,867 |      | 5,360,032 |   |
|                                                     |   |      |      |      |      |
| **INTEREST EXPENSE**                                     |   |      |      |      |      |
| Interest on Money Market, NOW and Savings                |   | 725,180   |      | 1,007,363 |      |
| Interest on Time Deposits                                |   | 959,899   |      | 1,124,849 |      |
| Other Interest Expense                                   |   | 44,593    |      | 10,557    |      |
| **TOTAL  INTEREST EXPENSE**                              |   |      | 1,729,672 |      | 2,142,769 |   |
|                                                     |   |      |      |      |      |   |
| **NET  INTEREST INCOME**                                 |   |      | 3,845,195 |      | 3,217,263 |   |
|                                                     |   |      |      |      |      |
| Provision for Loan Losses                                |   | 132,000   |      | 280,000   |      |
| **NET  INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES** |   |      | 3,713,195 |      | 2,937,263 |   |
|                                                     |   |      |      |      |      |
| **NONINTEREST INCOME**                                   |   |      |      |      |      |
| Gain on Sale of Loans                                    |   | 631,807   |      | 337,547   |      |
| Bank Enterprise Award                                    |   | 182,936   |      | 537,750   |      |
| Service Charges, Fees and Other Income                   |   | 543,886   |      | 638,328   |      |
|                                                     |   | 1,358,629 |      | 1,513,625 |      |
| **NONINTEREST EXPENSE**                                  |   |      |      |      |      |
| Salaries and Employee Benefits                           |   | 1,959,136 |      | 1,599,643 |      |
| Occupancy Expenses                                       |   | 279,070   |      | 244,163   |      |
| Furniture and Equipment                                  |   | 217,348   |      | 198,773   |      |
| Other Expenses                                           |   | 1,349,305 |      | 1,388,715 |      |
|                                                     |   | 3,804,859 |      | 3,431,294 |      |
| **INCOME  BEFORE INCOME TAXES**                          |   |      | 1,266,965 |      | 1,019,594 |   |
| Income Tax Expense                                       |   | 514,822   |      | —    |      |
|                                                     |   |      |      |      |      |
| **NET  INCOME**                                          |   |      | $         | 752,143   |      | $ | 1,019,594 |   |
| Per Share Data:                                          |   |      |      |      |      |
| Net Income - Basic                                       |   | $         | 1.07      |      | $         | 1.46 |   |
| Net Income - Diluted                                     |   | $         | 1.05      |      | $         | 1.46 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

F-4

----

 

**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

 

**STATEMENTSOF CHANGES IN SHAREHOLDERS’ EQUITY**

**YearsEnded December 31, 2002 and 2001**

 
|                                                                                   |   | **Preferred** | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Accumulated  Comprehensive** | ** ** |       | ** ** |
|----------------------------------------------------------------------------------------|--------|---------------|------------|------------------|------------|-------------------|------------|--------------|------------|--------------------------------|------------|------------|------------|
|                                                                                   |   | **Stock**     | ** ** | **Shares**       | ** ** | **Amount**        | ** ** | **Income**   | ** ** | **Earnings**                   | ** ** | **Income** | ** ** | **Total** | ** ** |
|                                                                                   |   |          | ** ** |             | ** ** |              | ** ** |         | ** ** |                           | ** ** |       | ** ** |   | ** ** |
| **Balance at January 1, 2001**                                                         |   | $             | 583,800    |             | 630,066    |              | $          | 6,272,276    |       |                           |       | $          | (1,172,779 | ) | $ | 40,878 |   | $ | 5,724,175 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| **Comprehensive Income:**                                                              |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Net Income                                                                             |   |          |       |             |       |              |       | $            | 1,019,594  |                           | 1,019,594  |       |       |   | 1,019,594 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Net Unrealized Appreciation on Available-for-Sale Securities, Net of  Taxes of $8,039  |   |          |       |             |       |              |       | 30,124       |       |                           |       | 30,124     |       | 30,124 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| **Total Comprehensive Income**                                                         |   |          |       |             |       |              |       | $            | 1,049,718  |                           |       |       |       |   |   |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| **Balance at December 31, 2001**                                                       |   | 583,800       |       | 630,066          |       | 6,272,276         |       |         |       | (153,185                       | )          | 71,002     |       | 6,773,893 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Issuance of Preferred Stock, Series C                                                  |   | 500,000       |       |             |       |              |       |         |       |                           |       |       |       | 500,000 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Exercise of Stock Options                                                              |   |          |       | 100              |       | 825               |       |         |       |                           |       |       |       | 825 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Dividends Paid                                                                         |   |          |       |             |       |              |       |         |       | (70,068                        | )          |       |       | (70,068 | ) |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| **Comprehensive Income:**                                                              |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Net Income                                                                             |   |          |       |             |       |              |       | $            | 752,143    |                           | 752,143    |       |       |   | 752,143 |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| Net Unrealized Appreciation on Available-for-Sale Securities, Net of  Taxes of $10,695 |   |          |       |             |       |              |       | (7,305       | )          |                           |       | (7,305     | )          | (7,305 | ) |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| **Total Comprehensive Income**                                                         |   |          |       |             |       |              |       | $            | 744,838    |                           |       |       |       |   |   |   |
|                                                                                   |   |          |       |             |       |              |       |         |       |                           |       |       |       |   |   |
| **Balance at December 31, 2002**                                                       |   | $             | 1,083,800  |             | 630,166    |              | $          | 6,273,101    |       |                           |       | $          | 528,890    |   | $ | 63,697 |   | $ | 7,949,488 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

F-5

----

 

**MISSION COMMUNITY BANCORP ANDSUBSIDIARY**

 

**STATEMENTSOF CASH FLOWS**

**Years Ended December 31, 2002 and2001**

 
|                                                                           |   | **2002**   |       | **2001**    |        |
|--------------------------------------------------------------------------------|--------|------------|------------|-------------|-------------|
| **OPERATING  ACTIVITIES**                                                      |   |       |       |        |        |
| Net Income                                                                     |   | $          | 752,143    |        | $           | 1,019,594 |   |
| Adjustments to  Reconcile Net Income to Net Cash Used by Operating Activities: |   |       |       |        |        |
| Depreciation and  Amortization                                                 |   | 218,452    |       | 198,773     |        |
| Provision for  Credit Losses                                                   |   | 132,000    |       | 280,000     |        |
| Gain on Loan  Sales                                                            |   | (631,807   | )          | (337,547    | )           |
| Loans Originated  for Sale                                                     |   | (7,753,505 | )          | (8,494,216  | )           |
| Proceeds from  Loan Sales                                                      |   | 6,329,992  |       | 5,466,365   |        |
| Deferred Taxes                                                                 |   | (5,000     | )          | (140,000    | )           |
| Net Change in  Other Assets and Liabilities                                    |   | (414,917   | )          | 662,478     |        |
| **NET CASH USED BY OPERATING  ACTIVITIES**                                     |   |       | (1,372,642 | )           | (1,344,553  | ) |
|                                                                           |   |       |       |        |        |
| **INVESTING  ACTIVITIES**                                                      |   |       |       |        |        |
| Net Change in  Federal Reserve Bank and Other Stock                            |   | (115,509   | )          | (78,900     | )           |
| Change in  Deposits in Other Banks                                             |   | 9,345      |       | (2,711,345  | )           |
| Purchase of  Available-for-Sale Securities                                     |   | (3,765,367 | )          | (7,469,861  | )           |
| Purchase of  Held-to-Maturity Securities                                       |   | (5,552,412 | )          | (5,567,309  | )           |
| Proceeds from  Maturities and Sales of Available-for-Sale Securities           |   | 4,829,733  |       | 11,626,075  |        |
| Proceeds from  Maturities of Held-to-Maturity Securities                       |   | 3,438,077  |       | 4,503,090   |        |
| Net Increase in  Loans                                                         |   | (2,693,392 | )          | (14,124,316 | )           |
| Purchases of  Premises and Equipment                                           |   | (316,379   | )          | (213,755    | )           |
| **NET CASH USED BY INVESTING  ACTIVITIES**                                     |   |       | (4,165,904 | )           | (14,036,321 | ) |
|                                                                           |   |       |       |        |        |
| **FINANCING  ACTIVITIES**                                                      |   |       |       |        |        |
| Net Increase in  Demand Deposits and Savings Accounts                          |   | 11,013,936 |       | 4,664,624   |        |
| Net Increase in  Time Deposits                                                 |   | 4,806,715  |       | 12,849,145  |        |
| Net Change in  Other Borrowings                                                |   | 2,080,000  |       | (2,228,000  | )           |
| Payment of  Dividends                                                          |   | (70,068    | )          | —      |        |
| Proceeds from  Exercise of Stock Options                                       |   | 825        |       | —      |        |
| Proceeds from  Issuance of Preferred Stock                                     |   | 500,000    |       | —      |        |
| **NET CASH PROVIDED BY FINANCING  ACTIVITIES**                                 |   |       | 18,331,408 |        | 15,285,769  |   |
|                                                                           |   |       |       |        |        |
| **NET INCREASE (DECREASE) IN CASH AND  CASH EQUIVALENTS**                      |   |       | 12,792,862 |        | (95,105     | ) |
| Cash and Cash  Equivalents at Beginning of Period                              |   | 2,526,189  |       | 2,621,294   |        |
| **CASH AND CASH EQUIVALENTS AT END OF  YEAR**                                  |   |       | $          | 15,319,051  |        | $ | 2,526,189 |   |
|                                                                           |   |       |       |        |        |
| **Supplemental  Disclosures of Cash Flow Information:**                        |   |       |       |        |        |
| Interest Paid                                                                  |   | $          | 1,704,969  |        | $           | 2,151,445 |   |
| Taxes Paid                                                                     |   | $          | 637,331    |        | $           | 3,200 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

F-6

----

 

**MISSION COMMUNITY BANCORP ANDSUBSIDIARY**

 

**NOTESTO FINANCIAL STATEMENTS**

**December 31, 2002 and 2001**

 

**NOTE A - SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

Principles ofConsolidation

 

The financialstatements include the accounts of Mission Community Bancorp and itssubsidiary, Mission Community Bank (“the Bank”), and the Bank’s subsidiary,Mission Community Development Corporation collectively referred to herein asthe “Company”.

 

Nature ofOperations

 

The Bank has beenorganized as a single reporting segment and operates four branches in theCentral Coast area of California.  TheBank’s primary source of revenue is providing Small Business Administration(“SBA”) guaranteed loans, real estate, commercial and consumer loans tocustomers, who are predominately small and middle-market businesses andindividuals.  The Company and the Bankare certified by the Department of Treasury as Community Development FinancialInstitution(s) (CDFI) with a commitment to focus on providing financialservices to low and moderate income communities.

 

Mission CommunityDevelopment Corporation

 

Mission CommunityDevelopment Corporation is a community development corporation, which providesfinancing for small businesses and low- and moderate-income areas andprojects.  The Board of Directors ofMission Community Development Corporation consists of four members of the Boardof Directors of the Company and three outside members who are actively involvedin supporting community affairs and activities. Community developmentinvestment is limited to 5% of the Company’s capital and up to 10% with priorapproval by the Comptroller of the Currency. Operations of Mission Community Development Corporation were notmaterial as of December 31, 2002.

 

###### *MissionCommunity Services Corporation*

 

Mission CommunityServices Corporation was organized and the corporation established in 1998 as anot-for-profit company.  This company’sprimary focus will be to provide technical support and training services to theunderserved segments of the community including small businesses, minoritiesand low-income entrepreneurs.  The Boardof Directors of Mission Community Services Corporation includes representativesfrom the Company and the Bank, together with members representing thecommunities represented.  Operations ofMission Community Services Corporation were not material as of December 31,2002.

 

Use of Estimatesin the Preparation of Financial Statements

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results could differfrom those estimates.

 

F-7

----

 

Cash and CashEquivalents

 

For purposes ofreporting cash flows, cash and cash equivalents include cash, due from banksand federal funds sold.  Generally,federal funds are sold for one-day periods.

 

Cash and Due FromBanks

 

Bankingregulations require that all banks maintain a percentage of their deposits asreserves in cash or on deposit with the Federal Reserve Bank.  The Bank complied with the reserverequirements as of December 31, 2002.

 

The Companymaintains amounts due from banks, which exceed federally insured limits.  The Company has not experienced any lossesin such accounts.

 

InvestmentSecurities

 

Bonds, notes, anddebentures for which the Company has the positive intent and ability to hold tomaturity are reported at cost, adjusted for premiums and discounts that arerecognized in interest income using the interest method over the period tomaturity.

 

Investments notclassified as trading securities nor as held to maturity securities areclassified as available-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 other comprehensive incomeincluded in shareholders’ equity. Premiums or discounts are amortized or accreted into income using theinterest method.  Realized gains orlosses on sales of held-to-maturity or available-for-sale securities arerecorded using the specific identification method.

 

Loans

 

Loans are reportedat the principal amount outstanding, net of any deferred loan origination feeincome and deferred direct loan origination costs, and net of any unearnedinterest on discounted 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.

 

Loans for whichthe accrual of interest has been discontinued are designated as nonaccrualloans.  Accrual of interest on suchloans is discontinued when there exists a reasonable doubt as to the full andtimely collection of either principal or interest.  Income on such loans is then only recognized to the extent thatcash is received and where the future collection of principal is probable.  Accrual of interest is resumed only whenprincipal and interest are brought fully current and when such loans areconsidered to be collectible as to both principal and interest.

 

F-8

----

 

For impairmentrecognized in accordance with Financial Accounting Standards Board (“FASB”)Statement of Financial 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 hasadopted SFAS No. 140, *“Accounting for Transfers and Servicing of FinancialAssets 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 thegain (loss) on sale of loans, the Bank’s investment in the loan is allocatedamong the retained portion of the loan, the servicing retained, theinterest-only strip and the sold portion of the loan, based on the relativefair market value of each portion.  Thegain (loss) on the sold portion of the loan is recognized at the time of salebased on the difference between the sale proceeds and the allocatedinvestment.  As a result of the relativefair value allocation, the carrying value of the retained portion isdiscounted, with the discount accreted to interest income over the life of theloan.  That portion of the excessservicing fees that represent contractually specified servicing fees(contractual servicing) are reflected as a servicing asset which is amortizedover an estimated life using a method approximating the level yield method; inthe event future prepayments exceed Management’s estimates and future expectedcash flows are inadequate to cover the unamortized servicing asset, additionalamortization would be recognized.  Theportion of excess servicing fees in excess of the contractual servicing fees isreflected as interest-only (I/O) strips receivable, which are classified asinterest-only strips receivable available for sale and are carried at fairvalue.

 

Allowance for LoanLosses

 

The allowance forloan losses is adjusted by charges to income and decreased by charge-offs (netof recoveries).  Management’s periodicevaluation of the adequacy of the allowance is based on the Company’s past loanloss experience, known and inherent risks in the portfolio, adverse situationsthat may affect the borrower’s ability to repay, the estimated value of anyunderlying collateral, and current economic conditions.

 

###### *Loans Held for Sale*

 

SBA loans originated and intended for sale in the secondary market arecarried at the lower of cost or estimated market value in the aggregate.  Net unrealized losses are recognized througha valuation allowance by charges to income.

 

F-9

----

 

Premises andEquipment

 

Land is carried atcost.  Premises and equipment arecarried at cost less accumulated depreciation and amortization.  Depreciation is computed using thestraight-line method over the estimated useful lives, which ranges from threeto ten years for furniture and fixtures and forty years for buildings.  Leasehold improvements are amortized usingthe straight-line method over the estimated useful lives of the improvements orthe remaining lease term, whichever is shorter.  Expenditures for betterments or major repairs are capitalized andthose for ordinary repairs and maintenance are charged to operations asincurred.

 

Income Taxes

 

Deferred taxassets and liabilities are reflected at currently enacted income tax ratesapplicable to the period in which the deferred tax assets or liabilities areexpected to be realized or settled.  Aschanges in tax laws or rates are enacted, deferred tax assets and liabilitiesare adjusted through the provision for income taxes.

 

ComprehensiveIncome

 

SFAS No. 130, *“ReportingComprehensive Income”*, requires the disclosure of comprehensiveincome and its components.  Changes inunrealized gain or loss on available-for-sale securities net of income taxes isthe only component of accumulated other comprehensive income for the Company.

 

FinancialInstruments

 

In the ordinarycourse of business, the Company has entered into off-balance sheet financialinstruments consisting of commitments to extend credit, commercial letters ofcredit, and standby letters of credit. Such financial instruments are recorded in the financial statements whenthey are funded or related fees are incurred or received.

 

Earnings Per Shares (EPS)

 

Basic EPS excludesdilution and is computed by dividing income available to common stockholders bythe weighted-average number of common shares outstanding for the period.  Diluted EPS reflects the potential dilutionthat could occur if securities 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 entity.

 

Stock-Based Compensation

 

SFAS No. 123*,“Accounting for Stock-Based Compensation,”* encourages, but does notrequire, companies to record compensation cost for stock-based employeecompensation plans at fair value.  TheBank accounts for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board (APB) Opinion No. 25, *“Accounting for Stock Issued to Employees,”*and related Interpretations. Accordingly, compensation cost for stock options will be measured as theexcess, if any, of the quoted market price of the Bank’s stock at the date ofthe grant over the amount an employee must pay to acquire the stock.

 

F-10

----

 

Had compensationcost for the Bank’s stock option plans been determined based on the fair valueat the grant dates for awards under those plans consistent with the method ofSFAS No. 123, the Bank’s net income and income per share would have beenreduced to the pro forma amounts indicated below:

 
|                                                                                            |   | **2002** |    | **2001** |   |
|-------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Net Income:                                                                                     |   |     |    |     |   |
| As Reported                                                                                     |   | $        | 752,143 |     | $      | 1,019,594 |   |
| Stock-Based Compensation using the Intrinsic Value Method                                       |   | —   |    | —   |   |
| Stock-Based Compensation that would have been reported  using the Fair Value Method of SFAS 123 |   | (37,243  | )       | (29,862  | )      |
|                                                                                            |   |     |    |     |   |
| Pro Forma                                                                                       |   | $        | 714,900 |     | $      | 989,732 |   |
|                                                                                            |   |     |    |     |   |
| Basic Income Per Share:                                                                         |   |     |    |     |   |
| As Reported                                                                                     |   | $        | 1.07    |     | $      | 1.46 |   |
| Pro Forma                                                                                       |   | 1.02     |    | 1.41     |   |
|                                                                                            |   |     |    |     |   |
| Diluted Income Per Share:                                                                       |   |     |    |     |   |
| As Reported                                                                                     |   | 1.05     |    | 1.46     |   |
| Pro Forma                                                                                       |   | 1.01     |    | 1.41     |   |

 

Current AccountingPronouncements

 

In August 2001, FASB issued SFAS No. 143, *“Accounting for Asset Retirement Obligations”*, whichrequires the Bank to record the fair value of an asset retirement obligation asa liability in the period in which it incurs a legal obligation associated withthe retirement of long-term assets. SFAS No. 143 is effective for the Bank in 2003; however, management doesnot believe adoption will have a material impact on the Banks’ financialstatements.

 

Reclassifications

 

Certainreclassifications were made to prior years’ presentations to conform to thecurrent year.  These reclassificationsare of a normal recurring nature.

 

F-11

----

 

**NOTE B - INVESTMENT SECURITIES**

 

Investmentsecurities have been classified in the Balance Sheets according to management’sintent.  The amortized cost ofsecurities and 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, 2002**              |   |                |       |                         |       |                          |       |                         |       |
| U.S. Government Agencies           |   | $                   | 3,249,116  |                         | $          | 85,264                        |       | $                            | —     |   | $ | 3,334,380 |   |
| Mortgage-Backed Securities         |   | 1,900,521           |       | 25,574                       |       | —                        |       | 1,926,095                    |       |
|                               |   |                |       |                         |       |                          |       |                         |       |
|                               |   | $                   | 5,149,637  |                         | $          | 110,838                       |       | $                            | —     |   | $ | 5,260,475 |   |
|                               |   |                |       |                         |       |                          |       |                         |       |
| **December 31, 2001**              |   |                |       |                         |       |                          |       |                         |       |
| U.S. Government Agencies           |   | $                   | 3,888,797  |                         | $          | 81,372                        |       | $                            | —     |   | $ | 3,970,169 |   |
| Mortgage-Backed Securities         |   | 2,335,136           |       | 26,206                       |       | (130                          | )          | 2,361,212                    |       |
|                               |   |                |       |                         |       |                          |       |                         |       |
|                               |   | $                   | 6,223,933  |                         | $          | 107,578                       |       | $                            | (130       | ) | $ | 6,331,381 |   |
|                               |   |                |       |                         |       |                          |       |                         |       |
| **Held-to-Maturity Securities:**   |   |                |       |                         |       |                          |       |                         |       |
| **December 31, 2002**              |   |                |       |                         |       |                          |       |                         |       |
| U.S. Government Agencies           |   | $                   | 1,363,260  |                         | $          | 4,378                         |       | $                            | —     |   | $ | 1,367,638 |   |
| Mortgage-Backed Securities         |   | 5,218,660           |       | 96,486                       |       | (355,631                      | )          | 4,959,515                    |       |
| Other                              |   | 48,529              |       | 10,637                       |       | —                        |       | 59,166                       |       |
|                               |   |                |       |                         |       |                          |       |                         |       |
|                               |   | $                   | 6,630,449  |                         | $          | 111,501                       |       | $                            | (355,631   | ) | $ | 6,386,319 |   |
|                               |   |                |       |                         |       |                          |       |                         |       |
| **December 31, 2001**              |   |                |       |                         |       |                          |       |                         |       |
| U.S. Government Agencies           |   | $                   | 1,915,960  |                         | $          | 22,813                        |       | $                            | (3,583     | ) | $ | 1,935,190 |   |
| Mortgage-Backed Securities         |   | 2,543,555           |       | 45,874                       |       | (16,316                       | )          | 2,573,113                    |       |
| Other                              |   | 44,429              |       | 8,194                        |       | —                        |       | 52,623                       |       |
|                               |   |                |       |                         |       |                          |       |                         |       |
|                               |   | $                   | 4,503,944  |                         | $          | 76,881                        |       | $                            | (19,899    | ) | $ | 4,560,926 |   |

 

F-12

----

 

Investmentssecurities carried at $5,493,000 and $5**,**648,000as of December 31, 2002 and 2001, respectively, were pledged to secureshort-term borrowings and other deposits as required by law.

 

The scheduledmaturities of securities available for sale at December 31, 2002, were asfollows:

 
|                           |   | **Available-for-Sale  Securities** |       | **Held-to-Maturity  Securities** |       |
|--------------------------------|--------|------------------------------------|------------|----------------------------------|------------|
|                           |   | **Amortized  Cost**                |       | **Fair  Value**                  | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|                           |   |                               | ** ** |                             | ** ** |   | ** ** |   | ** ** |
| Due in One Year to Five Years  |   | $                                  | 2,794,116  |                             | $          | 2,801,880 |   | $ | 750,000 |   | $ | 752,758 |   |
| Due in Five Years to Ten Years |   | 500,000                            |       | 532,500                          |       | 500,000 |   | 500,470 |   |
| Due in Greater Then Ten Years  |   | —                             |       | —                           |       | 113,260 |   | 114,410 |   |
| Mortgage-Backed Securities     |   | 1,900,521                          |       | 1,926,095                        |       | 5,218,660 |   | 4,959,515 |   |
| Other                          |   | —                             |       | —                           |       | 48,529 |   | 59,166 |   |
|                           |   |                               |       |                             |       |   |   |   |   |
|                           |   | $                                  | 5,194,637  |                             | $          | 5,260,475 |   | $ | 6,630,449 |   | $ | 6,386,319 |   |

 

Included in accumulated other comprehensiveincome at December 31, 2002 were net unrealized gains on investment securitiesavailable for sale of $110,838 less applicable income taxes of $47,141.  Included in accumulated other comprehensiveincome at December 31, 2001 were net unrealized gains on investment securitiesavailable for sale of $107,448 less applicable income taxes of $36,446.

 

### **NOTE C - LOANS**

 

The Bank’s loanportfolio consists primarily of loans to borrowers within the Central CoastArea of California.  Although the Bankseeks to avoid concentrations of loans to a single industry or based upon asingle class of collateral, real estate and real estate associated businessesare among the principal industries in the Bank’s market area and, as a result,the Bank’s loan and collateral portfolios are, to some degree, concentrated inthose industries.

 

The Bank alsooriginates SBA loans for sale to institutional investors.  At December 31, 2002 and 2001 the Bank wasservicing approximately $17,342,000 and $12,347,000, respectively in loanspreviously sold or participated.

 

F-13

----

 

A summary of thechanges in the allowance for possible loan losses as of December 31 follows:

 
|                                          |   | **2002** |    | **2001** |   |
|-----------------------------------------------|--------|----------|---------|----------|--------|
|                                          |   |     |    |     |   |
| Balance at Beginning of Year                  |   | $        | 635,468 |     | $      | 511,607 |   |
| Additions to the Allowance Charged to Expense |   | 132,000  |    | 280,000  |   |
| Recoveries on Loans Charged Off               |   | 32,774   |    | 7,483    |   |
|                                          |   | 800,242  |    | 799,090  |   |
|                                          |   |     |    |     |   |
| Less Loans Charged Off                        |   | (55,994  | )       | (163,622 | )      |
|                                          |   |     |    |     |   |
| Balance at End of Year                        |   | $        | 744,248 |     | $      | 635,468 |   |

 

The following is asummary of the investment in impaired loans, the related allowance for loanlosses, and income recognized thereon as of December 31:

 
|                                          |   | **2002** |    | **2001** |   |
|-----------------------------------------------|--------|----------|---------|----------|--------|
|                                          |   |     |    |     |   |
| Recorded Investment in Impaired Loans         |   | $        | —  |     | $      | 889,000 |   |
|                                          |   |     |    |     |   |
| Related Allowance for Loan Losses             |   | $        | —  |     | $      | 133,000 |   |
|                                          |   |     |    |     |   |
| Average Recorded Investment in Impaired Loans |   | $        | 540,000 |     | $      | 1,480,000 |   |
|                                          |   |     |    |     |   |
| Interest Income Recognized for Cash Payments  |   | $        | 2,905   |     | $      | — |   |

 

Included in totalloans are net deferred loans fess and discounts of $472,089 at December 31,2002 and $266,787 at December 31, 2001.

 

F-14

----

 

### **NOTE D - PREMISES ANDEQUIPMENT**

 

A summary ofpremises and equipment as of December 31 follows:

 
|                                      |   | **2002**  |       | **2001**  |       |
|-------------------------------------------|--------|-----------|------------|-----------|------------|
|                                      |   |      | ** ** |      | ** ** |
| Land                                      |   | $         | 976,498    |      | $          | 976,498 |   |
| Buildings                                 |   | 722,333   |       | 722,333   |       |
| Leasehold Improvements                    |   | 338,451   |       | 272,414   |       |
| Furniture, Fixtures, and Equipment        |   | 1,242,139 |       | 990,694   |       |
|                                      |   | 3,279,421 |       | 2,961,939 |       |
| Accumulated Depreciation and Amortization |   | (791,360  | )          | (572,908  | )          |
|                                      |   |      |       |      |       |
|                                      |   | $         | 2,488,061  |      | $          | 2,389,031 |   |

 

The Bank hasentered into operating leases for its branches and operating facilities, whichexpire at various dates through 2007. These leases include provisions for periodic rent increases as well aspayment by the lessee of certain operating expenses.

 

Rental expenserelating to these leases was approximately $121,000 in 2002 and $88,000 in 2001

 

At December 31, 2002, the approximate future minimum annual paymentsunder these leases are as follows:

 

| 2003   |   | $       | 126,051 |   |
|--------|--------|---------|---------|--------|
| 2004   |   | 114,539 |    |
| 2005   |   | 90,453  |    |
| 2006   |   | 35,856  |    |
| 2007   |   | 14,940  |    |
|   |   |    |    |
|   |   | $       | 381,839 |   |

 

The minimum rentalpayments shown above are given for the existing lease obligations and do notreflect any increases in rent.  It isnot a forecast of rental expenses.

 

F-15

----

 

**NOTE E - DEPOSITS**

 

At December 31,2002, the scheduled maturities of time deposits are as follows:

 

| Due in One Year          |   | $         | 25,570,126 |   |
|--------------------------|--------|-----------|------------|--------|
| Due in One to Five Years |   | 8,149,770 |       |
|                     |   |      |       |
|                     |   | $         | 33,719,896 |   |

 

**NOTE F - SHORT-TERM BORROWINGS**

 

Short-termborrowings at December 31, 2002 are comprised of the following advances fromthe Federal Home Loan Bank of San Francisco:

 

| **Maturity  Date** |   | **Interest  Rate** |   | **Amount** |      |
|--------------------|--------|--------------------|--------|------------|-----------|
| 1/30/2003          |   | 1.33               | %      | $          | 1,000,000 |   |
| 10/1/2004          |   | 2.09               | %      | 500,000    |      |
| 6/11/2003          |   | 2.48               | %      | 500,000    |      |
| 5/13/2004          |   | 3.58               | %      | 500,000    |      |
|               |   |               |   |       |      |
|               |   |               |   | $          | 2,500,000 |   |

 

These advances aresecured by investment securities as discussed in Note B.  The Bank also has unsecured borrowing lineswith correspondent banks totaling $4,000,000 and the Company had one borrowingline totaling $200,000.  As of December31, 2002, there were no balances outstanding on these lines.

 

**NOTE G - INCOME TAXES**

 

The income tax expense for the years ended December 31, 2002 and 2001is comprised of the following:

 
|           |   | **2002** |    | **2001** |   |
|----------------|--------|----------|---------|----------|--------|
| Current Taxes: |   |     |    |     |   |
| Federal        |   | $        | 385,318 |     | $      | 107,000 |   |
| State          |   | 134,504  |    | 33,000   |   |
|           |   | 519,822  |    | 140,000  |   |
| Deferred       |   | (5,000   | )       | (140,000 | )      |
|           |   |     |    |     |   |
|           |   | $        | 514,822 |     | $      | — |   |

 

F-16

----

 

A comparison ofthe federal statutory income tax rates to the Company’s effective income taxfollows:

 
|                                                   |   | **2002**   |    | **2001** |   |
|--------------------------------------------------------|--------|------------|---------|----------|--------|
|                                                   |   | **Amount** |    | **Rate** |   | **Amount** |   | **Rate** |   |
|                                                   |   |       |    |     |   |   |   |   |   |
| Federal tax rate                                       |   | $          | 431,000 |     | 34.0   | % | $ | 347,000 |   | 34.0 | % |
| California franchise taxes, net of federal tax benefit |   | 91,000     |    | 7.2      | %      | 73,000 |   | 7.2 | % |
| Reduction in valuation allowance                       |   | —     |    | —   |   | (376,000 | ) | (36.9 | )% |
| Other items - net                                      |   | (7,178     | )       | (0.6     | )%     | (44,000 | ) | (4.3 | )% |
|                                                   |   |       |    |     |   |   |   |   |   |
|                                                   |   | $          | 514,822 |     | 40.6   | % | $ | — |   | — |   |

 

Deferred taxes area result of differences between income tax accounting and generally acceptedaccounting principles 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 asummary of the components of the net deferred tax asset accounts recognized inthe accompanying Balance Sheets:

 
|                                             |   | **2002** |    | **2001** |   |
|--------------------------------------------------|--------|----------|---------|----------|--------|
| Deferred Tax Assets:                             |   |     |    |     |   |
| Organizational and Start-up Costs                |   | $        | —  |     | $      | 52,000 |   |
| Bank Enterprise Award Deferral                   |   | 112,000  |    | 186,000  |   |
| Allowance for Loan Losses Due to Tax Limitations |   | 268,000  |    | 219,000  |   |
| Other                                            |   | 109,000  |    | 69,000   |   |
|                                             |   | 489,000  |    | 526,000  |   |
| Deferred Tax Liabilities:                        |   |     |    |     |   |
| Cash Basis of Tax Reporting                      |   | (125,000 | )       | (191,000 | )      |
| Depreciation Differences                         |   | (36,000  | )       | (16,000  | )      |
| Unrealized Gain on Investment Securities         |   | (47,000  | )       | (36,000  | )      |
| Other                                            |   | (5,000   | )       | (1,000   | )      |
|                                             |   | (213,000 | )       | (244,000 | )      |
|                                             |   |     |    |     |   |
| Net Deferred Tax Assets                          |   | $        | 276,000 |     | $      | 282,000 |   |

 

F-17

----

 

**NOTE H - STOCK OPTION PLAN**

 

During 1998, the Board of Directors adopted a stock option plan, whichwas approved by the shareholders, under which 180,000 shares of the Company’scommon stock may be issued.  The Companyapplies APB Opinion No. 25 and related interpretations in accounting for itsplan.  Accordingly, no compensation costhas been recognized for its fixed stock option plan.

 

The fair value of each option grant was estimated on the date of grantusing the Black-Scholes option pricing model with the followingassumptions:  risk-free rate of 3.75%and 4.00% for 2002 and 2001 respectively, expected lives of five years, nodividend payments and disregarding any stock price volatility.

 

A summary of the status of the Company’s fixed stock option plan as ofDecember 31, 2002 and 2001 and changes during the years is presented below:

 
|                                                           |   | **2002**   |   | **2001**                               |   |
|----------------------------------------------------------------|--------|------------|--------|----------------------------------------|--------|
|                                                           |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   |
| Outstanding at Beginning of Year                               |   | 144,166    |   | $                                      | 9.41   |   | 117,666 |   | $ | 9.83 |   |
| Granted                                                        |   | 21,500     |   | $                                      | 11.30  |   | 36,500 |   | $ | 7.89 |   |
| Exercised                                                      |   | (100       | )      | $                                      | 8.25   |   | — |   | $ | — |   |
| Forfeited                                                      |   | (6,900     | )      | $                                      | 8.85   |   | (10,000 | ) | $ | 8.78 |   |
|                                                           |   |       |   |                                   |   |   |   |   |   |
| Outstanding at End of Year                                     |   | 158,666    |   | $                                      | 9.69   |   | 144,166 |   | $ | 9.41 |   |
|                                                           |   |       |   |                                   |   |   |   |   |   |
| Options Exercisable at Year-End                                |   | 89,133     |   | $                                      | 9.80   |   | 62,600 |   | $ | 9.98 |   |
|                                                           |   |       |   |                                   |   |   |   |   |   |
| Weighted-Average Fair Value of Options Granted During the Year |   |       |   | $                                      | 1.91   |   |   |   | $ | 1.51 |   |

 

F-18

----

 

 

The followingtable summarizes information about fixed options outstanding at December 31,2002:

 
|                |         | **Options  Outstanding** |    | **Options  Exercisable**                            |       |
|---------------------|--------------|--------------------------|---------|-----------------------------------------------------|------------|
| **Exercise  Price** |         | **Number  Outstanding**  |    | **Weighted  Average  Remaining  Contractual  Life** |       | **Weighted  Average  Exercise  Price** |   | **Number  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
| $                   | 10.00        |                     | 101,166 |                                                | 5.1  years |   | $ | 10.00 |   | 80,933 |   | $ | 10.00 |   |
| $                   | 7.50 - $8.25 |                     | 36,000  |                                                | 8.3  years |   | $ | 7.85 |   | 8,200 |   | $ | 7.87 |   |
| $                   | 11.30        |                     | 21,500  |                                                | 9.8  years |   | $ | 11.30 |   | — |   | — |   |
|                |         |                     |    |                                                |       |   |   |   |   |   |   |
|                |         | 158,666                  |    | 6.4  years                                          |       | $ | 9.69 |   | 89,133 |   | $ | 9.80 |   |

 

**NOTE I - OTHER EXPENSES**

 

Other expenses asof December 31 are comprised of the following:

 
|                                 |   | **2002** |      | **2001** |   |
|--------------------------------------|--------|----------|-----------|----------|--------|
|                                 |   |     |      |     |   |
| Data Processing                      |   | $        | 409,515   |     | $      | 583,865 |   |
| Professional Expenses                |   | 87,395   |      | 162,267  |   |
| Marketing and Business Promotion     |   | 138,997  |      | 112,737  |   |
| Insurance and Regulatory Assessments |   | 87,841   |      | 80,829   |   |
| Office Supplies and Expenses         |   | 195,009  |      | 117,304  |   |
| Other Expenses                       |   | 430,548  |      | 331,713  |   |
|                                 |   |     |      |     |   |
|                                 |   | $        | 1,349,305 |     | $      | 1,388,715 |   |

 

F-19

----

 

**NOTE J - PREFERRED STOCK**

 

Series A – theSeries A Preferred Stock has $5.00 stated value and is non-voting, convertibleand redeemable.  Each share isconvertible into voting common stock of the Company on a two-for-one exchange.  Series A shares are not entitled to anyfixed rate of return, but do participate on the same basis (as if converted ona two-for-one exchange) in any dividends declared on the Company’s commonstock. In the event of liquidation, the holders of Series A shares will beentitled to a liquidation preference of $5.00 per share before the holders ofcommon stock receive any distributions and after the holders of common stockreceive distributions of $10.00 per share, all distributions will be on thesame basis (as if converted on a two-for-one exchange).  These shares were issued for $392,194 (netof issuance costs of $107,806) pursuant to an award from the CommunityDevelopment Financial Institutions Fund of the Department of the Treasury.

 

Series B – theSeries B Preferred Stock has $10.00 stated value and is non-voting,non-convertible and non-redeemable. Series B shares are not entitled to any fixed rate of return but doparticipate on the same basis in any dividends declared on the Company’s commonstock. In the event of liquidation, the holders of Series B shares will beentitled to a liquidation preference of $10.00 per share before the holders ofcommon stock receive any distributions. Additionally, in the event of a so-called “change in control event” (includingcertain mergers or sales of assets) holders of the Series B Preferred Stockshall be entitled to receive payment on the same basis as the holders of thecommon stock of the Company.  Theseshares were issued for $191,606 (net of issuance costs of $13,394) pursuant toan investment from the National Community Investment Fund (“NCIF”).  In connection with this investment, NCIFalso purchased 29,500 shares of the Company’s common stock for $10.00 pershare.  As part of the investmentagreement, the Company by covenant agreed that so long as NCIF or any successorowns and holds any of the Shares to remain a CDFI and to meet certain reportingrequirements.

 

Series C – theSeries C Preferred Stock has $10.00 stated value and is non-voting, convertibleand redeemable.  Each share isconvertible into voting common stock of the Company on a one-for-oneexchange.  Series C shares are notentitled to any fixed rate of return, but do participate on the same basis (asif converted on a one-to-one exchange) in any dividends declared on theCompany’s common stock.  In the event ofliquidation, the holders of Series C shares will be entitled to a liquidationpreference of $10.00 per share (as adjusted for any stock dividends, combinationsor splits with respect to such shares) before the holders of common stockreceive any distributions.  These shareswere issued for $500,000 pursuant to an award from the Community DevelopmentFinancial Institutions Fund of the Department of the Treasury.

 

 

**NOTE K - RELATED PARTY TRANSACTIONS**

 

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

 

F-20

----

 

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

 

 
|                                 |   | **2002**  |      | **2001** |   |
|--------------------------------------|--------|-----------|-----------|----------|--------|
|                                 |   |      |      |     |   |
| Balance at the beginning of the year |   | $         | 1,608,000 |     | $      | 1,945,000 |   |
| New loans and renewals               |   | 1,590,000 |      | 499,000  |   |
| Repayments and renewals              |   | (542,000  | )         | (836,000 | )      |
|                                 |   |      |      |     |   |
| Balance at the end of the year       |   | $         | 2,656,000 |     | $      | 1,608,000 |   |

 

**NOTE L - COMMITMENTS ANDCONTINGENCIES**

 

In the normalcourse of business, the Bank enters into financial commitments to meet thefinancing needs of its customers.  Thesefinancial commitments include commitments to extend credit and standby lettersof credit.  Those instruments involve tovarying degrees, elements of credit and interest rate risk not recognized inthe statement of financial position.

 

The Bank’sexposure to credit loss in the event of nonperformance on commitments to extendcredit and standby letters of credit is represented by the contractual amountof those instruments.  The Bank uses thesame credit policies in making commitments as it does for loans reflected inthe financial statements.

 

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

 

 
|                         |   | **2002** |       | **2001** |   |
|------------------------------|--------|----------|------------|----------|--------|
|                         |   |     |       |     |   |
| Commitments to Extend Credit |   | $        | 18,079,000 |     | $      | 13,444,000 |   |
| Standby Letters of Credit    |   | 64,000   |       | 268,000  |   |
|                         |   |     |       |     |   |
|                         |   | $        | 18,143,000 |     | $      | 13,712,000 |   |

 

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

 

The Company isinvolved in various litigation, which has arisen in the ordinary course ofbusiness.  In the opinion of management,the disposition of such pending litigation will not have a material effect onthe Company’s financial statements.

 

F-21

----

 

**NOTE M - EARNINGS PER SHARE**

 

The following is a reconciliation on net income and shares outstandingto the income and number of shares used in the computation of earnings pershare:

 
|                                                                             |   | **2002**   |    | **2001**   |    |
|----------------------------------------------------------------------------------|--------|------------|---------|------------|---------|
|                                                                             |   | **Income** |    | **Shares** |    | **Income** |   | **Shares** |   |
|                                                                             |   |       |    |       |    |   |   |   |   |
| Net Income                                                                       |   | $          | 752,143 |       |    |   | $ | 1,019,594 |   |   |   |
| Average Common Shares Outstanding During the Year                                |   |       |    | 630,075    |    |   |   | 630,066 |   |
| Preferred Shares Participating in Net Income With Common Shareholders  - Average |   |       |    | 71,596     |    |   |   | 70,500 |   |
| Used in Basic EPS                                                                |   | 752,143    |    | 701,671    |    | 1,019,594 |   | 700,566 |   |
| Dilutive Effect of Outstanding Stock Options                                     |   |       |    | 14,590     |    |   |   | — |   |
|                                                                             |   |       |    |       |    |   |   |   |   |
| Used in Dilutive EPS                                                             |   | $          | 752,143 |       | 716,261 |   | $ | 1,019,594 |   | 700,566 |   |

 

Preferred shares are included in the computation of basic earnings pershare because they share equally with common shares in the distribution of netincome and they do not have a stated dividend rate.

 

The impact of stock options was excluded from the computation ofdiluted EPS in 2001 because they were anti-dilutive.

 

**NOTE N - REGULATORY MATTERS**

 

The Bank is subject tovarious regulatory capital requirements administered by the federal bankingagencies.  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 the regulatory frameworkfor prompt corrective action, the Bank must meet specific capital guidelinesthat involve quantitative measures of the Bank’s assets, liabilities, andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout 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, 2002, that the Bank meets all capital adequacy requirements towhich it is subject.

 

F-22

----

 

As of December 31, 2002,the most recent notification from the Comptroller of the Currency categorizedthe Bank as well-capitalized under the regulatory framework for promptcorrective action (there are no conditions or events since that notificationthat management believes have changed the Bank’s category).  To be categorized as well-capitalized, theBank must maintain minimum ratios as set forth in the table below.  The following table also sets forth theBank’s actual capital amounts and ratios (dollar amounts in thousands):

 
|                                      |   |       |   |                               |   | **Amount of  Capital Required** |   |
|-------------------------------------------|--------|------------|--------|------------------------------------|--------|---------------------------------|--------|
|                                      |   | **Actual** |   | **To Be  Adequately  Capitalized** |   | **To Be  Well-  Capitalized**   |   |
|                                      |   | **Amount** |   | **Ratio**                          |   | **Amount**                      |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| **As  of December 31, 2002:**             |   |       |   |                               |   |                            |   |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)  |   | $          | 8,625  |                               | 11.7   | %                               | $      | 5,907 |   | 8.0 | % | $ | 7,383 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |   | $          | 7,880  |                               | 10.7   | %                               | $      | 2,953 |   | 4.0 | % | $ | 4,430 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |   | $          | 7,880  |                               | 7.9    | %                               | $      | 3,973 |   | 4.0 | % | $ | 4,967 |   | 5.0 | % |
|                                      |   |       |   |                               |   |                            |   |   |   |   |   |   |   |
| **As  of December 31, 2001:**             |   |       |   |                               |   |                            |   |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)  |   | $          | 7,385  |                               | 12.1   | %                               | $      | 4,919 |   | 8.0 | % | $ | 6,149 |   | 10.0 | % |
| Tier 1 Capital  (to Risk-Weighted Assets) |   | $          | 6,750  |                               | 11.1   | %                               | $      | 2,459 |   | 4.0 | % | $ | 3,689 |   | 6.0 | % |
| Tier 1 Capital  (to Average Assets)       |   | $          | 6,750  |                               | 8.5    | %                               | $      | 3,173 |   | 4.0 | % | $ | 3,967 |   | 5.0 | % |

 

The Bank isrestricted as to the amount of dividends that can be paid.  Dividends declared by national banks thatexceed the net income (as defined) for the current year plus retained netincome for the preceding two years must be approved by the OCC.  The Bank may not pay dividends that wouldresult in its capital levels being reduced below the minimum requirements shownabove.

 

The Company is subject to similar requirements administered by itsprimary regulator, the Federal Reserve Board. For capital adequacy purposes,the Company must maintain total capital to risk-weighted assets, Tier 1 capitalto risk-weighted assets and Tier 1 capital to average assets of 8.0%, 4.0% and4.0%, respectively.  Its total capitalto risk-weighted assets, Tier 1 capital to risk-weighted assets and Tier 1capital to average assets was 11.7%, 10.7% and 7.9%, respectively, at December31, 2002 and 12.1%, 11.1% and 8.5%, respectively, at December 31, 2001.

 

 

**NOTE O -FORMATION OF MISSION COMMUNITY BANCORP**

 

On December 15,2000, Mission Community Bancorp acquired Mission Community Bank by issuing600,566 shares of common stock in exchange for the surrender of all outstandingshares of the Bank’s common stock. There was no cash involved in this transaction.  The acquisition was accounted for like apooling of interests and the financial statements contained herein have beenrestated to give full effect to this transaction.

 

Mission CommunityBancorp has no significant business activity other than its investment inMission Community Bank.  Accordingly, noseparate financial information on the Company is provided.

 

F-23

----

 

**MISSION COMMUNITY BANCORP ANDSUBSIDIARY**

 

**NOTES TO FINANCIAL STATEMENTS**

**December 31, 2002 and 2001**

 

 

**NOTE P -BANK ENTERPRISE AWARD**

 

During 2001, the Bank received a $990,000 award under the Fiscal Year2001 Bank Enterprise Award Program.  Theprogram is sponsored by the Department of Treasury, Community DevelopmentFinancial Institutions Fund.  The Bankreceived the award for making a total of $3,000,000 in deposits with certifiedCommunity Development Financial Institutions.

 

The Bank deferred approximately $452,000 of the award to increase thefuture earnings on the deposits to market rates.  The Bank recognized approximately $180,000 of this deferredamount in 2002.  The Bank will recognizeapproximately $180,000 in 2003 and the balance of approximately $92,000 in2004.

 

**NOTE Q - FAIR VALUE OF FINANCIALINSTRUMENTS**

 

The fair value ofa financial instrument is the amount at which the asset or obligation could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale.  Fair valueestimates are made at a specific point in time based on relevant market informationand information about the financial instrument.  These estimates do not reflect any premium or discount that couldresult from 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 based on financialinstruments both on and off the balance sheet without attempting to estimatethe value of anticipated future business and the value of assets andliabilities that are not considered financial instruments.  Additionally, tax consequences related tothe realization of the unrealized gains and losses can have a potential effecton fair value estimates and have not been considered in many of the estimates.

 

The followingmethods and assumptions were used to estimate the fair value of significantfinancial instruments:

 

## **Financial Assets**

 

The carrying amounts of cash, short-term investments, due fromcustomers on acceptances, and Bank acceptances outstanding are considered toapproximate fair value.  Short-terminvestments include federal funds sold, securities purchased under agreementsto resell, commercial paper 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 usinga combination of techniques, including discounting estimated future cash flowsand quoted market prices of similar instruments where available

 

F-24

----

 

Financial Liabilities

 

The carryingamounts of deposit liabilities payable on demand, commercial paper, and otherborrowed funds are considered to approximate fair value.  For fixed maturity deposits, fair value isestimated by discounting estimated future cash flows using currently offeredrates for deposits of similar remaining maturities.  The fair value of long-term debt is based on rates currentlyavailable to the Bank for debt with similar terms and remaining maturities.

 

Off-Balance Sheet Financial Instruments

 

The fair value of commitments to extend credit and standby letters ofcredit is estimated using the fees currently charged to enter into similaragreements.  The fair value of thesefinancial instruments is not material.

 

The estimated fairvalue of financial instruments is summarized as follows: (dollar amounts inthousands)

 
|                                   |   | **December  31,**   |   |
|----------------------------------------|--------|---------------------|--------|
|                                   |   | **2002**            |   | **2001** |   |
|                                   |   | **Carrying  Value** |   | **Fair  Value** |   | **Carrying  Value** |   | **Fair  Value** |   |
| **Financial Assets:**                  |   |                |   |   |   |   |   |   |   |
| Cash and due from banks                |   | $                   | 3,024  |   | $ | 3,024 |   | $ | 2,526 |   | $ | 2,526 |   |
| Federal funds sold                     |   | 12,295              |   | 12,295 |   | — |   | — |   |
| Interest-Bearing Deposits              |   | 3,000               |   | 2,727 |   | 3,009 |   | 2,557 |   |
| Investment securities                  |   | 11,891              |   | 11,646 |   | 10,835 |   | 10,892 |   |
| Loans, net                             |   | 64,443              |   | 64,384 |   | 59,826 |   | 60,093 |   |
| Federal Reserve Bank and other Stocks  |   | 338                 |   | 338 |   | 222 |   | 222 |   |
| Accrued interest receivable            |   | 430                 |   | 430 |   | 341 |   | 341 |   |
|                                   |   |                |   |   |   |   |   |   |   |
| **Financial Liabilities:**             |   |                |   |   |   |   |   |   |   |
| Deposits                               |   | 87,505              |   | 87,681 |   | 71,684 |   | 71,683 |   |
| Other borrowings                       |   | 2,500               |   | 2,519 |   | 420 |   | 420 |   |
| Accrued interest and other liabilities |   | 781                 |   | 781 |   | 560 |   | 560 |   |
|                                        |        |                     |        |  |  |  |  |  |  |  |  |  |  |

 
| **ITEM  8.** |   | **CHANGES WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE** |
|--------------|--------|----------------------------------------------------------------------|
|         |   | None.                                                                |

 

F-25

----

 

**PART III**

 

**ITEM 9.****                                                     DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION16(a) OF THE EXCHANGE ACT.**

 

The following table lists the names and certain information as ofDecember 31, 2002, concerning all directors and executive officers of theCompany and the Bank.  The Company andthe Bank have no “significant employees” except its executive officers.

 

| **Name and  Title**                                                                 |   | **Age** |   | **Business Experience for Past Five Years**                                                                                                                                                                                                                              |   | **Year First Elected  or Appointed  Director*** |
|-------------------------------------------------------------------------------------|--------|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Bruce M. Breault  Founding Chairman of the Board (Emeritus)                         |   | 60      |   | Partner and Owner, F. McLintocks, Inc. (restaurants)  (1973-)                                                                                                                                                                                                            |   | 1996                                            |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Roxanne M. Carr  Secretary                                                          |   | 65      |   | 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                                                             |   | 60      |   | President and Owner, Central California Investments  (1998-); Broker and Owner, Karla Cool Realty (1987-1998)                                                                                                                                                            |   | 1998                                            |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| William B. Coy  Vice Chairman of the Board                                          |   | 65      |   | Owner and Manager Managing Partner, Rancho Rio  Conejo (citrus and avocados) (1979-); Corporate Marketing Manager, San Luis  Obispo County Farm Supply Company (1991-2001)                                                                                               |   | 1996                                            |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| William C.  Demmin  Executive Vice President/ Chief Financial Officer               |   | 57      |   | Banker(1)                                                                                                                                                                                                                                                                |   | N/A                                             |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Richard Korsgaard  David A. Duarte

Executive Vice  President/ Chief Credit Officer |   | 61      |   | Banker(2)                                                                                                                                                                                                                                                                |   | N/A                                             |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Erol F. Giray,  M.D.  Director                                                      |   | 46      |   | Psychiatrist                                                                                                                                                                                                                                                             |   | 1997                                            |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Anita M.  Robinson  Director, President and Chief Executive Officer                 |   | 50      |   | Banker(3)                                                                                                                                                                                                                                                                |   | 1996                                            |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Robin L. Rossi  Director                                                            |   | 55      |   | President, Rossi Enterprises (property management)  (1991-); President, Infinite Horizons, Inc. (Manager of Avila Beach Resort)  (1979-)                                                                                                                                 |   | 1996                                            |
|                                                                                |   |    |   |                                                                                                                                                                                                                                                                     |   |                                            |
| Gary E. Stemper  Chairman of the Board                                              |   | 60      |   | Eagle Castle Eagles Crest Winery, LLC, Manager  (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  Director                                                        |   | 49      |   | Self-Employed-real estate development, ranching,  vineyards, investments, (1996-); President and CEO, Allwaste Transportation  and Remediation, Inc. (1992-1996)                                                                                                         |   | 1997                                            |

 

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

 

(1)                                  Mr. William C. Demmin joined the Bank on March12, 2001.  Mr. Demmin has over 32 yearsof banking experience.  For the period1999 to 2001 he served as Interim President/CEO, and Executive VicePresident/Chief Financial Officer, for Network

 

43

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Bank USA, Ontario,California.  From 1997 to 1999 he heldthe position of Executive Vice President/Chief Financial Officer with CuyamacaBank, N.A., in Santee, California.  From1996 to 1997 he served as President/Chief Executive Officer for Merchants Bankof California, Carson, California.  Forthe period 1987 to 1996, he served as Executive Vice President/Chief FinancialOfficer for Monarch Bancorp and Monarch Bank, Laguna Niguel, California.  Prior to 1987, he held various managementpositions with Commercial Center Bank, Southern California Bancorp and Bank ofAmerica.

 

(2)                                  Mr. Richard Korsgaard joined the Bank on July22, 2002 as the Executive Vice President and Chief Credit Officer.   Mr. Korsgaard has 37 years of bankingexperience.  For the period of March2001 to March 2002 he held the position of Senior Vice President withCalifornia Bank and Trust, San Diego, California. From 1995 to 2001 he servedas an Executive Vice President Eldorado Bank, Laguna Hills, California, whichwas acquired by California Bank and Trust in March 2001. From 1982 to 1995 hewas the Organizing President, Chief Executive Officer and Director of MarinersBank, San Clemente, California.  From1973 to May 1982 he held executive management positions, including ChiefOperating Officer with Eldorado Bank.

 

(3)                                  Ms.Robinson has over 30 years of banking experience.  From 1982 to 1989 she was a Vice President, Branch Manager andCommercial Loan Officer for National Bank of Southern California in Santa Ana,California.  From 1989 to 1993 Ms.Robinson served as Executive Vice President/Senior Loan Administrator ofCommerce Bank of San Luis Obispo.  In1994 she became the President and Chief Executive Officer of Commerce Bank ofSan Luis Obispo and served in that capacity until the bank was acquired byValliWide Bank in 1996.  Ms. Robinsonleft ValliWide Bank and joined the organizing effort of the Bank in 1996.

 

None of the Bank’s directors or executive officers were selectedpursuant to any arrangement or understanding, other than with the directors andexecutive officers of the Bank, acting within their capacities as such.  There are no family relationships betweenthe directors or executive officers of the Bank and none serve as directors ofany other company which has a class of securities registered under, or which issubject to the periodic reporting requirements of, the Securities Exchange Actof 1934 or any investment company registered under the Investment Company Actof 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’sofficers and directors, and persons who own more than 10% of the Company’sCommon Stock, are not subject to the reporting requirements under Section 16(a)of the Exchange Act.

 

44

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**ITEM10.               EXECUTIVE COMPENSATION**

 

**SummaryCompensation**

 

The following table sets forth a summary of annual and long-termcompensation for services in all capacities to the Bank for the Bank’sPresident and Chief Executive Officer and its Executive Vice President andChief Financial Officer. 

 
|                                                  |   | **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  Executive Officer                |   | 2002  2001  2000         |   | $  $  $                             | 130,000  115,000  90,000 |      | $                | 10,000  —  — |   | $  $  $ | 7,800  7,800  6,000 |   | —  5,000  — |   | —  —  — |   |
|                                                  |   |                     |   |                                |                     |      |             |   |   |   |   |   |   |
| **William C. Demmin**                                 |   |                     |   |                                |                     |      |             |   |   |   |   |   |   |
| Executive Vice  President and Chief Financial Officer |   | 2002  2001  2000         |   | $                                   | 100,020  N/A  N/A        |      | —  N/A  N/A |   | $ | 4,800  N/A  N/A |   | 2,000  N/A  N/A |   | —  N/A  N/A |   |
|                                                       |        |                          |        |                                     |                          |           |                  |  |  |  |  |  |  |  |  |  |

 

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(1) This figurerepresents automobile allowance paid during the year.

(2) Mr. Demmin, who was hired March 12, 2001, did not receive annualcompensation of $100,000 or more in 2001.

 

No other officer receivedannual compensation of $100,000 or more in 2002.  The Company currently pays no salaries to its officers.

 

**Option/SARGrants**

 

On January 20, 1998 the Bank’s Board of Directors adopted the 1998Stock Option Plan, pursuant to approval by the Bank’s shareholders prior toJanuary 20, 1999.  The Bank’sshareholders approved the 1998 Stock Option Plan at the Annual Meeting ofShareholders held on June 16, 1998.   In1998, a total of 125,099 incentive and non-qualified stock option shares weregranted at a price range of $10.00 to $11.00 per share; 5,000 stock optionshares were retired; and no stock options were exercised.  In 1999, a total of 11,000 incentive optionshares were granted at a price range of $8.125 to $9.00 per share; 17,433incentive and non-qualified stock options were retired; and no options wereexercised.  In 2000, a total of 7,500incentive and non-qualified stock option shares were granted at a price rangeof $7.875 to $8.188 per share; 5,486 stock option shares were retired; and nooptions were exercised.   In 2001, atotal of 36,500 incentive and non-qualified stock options were granted at aprice range of $7.50 to $8.25 per share; 10,000 stock options were retired; andno stock options were exercised. In 2002, a total of 21,500 incentive stockoption shares were granted at a price of $11.30 per share; 6,900 incentive stockoption shares were retired; and 100 incentive stock option shares wereexercised.  The 1998 Stock Option Planand the options granted pursuant thereto were assumed by the Company inconnection with the holding company formation transaction in which the Bankbecame a wholly-owned subsidiary of the Company.

 

**LongTerm Incentive Plan Awards**

 

There were no long-term incentive plan awards in 2000, 2001 or 2002.

 

45

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**EmploymentContracts**

 

In 1997 the Bankand Ms. Robinson entered into an employment contract, for a period of threeyears, which provides for a base salary of $7,500 per month, discretionarybonuses, an automobile allowance of $500 per month, expense reimbursement,$250,000 of life insurance and standard and customary medical and dentalinsurance benefits.  The contractprovides for severance benefits of six months’ compensation for terminationwithout cause and severance benefits equal to the greater of $100,000 or thebase salary for the balance of the contract term for termination after amerger, change in control, or other defined corporate reorganizations.  On February 27, 2001, the Board of Directorsapproved a new employment contract for Ms. Robinson, effective for a one yearterm beginning on January 1, 2001, which provides for a base salary of $9,583per month, discretionary bonuses, an automobile allowance of $650 per month,expense reimbursement, $250,000 of life insurance, standard and customarymedical and dental insurance benefits, and a stock option grant of 5,000shares.  The contract provides forseverance benefits of six months’ base salary for termination without cause,and severance benefits of twelve months’ base salary for termination after amerger, change in control, or other defined corporate reorganizations.   On February 25, 2002, the Board ofDirectors approved a new employment contract for Ms. Robinson, effective for afive 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 payable byDecember 31, 2002.  The five yearagreement provides for an annual review by the Board of Directors of the basesalary provided to Ms. Robinson, which shall not be less than $10,833 per monthduring the life of the agreement. The contract provides for severance benefitsof six months base salary for termination without cause, and severance benefitsof sixty months base salary, from the date of event, for termination after amerger, change in control, or other defined corporation reorganizations.

 

In 2001 and 2002,the Bank entered into Change in Control Employment agreements with ExecutiveOfficers Demmin and Korsgaard, and also with four of the Bank’s Senior VicePresidents, that will provide for severance benefits for termination after amerger, change in control, or other defined corporate reorganizations equal to alump sum amount equal to six months salary.

 

**Directors’Compensation**

 

During 2000, 2001 and 2002 the Bank’s directors were not paid forattending meetings of the Board or the committees on which they served.  On April 22, 2002 the bank’s Board ofDirectors approved a Director Compensation Program, which became effective onJuly 1, 2002, providing for outside directors to receive a monthly retainer of$500 for each Board Meeting attended and a fee of $100 for each DirectorCommittee meeting attended.  In 2002,the Board received, on a cumulative basis, $25,700 in Director fees formeetings attended in 2002.

 

There were no Stock Option grants to Directors during the year-endingDecember 31, 2002.

 

46

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**ITEM 11****                                                 SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The following table sets forth certain information as of December 31,2002, concerning the beneficial ownership of the Company’s outstanding CommonStock: (i) by each of the directors and executive officers; and(ii) by all directors and executive officers of the Company as agroup.  Management is not aware of anychange in control of the Company which has occurred since January 1, 2003 or ofany arrangement which may, at a subsequent date, result in such a change incontrol.  Management of the Company isaware of one person who owns, beneficially or of record, more than 5% of theCompany’s outstanding Common Stock: The Patrick W. Hopper Trust beneficiallyowns 41,834 shares of common stock, or 6.6% of total shares outstanding.

 

| **Name and Position Held**                             |   | **Common  Stock  Beneficially  Owned(1)** |   | **Shares  Subject to  Exercise(2)** |   | **Total  Shares  Beneficially  Owned** |   | **Percent of  Class** |   |
|--------------------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------|--------|----------------------------------------|--------|-----------------------|--------|
| Bruce M. Breault                                       |   | 21,250                                    |   | 14,333                              |   | 35,583                                 |   | 5.5                   | %      |
| Founding  Chairman of the Board                        |   |                                      |   |                                |   |                                   |   |                  |   |
| (Emeritus)                                             |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Roxanne M. Carr                                        |   | 10,000                                    |   | 8,200                               |   | 18,200                                 |   | 2.9                   | %      |
| Director and  Secretary                                |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Karla S. Cool                                          |   | 4,837                                     |   | 1,400                               |   | 6,237                                  |   | 1.0                   | %      |
| Director                                               |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| William B. Coy                                         |   | 7,750                                     |   | 8,200                               |   | 15,950                                 |   | 2.5                   | %      |
| Director and  Vice Chairman of the Board               |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Erol F. Giray,  M.D.                                   |   | 6,530                                     |   | 7,133                               |   | 13,663                                 |   | 2.1                   | %      |
| Director                                               |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Anita M.  Robinson                                     |   | 18,609                                    |   | 21,000                              |   | 39,609                                 |   | 6.1                   | %      |
| Director,  President and Chief Executive Officer       |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Robin L. Rossi                                         |   | 13,707                                    | (3)    | 12,200                              |   | 25,907                                 |   | 4.0                   | %      |
| Director                                               |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Gary E. Stemper                                        |   | 7,500                                     |   | 10,600                              |   | 18,100                                 |   | 2.8                   | %      |
| Chairman of the  Board                                 |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| Karl F.  Wittstrom                                     |   | 15,450                                    |   | 9,800                               |   | 25,250                                 |   | 3.9                   | %      |
| Director                                               |   |                                      |   |                                |   |                                   |   |                  |   |
|                                                   |   |                                      |   |                                |   |                                   |   |                  |   |
| All Directors  and Executive Officers as a  Group (11) |   | 105,633                                   |   | 93,866                              |   | 199,499                                |   | 27.6                  | %      |

 

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(1)          Includes sharesbeneficially owned, directly or indirectly, together with associates. Alsoincludes shares held as trustee and held by or as custodian for minor children,by a closely held business or other associate. Unless otherwise indicated, allshares are held as community property under California law or with sole vetoingand investment power.

 

(2)          Shares subject tooptions that were exercisable within 60 days of 12/31/02 are treated as issuedand outstanding for the purpose of computing the percent of class owned by suchperson but not for the purpose of computing the percent of class owned by anyother person.  Includes 1,000 sharessubject to option held by William C. Demmin exercisable within 60 days.

 

47

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(3)          Includes 457 shares heldin the name of The Rossi Foundation, of which, Mr. Rossi holds no votingrights.

 

**ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

**CertainTransactions**

 

There are no existing or proposed material transactions between theCompany or the Bank and any of its executive officers, directors, or beneficialowners of 5% or more of the Common Stock, or the immediate family or associatesof any of the foregoing persons, except as indicated below.

 

Some of the Bank’s directors and executive officers and their immediatefamilies, as well as the companies with which such directors and executiveofficers are associated, are customers of, and have had banking transactionswith the Bank in the ordinary course of business and anticipate having suchbanking transactions with such persons in the future.  In the opinion of Management, all loans and commitments to lendincluded in such transactions were made in compliance with applicable laws onsubstantially the same terms, including interest rates and collateral, as thoseprevailing at the time for comparable transactions with other persons ofsimilar creditworthiness and did not involve more than a normal risk ofcollectibility or present other unfavorable features.  As of December 31, 2002, loans outstanding to the Bank’sdirectors and executive officers (including associated companies) totaledapproximately $2,656,000 million.

 

48

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## **ITEM 13. EXHIBITSAND REPORTS ON FORM 8-K**

 

**Exhibits**

** **
| **Exhibit #** |   |                                                                                         |
|---------------|--------|----------------------------------------------------------------------------------------------|
| 2.1           |   | Plan of Reorganization  and Agreement of Merger dated as of October 4, 2000                  |
| 3.1           |   | Articles of  Incorporation                                                                   |
| 3.2           |   | Bylaws                                                                                       |
| 4.1           |   | Certificate of  Determination for Series A Non-Voting Convertible Redeemable Preferred Stock |
| 4.2           |   | Certificate of  Determination for Series B Non-Voting Preferred Stock                        |
| 4.3           |   | Certificate of  Determination for Class C Preferred Stock                                    |
| 10.1          |   | Purchase and Sale  Agreement and Lease dated January, 1997, as amended                       |
| 10.2          |   | Financial Facilities  Purchase Agreement                                                     |
| 10.3          |   | Employment Contract –  Ms. Robinson                                                     |
| 10.4          |   | Lease Agreement – Paso  Robles                                                          |
| 10.5          |   | Lease Agreement – San  Luis Obispo                                                      |
| 10.6          |   | Lease Agreement –  Arroyo Grande                                                        |
| 10.7          |   | 1998 Stock Option Plan                                                                       |
| 10.8          |   | Lease Agreement – 569  Higuera, San Luis Obispo                                         |
| 10.9          |   | Lease Agreement – 671  Tefft Street Nipomo CA                                           |
| 21            |   | Subsidiaries of the  registrant                                                              |
|          |   |                                                                                         |
| 23            |   | Consent of accountants                                                                       |
| 27            |   | Financial date  schedules in electronic format                                               |
| 99.1          |   | Certification of CEO  pursuant to Section 906 of Sarbanes Oxley Act of 2002                  |
| 99.1          |   | Certification of CFO  pursuant to Section 906 of Sarbanes Oxley Act of 2002                  |

 

**Reports on Form 8-K:**

#### ** **

#### **None.**

 

49

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**ITEM14.               CONTROLS AND PROCEDURES**

 

Within the 90 days prior to the date of this report,we carried out an evaluation, under the supervision and with the participationof our management, including our Chief Executive Officer and our ChiefFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures pursuant to Exchange Act Rule 13a-14.  Based upon that evaluation, the ChiefExecutive Officer and the Chief Financial Officer concluded that theRegistrant’s disclosure controls and procedures are effective in timelyalerting them to material information relating to the Registrant required to beincluded in our periodic filings with the Securities and Exchange Commission.

 

50

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**Signatures**

 

Pursuant to the requirements of Section 13 of the Securities ExchangeAct of 1934, the Company has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 
| **MISSION  COMMUNITY BANCORP**                       |
|------------------------------------------------------|
|                                                 |
|                                                 |
| By:                                                  |      /s/  Anita M. Robinson |   |
| ANITA M. ROBINSON                                    |
| President and Chief Executive officer                |
| Dated:                                               | March 28, 2003 |
|                                                 |
|                                                 |
| By:                                                  |      /s/  William C. Demmin |   |
| **WILLIAM  C. DEMMIN**                               |
| Executive Vice President and Chief Financial officer |
| Dated:                                               | March 28, 2003 |
|                                                 |
|                                                 |
| [Signatures continue on  next page]                  |
|                                                      |  |  |  |

 

51

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Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

** **
| /s/  Bruce M. Breault    |                                              | Founding Chairman of the Board                   | **March 28, 2003** |
|--------------------------|---------------------------------------------------|--------------------------------------------------|--------------------|
| BRUCE  M. BREAULT        | (Emeritus)                                        |                                             |
|                     |                                              |                                             |
| /s/  Roxanne M. Carr     |                                              | Secretary                                        | March 28, 2003     |
| ROXANNE  M. CARR         |                                              |                                             |
|                     |                                              |                                             |
| /s/  Karla S. Cool       |                                              | Director                                         | March 28, 2003     |
| KARLA  S. COOL           |                                              |                                             |
|                     |                                              |                                             |
| /s/  William B. Coy      |                                              | Vice Chairman of the  Board                      | March 28, 2003     |
| WILLIAM  B. COY          |                                              |                                             |
|                     |                                              |                                             |
| /s/  Erol F. Giray, M.D. |                                              | Director                                         | March 28, 2003     |
| EROL  F. GIRAY, M.D.     |                                              |                                             |
|                     |                                              |                                             |
| /s/  William C. Demmin   |                                              | Executive Vice President  and Chief              | March 28, 2003     |
| WILLIAM  C. DEMMIN       | Financial Officer  (Principal Accounting Officer) |                                             |
|                     |                                              |                                             |
| /s/  Anita M. Robinson   |                                              | Director, President and  Chief Executive Officer | March 28, 2003     |
| ANITA  M. ROBINSON       |                                              |                                             |
|                     |                                              |                                             |
| /s/  Robin L. Rossi      |                                              | Director                                         | March 28, 2003     |
| ROBIN  L. ROSSI          |                                              |                                             |
|                     |                                              |                                             |
| /s/  Gary E. Stemper     |                                              | Chairman of the Board                            | March 28, 2003     |
| GARY  E. STEMPER         |                                              |                                             |
|                     |                                              |                                             |
| /s/  Karl F. Wittstrom   |                                              | Director                                         | March 28, 2003     |
| KARL  F. WITTSTROM       |                                              |                                             |

 

52

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**SARBANES-OXLEYACT SECTION 302 CERTIFICATIONOF CHIEF EXECUTIVE OFFICER**

 

I, Anita M.Robinson, Chief Executive Officer, certify that:

 

1.          I have reviewed thisannual report on Form 10-KSB of Mission Community Bancorp (the “Company”);

 

2.          Based on my knowledge,this annual report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.          Based on my knowledge,the financial statements, and other financial information included in thisannual report, fairly present in all material respects the financial condition,results of operations and cash flows of the Company as of, and for, the periodspresented in this annual report;

 

4.          The Company’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the Company and have:

 

(a)               Designed suchdisclosure controls and procedures to ensure that material information relatingto the Company, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisannual report is being prepared;

 

(b)              Evaluated theeffectiveness of the Company’s disclosure controls and procedures as of a datewithin 90 days prior to the filing date of this annual report (the “EvaluationDate”); and

 

(c)               Presented in thisannual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.          The Company’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the Company ‘s auditors and the audit committee of the Company’s board ofdirectors:

 

(a)               All significantdeficiencies in the design or operation of internal controls which couldadversely affect the Company’s ability to record, process, summarize and reportfinancial data and have identified for the Company’s auditors any materialweaknesses in internal controls; and

 

(b)              Any fraud, whetheror not material, that involves management or other employees who have asignificant role in the Company’s internal controls; and

 

6.          The Company’s othercertifying officer and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  March  28, 2003 | By:    | /s/ Anita M. Robinson   |   |
|-----------------------------|--------|-------------------------|--------|
|                        |   | Anita M. Robinson       |
|                        |   | Chief Executive Officer |
|                             |        |                         |        |  |

 

53

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**SARBANES-OXLEY****ACT SECTION 302 CERTIFICATION**

**OF CHIEF FINANCIAL OFFICER**

 

I, William C.Demmin, Chief Financial Officer, certify that:

 

1.          I have reviewed thisannual report on Form 10-KSB of Mission Community Bancorp (the “Company”);

 

2.          Based on my knowledge,this annual report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.          Based on my knowledge,the financial statements, and other financial information included in thisannual report, fairly present in all material respects the financial condition,results of operations and cash flows of the Company as of, and for, the periodspresented in this annual report;

 

4.          The Company’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the Bank and have:

 

(a)               Designed suchdisclosure controls and procedures to ensure that material information relatingto the Company, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisannual report is being prepared;

 

(b)              Evaluated theeffectiveness of the Company’s disclosure controls and procedures as of a datewithin 90 days prior to the filing date of this annual report (the “EvaluationDate”); and

 

(c)               Presented in thisannual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.          The Company’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the Company’s auditors and the audit committee of the Company’s board ofdirectors:

 

(a)               All significantdeficiencies in the design or operation of internal controls which couldadversely affect the Bank’s ability to record, process, summarize and reportfinancial data and have identified for the Company’s auditors any materialweaknesses in internal controls; and

 

(b)              Any fraud, whetheror not material, that involves management or other employees who have asignificant role in the Company’s internal controls; and

 

6.          The Company’s othercertifying officer and I have indicated in this annual report whether or notethere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  March  28, 2003 | By:    | /s/ William C. Demmin   |   |
|-----------------------------|--------|-------------------------|--------|
|                        |   | William C. Demmin       |
|                        |   | Chief Financial Officer |
|                             |        |                         |        |  |

 

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