** **

**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 fiscal Year ended December 31, 2003** |
|                                                 |       |                                                                                               |
| **OR**                                               |
|                                                 |       |                                                                                               |
|                                                 | **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                 |       |                                                                                               |
| **Commission file number 333-12892**                 |

 

**MISSIONCOMMUNITY BANCORP**

(Exact name of registrant as specified in itscharter)

 

| **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 |

 

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

 

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

 

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

 

Check if there is no disclosure of delinquent filers pursuant to Item405 of Regulation S-B is not contained in this form, and no disclosure will becontained, to the best of the registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB **ý.**

 

Registrant’s revenue forthis year ended **December 31, 2003** was **$6,911,482.**

 

State the aggregatemarket value of the voting stock and non-voting common equity held bynon-affiliates computed by reference to the price at which the common equitywas sold, or the average bid and asked prices of such common equity; as of **March 1,2004**such aggregate market value was **$9,033,222.**

 

As of **March 1,2004**, the Registrant had **637,699** shares of Common Stock outstanding.

 

Transitional Small Business Disclosure Format (check one) Yes [ ] No**[X]**

 

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Prior to December 18, 2000, Mission Community Bancorp’ssubsidiary, Mission Community Bank, N.A., filed reports pursuant toSection 15(d) of the Securities Exchange Act of 1934 with the Comptrollerof the Currency.  On December 18,2000, Mission Community Bancorp filed an 8-K Report with the Commissionreporting that it had acquired Mission Community Bank, N.A. in a holdingcompany formation transaction and that it would thereafter file reports withthe Commission pursuant to Section 15(d) of the Securities Exchange Act of1934.

 

 

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**TABLEOF 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**                                  |   |
|                                                                                  |                                                                                                                            |   |
| **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**                                                                                            |   |
|                                                                                  |                                                                                                                            |
| **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** |                                                                                                                            |

 

2

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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 theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act ant the Private Securities Litigation Reform Act of 1995.  When the Company uses or incorporates byreference in this Annual Report on Form 10-KSB the words “anticipate,”“estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similarexpressions, the Company intends to identify forward-looking statements.  Such statements are subject to certainrisks, uncertainties and assumptions, including those described in this AnnualReport on Form 10-KSB.  Should one or moreof these risks or uncertainties materialize, or should underlying assumptionsprove incorrect, actual results may vary materially from those anticipated,estimated, expected, projected, intended, committed or believed.  Such risks and uncertainties include, butare not limited to, the following factors: (i) general economic conditions,whether national or regional, that could affect the demand for loans and otherbanking services or lead to increased loan losses; (ii) competitive factors,including increased competition with community, regional and national financialinstitutions that may lead to pricing pressures on rates the Bank charges onloans and pays on deposits or reduce the value of real estate collateralsecuring the Bank’s loans; (iii) loss of customers of greatest value to theBank or other losses; (iv) increasing or decreasing interest rate environmentsthat could lead to decreased net interest margin and increased volatility ofrate sensitive loans and deposits; (v) changing business conditions in thebanking industry; (vi) changes in the regulatory environment or new legislation;(vii) changes in technology or required investments in technology; (viii)credit quality deterioration which could cause an increase in the provision forloan losses; (ix) dividend restrictions; (x) the effects of theSeptember 11, 2001 terrorist attacks and their aftermath; (xi) continuedtensions in Iraq and elsewhere in the Middle East; and (xii) increasedregulation of the securities markets, whether pursuant to the Sarbanes-OxleyAct of 2002 or otherwise.

 

Investors and other readers are cautioned not to place undue relianceon forward-looking statements, which reflect management’s analysis only as ofthe date of the statement.

 

The Company undertakes no obligation to revise any forward-lookingstatement to reflect later events or circumstances.

 

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# **PART I**

# ** **

## **ITEM1.**                        DESCRIPTIONOF BUSINESS

 

**BUSINESS DEVELOPMENT**

 

**Mission CommunityBancorp**(the “Company”)

 

The Company is a California corporation  that was formed in September 2000. The Company’s principalbusiness is to serve as a bank holding company for Mission Community Bank (the“Bank”).

 

As of December 31, 2003, the Company had approximately $113million in total assets and $8.5 million in shareholders’ equity.

 

On October 14, 2003, the Company formed Mission Community CapitalTrust in order to complete a trust preferred security transaction and raisedapproximately $3,000,000 in net capital. See “ Market for Common Equity and Related Stockholder Matters.”

 

The Department ofTreasury, Community Development Financial Institution Fund, has certified theCompany and the Bank as Community Development Financial Institutions (“CDFI”).This status also conveys possible Community Reinvestment Act (CRA) credit toinstitutional depositors and investors in the Bank and Company.  It also opens various government sponsoredprograms, grants, and awards 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 second$500,000 Core Award in 2001 from the CDFI Fund which was funded inDecember 2002 in the form of preferred stock.  Neither the Company nor the Bank received any grants or awards in2003.

 

**Mission CommunityBank**(the “Bank”)

 

The Bank openedDecember 18, 1997 in San Luis Obispo, California 93401 as a national bankchartered by the Comptroller of the Currency and opened offices in the countyin Paso Robles in 1998, Arroyo Grande in 2000 and Nipomo in 2002. The Bank isauthorized 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, 2003, the Bank hadapproximately $113.5 million in assets, $78.7 million in net loans, $96.3million in deposits, and $10.7 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 is alsocertified by the California Department of Insurance to accept deposits underthe California Organized Investment Network (the “COIN”).  The COIN program provides California taxcredits and/or CRA credit to individuals, corporations, or partnerships thatinvest in below market rate deposits or specified term certificates of deposit.

 

On December 29,2003, the California Department of Financial Institutions (the “DFI”) approvedthe Bank’s conversion application to be chartered in the State of Californiaand effective on this date, the Bank returned its national charter from theComptroller of the Currency.  The changein charter was completed primarily to allow the Bank to benefit from the largersecured legal lending limit for banks chartered in California and specificallyto increase its legal lending limit from 15% to 25% for certain real estatesecured loans. Following the charter change, the Bank is now supervised by theFederal Reserve and the DFI.  Other thanthe change in legal lending limit, no material changes are anticipated from thecharter change.

 

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

 

The Bank wholly-ownsMCDC, a subsidiary community development corporation which was incorporated inAugust 1997.  Mission CommunityDevelopment Corporation is a “for-profit” Community Development Corporation(“CDC”), 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 local, outside members who are actively involved in representingand supporting the low income community.

 

At December 31,2003, MCDC had approximately $196,000 in net loans and $266,000 in shareholdersequity and provided loan accounting services for a very small pool of communitydevelopment micro loans which were funded by a group of banks through theEconomic Vitality Corporation.

 

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

 

The Company and Bank havea close relationship with, but no ownership of MCSC, which was incorporatedAugust 1997 and which received approval under IRS Section Code501(c)(3) a “not-for-profit” public charitable corporation inSeptember 2003.  This company’sprimary focus is to provide technical support, and training services to thecommunity including small business, minorities and low-income entrepreneurs.While MCSC has not engaged in any direct lending, it may provide some lendingin the future.  The Board of Directorsof MCSC includes representatives from the Bank’s Board together with membersrepresenting the low income and business community.

 

**The “Mission” Group**

 

The Company, the Bank andits subsidiary MCDC, and MCSC form an organizational structure intended toprovide traditional community bank financial services and to help provideeconomic revitalization and community development to its market areas.

 

**Bankruptcy or Similar Proceedings**

 

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

 

**Material Reclassifications or Other Changes**

 

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

 

**BUSINESS OF ISSUER**

 

**Principal Products,Services, and Markets**

 

Other than holding the shares of the Bank, the Company conducts nosignificant activities. The Company is authorized with the prior approval ofthe Board of Governors of the Federal Reserve System (the “Federal ReserveBoard”), its principal regulator, to engage in a variety of activities whichare deemed closely related to the business of banking.

 

The Bank offers checkingand savings accounts, money market accounts and time certificates of deposits;offers commercial, agribusiness, government guaranteed, real estate, automobileand other installment and term loans and leases; issues drafts, 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.

 

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The areas in which theBank has directed virtually all of its lending activities are (i) commercialloans, (ii) agricultural loans (iii) construction loans, (iv) real estateloans, and (v) consumer loans. As of December 31, 2003, these fivecategories accounted for approximately 19.9%, 1.9%, 6.2%, 70.3%, and 1.7%respectively, of the Bank’s gross loan portfolio. As of December 31, 2003,$60.7 million or 76.5% of the Bank’s net loans consisted of interimconstruction and real estate loans, for single family residences or forcommercial development.  The increase inconstruction and real estate is a material increase from the prior year’scombined 67.8%.  See Concentrations inManagements’ Discussion and Analysis of Financial Condition and Results ofOperations.

 

As of December 31,2003, the Bank had approximately 3,881 deposit accounts including demandaccounts of $24.0 million with 2,180 accounts with average balances ofapproximately $11,000; 1,170 savings accounts with balances totaling $37.9million with an average balance per account of approximately $32,400; and 533time certificate of deposit accounts with balances totaling $35.0 million andan average balance per account of approximately $65,600.

 

The principal sources ofthe Bank’s revenues are (i) interest and fees on loans, (ii) intereston investments, (iii) service charges on deposit accounts and othercharges and fees, (iv) BEA award, (v) gain on sale of loans, and (vi)interest on other investments including federal funds sold.  For the year ended December 31, 2003,these sources comprised 68.2%, 8.9%, 8.5%, 2.6%, 8.7% and 3.1%, respectively,of the Bank’s total operating income.

 

**Distribution Methods of the Products and Services**

 

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

 

The Bank operates out offour full service offices plus an administrative facility all of which arelocated in San Luis Obispo County as follows: 1) San Luis Obispo, 2) Paso Robles, 3) Arroyo Grande, 4) Nipomo, and 5)an administrative office in San Luis Obispo. The Bank provides some financial services through direct contact bycalling officers who travel into the neighboring counties.  Physical expansion into the neighboring countieswould most likely come from acquisitions or in the form of loan productionoffices although there are no immediate plans for acquisitions or loanproduction offices.

 

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. Most of the Bank’s deposits are attracted by relationship banking, localactivities, and advertising.

 

The business plan of theBank emphasizes providing highly specialized financial services in aprofessional and personalized manner to individuals and businesses in itsservice area. Its key strengths are customer service and an experiencedmanagement team familiar with the community through the Bank’s involvement invarious community lending and development projects.

 

In 2003, the Bankextended its use of Internet technology as a distribution tool to improve itscustomer service by use of email and Internet Banking including bill pay andACH origination.  While the Bankcontinues to focus on its local market areas, it has also been able to attractdeposits at market rates with non-local deposits becoming a more importantresource for funding growth.  Use of theInternet is considered a cost effective method of attracting deposits that isexpected to become more important in 2004 and beyond.

 

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**Status of and Publicly Announced New Products or Services**

 

There has been nosignificant change in the types of services offered by the Bank since itsinception. The Bank has no present plans to enter any material new line ofbusiness that would require the investment of a material amount of totalassets.

 

The Bank participates ina 3-year project (2002 - 2005) sponsored by the National Community InvestmentFund (NCIF) to explore and develop a profitable range of retail financialproducts and services to low income and unbanked customers (“low incomecustomers”).  NCIF is underwriting amajority of the costs associated with this project. The project seeks todevelop replicable and profitable business models for both particular productsand services targeted at low income customers, and coordinated suites ofproducts that meet a range of needs. Product and service specifications, targetmarket, cross selling and profitability data will be tracked over a two- tothree-year time horizon with the goal to develop suites of products that meethousehold financial and asset building needs while being profitable forfinancial institutions. Expected products include First Accounts, IndividualDevelopment Accounts, and access to debit cards and other electronicservices.  The Bank expects to increaseits focus on profitable financial services for the un- and under-bankedcustomers in its market area, but does not expect these services will be amaterial percentage of its deposit activities.

 

While there can be noassurance of success, the Bank anticipates applying to the CDFI in 2004 for atechnical assistance grant for up to $50,000 to help offset any costsassociated with providing additional services to the un- and under-banked inits market area.

 

In late 2003, the Bankemployed (new position) an experienced lender who has extensive contacts inKern, Kings and Fresno counties.  Thisnew Senior Vice President calling officer is expected to increase business developmentefforts in the neighboring counties in 2004.

 

**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 toits customers where possible. For borrowers requiring loans in excess of theBank’s legal lending limits, the Bank makes use of loan participations with itscorrespondent banks and with other independent banks, retaining the portion ofsuch loans which is within its legal lending limits. Commercial banks 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.

 

The Bank utilizestechnology to improve its competitive advantages by use of ATMs, InternetBanking, ACH Origination, electronic bill pay, email, and credit card andmerchant card relationships.

 

**Sources and availability of Raw Materials and PrincipalSuppliers**

 

As service organizationsneither the Company nor the Bank are dependent on raw materials.

 

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

 

The Bank is limited inthe size of loans it can make to any one individual borrower (in theaggregate), and it has over 600 loan customers.  As of December 31, 2003, the Bank’s legal lending limits toa single borrower, and such borrower’s related parties, on a secured basis(first trust deed) were approximately $2.9 million and $1.7 million forunsecured loans based on regulatory capital plus reserves of approximately$11.5 million.

 

A material portion of theBank’s deposits have not been obtained from a single person or a few persons,the loss of any one or more of which would have a materially adverse effect onthe business of the Bank.  The Bank hasa higher than average dependence (as measured by peer group analysis) on largerdeposit balances (deposits of $100,000 or more) with a total of 295 depositorsholding approximately $58.0 million for an average deposit of $197,000 and3,586 depositors holding $38,776 in deposits for an average balance ofapproximately $11,000 as of December 31, 2003.  These deposit ranges have been reasonably consistent during thepast several years and are consistent with the Bank’s deposit/fundingstrategy.   Deposits associated with theBank’s CDFI status total approximately $6.5 million or 6.7% of total depositsas of December 31, 2003.  Non-localdeposits (CDs) that have been obtained from the Internet totaled approximately$4.8 million and from the COIN program approximately $450,000.

 

The Bank’s business,based upon performance to date, does not appear to be seasonal.

 

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

 

The Bank holds no specialpatents, licenses (other than licenses obtained from bank regulatoryauthorities), franchises or concessions.

 

**Effectof Government Policies and Regulations**

 

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 are beyondthe control of the Bank. Accordingly, the earnings and growth of the Bank aresubject to the influence of domestic and foreign economic conditions, includinginflation, 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 “Effects of Existing or Probable Government Regulations.”

 

**Supervisionand Regulation**

 

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

 

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description does notpurport to be complete and is qualified in its entirety by reference to theapplicable laws and regulations.

 

**TheCompany**

 

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 banking or managing or controlling banks as to be a proper incidentthereto.

 

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 of 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 theauthority to regulate provisions of certain bank holding company debt,including authority to impose interest ceilings and reserve requirements onsuch debt. Under certain circumstances, the Company must file written noticeand obtain approval from the Federal Reserve Board prior to purchasing orredeeming its equity securities.

 

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 conductits operations in an unsafe and unsound manner. In addition, it is the FederalReserve Board’s policy that in serving as a source of strength to itssubsidiary banks, a bank holding company should stand ready to use availableresources to provide adequate capital funds to its subsidiary banks duringperiods of financial stress or adversity and should maintain the financialflexibility and capital-raising capacity to obtain additional resources forassisting its subsidiary banks. A bank holding company’s failure to meet itsobligations to serve as a source of strength to its subsidiary banks will generallybe considered by the Federal Reserve Board to be an unsafe and unsound bankingpractice or a violation of the Federal Reserve Board’s regulations or both.

 

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

 

**TheBank**

 

The Bank is charteredunder the laws of the state of California and its deposits are insured by theFDIC to the extent provided by law. Prior to December 2003 and its charter conversion, the Bank wassupervised by the Comptroller of the Currency. Following the conversion, the Bank is subject to the supervision of andregularly examined by the Federal Reserve Bank of San Francisco (the “FRB”) andthe DFI.  Such supervision andregulation include comprehensive reviews of all major aspects of the Bank’sbusiness and condition.

 

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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 FRB or DFI should determine that the financialcondition, capital resources, asset quality, earnings prospects, management,liquidity, or other aspects of the Bank’s operations are unsatisfactory or thatthe Bank or its management is violating or has violated any law or regulation,various remedies are available to such regulatory agency. Such remedies includethe power to enjoin “unsafe or unsound” practices, to require affirmativeaction to correct any conditions resulting from any violation or practice, toissue an administrative order that can be judicially enforced, to direct anincrease in capital, to restrict the growth of the Bank, to assess civilmonetary penalties, to remove officers and directors, and ultimately toterminate the Bank’s deposit insurance, which would result in a revocation ofthe Bank’s charter.

 

**CapitalStandards**

 

The Federal Reserve Boardhas adopted risk-based minimum capital guidelines intended to provide a measureof capital that reflects the degree of risk associated with a bankingorganization’s operations for both transactions reported on the balance sheetas 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.

 

A banking organization’s risk-basedcapital ratios are obtained by dividing its qualifying capital by its totalrisk adjusted assets. The regulators measure risk-adjusted assets, whichincludes off balance sheet items, against both total qualifying capital (thesum 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 required capital ratios or regulations or practices could further reduce theamount of capital recognized for purposes of capital adequacy. Such a changecould affect the ability of the Bank to grow and could restrict the amount ofprofits, 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 31,2003:

 

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|                     |   | **Bank  Actual** |   | **Minimum  Capital  Requirements** |   | **Well  Capitalized  Requirement** |   |
|--------------------------|--------|------------------|--------|------------------------------------|--------|------------------------------------|--------|
| LEVERAGE  RATIO          |   | 9.68             | %      | 4                                  | %      | 5                                  | %      |
| TIER  1 RISK-BASED RATIO |   | 11.51            | %      | 4                                  | %      | 6                                  | %      |
| TOTAL  RISK-BASED RATIO  |   | 12.39            | %      | 8                                  | %      | 10                                 | %      |

 

Under applicable regulatory guidelines, the Bank was considered “WellCapitalized” at December 31, 2003.

 

Under existingregulations of the Federal Reserve Board, the capital ratios of the bank holdingcompany with total assets of less than $150 million, such as the Company, aredeemed to be the same as those of the Bank.

 

**PromptCorrective Action and Other Enforcement 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.

 

**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:

 

•                                          conductperiodic asset-quality reviews to identify problem assets;

 

•                                          estimatethe inherent losses in problem assets and establish reserves that aresufficient to absorb estimated losses;

 

•                                          compareproblem asset totals to capital;

 

•                                          takeappropriate corrective action to resolve problem assets;

 

•                                          considerthe size and potential risks of material asset concentrations; and

 

•                                          provideperiodic asset quality reports with adequate information for management and theboard of directors to assess the level of asset risk.

 

11

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

 

**Premiumsfor 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-annualbasis. An increase in the assessment rate could have a material adverse effecton the Bank’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 FICO assessments areadjusted quarterly to reflect changes in the assessment bases of the FDIC’s insurancefunds and do not vary depending on a depository institution’s capitalization orsupervisory evaluations.

 

**CommunityReinvestment 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 examination,the Bank received a CRA rating of “Satisfactory.”

 

**RecentLegislation**

 

**Financial Holding Companies**

 

Bank holding companiesthat elect to become a financial holding company may affiliate with securitiesfirms and insurance companies and engage in other activities that are financialin nature or are incidental or complementary to activities that are financialin nature. A bank holding company that is not also a financial holding companyis limited to engaging in banking and such other activities as determined bythe Federal Reserve Board to be so closely related to banking or managing orcontrolling banks as to be a proper incident thereto. The Company has notelected to become a financial holding company.

 

12

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**USA Patriot Act of 2001**

 

InOctober 2001, the USA Patriot Act of 2001 was enacted in response to theterrorist attacks in New York, Pennsylvania and Washington D.C. which occurredon September 11, 2001. The Patriot Act is intended to strengthen U.S. lawenforcement’s and the intelligence communities’ abilities to work cohesively tocombat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of allkinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financialtransparency laws and imposes various regulations, including standards forverifying client identification at account opening, and rules to promotecooperation among financial institutions, regulators and law enforcemententities in identifying parties that may be involved in terrorism or moneylaundering.

 

**California Corporate Disclosure Act**

 

The California CorporateDisclosure Act, effective January 1, 2003, amends the Corporations Code byrequiring additional public disclosures by “publicly traded companies,”including domestic and foreign corporations, qualified to transact intrastatebusiness in California. The purpose of the new required disclosures is to helpcombat fraud and protect investors. “Publicly traded company” means a company with securities listed oradmitted to trading on a national or foreign exchange, or which is the subjectof two-way quotations that are regularly published.  Such companies must file with the Secretary of State a statement,in the form prescribed, including the following additional information:

 

•                  Nameof independent auditor, description of other services provided as specified,and date of the last audit, including a copy of the report;

 

•                  Annualcompensation paid to each director and executive officer;

 

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

 

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

 

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

 

•                  Statementindicating whether the corporation violated any federal security laws or any banking or security provisions ofCalifornia law during the previous 10 years for which the corporation was foundliable in an action before a federal or state court or regulatory agency or aself-regulatory agency in which a judgment over $10,000 was entered.

 

**Sarbanes-Oxley Act of 2002**

 

OnJuly 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of2002 (the “SOA”).  The stated goals ofthe SOA are to increase corporate responsibility, to provide for enhancedpenalties for accounting and auditing improprieties at publicly tradedcompanies and to protect investors by improving the accuracy and reliability ofcorporate disclosures pursuant to the securities laws.

 

The SOA isthe most far-reaching U.S. securities legislation enacted in some time.  The SOA generally applies to all companies,both U.S. and non-U.S., that file or are required to file periodic reports withthe SEC under the Securities Exchange Act of 1934.  Given the extensive SEC role in implementing rules relating tomany of the SOA’s new requirements, the final scope of these requirementsremains to be determined.

 

The SOAincludes very specific additional disclosure requirements and new corporategovernance rules, requires the SEC and securities exchanges to adopt extensiveadditional disclosure, corporate governance

 

13

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and otherrelated rules and mandates further studies of certain issues by the SEC.  The SOA represents significant federalinvolvement in matters traditionally left to state regulatory systems, such asthe regulation of the accounting profession, and to state corporate law, suchas the relationship between a board of directors and management and between aboard of directors and its committees.

 

The SOAaddresses, among other matters:

 

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

 

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

 

•                                          auditor independence provisions which restrictnon-audit services that independent accountants may provide to their auditclients;

 

•                                          certification of financial statements by thechief executive officer and the chief financial officer;

 

•                                          the forfeiture of bonuses or otherincentive-based compensation and profits from the sale of an issuer’ssecurities by directors and senior officers in the twelve month periodfollowing initial publication of any financial statements that later requirerestatement;

 

•                                          a prohibition on insider trading duringpension plan black out periods;

 

•                                          increased protection for whistleblowers andinformants;

 

•                                          disclosure of off-balance sheet transactions;

 

•                                          expedited filing requirements for ownershipreports by officers and directors;

 

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

 

•                                          “real time” filing of periodic reports; and

 

•                                          various increased criminal penalties forviolations of securities laws.

 

The SOAcontains provisions that became effective upon enactment on July 30, 2002,and provisions that will become effective within 30 days to one year fromenactment.  The SEC has been delegatedthe task of enacting rules to implement various provisions with respect to,among other matters, disclosure in periodic filings pursuant to the ExchangeAct.

 

**Transactions Between Affiliates**

 

Transactionsbetween a bank and its “affiliates” are quantitatively and qualitativelyrestricted under the Federal Reserve Act. The FRB has also recently issued Regulation W, which codifies priorregulations under Sections 23A and 23B of the Federal Reserve Act andinterpretative guidance with respect to affiliate transactions.  Regulation W incorporates the exemption fromthe affiliate transaction rules but expands the exemption to cover the purchaseof any type of loan or extension of credit from an affiliate. Affiliates of abank include, among other entities, companies that are under common controlwith the bank.  In general, subject tocertain specified exemptions, a bank or its subsidiaries are limited in theirability to engage in “covered transactions” with affiliates:

 

•                                          to an amount equal to 10% of the bank’s capital andsurplus, in the case of covered

 

14

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transactions with any oneaffiliate; and

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

 

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

 

•                                          aloan or extension of credit to an affiliate;

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

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

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

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

 

Inaddition, under Regulation W:

 

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

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

•                                          withsome exceptions, each loan or extension of credit by a bank to an affiliate mustbe secured by collateral with a market valueranging from 100% to 130%, depending on the type of collateral, of the amountof the loan or extension of credit.

 

RegulationW generally excludes all non-bank and non-savings association subsidiaries ofbanks from treatment as affiliates, except to the extent that the FRB decidesto treat these subsidiaries as affiliates.

 

Concurrently with the adoption of Regulation W, the FRB has proposed aregulation that would further limit the amount of loans that could be purchasedby a bank from an affiliate to not more than 100% of the bank’s capital andsurplus. Comments on the proposed rule were due by January 13, 2003.

 

**Environmental Regulations**

 

Management of the Bank isunaware of any material effect upon the Bank’s capital expenditures, earningsor competitive position as a result of federal, state or local environmentalregulation.

 

**Employees**

 

As of February 16, 2004 the Bank had a total of 47 employees. Themanagement of the Bank believes that its employee relations are satisfactory.Neither the Company nor MCDC have salaried employees; the Company’s officersall hold similar positions at the Bank. The Bank under intercompany arrangements may charge the Company and/or MCDCfor management, staff, and services; however, the time and services are notmaterial at this time.

 

**Certain Business Risk**

 

In addition to the otherinformation contained in this Report, the following risks may affect theCompany or Bank.  If any of these risksoccur, the Company’s or Bank’s business, financial condition or operatingresults could be adversely affected.

 

15

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**Dependence on Real Estate**

 

A significant portion ofthe loan portfolio of the Bank is dependent on real estate. At December 31,2003, real estate served as the principal source of collateral with respect toapproximately 77 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 andinterest-earning assets, the Bank’s interest rate spread can be expected to increasewhen market interest rates are rising, and to decline when market interestrates are declining. Although the Bank believes its current level of interestrate sensitivity is reasonable, significant fluctuations in interest rates mayhave an adverse impact on the Company’s and the Bank’s business, financialcondition and 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.

 

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**Limited Trading Market for the Company’s Common Stock**

 

The Company’s commonstock is traded over-the-counter and is not listed or quoted on any majorexchange. Trading volume is modest and can cause fluctuations in the marketvalue of the Company’s stock.  Thesefluctuations can be exaggerated, leading to price volatility in excess of otherstocks which are more actively traded. No assurances can be given concerning market value or the ability tosell shares of the Company’s common stock.

 

**REPORTS TO SECURITY HOLDERS.**

 

**Annual Report**

 

An annual report tosecurity holders including audited financial statements is sent each year bythe Company.

 

Certain reports are filedby the Company with the Securities Exchange Commission pursuant toSection 13 or 15(d).  The publicmay read and copy any materials filed with the SEC at the SEC’s PublicReference Room at 450 Fifth Street, N.W., Washington, D.C.  20549. The Public may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0300.  The SEC also maintains an Internet site that contains reports andother information statements. The Company files its reports electronically andthey may be viewed from the SEC Internet site http://www.sec.gov.

 

The Company’s Internetsite is http://missioncommunitybank.com.

 

## **ITEM2.**                        DESCRIPTIONOF PROPERTIES

## ** **

The Bank and the Companyoccupy a property owned by the Bank at 581 Higuera Street, San Luis Obispo,California, where the Bank’s main office is located. The land, 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,the Bank opened a loan production office at 1226 Park Street, Paso Robles,California. This office became a full service branch in April, 1999. The Bankleases approximately 2,500 sq. ft. at $1,855 per month. The term of the leaseis five years, and the Bank has an option to renew the lease for two additionalfive-year periods.

 

The Bank moved itsadministrative office from 570 Higuera Street to 569 Higuera in June 2001.The new offices have approximately 1,950 square feet with five year lease at acost of $3,315 per month. There are two additional option periods of five yearseach.  In October 2003, the Bankleased additional space in 569 Higuera at an additional suite withapproximately 1,000 square feet at a cost of $1,836 per month.  The new lease terms have the same maturitydate and option periods as the original lease. The administration office islocated immediately next to the Bank’s main office.

 

On December 15,2000, the Bank opened a loan production office at 154 West Branch Street,Arroyo Grande, California. This office was converted to a full service branchin mid 2002.  The lease is forapproximately 2,000 sq. ft. at $3,052 per month, plus common area operatingexpenses. The term of the lease is five years, and the Bank has an option torenew the lease for two additional sixty-month periods.

 

In June 2002, theBank leased premises at 671 Tefft Street, Nipomo under a five year lease at a costof $3,370 per month with approximately 2,500 square feet.  This lease has one five year option period.

 

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For the years endedDecember 31, 2003 and 2002, the Bank’s total occupancy costs were approximately$346,000 and $279,000, respectively. In the opinion of management, the premisesare adequate for the Bank’s purposes and the Bank has sufficient insurance tocover its interest in the premises.

 

## **ITEM 3.**                        LEGAL PROCEEDINGS

## ** **

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.

 

## **ITEM4.**                        SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

## ** **

No matters were submittedto a vote of security holders during the fourth quarter of 2003.

 

# **PART II**

 

## **ITEM5.**                        MARKET FORCOMMON EQUITY AND RELATED STOCKHOLDER 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, Seidler 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.

 

| **Quarter Ended** |   | **Bid Prices** |   |
|-------------------|--------|----------------|--------|
|              |   | **Low**        |   | **High** |   |
| 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 |   |
|              |   |           |   |   |   |
| 2003              |   |           |   |   |   |
| March 31     |   | 11.30          |   | 12.55 |   |
| June 30      |   | 11.30          |   | 12.80 |   |
| September 30 |   | 11.30          |   | 14.65 |   |
| December 31  |   | 11.30          |   | 16.10 |   |
|                   |        |                |        |  |  |  |  |

 

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**Holders**

 

As of March 1, 2004,there were approximately 357 holders of the Company’s Common Stock.

 

**Dividends**

 

The Company’sshareholders are entitled to receive dividends when and as declared by itsBoard of Directors, out of funds legally available therefore, subject to therestrictions set forth in the in the California General Corporation Law (the“Corporation Law”).  The Corporation Lawprovides that a corporation may make a distribution to its shareholders if thecorporation’s retained earnings equal at least the amount of the proposeddistribution.  The Corporation Law alsoprovides that, in the event that sufficient retained earnings are not availablefor the proposed distribution, a corporation may nevertheless make adistribution to its shareholders if it meets two conditions, which generallystated are as follows: (i) the corporation’s assets equal at least 1-1/4 timesits liabilities, and (ii) the corporation’s current assets equal at least itscurrent liabilities or, if the average of the corporation’s earnings beforetaxes on income and before interest expenses for the two preceding fiscal yearswas less than the average of the corporation’s interest expenses for suchfiscal years, then the corporation’s current assets  must equal at least 1-1/4 times its current liabilities.  The Company was eligible to pay dividends atthe end of 2002 and 2003.

 

The availability ofoperating funds for the Company and the ability of the Company to pay a cashdividend depends largely on the Bank’s ability to pay a cash dividend to theCompany.  The payment of cash dividendsby the Bank is subject to restrictions. In general, dividends may not be paid from any of the Bank’s capital.  Dividends must be paid out of available netprofits, after deduction of all current operating expenses, actual losses,accrued dividends on preferred stock, if any, and all federal and statetaxes.  Additionally, a bank isprohibited from declaring a dividend on its shares of common stock until itssurplus fund equals its common capital, or, if its surplus fund does not equalits common capital, until at least one-tenth of 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.  Regulatory approval is required if the total of all dividendsdeclared by a bank in any calendar year exceeds the total of its net profitsfor that year combined with its retained net profits of the two precedingyears, less any required transfers to surplus or a fund for the retirement ofany preferred stock.  Furthermore, bankregulators also have authority to prohibit the payment of dividends by a bankwhen it determines such payment to be an unsafe and unsound banking practice.

 

Additionally, bankregulatory agencies have authority to prohibit banks from engaging inactivities that, in their respective opinions, constitute unsafe and unsoundpractices in conducting its business. It is possible, depending upon the financial condition of the bank inquestion and other factors, that the bank regulatory agencies could assert thatthe payment of dividends or other payments might, under some circumstances, bean unsafe or unsound practice.  Further,the bank regulatory agencies have established guidelines with respect to themaintenance of appropriate levels of capital by banks or bank holding companiesunder their jurisdiction.  Compliancewith the standards set forth in such guidelines and the restrictions that areor may be imposed under the prompt corrective action provisions of federal lawcould limit the amount of dividends which the Bank may pay.

 

Under these provisionsand considering minimum regulatory capital requirements, the Bank was eligibleto pay dividends in 2002 and 2003.

 

The Company declared andpaid a cash dividend on December 23, 2002 to shareholders of record onDecember 9, 2002, in the amount of $0.10 per share on its 630,166 sharesof Common Stock outstanding, $0.05 per share on its 100,000 shares of Series APreferred Stock outstanding, and $0.10 per share on its 20,500 shares of SeriesB Preferred Stock outstanding, comprising a distribution in the aggregateamount of approximately $70,068.

 

On November 25, 2003, the Company declared a $0.10 per share cashdividend for holders of the Common Stock of record on December 8,2003.  The dividend was paid onDecember 22, 2003.   The cashdividend

 

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applies to Preferred Shares issued, with Series A Preferred Stockreceiving a $0.05 per share dividend and Series B Preferred Stock and Series CPreferred Stock receiving a $0.10 per share dividend. The total amount paid was$75,067.

 

The Bank paid acorresponding dividend in the total amount of $70,068 to the Company inDecember 2002.  No dividend waspaid from the Bank to the Company in 2003.

 

Prior to theDecember 2002 dividend, no dividends have been paid by the Bank or Companyand whether or not stock or cash dividends will be paid in the future by theCompany and/or the Bank will be determined by the Board of Directors afterconsideration of various factors including but not limited to profitability,regulatory capital ratios, and other financial conditions. Additionally,certain provisions of the preferred stock restrict the ability of the Companyto pay cash dividends unless the required dividends on the preferred stock arealso paid.

 

**Issuance of PreferredStock**

 

**SeriesA Non-Voting Convertible Redeemable Preferred Stock**

 

On December 29, 2000, the Company issued 100,000 shares ofpreferred stock to the Community Development Financial Institutions Fund, adivision of the U.S. Treasury Department (“CDFI”), for $500,000.  Such shares of preferred stock were designatedas “Series A Non-Voting Convertible Redeemable Preferred Stock” and haveidentical rights and privileges in every respect to Common Stock except thatthey are non-voting.  The dividendrights attributable to the holders of “Non-Voting Convertible RedeemablePreferred Stock” are proportioned to those of the holders of the Common Stockbased upon two for one conversion ratio set forth below; that is, theNon-Voting Convertible Redeemable Preferred Stock participates on a per sharebasis in any dividend declared on Common Stock at the rate of one-half of theper share common dividend, but are not entitled to any fixed rate of return(zero percent cumulative).  ThisNon-Voting Convertible Redeemable Preferred Stock may be converted into CommonStock of the Company on a two-for-one exchange (and 50,000 shares if CommonStock shall be set aside and reserved by the Company for such purpose) at anytime upon the request of a holder of such Non-Voting Convertible RedeemablePreferred Stock upon or after the transfer of Non-Voting Convertible RedeemablePreferred Stock by the initial holder thereof. In the event the Company is liquidated, for any reason, the holders ofNon-Voting Convertible Redeemable Preferred Stock shall be entitled to aliquidation preference of Five Dollars ($5.00) per share before holders ofCommon Stock receive any distribution and after the holders of Common Stockreceive Ten Dollars ($10.00) per share, any further distributions on Non-VotingConvertible Redeemable Preferred Stock and Common Stock shall be at the ratioof One Dollar ($1.00) per share on the Non-Voting Convertible RedeemablePreferred Stock to Two Dollars ($2.00) per share for Common Stock.  If the Common Stock is subdivided, combinedor reclassified, the Non-Voting Convertible Redeemable Preferred Stock****shallbe subdivided, combined or reclassified on the same basis.  The holders of the Non-Voting ConvertibleRedeemable Preferred Stock shall have no right to vote any such shares exceptas may be required by applicable 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 FinancialInstitutions Program 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 investment was included in theaudited financial statement of the Bank for the year-ended December 31,1999 because the CDFI award had occurred during such year.  When the proceeds from the sale ofNon-Voting Convertible Redeemable Preferred Stock were received, $401,675 wasinvested as a capital contribution to the Bank with the remaining $98,325 usedfor expenses related to the transaction.

 

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**SeriesB Non-Voting Preferred Stock**

 

On December 29 2000, the Company issued 29,500 shares of CommonStock and 20,500 shares of preferred stock to National Community InvestmentFund (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.

 

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”(including certain mergers, sales of assets or tender offers), holders of theSeries B Non-Voting Preferred Stock shall be entitled to receive a payment inthe same form of consideration and in the same amount as the per share pricereceived, or deemed to be received, by the holders of the common stock of theCompany in or 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.

 

**SeriesC Non-Voting Convertible Redeemable Preferred Stock**

 

On December 18, 2002, the Company issued 50,000 shares ofpreferred stock 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 ofCommon Stock of the Company as is determined by dividing $10.00 by the theneffective Conversion Price. In the event of any liquidation, dissolution orwinding up of the Company, either voluntary or involuntary, the holders of theSeries C Preferred Stock shall not be entitled to receive, from any of theassets or surplus funds of the Company legally available for distribution, anypayment or distribution until payment in full of all preferential amountsprovided for in Prior Stock of the Company. In the event of any liquidation,dissolution or winding up of the Company, for any reason, the holders of theSeries C Preferred Stock shall be entitled to receive, prior and in preferenceto any distribution of any of the assets or surplus funds of the Companylegally available for distribution to the holders of the Common Stock or anyJunior Stock, the amount of $10.00 per share (as adjusted for any stockdividends, combinations or splits with respect to such shares) plus alldeclared but unpaid dividends on such shares. If the assets and funds availablefor distribution to the holders of the Series C Preferred Stock and any ParityStock shall be insufficient to pay the stated preferential amounts in full,then the entire assets and funds of the Company legally available fordistribution shall be distributed to the holders of the Series C PreferredStock and the Parity Stock in

 

21

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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 is bound.   No sinking fund will be established for theredemption of shares of the Series C Preferred Stock.

 

The $500,000 proceedsfrom the Series Preferred Stock were used to provide a $400,000 equitycontribution to the Bank with the remainder used to repay Company borrowingsand to provide the Company with cash flow.

 

**Trust Preferred Security**

 

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

 

On October 14, 2003, the Company issued $3,093 million in Debentures to the Trust.  Concurrently, the Trust issued $3.0 million of the Capital Securities to Bear, Sterns & Co., Inc., the initial purchaser, and $93,000 of Common Securities to the Company.  The Debentures were purchased by the Trust concurrently with the Trust’s issuance of the Capital Securities and Common Securities.  The proceeds to the Company, net of the Initial Purchaser’s fees and other offering expenses, was approximately $2.924 million which will be treated as Tier 1 capital for regulatory purposes. The proceeds were used to increase Mission Community Bank’s capital by $2.0 million with the balance used for general corporate purposes.

 

The Debentures and Capital Securities mature in 30 years and will bear a floating interest rate equal to LIBOR plus 2.95%.  The floating interest rate is adjustable quarterly with changes in LIBOR.  The interest on the Debentures is deductible and paid by the Company and represents the sole source of the Trust’s revenues available for distributions to the holders of the Capital Securities.  The undertakings of the Company with regard to the issuance constitute the Company’s full and unconditional guarantee of the Trust’s obligations pursuant to the Amended and Restated Declaration of Trust.

 

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

 

The following table shows each category of equity compensation along with i) the number of securities to be issued upon the exercise of outstanding options, warrants and rights, ii) the weighted-average exercise price of the outstanding options, warrants and rights, and the remaining number of securities remaining available for future issuance under the plan as of December 31, 2003.

 

22

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### **Equity Compensation Plan Information**

 
| **Plan category**                                           |   | **Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** |   | **Weighted  average  exercise price  of outstanding  options,  warrants and  rights** |   | **Number of  securities  remaining  available for  future issuance** |   |
|-------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
|                                                        |   | **(a)**                                                                                               |   | **(b)**                                                                               |   | **(c)**                                                              |   |
| Equity compensation plans approved by  security holders     |   | 154,966                                                                                               |   | $                                                                                     | 9.66   |                                                                 | 25,034 |   |
| Equity compensation plans not approved by  security holders |   | —                                                                                                |   | —                                                                                |   | —                                                               |   |
| Total                                                       |   | 154,966                                                                                               |   | $                                                                                     | 9.66   |                                                                 | 25,034 |   |

 

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

 

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

 

**Significant Critical Accounting Policies**

** **

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

 

**Use of Estimates inthe 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.  .

 

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.

 

See — Note A to the Financial Statements describes the significantaccounting policies used in the preparation of the Financial Statements

 

23

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**Selected FinancialData**

 

The following is selected consolidated financial data with respect tothe Company’s statement of financial position for the two years endedDecember 31, 2003 and 2002. The information presented has been derivedfrom the audited consolidated financial statements included in Item 7 of thisForm 10-KSB.  This information should beread in conjunction with such consolidated financial statements and the notesthereto.

 
|                                                |   | **Year ended  December 31,** |   |
|-----------------------------------------------------|--------|-----------------------------------|--------|
| **(Dollars in thousands)**                          |   | **2003**                          |   | **2002** |   |
| Summary of Operations                               |   |                              |   |   |   |
| Interest Income                                     |   | $                                 | 5,544  |   | $ | 5,575 |   |
| Interest Expense                                    |   | 1,268                             |   | 1,730 |   |
| Net Interest Income                                 |   | 4,276                             |   | 3,845 |   |
| Provision for Loan Losses                           |   | 120                               |   | 132 |   |
| Net Interest Income After Provision                 |   | 4,156                             |   | 3,713 |   |
| Noninterest Income                                  |   | 1,367                             |   | 1,359 |   |
| Noninterest expense                                 |   | 4,390                             |   | 3,805 |   |
| Income Before Taxes                                 |   | 1,133                             |   | 1,267 |   |
| Income Tax                                          |   | 416                               |   | 515 |   |
| Net Income                                          |   | $                                 | 717    |   | $ | 752 |   |
| Per Share Data                                      |   |                              |   |   |   |
| Net Income – Basic                             |   | $                                 | 0.95   |   | $ | 1.07 |   |
| Net Income - Diluted                                |   | $                                 | 0.91   |   | $ | 1.05 |   |
| Number of Shares Basic                              |   | 750,666                           |   | 701,671 |   |
| Number of Shares Diluted                            |   | 788,514                           |   | 716,261 |   |
| Balance Sheet Data – At Period End             |   |                              |   |   |   |
| Total Assets                                        |   | 113,465                           |   | 99,008 |   |
| Total Loans                                         |   | 79,463                            |   | 65,187 |   |
| Allowance for Loan Losses                           |   | 812                               |   | 744 |   |
| Investment Securities                               |   | 18,252                            |   | 11,891 |   |
| Total Deposits                                      |   | 96,286                            |   | 87,505 |   |
| Total Shareholders’ Equity                     |   | 8,546                             |   | 7,949 |   |
| Operating Ratios and Other Selected Data            |   |                              |   |   |   |
| Return on Average Assets                            |   | 0.7                               | %      | 0.8 | % |
| Return on Average Equity                            |   | 8.8                               | %      | 10.6 | % |
| Dividend Payout Ratio                               |   | 10.5                              | %      | 9.3 | % |
| Operating Efficiency Ratio                          |   | 77.8                              | %      | 73.1 | % |
| Net Interest Margin                                 |   | 4.5                               | %      | 4.6 | % |
| Average Equity to Average Assets                    |   | 8.0                               | %      | 7.9 | % |
| Selected Asset Quality Ratios – At Period  End |   |                              |   |   |   |
| Nonperforming Loans to Total Loans                  |   | 0.7                               | %      | 0.0 | % |
| Nonperforming Assets to Total Assets                |   | 0.5                               | %      | 0.0 | % |
| ALL as a Percentage of Nonperforming Loans          |   | 156                               | %      | na |   |
| ALL as a Percentage of Total Loans                  |   | 1.02                              | %      | 1.14 | % |

 

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**Overview**

 

The Company issued $3 million trust preferred securities (the “TPS”) inOctober 2003 and contributed $2 million in additional capital to theBank.  The TPS also provided the Companywith adequate operating cash and cash liquidity to meet expected cash flowneeds for the foreseeable future.

 

The Company also has pledged a $250,000 certificate of deposit toanother financial institution as collateral for a term loan to MCSC.  Based on strategic plans and budgets, it isexpected that MCSC will be able to fully service its loan, and there will be nocall on the Company’s pledged collateral.

 

The Bank has operated since December 1997 as a full servicecommunity bank.

 

The intent of the MCDC is to provide financing for small businesses andlow- to moderate-income areas based on direct loans or funding poolsestablished in conjunction with others. MCDC currently provides loan servicing for the San Luis Obispo CountyEconomic Vitality Corporation and has one small community development loanoutstanding.  MCDC also expects toservice a loan pool funded by local banks including the Bank under the $1million San Simeon Earthquake Recovery Loan Fund (the “Fund”).  This Fund is was structured to provide lowcost financing to individuals and business in San Luis Obispo and NorthernSanta Barbara counties which experienced severe damage in the December 22,2003 San Simeon Earthquake.  As ofFebruary 20, 2004, it remains unclear how much of the Fund will be usedsince FEMA and SBA funding is only available until March 15, 2004.  MCSC is expected to provide technicalassistance to applicants for the Fund.

 

MCSC is expected to provide services to Bank and non-bank customers inthe form of technical services and training services to the underservedsegments of the community including small businesses, minorities and low-incomeentrepreneurs.  As of December 31,2003, the Bank has had limited direct benefit from its association withMCSC.  However, MCSC has received grantsand loan funds and has developed a strategic plan to achieve its objectives.

 

The Bank operates as a traditional community bank, but has also usedmanagement’s expertise as a CDFI to provide a selection of financial servicesidentified as “community development” activities with a focus on financialservices to small businesses and business professionals.  The Company and Bank have received and usedboth grants and deposits under programs authorized by CDFI and consistentlyreview various options for both grants and deposit programs from variousgovernment and public/private entities. The CDFI status is dependent on managements’ specialized knowledge ofworking with various governmental programs and requires a material increase inreporting and documentation.

 

In mid-2001, the Bank received a $990,000 cash award from the BankEnterprise Award (BEA) Program thru the CDFI. The Bank was awarded this cash payment for investing $3 million indeposits 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, $180,900 in 2002, and $180,800 in 2003 with the remaining approximately$92,000 to be taken into income in the first six months of 2004.

 

#### **Basis ofPresentation**

 

The following discussion and analysis is intended to assist in an understandingof the significant factors that influenced our consolidated financial conditionat December 31, 2003 and December 31, 2002. The following discussionand analysis, which refers to the Company on a consolidated basis, should beread in conjunction with the Company’s financial statements and correspondingnotes.

 

The Company is inactive except for minimal expenses and interestassociated the TPS and the financial information is primarily reflective of theBank.

 

25

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**Assets**

 

The following table presents average balance sheet information for thetwo year ended December 31, 2003 and 2002:

 

**Distributionof Assets, Liabilities, and Stockholder’s Equity**

 
|                                                |   | **31-Dec-03**        |   | **31-Dec-02**   |   |
|-----------------------------------------------------|--------|----------------------|--------|-----------------|--------|
| **(dollars in thousands)**                          |   | **Average  Balance** |   | **% of  Total** |   | **Average  Balance** |   | **% of  Total** |   |
| Cash and Due From Banks                             |   | 3,801                |   | 3.7             | %      | 2,623 |   | 2.9 | % |
| Interest - Bearing Deposits Other Banks             |   | 3,006                |   | 3.0             | %      | 3,000 |   | 3.3 | % |
| Investment securities                               |   | 16,022               |   | 15.8            | %      | 12,105 |   | 13.5 | % |
| Federal funds sold                                  |   | 8,561                |   | 8.4             | %      | 5,568 |   | 6.2 | % |
| Loans                                               |   | 66,441               |   | 65.4            | %      | 63,229 |   | 70.5 | % |
| Allowance for loan loss                             |   | (765                 | )      | -0.8            | %      | (685 | ) | -0.8 | % |
| Property, Premises, and Equipment                   |   | 2,477                |   | 2.4             | %      | 2,422 |   | 3 | % |
| Other Investments                                   |   | 363                  |   | 0.4             | %      | 306 |   | 0.3 | % |
| Other Assets                                        |   | 1,634                |   | 1.6             | %      | 1,178 |   | 1.3 | % |
| Total Assets                                        |   | 101,540              |   | 100             | %      | 89,747 |   | 100.0 | % |
| Deposits:                                           |   |                 |   |            |   |   |   |   |   |
| Demand, non-interest-bearing                        |   | 16,630               |   | 16.4            | %      | 13,851 |   | 15.4 | % |
| Demand, interest-bearing                            |   | 2,682                |   | 2.6             | %      | 3,277 |   | 3.7 | % |
| Savings                                             |   | 36,482               |   | 35.9            | %      | 30,494 |   | 34.0 | % |
| Time                                                |   | 34,095               |   | 33.6            | %      | 32,153 |   | 35.8 | % |
| Total deposits                                      |   | 89,889               |   | 88.5            | %      | 79,776 |   | 88.9 | % |
| Short-term Borrowings                               |   | 1,172                |   | 1.2             | %      | 1,595 |   | 1.8 | % |
| Long Term Borrowings                                |   | 635                  |   | 0.6             | %      | 0 |   | — |   |
| Trust Preferred Security                            |   | 669                  |   | 0.7             | %      | 0 |   | — |   |
| Other liabilities                                   |   | 1,713                |   | 1.7             | %      | 1,262 |   | 1.4 | % |
| Total Liabilities                                   |   | 93,409               |   | 92.0            | %      | 82,632 |   | 92.1 | % |
| Common stock                                        |   | 6,273                |   | 6.2             | %      | 5,771 |   | 6.4 | % |
| Preferred Stock                                     |   | 1,084                |   | 1.1             | %      | 1,084 |   | 1.2 | % |
| Unrecognized gain on Available-for-sale  Securities |   | 49                   |   | 0.0             | %      | 58 |   | 0.1 | % |
| Accumulated deficit                                 |   | 725                  |   | 0.7             | %      | 201 |   | 0.2 | % |
| Total stockholders’ equity                     |   | 8,131                |   | 8.0             | %      | 7,115 |   | 7.9 | % |
| Total liabilities and stockholders’ equity     |   | 101,540              |   | 100.0           | %      | 89,747 |   | 100.0 | % |

 

During 2003, total assets increased by $11.8 million or 13.2%. Thisfollows an increase in assets of $18.2 million or 25.5% in 2002.  This slowing in volume and percent gain wasconsistent with the budgeted expectations for growth in 2003 following theevents of September 11, 2001, the expectation of a (mild) recession andthe expectation of a general slowing of growth in general following severalyear of consistent 25% growth.

 

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**Analysis of NetInterest Income**

 

The following table presents, for the periods indicated, the totaldollar amounts of interest income from average interest-earning assets and theresultant yields. Also presented are the dollar amounts of interest expense andaverage interest-bearing liabilities, expressed both in dollars and in rates.

 

Nonaccrual loans are included in the calculation of the averagebalances of loans, and interest not accrued is excluded.

 
|                                 |   | **31-Dec-03**        |   | **31-Dec-02**        |   |
|--------------------------------------|--------|----------------------|--------|----------------------|--------|
| **(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   |   | 3,006                |   | 103                  |   | 3.43 | % | 3,000 |   | 103 |   | 3.43 | % |
| Investment securities                |   | 16,385               |   | 634                  |   | 3.87 | % | 12,105 |   | 667 |   | 5.51 | % |
| Federal funds sold                   |   | 8,561                |   | 90                   |   | 1.05 | % | 5,568 |   | 84 |   | 1.51 | % |
| Loans                                |   | 66,441               |   | 4,717                |   | 7.10 | % | 63,229 |   | 4,721 |   | 7.47 | % |
| Total Interest-earning assets        |   | 94,393               |   | 5,544                |   | 5.87 | % | 83,903 |   | 5,575 |   | 6.64 | % |
|                                 |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:        |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Deposits:                            |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Demand, interest-bearing             |   | 2,682                |   | 10                   |   | 0.37 | % | 3,277 |   | 35 |   | 1.07 | % |
| Savings                              |   | 36,482               |   | 482                  |   | 1.32 | % | 30,494 |   | 690 |   | 2.26 | % |
| Time                                 |   | 34,095               |   | 697                  |   | 2.04 | % | 32,153 |   | 960 |   | 2.99 | % |
| Borrowings                           |   | 1,807                |   | 50                   |   | 2.77 | % | 1,595 |   | 45 |   | 2.82 | % |
| Subordinated Debt                    |   | 669                  |   | 29                   |   | 4.33 | % | — |   | — |   | — |   |
| Total interest-bearing liabilities   |   | 75,735               |   | 1,268                |   | 1.67 | % | 67,519 |   | 1,730 |   | 2.56 | % |
|                                 |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Net interest income and yield:       |   |                 |   |                 |   |   |   |   |   |   |   |   |   |
| Net Interest income                  |   |                 |   | 4,276                |   |   |   |   |   | 3,845 |   |   |   |
| Net yield on interest-earning assets |   |                 |   |                 |   | 4.53 | % |   |   |   |   | 4.58 | % |

 

**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. Nonaccrual loans areincluded in the calculation of the average balances of loans, and interest notaccrued is excluded.  There are no outof period items or adjustments. However, loan fees are included as part of theinterest income yield on loans but do not represent a material amount of theloan interest

 

27

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income.  While the Companycompleted tax exempt investments in December, 2003, the tax exempt income was notmaterial for 2003.

 

|                          |   | **Year Ended  December 31, 2003  over  Year Ended December 31, 2002** |       |
|-------------------------------|--------|---------------------------------------------------------------------------------|------------|
|                          |   | **Increase  (Decrease)  Due to Change**                                         |       |
| **(dollars in thousands)**    |   | **Volume**                                                                      | ** ** | **Rate** | ** ** | **Change** | ** ** |
| Interest-Bearing Assets:      |   |                                                                            |       |   |   |   |   |
| IBA other Banks               |   | —                                                                          |       | — |   | — |   |
| Investments                   |   | 198                                                                             |       | (231 | ) | (33 | ) |
| Federal funds sold            |   | 54                                                                              |       | (48 | ) | 6 |   |
| Loans                         |   | 246                                                                             |       | (250 | ) | (4 | ) |
| Total Interest Income         |   | 498                                                                             |       | (529 | ) | (31 | ) |
|                          |   |                                                                            |       |   |   |   |   |
| Interest-Bearing Liabilities: |   |                                                                            |       |   |   |   |   |
| Demand, interest-bearing      |   | (5                                                                              | )          | (20 | ) | (25 | ) |
| Savings                       |   | 154                                                                             |       | (362 | ) | (208 | ) |
| Time                          |   | 61                                                                              |       | (324 | ) | (263 | ) |
| Borrowings                    |   | 6                                                                               |       | (1 | ) | 5 |   |
| Subordinated Debt             |   | 29                                                                              |       | — |   | 29 |   |
| Total Interest Expense        |   | 245                                                                             |       | (707 | ) | (462 | ) |
|                          |   |                                                                            |       |   |   |   |   |
| Increase in                   |   |                                                                            |       |   |   |   |   |
| Net Interest Income           |   | 253                                                                             |       | 178 |   | 431 |   |

 

#### **Year EndedDecember 31, 2003 Compared to December 31, 2002**

 

#### **There were several significanttrends or events in 2003 that influenced asset and loan growth and net incomeincluding: historically low interest rates, a mild “recession”, unutilizedbranch capacity, expenses associated with the TPS including interest, and flatnon-interest income.  The combination ofthese factors resulted in a small ($35,000) decrease in net income for 2003compared to 2002.**

#### ** **

Interest rates were at their lowest levels in over 40 years during2003.  The Bank experienced decreases inboth yield on earning assets and deposits, but managed to keep its net yield oninterest earning assets within 5 basis points of 2002.  Net interest income did increase compared to2002 by $431,000 or 11.2%.  The mostpronounced impact of the low interest rates was the extremely high level ofloan refinancing with borrowers seeking and finding low fixed-rate, long-termloans.  The Bank was generally reluctantto commit to long-term fixed-rate loans and experienced a net decrease in loanvolume through the first half of 2003. For 2003, the average loan to depositratio dipped to 73.9% from 79.3% for 2002 while lower yielding investments andFederal Funds Sold levels increased. Had the Bank been able to maintain loan volume (without sacrificinginterest rate risk or credit quality), net interest income would have beenincrementally improved.

 

While the local areas did not experience the “recession” as much asmany other area, there was a general reluctance by management to push creditrisk until there was a clearer direction for the economy.  This also limited the Bank’s willingness tobuild loan volume without consideration of interest rate risk.

 

In mid 2002, the Bank opened a new full service branch and converted aloan production office to a full service branch.  Both of these branches have experienced slower than expectedgrowth, and neither has reached the level of activity required to offset theadditional overhead expenses associated with new operations and non-interestexpenses increased faster in 2003 than increases in income.  Specific focus on

 

28

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these two branches has been given a high priority for 2004.

 

The Bank has traditionally been dependent on gain of sale income fromU.S. Small Business Administration (“SBA”) loans.  During the first months of 2003, the SBA experienced fundingdelays and reduced the level of its guarantee program.  While sale income increased during the lasthalf of the year, the Bank was unable to recapture sale income lost during thefirst part of 2003.

 

**Based on**informationreceived in early 2004, the SBA has revised its 7a program and reduced thelevel of its guarantee from 75% to 50% on any loan up to $2 million.  The Bank is unsure what effect this changewill have on the volume of SBA loans it process or the fees income generatedfrom SBA loans.  It will increase theneed for higher underwriting standards to mitigate the lower guarantee.

 

**Provision for LoanLosses**

 

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 $120,000 for 2003 compared to $132,000 for 2002.

 

See – Lending Activitiesand Asset Quality below.

 

#### **Non-interestIncome**

#### ** **

Non-interest income marginally increased in 2003 compared to 2002 (by$9,000).  The Bank has not stressedservice charge fee income but service charges and fees did increase in 2003 byapproximately $13,300 to $198,000 with the bulk of the this income from feesfor NSF checks ($158,000).  The two newbranches continue to offer “free checking” (free of normal service charges) andare not expected to provide any material service charge income unless there isa strategic change in pricing strategy.

 

Gain on Sale of SBA loans decreased by $31,000 in 2003 compared to 2002due to reduced loan activity in the first months of 2003 when the SBA loanprograms were decreased due to funding limitations.

 

As expected, fees from the Bank’s merchant card program dropped by$13,800 in 2003 as a result of a decision in 2002 to outsource most of theprocessing and utilize Bank staff resources for other activities.

 

To increase non-interest income in 2004 and beyond, the Bank expects tointroduce a new overdraft privilege product in mid 2004. The Bank alsoanticipates generating additional fee income from a loan broker program wherebyloans generated by the bank will be brokered to other financial institutions.  These loans are expected to be primarilylonger term fixed rate loans that the Bank would not as a rule make for its ownportfolio.  The Bank also expects toincrease mortgage loan fee income by increasing the volume of its mortgage loanreferrals.

 

The Bank recorded $537,750 in non-interest income for 2001 based on a$990,000 award from the Banker Enterprise Award program under the Department ofTreasury’s CDFI program.  Thisincome/award was based on the Bank meeting its investment goals by investing $3million in other CDFIs at below market rates. The balance of the award funds are being accrued to income based on ayield formula with income in 2003 of $183,000. Income from the BEA award will accrue until June 2004 at the rateof approximately $15,000 per month.

 

While no assurances can be given, the Bank expects to apply for a BEAaward in 2004.

 

29

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#### **Non interestExpense**

 

Non interest expense increased in 2003 by $585,000 or 15.4%.

 

Salary and Benefits increased by $422,000 or 21.5% due to normal salaryincreases during the year, additions to staff and from the effect of a fullyear’s salary for the new Nipomo branch and the added staff when the ArroyoGrande office was converted to full service. The conversion and new branch were opened in mid 2002.  The Bank also added a human resourcesofficer and an experienced loan officer which were both new positions.

 

Occupancy expense also increased due to the new offices by $67,000 or23.9%.  Primary areas that increasedoccupancy expense were lease expense, which increased by approximately $31,000or 25% and, utilities, which increased by approximately $5,000 or 16.0%, andservice contracts, which increased by $13,000 or 18.7%.

 

Furniture Fixtures and Equipment expenses decreased by $14,000 or6.8%.  The decrease is primarily due toa large number of computer related items that were fully depreciated by thestart of 2003 and a reduction in depreciation for this equipment ofapproximately $30,000 or 26.4%.

 

Other expenses increased by approximately $110,000 or 8.2%.  Other expenses that had material changesfrom 2002 to 2003 were:

1)              marketing and advertising decreasedby $25,000 or 17.8%;

2)              data processing decreased byapproximately $38,000 or 10.1% with the renegotiation of core processingcontracts which matured December 2002;

3)              professional fees increased byapproximately $47,000 or 56.0% due to increased expenses for auditing andnonrecurring legal expenses relating to the charter change and TPS;

4)              director fees including trainingincreased by approximately $34,000 or 83.9% to $74,000 (directors fees werepaid for part of 2002 and all of 2003);

5)              loan expenses for serviced loansincreased by $28,000 or 30.5% as the volume of activity increased; and

6)              telephone expenses decreased byapproximately $12,000 or 14.3% when the Bank implemented a new phone system inearly 2003.

 

#### **Income Taxes**

#### ** **

The Company and Bank invested $550,000 in certificates of deposit withother COIN certified financial institutions and received a California incometax credit of 20% for 12003.  The COINcertificates of deposit are at zero interest for 60 months.  The COIN CDs will also provide the Bank withinvestment credit under the Community Reinvestment Act (“CRA”).

 

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

 

#### **LiquidityManagement**

#### ** **

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

 

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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, 2003 and 2002, the Bank’s liquidity ratios were19.5% and 23.6%, respectively.  The Bankhad $5.5 million in Federal Funds Sold (immediate liquidity) on December 31,2003 and $12.3 million on December 31, 2002. This material decrease in immediate liquidity was consistent withfunding a large volume of loans at the end of 2003 while loan activity slowedat the end of 2002.

 

While the Bank primarily uses Federal Funds Sold as the immediatemeasure of cash liquidity, it also has established short-term borrowing lines(Federal Funds Purchased) for a total of $4 million from its correspondentbanks.  These lines are for short-termneeds and are generally not actively used.

 

As of December 31, 2003, the Bank had outstanding borrowings from theFederal Home Loan Bank of San Francisco (FHLB) of $4.5 million. Of the $4.5 million,$3 million was borrowed for 10 years to offset a specific pool of the Bank’sfixed rate loans. Total borrowings were increased to $5.5 million in January2004 the additional $1 million used to fund short and mid-term loans.  Interest rate and term for FHLB borrowingsare generally more favorable than the rates for similar term certificates ofdeposits.  The Bank has the potential(on a secured basis) to borrow up to 20 percent of its total assets or approximately$20.5 million from the FHLB.  The Bankanticipates utilizing FHLB borrowings in 2004 when needed as part of its normalliquidity management to cost effectively fund asset growth and has more thanadequate loans to pledge as collateral should it need additional liquidity thatcan not be funded by deposits.

 

The Bank has also established contacts using the Internet to provide asecondary source for deposits.  Whilecore, local deposits remain the primary source of deposits, the Bank continuesto seek alternate sources for competitive rate deposits.  The Bank also expects to continue to use isCDFI and COIN designations to attract lower cost deposits.

 

The Company’s liquidity is provided by a line of credits from PacificCoast Bankers’ Bank.  As of December 31,2003, the Company had no borrowings under its line of credit and approximately$570,000 in available cash.  The Companyimproved its cash liquidity in October 2003 when it issued a trust preferredsecurity with net cash proceeds of approximately $2.9 million and retained allbut $2.0 million which was used to increase the Bank’s capital.

 

**Investment Activities**

 

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 (the CFO) within policies limits established by the board of directors.The CFO reports 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 highest yield consistent withmaintaining a stable overall asset and liability position while limitingeconomic risks. In accordance with this policy, management actively manages itsinvestment portfolio between available for sale and held to maturityinvestments, the composition of which may shift substantially over time.

 

See Item 7 Note B — Investment Securities notes to consolidatedfinancial statements.

 

As of December 31, 2003, 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 $474,000, was $18,726,000.

 

Investments in US Government and agency securities are generallylimited to $500,000 to $1,000,000 per

 

31

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issue and no corporate or other investments equal or exceed ten percentof the shareholders’ equity.

 

The Bank has structured the investment portfolio primarily withmortgage backed securities and callable agencies which provide monthly cashflows or reinvestments of approximately $1 million to $2 million per month.

 

The Bank owns one $427,000 MBS security issued by a company that hasbeen in bankruptcy for the past year and which has seen a material decline inmarket value to approximately $217,000. The investment as of December 31, 2003 was rated as BBB by Standard andPoors and is carried at book value in the HTM portfolio.  While there can be no assurance that thisinvestment will maintain its investment grade, management will be closelymonitoring it and will take appropriate action to write it down in the event itis downgraded below investment grade.

 

See Note B in the — Investment Securities in the notes consolidatedfinancial statements.

 

The following table presents the distribution of investments by sector(dollars in thousands), the stated due dates of the investments, and theweighted yield of the investments:

 

For the year ended December 31, 2003

 
| **(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   |   | —              |   | 8,026            |   | 3,000             |   | 2,498               |   | 13,524    |   |
| Mortgage Backed Securities                       |   | —              |   | 457              |   | 792               |   | 3,479               |   | 4,728     |   |
| Other Securities including stock in FRB and FHLB |   |                |   |             |   |              |   | 474                 |   | 474       |   |
| Total                                            |   | —              |   | 8,483            |   | 3,792             |   | 6,451               |   | 18,726    |   |
|                                             |   |                |   |             |   |              |   |                |   |      |   |
| Weigted Average Yield:                           |   |                |   |             |   |              |   |                |   |      |   |
| US Treasury and other U.S. Government agencies   |   | 0.00                | %      | 3.21             | %      | 4.19              | %      | 4.56                | %      | 3.68      | %      |
| Mortgage Backed Securities                       |   | 0.00                | %      | 3.33             | %      | 4.72              | %      | 4.36                | %      | 4.32      | %      |
| Other Securities including stock in FRB and FHLB |   |                |   |             |   |              |   | 5.00                | %      | 5.00      | %      |
|                                             |   |                |   |             |   |              |   |                |   |      |   |
| Weighted Average Total                           |   | 0.00                | %      | 3.22             | %      | 4.30              | %      | 4.49                | %      | 3.87      | %      |

 

32

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For the year ended December 31, 2002

 
| **(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 and the end of 2002 or 2003.

 

 **Asset Liability 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 of interest-earningassets and interest-bearing liabilities as of December 31, 2003, using theinterest 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.

 

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| **(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 |   | 6,015               |   | 6,533                          |   | 5,704                  |   | 474               |   | 18,726    |   |
| CD’s other Banks                 |   | —              |   | 3,000                          |   | 550                    |   | —            |   | 3,550     |   |
| FFS                                   |   | 5,495               |   | —                         |   | —                 |   | —            |   | 5,495     |   |
| Loans                                 |   | 54,231              |   | 12,887                         |   | 6,777                  |   | 5,568             |   | 79,463    |   |
| Total                                 |   | 65,741              |   | 22,420                         |   | 13,031                 |   | 6,042             |   | 107,234   |   |
| Interest-Bearing Liabilities:         |   |                |   |                           |   |                   |   |              |   |      |   |
| Money Market and Now Accounts         |   | 3,748               |   | —                         |   | —                 |   | —            |   | 3,748     |   |
| Savings                               |   | 37,859              |   | —                         |   | —                 |   | —            |   | 37,859    |   |
| Time Deposits                         |   | 12,527              |   | 20,187                         |   | 2,270                  |   |              |   | 34,984    |   |
| Other Borrowings (FHLB)               |   | —              |   | 1,000                          |   | 500                    |   | 3,000             |   | 4,500     |   |
| Subordinated Debt                     |   |                |   |                           |   | 3,093                  |   |              |   | 3,093     |   |
| Total                                 |   | 54,134              |   | 21,187                         |   | 5,863                  |   | 3,000             |   | 84,184    |   |
|                                  |   |                |   |                           |   |                   |   |              |   |      |   |
| Interest Rate Sensitive Gap           |   | 11,607              |   | 1,233                          |   | 9,961                  |   | 3,042             |   | 25,843    |   |
|                                  |   |                |   |                           |   |                   |   |              |   |      |   |
| Cumulative Gap Sensitivity            |   | 11,607              |   | 12,840                         |   | 11,194                 |   | 13,003            |   | 28,885    |   |
|                                  |   |                |   |                           |   |                   |   |              |   |      |   |
| Cumulative Gap Ratio                  |   | 121.4               | %      | 117.0                          | %      | 45.0                   | %      | 23.2              | %      | 131.9     | %      |
|                                  |   |                |   |                           |   |                   |   |              |   |      |   |
| Cumulative Gap to Total Assets        |   | 11.7                | %      | 13.0                           | %      | 11.3                   | %      | 13.1              | %      | 29.2      | %      |

 

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 interest rate forecasts which suggest nomaterial change in short term rates until after the November 2004 elections andthe potential for a modest steepening of the yield curve moving into 2005, theBank expects to continue to remain asset sensitive in 2004.  Strategies that are being used include butare not limited to maintaining a majority of its loans on a floating basic,selling or brokering fixed rate long term loans, maintaining short terms andadjustable rates for investments and closely monitoring deposit rates andtrends.

#### ** **

#### **Lending Activities**

 

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

 

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

 

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|                         |   | **31-Dec-03** |   | **31-Dec-02** |   |
|------------------------------|--------|---------------|--------|---------------|--------|
| **(dollars in thousands)**   |   | **Amount**    |   | **Percent**   |   | **Amount** |   | **Percent** |   |
| Loan Category:               |   |          |   |          |   |   |   |   |   |
| Commercial                   |   | 14,289        |   | 17.98         | %      | 15,399 |   | 23.62 | % |
| Agricultural                 |   | 1,526         |   | 1.92          | %      | 2,324 |   | 3.57 | % |
| Real Estate                  |   | 55,840        |   | 70.27         | %      | 37,662 |   | 57.78 | % |
| Construction                 |   | 4,920         |   | 1.75          | %      | 6,539 |   | 10.03 | % |
| Consumer Loans               |   | 1,393         |   | 1.75          | %      | 1,891 |   | 2.90 | % |
| Leases                       |   | 1,495         |   | 1.88          | %      | 1,372 |   | 2.10 | % |
| Total Loans                  |   | 79,463        |   | 100           | %      | 65,187 |   | 100.00 | % |
|                         |   |          |   |          |   |   |   |   |   |
| Standby Letters of Credit    |   | 30            |   |          |   | 64 |   |   |   |
|                         |   |          |   |          |   |   |   |   |   |
| Undisbursed Loan Commitments |   | 27,578        |   |          |   | 18,079 |   |   |   |

 

The following table sets forth as of December 31, 2003 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                     |   | 14,025              |   | 113              |   | 151                    |   | 14,289    |   |
| Agricultural                   |   | 1,429               |   | 97               |   | 0                      |   | 1,526     |   |
| Real Estate                    |   | 44,393              |   | 6,050            |   | 5,397                  |   | 55,840    |   |
| Construction                   |   | 4,920               |   | 0                |   | 0                      |   | 4,920     |   |
| Consumer Loans                 |   | 1,294               |   | 99               |   | 0                      |   | 1,393     |   |
| Leases                         |   | 1,200               |   | 295              |   | 0                      |   | 1,495     |   |
| Total Loans                    |   | 67,261              |   | 6,654            |   | 5,548                  |   | 79,463    |   |
|                           |   |                |   |             |   |                   |   |      |   |
| Fixed and Variable Rate Loans: |   |                |   |             |   |                   |   |      |   |
| Fixed Rate                     |   | 13,919              |   | 6,654            |   | 5,548                  |   | 26,121    |   |
| Variable Rate                  |   | 52,834              |   | 0                |   | 0                      |   | 52,834    |   |
| Nonaccrual Loans               |   | 508                 |   |             |   |                   |   | 508       |   |
| Total Loans                    |   | 67,261              |   | 6,654            |   | 5,548                  |   | 79,463    |   |

 

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

 

35

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single family residential property. While the construction loan totals are down as of December 31, 2003,there are a number of new construction loans and loan commitments that have notas yet been funded.  These loans aretypically short term of 12 to 18 months. As a rule, the Bank does not provide loans for speculative purposesexcept to known builders who have a track record of successful projects and theexpertise and financial strength for this kind of building.

 

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.  In January 2003, the Bank contracted withanother intermediary to provide residential lending services, systems andsupport.  This service is expected toresult in a higher volume of residential loans and improved lending servicesfor the Bank’s customers.  This programis being specifically designed to meet the needs of low to moderate incomeresidents in the Bank’s market area in 2004.

 

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 25years, unless the loans are SBA loans secured by real estate or othercommercial real estate loans easily sold in the secondary 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, 2003 and 2002, the Bank serviced approximately $19.7million and $17.3 million, respectively, in SBA loans. SBA loans arecategorized as Commercial or Real Estate depending on the underlyingcollateral.

 

#### **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 Bank’s federal and state regulators, and the Bank engages anoutside firm to perform periodic reviews of the loan portfolio and to test theadequacy of the Allowance for Loan 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 marketinterest rates and future principal and interest payments are no longer indoubt at which 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:

 

36

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| **(dollars in thousands)**                       |   | **31-Dec-03** |   | **31-Dec-02** |   |
|--------------------------------------------------|--------|---------------|--------|---------------|--------|
| Loans on Nonaccrual Basis                        |   | 508           |   | 0             |   |
| Loans Past Due 90 Day or more                    |   | 11            |   | 0             |   |
| Restructured Loans                               |   | 0             |   | 0             |   |
| Total Nonperforming Loans                        |   | 519           |   | 0             |   |
| Other Real Estate Owned                          |   |          |   |          |   |
| Total Nonperforming Assets                       |   | 519           |   | 0             |   |
|                                             |   |          |   |          |   |
| Nonaccrual Loans to Total Loans                  |   | 0.84          | %      | 0.00          | %      |
| Past Due 90 Days or More to Total Loans          |   | 0.02          | %      | 0.00          | %      |
| Restructured Loans to Total Loans                |   | 0.00          | %      | 0.00          | %      |
| Nonperforming Loans to Total Loans               |   | 0.65          | %      | 0.00          | %      |
|                                             |   |          |   |          |   |
| Allowance for Loan Losses to Nonperforming Loans |   | 156           | %      | na            |   |
|                                             |   |          |   |          |   |
| Nonperforming Assets to Total Assets             |   | 0.46          | %      | 0.00          | %      |

 

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.

 

As of December 31, 2003 the nonarrual loans were all SBA loans with$436,000 of the total guaranteed.  Theseloans are well secured and no loss is currently anticipated.  The $11,000 in past due loans represents twoleases which are secured by equipment and in the process of collection.  At December 31, 2002, the Bank had no loanson nonaccrual or past due 90 days 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, 2003 and 2002

 

While credit quality asmeasured by loan delinquencies appears to be satisfactory as of December 31,2003, there can be no assurances that new problem loans will not develop infuture periods.  The Bank has welldefined underwriting standards and expects to continue with prompt collectionefforts, but economic uncertainties or changes cause on or more borrowers toexperience problems in the coming months.

 

The Bank has not identified anyloans that have deteriorated or where credit risk has increased following theDecember 22, 2003 San Simeon Earthquake which caused more than $200 million indamage in Paso Robles.  While most ofthe damage assessment has been completed, there is no assurance that additionalproblems which could impact the Bank’s borrowers will not arise.  A limited number of loans in the Paso areawere placed on the internal watch list to allow management to increasemonitoring of these loans during the recovery period.

 

The Bank has no foreign loans.

 

**PotentialProblem Loans**

 

As of March 1, 2004, there hasbeen no material change in asset quality.

** **

**LoanConcentrations**

 

The Board of Directors hasapproved concentrations (of capital) levels for various loan types based on theBank’s business plan and historic loss experience. On a quarterly basis,management provides a loan concentration report to the board in writing withinformation relating to concentrations. Management’s

 

37

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review of possibleconcentrations includes an assessment of loans to a multiple of borrowersengaged in similar activities which would cause them to be similarly impactedby economic conditions or other conditions. Management is not aware of any such concentrations in similaractivities.

 

The following table reflects the major concentrations in real estatelending as of December 31, 2003 as compared to a September 2003 (most currentlyavailable) California peer group of 50 banks with total assets of $100 millionto $200 million:

 

Reportof Real Estate Loan Concentrations

(dollars in thousands)

 
| **Real Estate**        |   | **Loans** |   | **%****of Assets** |   | **Peer Group** |   |
|------------------------|--------|-----------|--------|--------------------|--------|----------------|--------|
| Construction and Land  |   | 4,919     |   | 4.34               | %      | 8.40           | %      |
| Commercial Real Estate |   | 51,559    |   | 45.44              | %      | 41.94          | %      |
| 1-4 family             |   | 4,280     |   | 3.77               | %      | 5.89           | %      |
| Mulit Family           |   | —    |   | 0.00               | %      | 6.04           | %      |
| Farmland               |   | —    |   | 0.00               | %      | 0.75           | %      |
|                   |   | 60,758    |   | 53.55              | %      | 49.16          | %      |

 

As of December 31, 2003, the report shows a concentration in commercialreal estate loans.  However, these loansare well secured, seasoned loans with no classified loans or lossexperience.  The commercial real estatemarket in San Luis Obispo County remains very strong, with good demand, limitedvacancies and rising rents.

 

The Bank had previously purchased a large number of commercial realestate loans from another financial institution.  A majority of these loans have been paid off or were refinancedby other financial institutions during 2003. The remaining balance for these seasoned loans totaled $1.7 million asof December 31, 2003.

 

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 carefully consider economic trends and realestate values to the best of its ability.

 

**Allowancefor Loan Losses**

 

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:

 

38

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| **(dollars in thousands)**               |   | **31-Dec-03** |   | **31-Dec-02** |   |
|------------------------------------------|--------|---------------|--------|---------------|--------|
| Allowance For Loan Losses:               |   |          |   |          |   |
| Balance at Beginning of Period           |   | 744           |   | 635           |   |
| Actual Charge-offs:                      |   |          |   |          |   |
| Commercial                               |   | 110           |   | 49            |   |
| Consumer                                 |   | —        |   | 6             |   |
| Real Estate                              |   |          |   |          |   |
| Total Charge-Offs                        |   | 110           |   | 55            |   |
| Less Recoveries:                         |   |          |   |          |   |
| Commercial                               |   | 57            |   | 32            |   |
| Consumer                                 |   | 1             |   | —        |   |
| Real Estate                              |   | —        |   | —        |   |
| Total Recoveries                         |   | 58            |   | 32            |   |
|                                     |   |          |   |          |   |
| Net Loans Charged Off                    |   | 52            |   | 23            |   |
| Provision for Loan Losses                |   | 120           |   | 132           |   |
| Balance at End of Period                 |   | 812           |   | 744           |   |
|                                     |   |          |   |          |   |
| Ratios:                                  |   |          |   |          |   |
| Net Loans Charged Off to Average Loans   |   | 0.08          | %      | 0.04          | %      |
| Allowance for Loan Losses to Total Loans |   | 1.02          | %      | 1.14          | %      |

 

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 various regulatory policy statements on the allowance for loanlosses.

 

A key element of the Bank’s methodology is the previously discussedcredit classification process.  As ofDecember 31, 2003, 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.

 

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 would decreaseearnings and capital and would thereby reduce the ability to pay distributionsamong other adverse consequences.

 

The ratio of allowance for loan losses to total loans as of December31, 2003 was 1.02%, 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 qualityproblems following the “recession” and a continued resumption of economicgrowth in the Central Coast.

 

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 31,2003.

 

39

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|                            |   | **31-Dec-03** |   | **31-Dec-02** |   |
|---------------------------------|--------|---------------|--------|---------------|--------|
| **(dollars in thousands)**      |   | **Loans**     |   | **Percent**   |   | **Factor** |   | **Reserve  Amt.** |   | **Loans** |   | **Percent** |   | **Factor** |   | **Reserve  Amt.** |   |
| Total Loans:                    |   |          |   |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real Estate                     |   | 51,643        |   | 67            | %      | 0.31 | % | 160 |   | 37,477 |   | 57 | % | 0.40 | % | 150 |   |
| Other Security                  |   | 23,760        |   | 30            | %      | 1.24 | % | 294 |   | 24,394 |   | 37 | % | 1.13 | % | 275 |   |
| Unsecured                       |   | 2,852         |   | 4             | %      | 0.81 | % | 23 |   | 3,316 |   | 5 | % | 0.75 | % | 25 |   |
| Total Loans                     |   | 78,255        |   | 100           | %      | 0.59 | % | 477 |   | 65,187 |   | 100 | % | 0.69 | % | 450 |   |
| Other Factors:                  |   |          |   |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Economic Factors          |   |          |   |          |   |   |   | 178 |   |   |   | — |   |   |   | 176 |   |
| Total Other                     |   | 30            |   |          |   |   |   | 178 |   |   |   |   |   |   |   | 176 |   |
|                            |   |          |   |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Classified Loans                |   | 1,208         |   |          |   | 12.91 | % | 156 |   | 875 |   |   |   | 13.49 | % | 118 |   |
| Total Allowance for Loan Losses |   |          |   |          |   |   |   | 811 |   |   |   |   |   |   |   | 744 |   |
|                            |   |          |   |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Actual Allowance                |   |          |   |          |   |   |   | 811 |   |   |   |   |   |   |   | 744 |   |

 

**Deposits**

 

Deposits are the primary source of funding for lending and investingneeds. Total deposits were $96.3 million at December 31, 2003 and $87.5 millionat the end of 2002.  Deposits increasedby $8.8 million or 10.1% in 2003 following a 22% or $15.8 million increase in2002.

 

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

 
|                          |   | **31-Dec-03**        |   | **31-Dec-02**          |   |
|-------------------------------|--------|----------------------|--------|------------------------|--------|
| **(dollars in thousands)**    |   | **Average  Balance** |   | **Average  Rate Paid** |   | **Average  Balance** |   | **Averag  Rate Paid** |   |
| Deposits in Domestic Offices: |   |                 |   |                   |   |   |   |   |   |
| Noninterest bearing demand    |   | 16,630               |   | 0.00                   | %      | 13,851 |   | 0.00 | % |
| Demand, interest-bearing      |   | 2,682                |   | 0.37                   | %      | 3,277 |   | 1.07 | % |
| Savings                       |   | 36,482               |   | 1.32                   | %      | 30,494 |   | 2.26 | % |
| Time                          |   | 34,095               |   | 2.04                   | %      | 32,153 |   | 2.99 | % |
| Total Deposits                |   | 89,889               |   | 1.32                   | %      | 79,776 |   | 2.11 | % |

 

The Bank generally prices deposits at or above the median rate byclassification based on periodic interest rate surveys in the localmarket.  Deposit rates are then adjustedto balance the cost of funds versus funding needs and asset liability considerations.  The Bank has used and expects to continue touse an Investor Savings product that pays higher rates than normal savings andsimilar rates to money market accounts as a special product unique to the Bank,but management also expect to see the relative percentage of Investor Savingsto total deposit to continue to decline.

 

The Bank anticipates that interest rates will begin to increase in late2004 as the current economic conditions continue to show improvement, theNovember election, and geopolitical issues are resolved and when the economybegins to shift back into consistent growth.

 

40

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The following table reflects the maturity distribution of certificatesof deposit in the amounts of $100,000 or more as of December 31, 2003:

 
| **(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 |   | 9,479                  |   | 4,697             |   | 9,395              |   | 1,238               |   | 24,809    |   |

 

**ShortTerm and Other Borrowings**

 

As of December 31, 2003, the Bank had $4.5 million in outstanding loansto the Federal Home Loan Bank of San Francisco.

 

See Note F of the notes to consolidated financial statements.

 

See Note G Junior Subordinated Securities.

 

**Effectsof Inflation and Economic 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 for both residential and commercial properties.  There can be no assurance that the economywill improve in the short term, and the Bank has adopted a cautiouslyoptimistic outlook with close attention to credit quality, to interest raterisk, and control of operational expenses.

 

On December 22, 2003, the San Simeon Earthquake hit the Paso Roblesarea around the Bank’s branch the hardest but was felt throughout thecounty.  Estimates suggest damages inexcess of $200 million.  To the best ofmanagement’s knowledge there was no material damage to the Bank’s leased officein Paso and there has been no reported major increase in credit risk for theBank’s loans in the Paso area or in other parts of the county.  The County was declared a Federal DisasterArea and residents and businesses were eligible for FEMA & SBA assistanceuntil March 15, 2004.

 

**Return on Equity andAssets**

 

The following table shows the Company’s return on average assets andreturn on average equity for the two reporting periods:

 
|                     |   | **31-Dec-03** |   | **31-Dec-02** |   |
|--------------------------|--------|---------------|--------|---------------|--------|
| Return on Assets         |   | 0.71          | %      | 0.84          | %      |
| Return on Average Equity |   | 8.82          | %      | 10.57         | %      |

 

The impact of the mild recession in 2003, the impact of very slow loanactivity in 2003 due to a high volume of loan refinancing at low, long-term,fixed-rates which the Bank was not willing to match and the added overheadexpenses for a full year of the Nipomo and Arroyo Grande branches were theprimary contributing factors to the decline in ROA and ROE in 2003 compared to2002.

 

41

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**Item7.****        FinancialStatements**

 

42

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**CONTENTS**

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

 

43

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

 

#### **INDEPENDENT AUDITORS’ REPORT**

 

Board of Directors and Shareholders of

Mission Community Bancorp and Subsidiary

 

We have audited the accompanying consolidated balance sheets of MissionCommunity Bancorp and Subsidiary as of December 31, 2003 and 2002 and therelated consolidated statements of income, changes in shareholders’ equity, andcash flows of the years then ended. These consolidated financial statements are the responsibility of theCompany’s management.  Ourresponsibility is to express an opinion on these consolidated financialstatements 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 toobtain reasonable assurance about whether the consolidated financial statementsare free of material misstatement.  Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles usedand significant 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 consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of MissionCommunity Bancorp and Subsidiary as of December 31, 2003 and December 31, 2002,and the results of its operations and its cash flows for the years then ended,in conformity with accounting principles generally accepted in the UnitedStates of America.

### ** **

**Draft – for discussion purposes only**

 

Laguna Hills, California

January 27, 2004

 

25231 Paseo De Alicia, Suite 100    Laguna Hills, CA  92653    Tel:949.768.0833    Fax: 949.768.8408    www.vtdcpa.com

**FRESNO ****• LAGUNA HILLS ****•  PLEASANTON ****•  RANCHO CUCAMONGA ****•  SAN JOSE**

 

44

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#### **MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATED BALANCESHEETS**

**December31, 2003 and 2002**

 
|                                                 |   | **2003**   |        | **2002**   |   |
|------------------------------------------------------|--------|------------|-------------|------------|--------|
| **ASSETS**                                           |   |       |        |       |   |
|                                                 |   |       |        |       |   |
| Cash and Due from Banks                              |   | $          | 2,798,175   |       | $      | 3,024,051 |   |
| Federal Funds Sold                                   |   | 5,495,000  |        | 12,295,000 |   |
| **TOTAL CASH AND CASH EQUIVALENTS**                  |   | 8,293,175  |        | 15,319,051 |   |
|                                                 |   |       |        |       |   |
| Interest-Bearing Deposits in Other Banks             |   | 3,550,000  |        | 3,000,000  |   |
|                                                 |   |       |        |       |   |
| Investment Securities:                               |   |       |        |       |   |
| Investment Securities Available for Sale             |   | 6,951,780  |        | 5,260,475  |   |
| Investment Securities Held to Maturity               |   | 11,300,627 |        | 6,630,449  |   |
| **TOTAL INVESTMENT SECURITIES**                      |   | 18,252,407 |        | 11,890,924 |   |
|                                                 |   |       |        |       |   |
| Loans:                                               |   |       |        |       |   |
| Commercial                                           |   | 15,784,061 |        | 16,770,152 |   |
| Agricultural                                         |   | 1,526,632  |        | 2,324,468  |   |
| Construction                                         |   | 4,919,585  |        | 6,539,327  |   |
| Real Estate                                          |   | 55,839,615 |        | 37,662,315 |   |
| Consumer                                             |   | 1,393,407  |        | 1,891,124  |   |
| **TOTAL LOANS**                                      |   | 79,463,300 |        | 65,187,386 |   |
|                                                 |   |       |        |       |   |
| Allowance for Loan Losses                            |   | (811,925   | )           | (744,248   | )      |
| **NET LOANS**                                        |   | 78,651,375 |        | 64,443,138 |   |
|                                                 |   |       |        |       |   |
| Federal Reserve Bank Stock and Other Stock,  at Cost |   | 473,609    |        | 337,984    |   |
| Premises and Equipment                               |   | 2,429,851  |        | 2,488,061  |   |
| Accrued Interest and Other Assets                    |   | 1,815,007  |        | 1,529,071  |   |
|                                                 |   |       |        |       |   |
|                                                 |   | $          | 113,465,424 |       | $      | 99,008,229 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

45

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|                                                                                                           |   | **2003**    |        | **2002**   |   |
|----------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                  |   |        |        |       |   |
|                                                                                                           |   |        |        |       |   |
| Deposits:                                                                                                      |   |        |        |       |   |
| Noninterest-Bearing Demand                                                                                     |   | $           | 20,195,209  |       | $      | 15,005,159 |   |
| Money Market, NOW and Savings                                                                                  |   | 41,106,568  |        | 38,779,946 |   |
| Time Deposits Under $100,000                                                                                   |   | 10,174,539  |        | 10,331,312 |   |
| Time Deposits $100,000 and Over                                                                                |   | 24,809,222  |        | 23,388,584 |   |
| **TOTAL DEPOSITS**                                                                                             |   | 96,285,538  |        | 87,505,001 |   |
|                                                                                                           |   |        |        |       |   |
| Other Borrowings                                                                                               |   | 4,500,000   |        | 2,500,000  |   |
| Junior Subordinated Debt Securities                                                                            |   | 3,093,000   |        | —     |   |
| Accrued Interest and Other Liabilities                                                                         |   | 1,041,360   |        | 1,053,740  |   |
| **TOTAL LIABILITIES**                                                                                          |   | 104,919,898 |        | 91,058,741 |   |
|                                                                                                           |   |        |        |       |   |
| Commitments and Contingencies - Notes D and  M                                                                 |   | —      |        | —     |   |
|                                                                                                           |   |        |        |       |   |
| Shareholders’ Equity:                                                                                     |   |        |        |       |   |
| Preferred Stock Authorized 1,000,000  Shares:                                                                  |   |        |        |       |   |
| Series A - $5 Stated Value; Issued and  Outstanding, 100,000 Liquidation Value of $500,000                     |   | 392,194     |        | 392,194    |   |
| Series B - $10 Stated Value; Issued and  Outstanding, 20,500 Liquidation Value of $205,000                     |   | 191,606     |        | 191,606    |   |
| Series C - $10 Stated Value; Issued and  Outstanding, 50,000 Liquidation Value of $500,000                     |   | 500,000     |        | 500,000    |   |
| Common Stock - Authorized 1,000,000 Shares;  Issued and Outstanding, 630,166 in 2003 and 2002                  |   | 6,273,101   |        | 6,273,101  |   |
| Retained Earnings                                                                                              |   | 1,170,337   |        | 528,890    |   |
| Accumulated Other Comprehensive Income -  Unrealized Appreciation on Available-for-Sale Securities, net of tax |   | 18,288      |        | 63,697     |   |
| **TOTAL SHAREHOLDERS’ EQUITY**                                                                            |   | 8,545,526   |        | 7,949,488  |   |
|                                                                                                           |   |        |        |       |   |
|                                                                                                           |   | $           | 113,465,424 |       | $      | 99,008,229 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

46

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**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF INCOME**

**YearsEnded December 31, 2003 and 2002**

 
|                                                     |   | **2003**  |      | **2002**  |   |
|----------------------------------------------------------|--------|-----------|-----------|-----------|--------|
| **INTEREST INCOME**                                      |   |      |      |      |   |
| Interest and Fees on Loans                               |   | $         | 4,716,796 |      | $      | 4,721,149 |   |
| Interest on Investment Securities                        |   | 614,221   |      | 649,398   |   |
| Other Interest Income                                    |   | 213,295   |      | 204,320   |   |
| **TOTAL INTEREST INCOME**                                |   | 5,544,312 |      | 5,574,867 |   |
|                                                     |   |      |      |      |   |
| **INTEREST EXPENSE**                                     |   |      |      |      |   |
| Interest on Money Market, NOW and Savings                |   | 492,121   |      | 725,180   |   |
| Interest on Time Deposits                                |   | 697,557   |      | 959,899   |   |
| Other Interest Expense                                   |   | 79,037    |      | 44,593    |   |
| **TOTAL INTEREST EXPENSE**                               |   | 1,268,715 |      | 1,729,672 |   |
|                                                     |   |      |      |      |   |
| **NET INTEREST INCOME**                                  |   | 4,275,597 |      | 3,845,195 |   |
|                                                     |   |      |      |      |   |
| Provision for Loan Losses                                |   | 120,000   |      | 132,000   |   |
| **NET INTEREST INCOME AFTER PROVISION FOR  LOAN LOSSES** |   | 4,155,597 |      | 3,713,195 |   |
|                                                     |   |      |      |      |   |
| **NONINTEREST INCOME**                                   |   |      |      |      |   |
| Gain on Sale of Loans                                    |   | 600,015   |      | 631,807   |   |
| Bank Enterprise Award                                    |   | 180,900   |      | 182,936   |   |
| Service Charges, Fees and Other Income                   |   | 586,255   |      | 543,886   |   |
|                                                     |   | 1,367,170 |      | 1,358,629 |   |
| **NONINTEREST EXPENSE**                                  |   |      |      |      |   |
| Salaries and Employee Benefits                           |   | 2,381,261 |      | 1,959,136 |   |
| Occupancy Expenses                                       |   | 345,892   |      | 279,070   |   |
| Furniture and Equipment                                  |   | 202,622   |      | 217,348   |   |
| Other Expenses                                           |   | 1,459,704 |      | 1,349,305 |   |
|                                                     |   | 4,389,479 |      | 3,804,859 |   |
| **INCOME BEFORE INCOME TAXES**                           |   | 1,133,288 |      | 1,266,965 |   |
| Income Tax Expense                                       |   | 416,774   |      | 514,822   |   |
|                                                     |   |      |      |      |   |
| **NET INCOME**                                           |   | $         | 716,514   |      | $      | 752,143 |   |
| Per Share Data:                                          |   |      |      |      |   |
| Net Income   - Basic                                |   | $         | 0.95      |      | $      | 1.07 |   |
| Net Income   - Diluted                              |   | $         | 0.91      |      | $      | 1.05 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

47

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**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY**

**Years Ended December 31, 2003 and 2002**

 
|                                                                           |   |          |      |              |    |              |   |         |    |              |    | **Accumulated** |      |      |    |
|--------------------------------------------------------------------------------|--------|---------------|-----------|-------------------|---------|-------------------|--------|--------------|---------|-------------------|---------|-----------------|-----------|-----------|---------|
|                                                                           |   | **Preferred** |      | **Common  Stock** |    | **Comprehensive** |   | **Retained** |    | **Comprehensive** |    |            |      |
|                                                                           |   | **Stock**     |      | **Shares**        |    | **Amount**        |   | **Income**   |    | **Earnings**      |    | **Income**      |      | **Total** |    |
|                                                                           |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| **Balance at January 1, 2002**                                                 |   | $             | 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 Loss 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 |    |
|                                                                           |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| Dividends Paid                                                                 |   |          |      |              |    |              |   |         |    | (75,067           | )       |            |      | (75,067   | )       |
|                                                                           |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| **Comprehensive Income:**                                                      |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| Net Income                                                                     |   |          |      |              |    |              |   | $            | 716,514 |              | 716,514 |            |      |      | 716,514 |   |
|                                                                           |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| Net Unrealized Loss on Available-for-Sale  Securities, Net of Taxes of $34,433 |   |          |      |              |    |              |   | (45,409      | )       |              |    | (45,409         | )         | (45,409   | )       |
|                                                                           |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| **Total Comprehensive Income**                                                 |   |          |      |              |    |              |   | $            | 671,105 |              |    |            |      |      |    |   |
|                                                                           |   |          |      |              |    |              |   |         |    |              |    |            |      |      |    |
| **Balance at December 31, 2003**                                               |   | $             | 1,083,800 |              | 630,166 |              | $      | 6,273,101    |    |              |    | $               | 1,170,337 |      | $       | 18,288 |   | $ | 8,545,526 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

48

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**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2003 and 2002**

 
|                                                                               |   | **2003**    |      | **2002**    |   |
|------------------------------------------------------------------------------------|--------|-------------|-----------|-------------|--------|
| **OPERATING ACTIVITIES**                                                           |   |        |      |        |   |
| Net Income                                                                         |   | $           | 716,514   |        | $      | 752,143 |   |
| Adjustments to Reconcile Net Income to Net  Cash Provided by Operating Activities: |   |        |      |        |   |
| Depreciation and Amortization                                                      |   | 202,623     |      | 218,452     |   |
| Provision for Credit Losses                                                        |   | 120,000     |      | 132,000     |   |
| Gain on Loan Sales                                                                 |   | (600,015    | )         | (631,807    | )      |
| Net Change in Other Assets and Liabilities                                         |   | (261,358    | )         | (419,917    | )      |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                                      |   | 177,764     |      | 50,871      |   |
|                                                                               |   |        |      |        |   |
| **INVESTING ACTIVITIES**                                                           |   |        |      |        |   |
| Net Change in Federal Reserve Bank and  Other Stock                                |   | (135,625    | )         | (115,509    | )      |
| Change in Deposits in Other Banks                                                  |   | (550,000    | )         | 9,345       |   |
| Purchase of Available-for-Sale Securities                                          |   | (10,567,042 | )         | (3,765,367  | )      |
| Purchase of Held-to-Maturity Securities                                            |   | (10,512,031 | )         | (5,552,412  | )      |
| Proceeds from Maturities of  Available-for-Sale Securities                         |   | 8,772,080   |      | 4,829,733   |   |
| Proceeds from Maturities of  Held-to-Maturity Securities                           |   | 5,932,807   |      | 3,438,077   |   |
| Proceeds from Loan Sales                                                           |   | 6,701,730   |      | 6,329,992   |   |
| Net Increase in Loans                                                              |   | (20,499,616 | )         | (10,446,897 | )      |
| Purchases of Premises and Equipment                                                |   | (144,413    | )         | (316,379    | )      |
| **NET CASH USED BY INVESTING ACTIVITIES**                                          |   | (21,002,110 | )         | (5,589,417  | )      |
|                                                                               |   |        |      |        |   |
| **FINANCING ACTIVITIES**                                                           |   |        |      |        |   |
| Net Increase in Demand Deposits and Savings  Accounts                              |   | 7,516,672   |      | 11,013,936  |   |
| Net Increase in Time Deposits                                                      |   | 1,263,865   |      | 4,806,715   |   |
| Net Change in Other Borrowings                                                     |   | 2,000,000   |      | 2,080,000   |   |
| Proceeds from Issuance of Junior  Subordinated Debt Securities                     |   | 3,093,000   |      | —      |   |
| Payment of Dividends                                                               |   | (75,067     | )         | (70,068     | )      |
| Proceeds from Exercise of Stock Options                                            |   | —      |      | 825         |   |
| Proceeds from Issuance of Preferred Stock                                          |   | —      |      | 500,000     |   |
| **NET CASH PROVIDED BY****FINANCING  ACTIVITIES**                                  |   | 13,798,470  |      | 18,331,408  |   |
|                                                                               |   |        |      |        |   |
|                                                                               |   |        |      |        |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                          |   | (7,025,876  | )         | 12,792,862  |   |
| Cash and Cash Equivalents at Beginning of  Period                                  |   | 15,319,051  |      | 2,526,189   |   |
| **CASH AND CASH EQUIVALENTS AT END OF YEAR**                                       |   | $           | 8,293,175 |        | $      | 15,319,051 |   |
|                                                                               |   |        |      |        |   |
| **Supplemental Disclosures of Cash Flow  Information:**                            |   |        |      |        |   |
| Interest Paid                                                                      |   | $           | 1,297,991 |        | $      | 1,704,969 |   |
| Taxes Paid                                                                         |   | $           | 359,823   |        | $      | 637,331 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

49

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**MISSIONCOMMUNITY BANCORP AND SUBSIDIARY**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**December31, 2003 and 2002**

 

**NOTE A - SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

Principles of Consolidation

 

The financial statements include the accounts of Mission CommunityBancorp and its subsidiary, Mission Community Bank (“the Bank”), and the Bank’ssubsidiary, Mission Community Development Corporation collectively referred toherein as the “Company”.

 

Nature of Operations

 

The Bank has been organized as a single reporting segment and operatesfour branches in the Central Coast area of California.  The Bank’s primary source of revenue isproviding Small Business Administration (“SBA”) guaranteed loans, real estate,commercial and consumer loans to customers, who are predominately small andmiddle-market businesses and individuals. The Company and the Bank are certified by the Department of Treasury asCommunity Development Financial Institution(s) (CDFI) with a commitment tofocus on providing financial services to low and moderate income communities.

 

Mission Community Development Corporation

 

Mission Community DevelopmentCorporation is a community development corporation, which provides financingfor small businesses and low- and moderate-income areas and projects.  The Board of Directors of Mission CommunityDevelopment Corporation consists of four members of the Board of Directors ofthe Company and three outside members who are actively involved in supportingcommunity affairs and activities. Community development investment is limitedto 5% of the Bank’s capital and up to 10% with prior approval by the FederalReserve Board.  Operations of MissionCommunity Development Corporation were not material as of December 31, 2003.

 

MissionCommunity Services Corporation

 

Mission Community Services Corporation was organized and thecorporation established in 1998 as a not-for-profit company.  This company’s primary focus will be toprovide technical support and training services to the underserved segments ofthe community including small businesses, minorities and low-incomeentrepreneurs.  The Board of Directorsof Mission Community Services Corporation includes representatives from theCompany and the Bank, together with members representing the communitiesrepresented.  During 2003, the Companypledged a $250,000 interest-bearing deposit as collateral for borrowings ofMission Community Services Corporation.

 

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 requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

50

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Cash and Cash Equivalents

 

For purposes of reporting cash flows, cash and cash equivalents includecash, due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.

 

Cash and Due From Banks

 

Banking regulations require that all banks maintain a percentage oftheir deposits as reserves in cash or on deposit with the Federal ReserveBank.  The Bank complied with thereserve requirements as of December 31, 2003.

 

The Company maintains amounts due from banks, which exceed federallyinsured limits.  The Company has notexperienced any losses in such accounts.

 

Investment Securities

 

Bonds, notes, and debentures for which the Company has the positiveintent and ability to hold to maturity are reported at cost, adjusted forpremiums and discounts that are recognized in interest income using theinterest method over the period to maturity.

 

Investments not classified as trading securities nor asheld-to-maturity securities are classified as available-for-sale securities andrecorded at fair value.  Unrealizedgains or losses on available-for-sale securities are excluded from net incomeand reported as an amount net of taxes as a separate component of othercomprehensive income included in shareholders’ equity.  Premiums or discounts are amortized oraccreted into income using the interest method.  Realized gains or losses on sales of held-to-maturity oravailable-for-sale securities are recorded using the specific identification method.

 

Loans

 

Loans are reported at the principal amount outstanding, net of anydeferred loan origination fee income and deferred direct loan originationcosts, and net of any unearned interest on discounted loans.  Deferred loan origination fee income anddirect loan origination costs are amortized to interest income over the life ofthe loan using the interest method. Interest on loans is accrued to income daily based upon the outstandingprincipal balances.

 

Loans for which the accrual of interest has been discontinued aredesignated as nonaccrual loans.  Accrualof interest on such loans is discontinued when principal or interest is pastdue 90 days based on the contractual terms of the loan or when, in the opinionof management, there exists a reasonable doubt as to the full and timely collectionof either principal or interest.  Incomeon such loans is then only recognized to the extent that cash is received andwhere the future collection of principal is probable.  Accrual of interest is resumed only when principal and interestare brought fully current and when such loans are considered to be collectibleas to both principal and interest.

 

51

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For impairment recognized in accordance with Financial AccountingStandards 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 has adopted 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 the gain (loss) on sale of loans, the Bank’s investment inthe loan is allocated among the retained portion of the loan, the servicingretained, the interest-only strip and the sold portion of the loan, based onthe relative fair market value of each portion.  The gain (loss) on the sold portion of the loan is recognized atthe time of sale based on the difference between the sale proceeds and theallocated investment.  As a result ofthe relative fair value allocation, the carrying value of the retained portionis discounted, with the discount accreted to interest income over the life ofthe loan.  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 Loan Losses

 

The allowance for loan losses is adjusted by charges to income anddecreased by charge-offs (net of recoveries). Management performs quarterly analysis of the allowance for loan lossesto determine its adequacy.  In thisanalysis, all non-classified loans are segmented into components by loans typeand internal risk ratings.  Estimatedloss factors are applied to each loan pool based on historical losses as wellas managements assessment of current factors that may impact these historicalfactors such as changes in the local economy, changes in underwritingstandards, changes in loans concentrations and changes in past due andnon-performing trends.  Significantloans classified as less than acceptable by either the Bank’s regulators,external credit review consultants or internally by management are evaluatedseparately in the process.  In thisevaluation, management reviews the borrower’s ability to repay as well as theestimated value of any underlying collateral.

 

52

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Premises and Equipment

 

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

 

AdvertisingCosts

 

The Bank expenses the costs ofadvertising in the period incurred.

 

Income Taxes

 

Deferred tax assets and liabilities are reflected at currently enactedincome tax rates applicable to the period in which the deferred tax assets orliabilities are expected to be realized or settled.  As changes in tax laws or rates are enacted, deferred tax assetsand liabilities are adjusted through the provision for income taxes.

 

Comprehensive Income

 

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

 

Financial Instruments

 

In the ordinary course of business, the Company has entered intooff-balance sheet financial instruments consisting of commitments to extendcredit, commercial letters of credit, and standby letters of credit.  Such financial instruments are recorded inthe financial statements when they are funded or related fees are incurred orreceived.

 

Earnings Per Shares (EPS)

 

Basic EPS excludes dilution and is computed by dividing incomeavailable to common stockholders by the weighted-average number of commonshares outstanding for the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharedin the earnings of the entity.

 

53

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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 Bank accounts for stock-basedcompensation using the intrinsic value method prescribed in AccountingPrinciples Board (APB) Opinion No. 25, *“Accountingfor Stock Issued to Employees,”* and related Interpretations.

 

Accordingly, compensation cost for stock options will be measured asthe excess, if any, of the quoted market price of the Bank’s stock at the dateof the grant over the amount an employee must pay to acquire the stock.

 

Had compensation cost for the Bank’s stock option plans been determinedbased on the fair value at the grant dates for awards under those plans consistentwith the method of SFAS No. 123, the Bank’s net income and income per sharewould have been reduced to the pro forma amounts indicated below:

 
|                                                                                            |   | **2003** |    | **2002** |   |
|-------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Net Income:                                                                                     |   |     |    |     |   |
| As Reported                                                                                     |   | $        | 716,514 |     | $      | 752,143 |   |
| Stock-Based Compensation using the  Intrinsic Value Method                                      |   | —   |    | —   |   |
| Stock-Based Compensation that would have  been reported using the Fair Value Method of SFAS 123 |   | (43,106  | )       | (37,243  | )      |
|                                                                                            |   |     |    |     |   |
| Pro Forma                                                                                       |   | $        | 673,408 |     | $      | 714,900 |   |
|                                                                                            |   |     |    |     |   |
| Basic Income Per Share:                                                                         |   |     |    |     |   |
| As Reported                                                                                     |   | $        | 0.95    |     | $      | 1.07 |   |
| Pro Forma                                                                                       |   | 0.90     |    | 1.02     |   |
|                                                                                            |   |     |    |     |   |
| Diluted Income Per Share:                                                                       |   |     |    |     |   |
| As Reported                                                                                     |   | 0.91     |    | 1.05     |   |
| Pro Forma                                                                                       |   | 0.85     |    | 1.01     |   |

 

Reclassifications

 

Certain reclassifications were made to prior years’ presentations toconform to the current year.  Thesereclassifications are of a normal recurring nature.

 

54

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**NOTE B - INVESTMENTSECURITIES**

 

Investment securities have been classified in the consolidated balancesheets according to management’s intent. The amortized cost of securities and their approximate fair values atDecember 31 were as follows:

 
|                               |   | **Amortized  Cost** |       | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |     |
|------------------------------------|--------|---------------------|------------|------------------------------|--------|-------------------------------|--------|------------------------------|----------|
|                               |   |                |       |                         |   |                          |   |                         |     |
| **Available-for-Sale Securities:** |   |                |       |                         |   |                          |   |                         |     |
| **December 31, 2003:**             |   |                |       |                         |   |                          |   |                         |     |
| U.S. Government Agencies           |   | $                   | 5,501,031  |                         | $      | 36,381                        |   | $                            | (10,470  | ) | $ | 5,526,942 |   |
| Mortgage-Backed Securities         |   | 1,419,753           |       | 8,390                        |   | (3,305                        | )      | 1,424,838                    |     |
|                               |   |                |       |                         |   |                          |   |                         |     |
|                               |   | $                   | 6,920,784  |                         | $      | 44,771                        |   | $                            | (13,775  | ) | $ | 6,951,780 |   |
|                               |   |                |       |                         |   |                          |   |                         |     |
| **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 |   |
|                               |   |                |       |                         |   |                          |   |                         |     |
| **Held-to-Maturity Securities:**   |   |                |       |                         |   |                          |   |                         |     |
| **December 31, 2003:**             |   |                |       |                         |   |                          |   |                         |     |
| U.S. Government Agencies           |   | $                   | 7,997,592  |                         | $      | 21,852                        |   | $                            | (82,463  | ) | $ | 7,936,981 |   |
| Mortgage-Backed Securities         |   | 3,303,035           |       | 53,421                       |   | (219,455                      | )      | 3,137,001                    |     |
|                               |   |                |       |                         |   |                          |   |                         |     |
|                               |   | $                   | 11,300,627 |                         | $      | 75,273                        |   | $                            | (301,918 | ) | $ | 11,073,982 |   |
|                               |   |                |       |                         |   |                          |   |                         |     |
| **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 |   |

 

55

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Investments securities carried at $5,500,000 and $5,493,000 as ofDecember 31, 2003 and 2002, respectively, were pledged to secure short-termborrowings and other deposits as required by law.

 

One of the Company’sheld-to-maturity mortgage-backed securities has been in an unrealized lossposition for over twelve months.  Thissecurity had a carrying value of $427,024 as of December 31, 2003.  Unrealized losses on this security havedeclined from $345,561 at December 31, 2002 to $209,524 as of December 31,2003.  The Company does not consider thesecurity to be permanently impaired due to its investment grade rating and continuedperformance on the underlying mortgages.

 

The scheduled maturities of securities available for sale at December31, 2003, were as follows.  Actualmaturities may differ from contractual maturities because some investmentsecurities may allow the right to call or prepay the obligation with or withoutcall or prepayment penalties.

 
|                           |   | **Available-for-Sale  Securities** |      | **Held-to-Maturity  Securities** |   |
|--------------------------------|--------|------------------------------------|-----------|----------------------------------|--------|
|                           |   | **Amortized  Cost**                |      | **Fair  Value**                  |   | **Amortized  Cost** |   | **Fair  Value** |   |
|                           |   |                               |      |                             |   |   |   |   |   |
| Due in One Year to Five Years  |   | $                                  | 4,466,300 |                             | $      | 4,490,485 |   | $ | 4,000,000 |   | $ | 3,988,405 |   |
| Due in Five Years to Ten Years |   | 1,000,000                          |      | 1,004,375                        |   | 2,000,000 |   | 1,988,755 |   |
| Due in Greater Then Ten Years  |   | 34,731                             |      | 32,082                           |   | 1,997,592 |   | 1,959,820 |   |
| Mortgage-Backed Securities     |   | 1,419,753                          |      | 1,424,838                        |   | 3,303,035 |   | 3,137,001 |   |
|                           |   |                               |      |                             |   |   |   |   |   |
|                           |   | $                                  | 6,920,784 |                             | $      | 6,951,780 |   | $ | 11,300,627 |   | $ | 11,073,981 |   |

 

Included in accumulated othercomprehensive income at December 31, 2003 were net unrealized gains oninvestment securities available for sale of $30,996 less applicable incometaxes of $12,708.  Included inaccumulated other comprehensive income at December 31, 2002 were net unrealizedgains on investment securities available for sale of $110,838 less applicableincome taxes of $47,141.

 

**NOTEC - LOANS**

 

The Bank’s loan portfolio consists primarily of loans to borrowerswithin the Central Coast Area of California. Although the Bank seeks to avoid concentrations of loans to a singleindustry or based upon a single class of collateral, real estate and real estateassociated businesses are among the principal industries in the Bank’s marketarea and, as a result, the Bank’s loan and collateral portfolios are, to somedegree, concentrated in those industries.

 

56

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The Bank also originates SBA loans for sale to institutionalinvestors.  At December 31, 2003 and2002 the Bank was servicing approximately $19,707,230 and $17,342,000,respectively in loans previously sold or participated. The Bank has recordedservicing assets related to these loans totaling $606,698 and $427,536 atDecember 31, 2003 and 2002, respectively. The estimated fair value of theservicing assets approximated the carrying amount at December 31, 2003 and2002.

 

Included in total loans are net deferred loan fees of $78,349 anddiscounts related to the unguaranteed portion of SBA loans of $627,855 atDecember 31, 2003.  Included in totalloans are net deferred loan fees of $8,685 and discounts related to the unguaranteedportion of SBA loans of $480,774 at December 31, 2002.

 

A summary of the changes in the allowance for possible loan losses asof December 31 follows:

 
|                                           |   | **2003** |    | **2002** |   |
|------------------------------------------------|--------|----------|---------|----------|--------|
|                                           |   |     |    |     |   |
| Balance at Beginning of Year                   |   | $        | 744,248 |     | $      | 635,468 |   |
| Additions to the Allowance Charged to  Expense |   | 120,000  |    | 132,000  |   |
| Recoveries on Loans Charged Off                |   | 57,962   |    | 32,774   |   |
|                                           |   | 922,210  |    | 800,242  |   |
|                                           |   |     |    |     |   |
| Less Loans Charged Off                         |   | (110,285 | )       | (55,994  | )      |
|                                           |   |     |    |     |   |
| Balance at End of Year                         |   | $        | 811,925 |     | $      | 744,248 |   |

 

The following is a summary of the investment in impaired loans, therelated allowance for loan losses, and income recognized thereon andinformation pertaining to loans on nonaccrual and certain past due loans as ofDecember 31:

 
|                                                     |   | **2003** |    | **2002** |   |
|----------------------------------------------------------|--------|----------|---------|----------|--------|
|                                                     |   |     |    |     |   |
| Recorded Investment in Impaired Loans                    |   | $        | 508,000 |     | $      | — |   |
| Related Allowance for Loan Losses                        |   | $        | 36,000  |     | $      | — |   |
| Average Recorded Investment in Impaired  Loans           |   | $        | 127,000 |     | $      | 540,000 |   |
| Interest Income Recognized for Cash  Payments            |   | $        | 2,666   |     | $      | 2,905 |   |
| Total Loan on Nonaccrual                                 |   | $        | 508,000 |     | $      | 2,905 |   |
| Total Loans Past Due 90 Days or More and  Still Accruing |   | $        | 11,000  |     | $      | — |   |

 

57

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**NOTED - PREMISES AND EQUIPMENT**

 

A summary of premises and equipment as of December 31 follows:

 
|                                      |   | **2003**  |      | **2002**  |   |
|-------------------------------------------|--------|-----------|-----------|-----------|--------|
|                                      |   |      |      |      |   |
| Land                                      |   | $         | 976,498   |      | $      | 976,498 |   |
| Buildings                                 |   | 722,333   |      | 722,333   |   |
| Leasehold Improvements                    |   | 341,519   |      | 338,451   |   |
| Furniture, Fixtures, and Equipment        |   | 1,385,139 |      | 1,242,139 |   |
|                                      |   | 3,425,489 |      | 3,279,421 |   |
| Accumulated Depreciation and Amortization |   | (995,638  | )         | (791,360  | )      |
|                                      |   |      |      |      |   |
|                                      |   | $         | 2,429,851 |      | $      | 2,488,061 |   |

 

The Bank has entered into operating leases for its branches andoperating facilities, which expire at various dates through 2008.  These leases include provisions for periodicrent increases as well as payment by the lessee of certain operating expenses.

 

Rental expense relating to these leases was approximately $155,000 in2003 and $121,000 in 2002.

 

At December 31, 2003, the approximate future minimum annualpayments under these leases are as follows:

 

| 2004   |   | $       | 157,392 |   |
|--------|--------|---------|---------|--------|
| 2005   |   | 123,361 |    |
| 2006   |   | 62,712  |    |
| 2007   |   | 39,122  |    |
| 2008   |   | 12,754  |    |
|   |   |    |    |
|   |   | $       | 395,341 |   |

 

The minimum rental payments shown above are given for the existinglease obligations and do not reflect any increases in rent.  It is not a forecast of rental expenses.

 

58

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**NOTE E - DEPOSITS**

 

At December 31, 2003, the scheduled maturities of time deposits are asfollows:

 
| Due in One Year          |   | $         | 27,412,916 |   |
|--------------------------|--------|-----------|------------|--------|
| Due in One to Five Years |   | 7,566,277 |       |
| Due in Five to Ten Years |   | 4,568     |       |
|                     |   |      |       |
|                     |   | $         | 34,983,761 |   |

 

**NOTE F - OTHERBORROWINGS**

 

Other borrowings at December31, 2003 are comprised of the following advances from the Federal Home LoanBank of San Francisco:

 

| **Maturity  Date** |   | **Interest  Rate** |   | **Amount** |      |
|--------------------|--------|--------------------|--------|------------|-----------|
| 5/13/2004          |   | 3.58               | %      | 500,000    |      |
| 10/1/2004          |   | 2.09               | %      | 500,000    |      |
| 6/5/2006           |   | 1.76               | %      | 500,000    |      |
| 11/19/2013         |   | 4.82               | %      | 1,000,000  |      |
| 12/11/2013         |   | 4.98               | %      | 1,000,000  |      |
| 12/16/2013         |   | 4.88               | %      | 1,000,000  |      |
|               |   |               |   |       |      |
|               |   |               |   | $          | 4,500,000 |   |
|                    |        |                    |        |            |           |  |

 

These advances are secured byloans of approximately $11 million.  Asof December 31, 2003, the Bank had a total borrowing capacity of approximately$5.6 million with the Federal Home Loan Bank of San Francisco.

 

The Bank also has unsecuredborrowing lines with correspondent banks totaling $4,000,000 and the Companyhad one borrowing line totaling $200,000. As of December 31, 2003, there were no balances outstanding on theselines.

 

59

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**NOTEG – JUNIOR SUBORDINATED DEBT SECURITIES**

 

On October 14, 2003, the Company issued $3,093,000 of junior subordinateddebt securities (the “debt securities”) to Mission Community Capital Trust, astatutory trust created under the laws of the State of Delaware.  These debt securities are subordinated toeffectively all borrowings of the Company and are due and payable on October 7,2033.  Interest is payable quarterly onthese debt securities at LIBOR plus 2.95% for an effective rate of 4.1% as ofDecember 31, 2003.  The debt securitiescan be redeemed for 105% of the principal balance through October 7, 2008 and atpar thereafter.  The debt securities canalso be redeemed at par if certain events occur that impact the tax treatmentor the capital treatment of the issuance.

 

The Company also purchased a 3% minority interest in Mission CommunityCapital Trust. The balance of the equity of Mission Community Capital Trust iscomprised of mandatorily redeemable preferred securities.  Under FASB Interpretation (FIN) No. 46, “*Consolidation of Variable Interest Entities, aninterpretation of ARB No.51”*the Company is not allowed toconsolidate Mission Community Capital Trust into the Company financialstatements.  Prior to the issuance ofFIN No. 46, Bank Holding Companies typically consolidated these entities.  The Federal Reserve Board had ruled thatcertain mandatorily redeemable preferred securities of a consolidated entityqualified as Tier 1 Capital.  TheFederal Reserve Board is evaluating the capital impact from FIN No. 46 but hasnot issued any final ruling.  As ofDecember 31, 2003, the Company has included the net junior subordinated debt inits Tier 1 Capital for regulatory capital purposes.

 

**NOTE H - INCOME TAXES**

 

The income tax expense for the years ended December 31, 2003 and 2002is comprised of the following:

 
|           |   | **2003** |    | **2002** |   |
|----------------|--------|----------|---------|----------|--------|
| Current Taxes: |   |     |    |     |   |
| Federal        |   | $        | 333,276 |     | $      | 385,318 |   |
| State          |   | 106,498  |    | 134,504  |   |
|           |   | 439,774  |    | 519,822  |   |
| Deferred       |   | (23,000  | )       | (5,000   | )      |
|           |   |     |    |     |   |
|           |   | $        | 416,774 |     | $      | 514,822 |   |

 

60

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A comparison of the federal statutory income tax rates to the Company’seffective income tax follows:

 
|                                                    |   | **2003**   |    | **2002** |   |
|---------------------------------------------------------|--------|------------|---------|----------|--------|
|                                                    |   | **Amount** |    | **Rate** |   | **Amount** |   | **Rate** |   |
|                                                    |   |       |    |     |   |   |   |   |   |
| Federal tax rate                                        |   | $          | 385,000 |     | 34.0   | % | $ | 431,000 |   | 34.0 | % |
| California franchise taxes, net of federal  tax benefit |   | 82,000     |    | 7.2      | %      | 91,000 |   | 7.2 | % |
| Other items - net                                       |   | (50,226    | )       | (4.4     | )%     | (7,178 | ) | (0.6 | )% |
|                                                    |   |       |    |     |   |   |   |   |   |
|                                                    |   | $          | 416,774 |     | 36.8   | % | $ | 514,822 |   | 40.6 | % |

 

Deferred taxes are a result of differences between income taxaccounting and generally accepted accounting principles with respect to incomeand expense recognition.  The Company’sprincipal timing differences are from the cash basis of tax reporting and theallowance for loan and lease losses.

 

The following is a summary of the components of the net deferred taxasset accounts recognized in the accompanying consolidated balance sheets:

 
|                                              |   | **2003** |    | **2002** |   |
|---------------------------------------------------|--------|----------|---------|----------|--------|
| Deferred Tax Assets:                              |   |     |    |     |   |
| Bank Enterprise Award Deferral                    |   | $        | 38,000  |     | $      | 112,000 |   |
| Allowance for Loan Losses Due to Tax  Limitations |   | 296,000  |    | 268,000  |   |
| Other                                             |   | 188,000  |    | 109,000  |   |
|                                              |   | 522,000  |    | 489,000  |   |
| Deferred Tax Liabilities:                         |   |     |    |     |   |
| Cash Basis of Tax Reporting                       |   | (96,000  | )       | (125,000 | )      |
| Depreciation Differences                          |   | (74,000  | )       | (36,000  | )      |
| Unrealized Gain on Investment Securities          |   | (13,000  | )       | (47,000  | )      |
| Other                                             |   | (6,000   | )       | (5,000   | )      |
|                                              |   | (189,000 | )       | (213,000 | )      |
|                                              |   |     |    |     |   |
| Net Deferred Tax Assets                           |   | $        | 333,000 |     | $      | 276,000 |   |

 

61

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**NOTE I - STOCK OPTIONPLAN**

 

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 optiongranted in 2002 was estimated on the date of grant using the Black-Scholesoption pricing model with the following assumptions:  risk-free rate of 3.75%, 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, 2003 and 2002 and changes during the years is presented below:

 
|                                                            |   | **2003**   |   | **2002**                                |   |
|-----------------------------------------------------------------|--------|------------|--------|-----------------------------------------|--------|
|                                                            |   | **Shares** |   | **Weighted-  Average  Exercise  Price** |   | **Shares** |   | **Weighted-  Average  Exercise  Price** |   |
| Outstanding at Beginning of Year                                |   | 158,666    |   | $                                       | 9.69   |   | 144,166 |   | $ | 9.41 |   |
| Granted                                                         |   | —     |   | $                                       | — |   | 21,500 |   | $ | 11.30 |   |
| Exercised                                                       |   | —     |   | $                                       | — |   | (100 | ) | $ | 8.25 |   |
| Forfeited                                                       |   | (3,700     | )      | $                                       | 10.88  |   | (6,900 | ) | $ | 8.85 |   |
|                                                            |   |       |   |                                    |   |   |   |   |   |
| Outstanding at End of Year                                      |   | 154,966    |   | $                                       | 9.66   |   | 158,666 |   | $ | 9.69 |   |
|                                                            |   |       |   |                                    |   |   |   |   |   |
| Options Exercisable at Year-End                                 |   | 119,966    |   | $                                       | 9.71   |   | 89,133 |   | $ | 9.80 |   |
|                                                            |   |       |   |                                    |   |   |   |   |   |
|                                                            |   |       |   |                                    |   |   |   |   |   |
| Weighted-Average Fair Value of Options  Granted During the Year |   |       |   | N/A                                     |   |   |   | $ | 1.91 |   |

 

62

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The following table summarizes information about fixed optionsoutstanding at December 31, 2003:

 
|                |   | **Options  Outstanding** |   |                                                 |                                    |   |                    |
|---------------------|--------|--------------------------|--------|------------------------------------------------------|-----------------------------------------|--------|-------------------------|
|                |   |                     |   | **Weighted-  Average  Remaining  Contractual  Life** |                                    |   |                    | **Options  Exercisable** |   |
| **Exercise  Price** |   | **Number  Outstanding**  |   |                                                 | **Weighted-  Average  Exercise  Price** |   | **Number  Exercisable** |   | **Weighted-  Average  Exercise  Price** |   |
| $10.00              |   | 99,966                   |   | 4.1 years                                            |                                    | $      | 10.00                   |   | 99,966 |   | $ | 10.00 |   |
| $7.50 - $8.25       |   | 36,000                   |   | 7.3 years                                            |                                    | $      | 7.85                    |   | 15,400 |   | $ | 7.86 |   |
| $11.30              |   | 19,000                   |   | 8.7 years                                            |                                    | $      | 11.30                   |   | 3,800 |   | $ | 11.30 |   |
|                |   |                     |   |                                                 |                                    |   |                    |   |   |   |   |
|                |   | 154,966                  |   | 5.6 years                                            |                                    | $      | 9.66                    |   | 119,166 |   | $ | 9.71 |   |

 

**NOTE J - OTHEREXPENSES**

 

Other expenses as of December 31 are comprised of the following:

 
|                                 |   | **2003** |      | **2002** |   |
|--------------------------------------|--------|----------|-----------|----------|--------|
|                                 |   |     |      |     |   |
| Data Processing                      |   | $        | 371,863   |     | $      | 409,515 |   |
| Professional Expenses                |   | 132,190  |      | 87,395   |   |
| Marketing and Business Promotion     |   | 114,216  |      | 138,997  |   |
| Insurance and Regulatory Assessments |   | 93,127   |      | 87,841   |   |
| Office Supplies and Expenses         |   | 193,701  |      | 195,009  |   |
| Other Expenses                       |   | 554,607  |      | 430,548  |   |
|                                 |   |     |      |     |   |
|                                 |   | $        | 1,459,704 |     | $      | 1,349,305 |   |

 

63

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**NOTE K - PREFERRED STOCK**

 

Series A – the Series A Preferred Stock has $5.00 stated value and isnon-voting, convertible and redeemable. Each share is convertible into voting common stock of the Company on atwo-for-one exchange.  Series A sharesare not entitled to any fixed rate of return, but do participate on the samebasis (as if converted on a two-for-one exchange) in any dividends declared onthe Company’s common stock. In the event of liquidation, the holders of SeriesA shares will be entitled to a liquidation preference of $5.00 per share beforethe holders of common stock receive any distributions and after the holders ofcommon stock receive distributions of $10.00 per share, all distributions willbe on the same 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 – the Series B Preferred Stock has $10.00 stated value and isnon-voting, non-convertible and non-redeemable.  Series B shares are not entitled to any fixed rate of return butdo participate on the same basis in any dividends declared on the Company’scommon stock. In the event of liquidation, the holders of Series B shares willbe entitled to a liquidation preference of $10.00 per share before the holdersof common stock receive any distributions. Additionally, in the event of a so-called “change in control event”(including certain mergers or sales of assets) holders of the Series BPreferred Stock shall be entitled to receive payment on the same basis as the holdersof the common stock of the Company. These shares were issued for $191,606 (net of issuance costs of $13,394)pursuant to an investment from the National Community Investment Fund (“NCIF”).  In connection with this investment, 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 – the Series C Preferred Stock has $10.00 stated value and isnon-voting, convertible and redeemable. Each share is convertible into voting common stock of the Company on aone-for-one exchange.  Series C sharesare not entitled to any fixed rate of return, but do participate on the samebasis (as if converted on a one-to-one exchange) in any dividends declared onthe Company’s common stock.  In theevent of liquidation, the holders of Series C shares will be entitled to aliquidation preference of $10.00 per share (as adjusted for any stockdividends, combinations or splits with respect to such shares) before theholders of common stock receive any distributions.  These shares were issued for $500,000 pursuant to an award fromthe Community Development Financial Institutions Fund of the Department of theTreasury.

 

**NOTEL - RELATED PARTY TRANSACTIONS**

 

In the ordinary course ofbusiness, the Bank has granted loans to certain directors and the companieswith which they are associated.  In theBank’s opinion, all loans and loan commitments to such parties are made onsubstantially the same terms, including interest rate and collateral, as thoseprevailing at the time for comparable transactions with other persons.

 

64

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The following is a summary ofthe activity in these loans:

 
|                                 |   | **2003**   |      | **2002**  |   |
|--------------------------------------|--------|------------|-----------|-----------|--------|
|                                 |   |       |      |      |   |
| Balance at the beginning of the year |   | $          | 2,656,000 |      | $      | 1,608,000 |   |
| New loans and renewals               |   | 1,300,000  |      | 1,590,000 |   |
| Repayments and renewals              |   | (1,831,262 | )         | (542,000  | )      |
|                                 |   |       |      |      |   |
| Balance at the end of the year       |   | $          | 2,124,738 |      | $      | 2,656,000 |   |

 

Deposits from related parties held by the Bank at December 31, 2003amounted to approximately $1,115,000.

 

**NOTE M - COMMITMENTSAND CONTINGENCIES**

 

In the normal course of business, the Bank enters into financialcommitments to meet the financing needs of its customers.  These financial commitments includecommitments to extend credit and standby letters of credit.  Those instruments involve to varyingdegrees, elements of credit and interest rate risk not recognized in thestatement of financial position.

 

The Bank’s exposure to credit loss in the event of nonperformance oncommitments to extend credit and standby letters of credit is represented bythe contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it doesfor loans reflected in the financial statements.

 

As of December 31, the Bank had the following outstanding financialcommitments whose contractual amount represents credit risk:

 
|                         |   | **2003** |       | **2002** |   |
|------------------------------|--------|----------|------------|----------|--------|
|                         |   |     |       |     |   |
| Commitments to Extend Credit |   | $        | 27,578,000 |     | $      | 18,079,000 |   |
| Standby Letters of Credit    |   | 30,000   |       | 64,000   |   |
|                         |   |     |       |     |   |
|                         |   | $        | 27,608,000 |     | $      | 18,143,000 |   |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Standby letters of credit areconditional commitments to guarantee the performance of a Bank customer to athird party.  Since many of thecommitments and standby letters of credit are expected to expire without beingdrawn upon, the total amounts do not necessarily represent future cashrequirements.  The Bank evaluates eachcustomer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by the Bankis based on management’s credit evaluation of the customer.

 

65

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The Company is involved in various litigation, which has arisen in theordinary course of business.  In theopinion of management, the disposition of such pending litigation will not havea material effect on the Company’s financial statements.

 

 

**NOTEN - EARNINGS PER SHARE**

 

The following is areconciliation on net income and shares outstanding to the income and number ofshares used in the computation of earnings per share:

 
|                                                                             |   | **2003**   |    | **2002**   |    |
|----------------------------------------------------------------------------------|--------|------------|---------|------------|---------|
|                                                                             |   | **Income** |    | **Shares** |    | **Income** |   | **Shares** |   |
|                                                                             |   |       |    |       |    |   |   |   |   |
| Net Income                                                                       |   | $          | 716,514 |       |    |   | $ | 752,143 |   |   |   |
| Average Common Shares Outstanding During  the Year                               |   |       |    | 630,166    |    |   |   | 630,075 |   |
| Preferred Shares Participating in Net  Income With Common Shareholders - Average |   |       |    | 120,500    |    |   |   | 71,596 |   |
| Used in  Basic EPS                                                               |   | 716,514    |    | 750,666    |    | 752,143 |   | 701,671 |   |
| Dilutive Effect of Outstanding Stock  Options                                    |   |       |    | 37,848     |    |   |   | 14,590 |   |
|                                                                             |   |       |    |       |    |   |   |   |   |
| Used in  Dilutive EPS                                                            |   | $          | 716,514 |       | 788,514 |   | $ | 752,143 |   | 716,261 |   |

 

Preferred shares are includedin the computation of basic earnings per share because they share equally withcommon shares in the distribution of net income and they do not have a stateddividend rate.

 

 

**NOTE O - REGULATORYMATTERS**

 

The Bank is subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certainmandatory - and possibly additional discretionary - actions by regulators that,if undertaken, could have a direct material effect on the Bank’s financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

 

66

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Quantitative measures established by regulation to ensure capitaladequacy require the Bank to maintain minimum amounts and ratios (set forth inthe table below) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier 1 capital (as defined) toaverage assets (as defined).  Managementbelieves, as of December 31, 2003, that the Bank meets all capital adequacyrequirements to which it is subject.

 

As of December 31, 2003, themost recent notification from the Federal Reserve Board categorized the Bank aswell-capitalized under the regulatory framework for prompt corrective action(there are no conditions or events since that notification that managementbelieves have changed the Bank’s category). To be categorized as well-capitalized, the Bank must maintain minimumratios as set forth in the table below. The following table also sets forth the Bank’s actual capital amountsand 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, 2003:**             |   |       |   |                               |   |                            |   |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |   | $          | 10,651 |                               | 12.4   | %                               | $      | 7,390 |   | 8.0 | % | $ | 9,238 |   | 10.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |   | $          | 10,633 |                               | 11.5   | %                               | $      | 3,695 |   | 4.0 | % | $ | 5,543 |   | 6.0 | % |
| Tier 1 Capital (to Average Assets)       |   | $          | 10,633 |                               | 9.7    | %                               | $      | 4,395 |   | 4.0 | % | $ | 5,494 |   | 5.0 | % |
|                                     |   |       |   |                               |   |                            |   |   |   |   |   |   |   |
| **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 | % |

 

The Company will be subject to similar requirements when itsconsolidated assets exceed $150 million. For capital adequacy purposes, the Company must then maintain totalcapital to risk-weighted assets, Tier 1 capital to risk-weighted assets andTier 1 capital to average assets of 8.0%, 4.0% and 4.0%, respectively.  Its total capital to risk-weighted assets,Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets was13.4%, 12.3% and 10.4%, respectively at December 31, 2003, and 11.7%, 10.7% and7.9%, respectively, at December 31, 2002.

 

**NOTEP - FORMATION OF MISSION COMMUNITY BANCORP**

 

On December 15, 2000, Mission Community Bancorp acquired MissionCommunity Bank by issuing 600,566 shares of common stock in exchange for thesurrender of all outstanding shares of the Bank’s common stock.  There was no cash involved in thistransaction.  The acquisition wasaccounted for like a pooling of interests and the consolidated financialstatements contained herein have been restated to give full effect to thistransaction.

 

Mission Community Bancorp has no significant business activity otherthan its investment in Mission Community Bank. Accordingly, no separate financial information on the Company isprovided.

 

67

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**NOTEQ - BANK ENTERPRISE AWARD**

 

During 2001, the Bank receiveda $990,000 award under the Fiscal Year 2001 Bank Enterprise Award Program.  The program is sponsored by the Departmentof Treasury, Community Development Financial Institutions Fund.  The Bank received the award for making atotal of $3,000,000 in deposits with certified Community Development FinancialInstitutions.

 

The Bank deferred approximately$452,000 of the award to increase the future earnings on the deposits to marketrates.  The Bank recognizedapproximately $180,000 of this deferred amount in 2003.  The Bank will recognize the balance ofapproximately $92,000 in 2004.

 

**NOTE R - FAIR VALUEOF FINANCIAL INSTRUMENTS**

 

The fair value of a financial instrument is the amount at which theasset or obligation could be exchanged in a current transaction between willingparties, other than in a forced or liquidation sale.  Fair value estimates are made at a specific point in time basedon relevant market information and information about the financialinstrument.  These estimates do notreflect any premium or discount that could result from offering for sale at onetime the entire holdings of a particular financial instrument.  Because no market value exists for asignificant portion of the financial instruments, fair value estimates arebased on judgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments, and otherfactors.  These estimates are subjectivein nature, involve uncertainties and matters of judgment and, therefore, cannotbe determined with precision.  Changesin assumptions could significantly affect the estimates.

 

 Fair value estimates are basedon financial instruments both on and off the balance sheet without attemptingto estimate the value of anticipated future business and the value of assetsand liabilities 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 following methods and assumptions were used to estimate the fairvalue of significant financial instruments:

 

FinancialAssets

 

The carrying amounts of cash,short-term investments, due from customers on acceptances, and Bank acceptancesoutstanding are considered to approximate fair value.  Short-term investments include federal funds sold, securitiespurchased under agreements to resell, commercial paper and interest bearingdeposits with Banks.  The fair values ofinvestment securities, including available-for-sale, are generally based onquoted market prices.  The fair value ofloans are estimated using a combination of techniques, including discountingestimated future cash flows and quoted market prices of similar instrumentswhere available

 

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FinancialLiabilities

 

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

 

Off-BalanceSheet Financial Instruments

 

The fair value of 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 fair value of financial instruments is summarized asfollows: (dollar amounts in thousands)

 
|                                   |   | **December  31,**   |   |
|----------------------------------------|--------|---------------------|--------|
|                                   |   | **2003**            |   | **2002** |   |
|                                   |   | **Carrying  Value** |   | **Fair  Value** |   | **Carrying  Value** |   | **Fair  Value** |   |
| **Financial Assets:**                  |   |                |   |   |   |   |   |   |   |
| Cash and due from banks                |   | $                   | 2,798  |   | $ | 2,798 |   | $ | 3,024 |   | $ | 3,024 |   |
| Federal funds sold                     |   | 5,495               |   | 5,495 |   | 12,295 |   | 12,295 |   |
| Interest-Bearing Deposits              |   | 3,550               |   | 3,550 |   | 3,000 |   | 2,727 |   |
| Investment securities                  |   | 18,252              |   | 18,026 |   | 11,891 |   | 11,646 |   |
| Loans, net                             |   | 78,651              |   | 78,583 |   | 64,443 |   | 64,384 |   |
| Federal Reserve Bank and other Stocks  |   | 474                 |   | 474 |   | 338 |   | 338 |   |
| Accrued interest receivable            |   | 400                 |   | 400 |   | 430 |   | 430 |   |
|                                   |   |                |   |   |   |   |   |   |   |
| **Financial Liabilities:**             |   |                |   |   |   |   |   |   |   |
| Deposits                               |   | 96,286              |   | 96,360 |   | 87,505 |   | 87,681 |   |
| Other borrowings                       |   | 7,593               |   | 7,593 |   | 2,500 |   | 2,519 |   |
| Accrued interest and other liabilities |   | 1,041               |   | 1,041 |   | 781 |   | 781 |   |
|                                        |        |                     |        |  |  |  |  |  |  |  |  |  |  |

 

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**MISSION COMMUNITYBANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

**WITH**

**INDEPENDENT AUDITORS’REPORT**

 

**DECEMBER 31, 2003 and2002**

 

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**Item 8.  Changes In and Disagreements WithAccountants on Accounting and Financial Disclosure**

 

There have been no change is or disagreements with the Company’saccountants.

 

**Item 8A. Controls and Procedures**

 

Within the 90days prior to the date of this report, our Chief Executive Officer and ourChief Financial Officer carried out an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toExchange Act Rule 13a-15.  Based uponthat evaluation, the Chief Executive Officer and the Chief Financial Officerconcluded that current disclosure controls and procedures are effective intimely alerting them to material information relating to the Company and/orBank that is required to be included in our periodic filings with theSecurities and Exchange Commission and also with bank or bank holding companyregulatory agencies.

 

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

 

Internalcontrols over the Bank’s operational, lending procedures and underwriting,financial systems and other systems are reviewed by internal auditors, holdingcompany and/or bank examiners, and by registered public accountants.  At present, the Company based on its assetsize and lack of activity other than banking is not independently examined bythe FRB.

 

The Companyand Bank have elected to outsource the internal audit function to firms whospecialize in performing such auditing functions for community banks.  During 2003, the Bank had internal auditspreformed for operational procedures, financial reporting, and human resources.  Additional internal audits were conducted ofthe Bank’s computers and information management systems including informationsecurity, and the Bank has contracted for several years for an independent loanreview function which reviews loans and lending activity once every twomonths.  Each of the internal auditsalong with management’s response to any observations are completed in writingand presented to the Board Audit Committee. Management is then responsible to take any corrective action required tochange, modify procedures or policies to improve internal controls andprocedures. Internal audit engagements are in writing including the anticipatedscope and are generally for 18 to 24 months with interim auditing during theterm of the engagement.  Engagements arepresented to and approved by the Board Audit Committee.  Based on internal audits preformed in 2003,neither management nor the Board Audit Committee have been informed of anymaterial weaknesses in internal controls over financial reporting.

 

Internalcontrols, lending, and financial reporting are also periodically reviewed bybank and banking holding company examination. As a state charted bank, the Bankis examined by the FRBSF and the DFI. Prior to the December 2003 charter conversion, the Bank was periodicallyexamined by the Comptroller of the Currency (OCC) as required by law includingexaminations for safety and soundness, lending, compliance, CommunityReinvestment Act, and information technology. Written reports of examination by state or federal regulators areprovided to the Bank, reviewed by management and by the Board AuditCommittee.  Should an examination revealmaterial issues, the Bank could be subject to regulatory action includingformal or informal agreements to take corrective action. Bank examinationreports are confidential, and the results are not disclosed unless there arematerial exceptions noted.  In the eventof

 

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materialexceptions, a bank could be required to agree to a formal agreement (such as aMemorandum of Understanding or Cease and Desist Order) which would document thespecific weaknesses and corrective action that must be taken.  These formal agreements are generallyrequired to be disclosed to the public. As of December 2003, the Bank is notoperating under any formal or informal agreement with the FRB, DFI or OCC norare any such agreements pending or anticipated.

 

Finally,internal controls and financial reporting is reviewed by registered public accountantson an annual basis.  These auditedreports including any recommendations for improvements in accounting orinternal controls are presented to management and the Board Audit Committee.  As of December 31, 2003, the auditedfinancial statements of the Company have been certified by the Company’sregistered public accountants with no material weaknesses identified ininternal controls or financial reporting. Beginning in 2005, the Company will be required to have its registeredpublic accountants provide an attestation of management’s assessment ofinternal controls over financial reporting.

 

No materialchanges have been made in internal controls during the past year.  However, the Bank did increase its budgetand expenses for internal control reviews and internal auditing in 2003 and2004. It also engaged a firm to perform a specific internal audit of the Bank’sinformation technology and information reporting systems including informationsecurity in 2003 with work to continue in 2004.  It has made minor staffing changes to improve internal controlsbased on recommendations made during the internal auditing process.

 

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**PART III**

 

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

 

The following table lists thenames and certain information as of December 31, 2003, concerning all directorsand executive officers of the Company and the Bank.  The Company and the Bank have no “significant employees” exceptits 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)         |   | 61      |   | Partner and Owner, F. McLintocks, Inc. (restaurants) (1973-)                                                                                                                                                                                                            |   | 1996                                             |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| Roxanne M. Carr  Vice Chairman of the Board                         |   | 66      |   | 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                                             |   | 61      |   | President and Owner, Central California Investments (1998-); Broker  and Owner, Karla Cool Realty (1987-1998)                                                                                                                                                           |   | 1998                                             |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| William B. Coy  Chairman of the Board                               |   | 66      |   | 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 |   | 58      |   | Banker (1)                                                                                                                                                                                                                                                              |   | N/A                                              |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| Erol F. Giray, M.D.(2)                                              |   | 47      |   | Psychiatrist                                                                                                                                                                                                                                                            |   | 1997                                             |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| Richard Korsgaard  Executive Vice President/Chief Credit Officer    |   | 62      |   | Banker (3)                                                                                                                                                                                                                                                              |   | N/A                                              |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| Anita M. Robinson  Director, President and Chief Executive Officer  |   | 51      |   | Banker(4)                                                                                                                                                                                                                                                               |   | 1996                                             |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| Robin L. Rossi  Director                                            |   | 56      |   | President, Rossi Enterprises (property management) (1991-);  President, Infinite Horizons, Inc. Manager of Avila Beach Resort and  Blacklake Resort - Real estate investments   (1979-)                                                                            |   | 1996                                             |
|                                                                |   |    |   |                                                                                                                                                                                                                                                                    |   |                                             |
| Gary E. Stemper  Immediate Past Chairman of the Board               |   | 61      |   | Eagle Castle Eagle 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  Secretary                                        |   | 50      |   | 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 electedor appointed to Board of the Bank

 

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(1)                                  Mr. William C. Demminjoined the Bank on March 12, 2001.  Mr.Demmin has over 32 years of banking experience.  For the period 1999 to 2001 he served as Interim President/CEO, andExecutive Vice President/Chief Financial Officer, for Network Bank USA,Ontario, California.  From 1997 to 1999he held the position of Executive Vice President/Chief Financial Officer withCuyamaca Bank, N.A., in Santee, California. From 1996 to 1997 he served as President/Chief Executive Officer forMerchants Bank of California, Carson, California.  For the period 1987 to 1996, he served as Executive VicePresident/Chief Financial Officer for Monarch Bancorp and Monarch Bank, LagunaNiguel, California.  Prior to 1987, heheld various management positions with Commercial Center Bank, SouthernCalifornia Bancorp and Bank of America.

 

(2)                                  Erol F. Giray, M.D.resigned from the Board of Directors of the Company and Bank effective November21, 2003.  Dr. Giray remains subject toRule 144 restrictions until February 21, 2004.

 

(3)                                  Mr. Richard Korsgaardjoined the Bank on July 22, 2002 as the Executive Vice President and ChiefCredit Officer.  Mr. Korsgaard has38  years of banking experience.  For the period of March 2001 to March 2002he held the position of Senior Vice President with California Bank and Trust,San Diego, California. From 1995 to 2001 he served as an Executive VicePresident with Eldorado Bank, Laguna Hills, California, which was acquired byCalifornia Bank and Trust in March 2001. From 1982 to 1995 he was theOrganizing President, Chief Executive Officer and Director of Mariners Bank,San Clemente, California.  From 1973 toMay 1982 he held executive management positions, including Chief OperatingOfficer with Eldorado Bank.

 

(4)                                  Ms. Robinson has over32 years of banking experience.  From1982 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. Robinsonserved as Executive Vice President/Chief Credit Officer of Commerce Bank of SanLuis Obispo.  In 1994 she became thePresident and Chief Executive Officer of Commerce Bank of San Luis Obispo andserved in that capacity until the bank was acquired by ValliWide Bank in1996.  Ms. Robinson began the organizingeffort of the Bank in 1996 after the close of the acquisition.

 

None of the Bank’s directors orexecutive officers were selected pursuant to any arrangement or understanding,other than with the directors and executive officers of the Bank, acting withintheir capacities as such.  There are nofamily relationships between the directors or executive officers of the Bankand none serve as directors of any other company which has a class ofsecurities registered under, or which is subject to the periodic reportingrequirements of, the Securities Exchange Act of 1934 or any investment companyregistered under the Investment Company Act of 1940.

 

**Section 16(a)Beneficial Ownership Reporting Compliance**

 

TheCompany does not have a class of equity securities registered pursuant toSection 12 of the Securities Exchange Act of 1934 (the “Exchange Act”).  Therefore, the Company’s officers anddirectors, and persons who own more than 10% of the Company’s Common Stock, arenot subject to the reporting requirements under Section 16(a) of the ExchangeAct.

 

**The Board of Directors and Committees**

 

During 2003, the Board of Directors held 12regular meetings, and 2 special meetings. In addition to attending Board meetings, certain of the directors serveon committees of the Board, with the Chairman and Vice Chairman being an Exofficio member of all of the committees.

 

The Executive Committee, which currentlyconsists of Directors William B. Coy (Chairman), Bruce M. Breault, RoxanneCarr, Anita M. Robinson, Gary E. Stemper, and Karl F. Wittstrom, met 4 times in2003.

 

The Audit Committee, which currently consistsof Directors Karl F. Wittstrom (Chairman), Bruce M. Breault, Roxanne Carr,William B. Coy and Gary E. Stemper, reviews all internal and externalexamination reports and selects the Company’s/Bank’s independentaccountants.  The Audit Committee met 4times in 2003.

 

The Loan Committee, which currently consistsof Directors Bruce M. Breault (Chairman), William B. Coy, Anita Robinson, GaryE. Stemper, Karl F. Wittstrom and Roxanne Carr (ex-officio), as well as Mr.Richard Korsgaard (non-voting), establishes the Bank’s loan policy, reviewsloans made by Management, and approves loans in excess of Management’s lending authority.  The Loan Committee met 47 times in 2003.

 

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The Bank’s Investment Committee, whichcurrently consists of Directors Robin L. Rossi (Chairman), Bruce M. Breault,Roxanne Carr, Karla S. Cool, Anita M. Robinson, Karl F. Wittstrom and WilliamB. Coy (ex-officio), as well as Mr. William C. Demmin (non-voting), setspolicies and oversees the Bank’s investments. There were 3 meetings of theInvestment Committee during 2003.

 

The Personnel and Compensation Committee,which currently consists of Directors Karla S. Cool (Chairman), Bruce M.Breault, William B. Coy, Anita M. Robinson, Karl F. Wittstrom and Roxanne Carr(ex-officio), reviews and approves the Bank’s overall compensation and benefitprograms and administers the compensation for the Bank’s executive and seniorofficers. There were 3 meetings of the Personnel and Compensation Committeeduring 2003.

 

The Technology Committee, which currentlyconsists of Directors Karla S. Cool (Chairman), Bruce M. Breault, William B.Coy, Anita M. Robinson, Gary E. Stemper and Roxanne Carr (ex-officio), isresponsible for overseeing the Bank’s electronic banking and informationsystems and assisting management with technological changes in the banking andbusiness environment.  There were 3meetings of the Technology Committee in 2003.

 

The Bank does not have a standing NominatingCommittee.  In connection with selectingcandidates for nomination to the Board of Directors, including any nomineesrecommended by security holders, the Board of Directors (i) review complianceby the security holders with the Bank’s nominating procedures contained in theBylaws and summarized in the Notice of Annual Meeting; (ii) review informationassembled for the purpose of selecting candidates for nomination to membershipon the Board of Directors;  and (iii)following appropriate investigation, ascertains the willingness of selectedcandidates to serve and extends on behalf of the Board of Director, invitationsto become candidates.

 

During 2003, except for Roxanne Carr and KarlF. Wittstrom, all Directors attended at least 75% of the Board and Committeemeetings.

 

**Audit Committee Report**

 

Pursuant to the Sarbanes-Oxley Act and SECRegulation 14A, the Bank’s Audit Committee makes the following statements:

 

•                  The Audit Committee has reviewed anddiscussed the Bank’s audited financial statements with management;

 

•                  The Audit Committee has also discussed withthe Bank’s independent auditors the matters required to be discussed by SAS 61,as may be modified or supplemented;

 

•                  The Audit Committee has received the writtendisclosures and the letter from the independent accountants required byIndependence Standards Board Standard No.1, as may be modified or supplemented,and has discussed with the independent accountant the independent accountant’sindependence; and

 

•                  Based on the review and discussions referredto in the above paragraphs, the Audit Committee recommended to the Board ofDirectors that the audited financial statements be included in the Bank’sRegistration Statement on Form 10-SB for the fiscal year ended December 31,2003 for filing with the SEC.

 

The members of the Bank’s Audit Committee areKarl F. Wittstrom (Chairman), Bruce M. Breault, Roxanne Carr, William B. Coyand Gary E. Stemper. These same individuals sit on the Audit Committee for boththe Bank and the Company. Audit committee meetings are generally heldsimultaneously.

 

The information indicated in this sectionshall not be deemed to be “soliciting material,” or to be “filed” with the SECor subject to Regulation 14A or 14C, other than as provided in this section, orto the liabilities

 

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of section 18 or the Exchange Act.

 

The Bank’s Audit Committee was established byand among the Board of Directors of the Bank for the purpose of overseeing theaccounting and financial reporting processes of the Bank, and the audits of thefinancial statements of the Bank, and the members of the committee areconsidered to be independent according to the definition of a nationalsecurities association registered pursuant to Section 15 of the SecuritiesExchange Act of 1934.

 

Pursuant to its Charter, the Audit Committeeis a standing committee appointed annually by the Board of Directors.  The Committee assists the Board of Directorsin fulfilling its responsibilities to the shareholders and depositors relatingto the quality and integrity of the Bank’s accounting systems andfinancial-reporting processes, the identification and assessment of businessrisks and adequacy of the overall control environment within the Bank.  In so doing, they will:

 

•                  Carry out their responsibilities in goodfaith and in an informed and vigilant manner;

 

•                  Review recommendations and reports submittedby the regulatory agencies, its external financial statement auditors,management, and other consultants and auditors;

 

•                  Routinely report to the Board of Directors,the Committee’s activities and all matters of significance, makingrecommendations for change as deemed advisable;

 

•                  Establish and maintain contact with theregulatory agencies, the external financial statement auditors, and otherconsultants and auditors to satisfy themselves that:  audit coverage is adequate, appropriate programs are maintained,and activities are executed properly;

 

•                  Discuss directly with management any issuesof concern or interest to the Committee; and

 

•                  Employ such resources in the performance oftheir duties, including access to separate legal counsel and externalconsultants, as the Committee deems necessary.

 

**Audit Committee Financial Expert**

 

Pursuant to the requirements of Section401(e) of Regulation SB, the Bank’s Board of Directors has determined that theBank has two audit committee financial experts serving on its auditcommittee.  As defined in Item 401(e)(1)of Regulation SB, an audit committee financial expert means a person who hasthe following attributes:

 

•                  An understanding of generally acceptedaccounting principles and financial statements;

 

•                  The ability to assess the generalapplication of such principles in connection with the accounting for estimates,accruals and reserves;

 

•                  Experience preparing auditing, analyzing orevaluating financial statements that present a breadth and level of complexityof accounting issues that are generally comparable to the breadth andcomplexity of issues that can reasonably be expected to be raised by the Bank’sfinancial statements, or experience actively supervising one or more personsengaged in such activities;

 

•                  An understanding of internal controls andprocedures for financial reporting; and

 

•                  An understanding of audit committeefunctions.

 

An audit committee financial expert shallhave acquired such attributes through:

 

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•                  Education and experience as a principalfinancial officer, principal accounting officer, controller, public accountantor auditor or experience in one or more positions that involve the performanceof similar functions;

 

•                  Experience actively supervising a principalfinancial officer, principal accounting officer, controller, public accountant,auditor or person performing similar functions;

 

•                  Experience overseeing or assessing theperformance of companies or public accountants with respect to the preparation,auditing or evaluation of financial statements; or

 

•                  Other relevant experience.

 

Thefollowing two individuals have been determined to be “financial experts” asdefined:

 

**Bruce M. Breault**

**Founding Chairman ofthe Board (*Emeritus*)**

 

Mr. Breault has many years of local business experience on the CentralCoast in the restaurant, food and beverage sales industry.  Mr. Breault is presently Partner and Ownerof the very successful *F. McLintock’s Restaurants*, which has over400 employees with approximately annual sales of $16,000,000.  Mr. Breault regularly reviews all of hiscompany’s unaudited financial statements, tax returns and internal or externalaudits that may be performed on the company.

 

Prior to becoming the Founding Chairman of the Board for MissionCommunity Bank in 1997, Mr. Breault had 12 years of former bank experience withCommerce Bank, San Luis Obispo, California which was a well-run, *PremierPerforming**Bank*. Mr. Breault was an organizing director of Commerce Bank, served as thecompany’s Secretary, and also, served as Chairman of the bank’s InvestmentCommittee.  Mr. Breault served as amember of the bank’s Audit Committee for 12 years, and as such, he regularlyreviewed internal and external audits conducted on the bank, which includedregulatory examinations, annual CPA audits, and internal or outsourced audits.

 

Mr. Breault has served as a member of Mission Community Bank’s AuditCommittee since March 17, 1998.  Mr.Breault has reviewed all audits performed on the bank since it’s inception inDecember 1997.  This includes regulatoryexaminations, annual CPA audits, internal audits and outsourced audits.

 

**Gary E. Stemper**

**Immediate PastChairman of the Board**

 

Mr. Stemper has many years of local business experience on the CentralCoast, primarily in the construction and wine industries.  He is presently a contractor and owner ofGary Stemper Construction; and Partner and Manager of Eagle Castle Winery,LLC.  As owner and/or partner in thesebusinesses, Mr. Stemper regularly reviews all of the companies’ financialstatements, tax returns as well as any audits that may be performed on thecompanies.

 

Prior to becoming the a Director of Mission Community Bank in 1997, Mr.Stemper had 12 years of former bank experience with a Central Coast communitybank,  Citizens Bank of PasoRobles.  During his association withCitizens Bank of Paso Robles, Mr. Stemper served as Chairman of the Board for10 years, as well as a member of the Audit Committee for 10 years.  Mr. Stemper regularly reviewed auditsconducted on the bank, including regulatory examinations, annual CPA audits,and all internal and/or outsourced audits.

 

Mr. Stemper has served as a member of Mission Community Bank’s AuditCommittee since March 17, 1998 and has reviewed all audits performed on thebank since it’s inception in December 1997. This includes regulatory examinations, annual CPA audits, internalaudits and outsourced audits.

 

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A person who is determined to be an auditcommittee financial expert will not be deemed an expert for any purpose,including without limitation for purposed of section 11 of the Securities Actof 1933, as a result of being designated or identified as an audit committeefinancial expert pursuant to Item 401 of Regulation SB.  Further, the designation or identificationof a person as an audit committee financial expert pursuant to Item 401 ofRegulation S-B does not impose on such person any duties, obligations or liabilitythat are greater than the duties, obligations and liability imposed on suchperson as a member of the audit committee and board of directors in the absenceof such designation or identification. In addition, the designation or identification of a person as an auditcommittee financial expert pursuant to Item 401 of Regulation SB does notaffect the duties, obligations or liability of any other member of the auditcommittee or board of directors.

 

While the Company has designed two “financialexperts”, there is currently one opening on the board for a person to replaceMr. Giray who resigned from the board at the end of 2003 due to personalreasons not related to the Company. While no final candidate has been selected, the Company is usingqualification as “financial expert” as one of the considerations in its searchto fill this vacant position.

 

**Corporate Governance**

 

Wehave a strong commitment to good corporate governance and to the higheststandards of ethical conduct.  Corporategovernance received a heightened degree of focus from our Board of Directorsand management during 2003.  On July 30,2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the“SOA”). The SOA includes very specific additional disclosure requirements andnew corporate governance rules, requires the Securities and Exchange Commission(the “SEC”) and securities exchanges to adopt extensive additional disclosure,corporate governance and other related rules and mandates further studies ofcertain issues by the SEC.  We havetaken all required actions to comply with all the currently applicableprovisions of the SOA and implementing regulations. Additionally, we continueto monitor regulations and rules proposed by the SEC and the FDIC relating tothese matters and to plan for their implementation.

 

During2003, we took a series of steps to review and improve our existing corporategovernance practices. These steps included:

 

•                  A review of the composition of our Board ofDirectors to determine that we continue to have at least a majority of ourdirectors that are independent, non-employee directors.  This has been the case at the Bank since theBank’s inception.

 

•                  A review of our audit committee compositionto assure that all current members meet both the existing as well as theproposed criteria for independence.

 

•                  The preparation of a draft of a revised auditcommittee charter which would, among other things, provide the committee withauthority to (i) control directly the outside auditor, (ii) make hiring andtermination decisions concerning the auditor, and (iii) approve all non-auditservices. We expect that the revised charter will be adopted in the firstquarter of 2004.

 

•                  The preparation of a code of conduct for ourChief Executive Officer and Chief Financial Officer as required by the SOA.

 

•                  Our Chief Executive Officer and ChiefFinancial Officer have begun certifying all quarterly and annual financialreports which we file with the FDIC, FRB and OCC.

 

•                  We have completed a review of our internalcontrols and our disclosure controls and procedures to ensure that we providecomplete and accurate disclosures in our regulatory filings and other publicreports.

 

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•                  During 2003, the Bank considered severalproposals to provide internal audit services from independent firmsspecializing in such work for community banks. After reviewing engagement proposals, the BAC employed three separatefirms based on the special nature of their work with community banks, to assist the Bank with its internal auditing program.  An additional firm has been contracted toassist the Bank for regulatory compliance auditing in 2004. With the exceptionof the compliance audit, each of the engagements are for 18 to 24 months withperiodic work to be done during the life of the engagement.

 

**ITEM 10.****               EXECUTIVE COMPENSATION**

 

**Summary Compensation**

 

The following table sets fortha summary of annual and long-term compensation for services in all capacitiesto the Bank for the Bank’s President and Chief Executive Officer, its ExecutiveVice President and Chief Financial Officer, and its Executive Vice Presidentand Chief Credit 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    |   | 2003                     |       | $                                   | 140,400    |      | —     |   | $ | 7,800 |   | — |   | — |   |
| Executive Officer      |   | 2002                     |       | $                                   | 130,000    |      | $          | 10,000 |   | $ | 7,800 |   | — |   | — |   |
|                   |   | 2001                     |       | $                                   | 115,000    |      | —     |   | $ | 7,800 |   | 5,000 |   | — |   |
|                   |   |                     |       |                                |       |      |       |   |   |   |   |   |   |
| **William C. Demmin**  |   |                     |       |                                |       |      |       |   |   |   |   |   |   |
| Executive Vice         |   | 2003                     |       | $                                   | 110,000    |      | —     |   | $ | 4,800 |   | — |   | — |   |
| President and Chief    |   | 2002                     |       | $                                   | 100,020    |      | —     |   | $ | 4,800 |   | 2,000 |   | — |   |
| Financial Officer      |   | 2001                     |       | —                              |       | —    |       | — |   | — |   | — |   |
|                   |   |                     |       |                                |       |      |       |   |   |   |   |   |   |
| **Richard  Korsgaard** |   |                     | ** ** |                                | ** ** |      | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Executive Vice         |   | 2003                     |       | $                                   | 105,000    |      | —     |   | $ | 4,800 |   | — |   | — |   |
| President and Chief    |   | 2002                     |       | —                              |       | —    |       | — |   | — |   | — |   |
| Credit Officer         |   | 2001                     |       |                                |       |      |       |   |   |   |   |   |   |
|                        |        |                          |            |                                     |            |           |            |  |  |  |  |  |  |  |  |  |

 

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(1) This figure representsautomobile allowance paid during the year.

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

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

 

No other officer receivedannual compensation of $100,000 or more in 2003.  The Company currently pays no salaries to its officers.

 

**Option/SAR Grants**

 

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.

 

In 2003, no stock options were granted, 3,700 incentive andnon-qualified stock options were retired, and no stock options were exercised.

 

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

 

79

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**Long Term IncentivePlan Awards**

 

There were no long-term incentive plan awards in 2002 or 2003.

 

**Employment Contracts**

 

On February 25, 2002, the Board of Directors approved a new employmentcontract for Ms. Robinson, effective for a five year term beginning on January1, 2002, which provides for a base salary of $10,833 per month, an automobileallowance of $650 per month, expense reimbursement, $250,000 of life insurance,standard and customary medical and dental insurance benefits, and anon-recurring bonus of $10,000 payable by December 31, 2002.  The five year agreement provides for anannual review by the Board of Directors of the base salary provided to Ms.Robinson, which shall not be less than $10,833 per month during the life of theagreement. Effective January 1, 2003, the Board of Directors approved anincrease to Ms. Robinson’s annual base salary to $11,700 per month. Thecontract provides for severance benefits of six months base salary fortermination without cause, and severance benefits of sixty months base salary,from the date of event, for termination after a merger, change in control, orother defined corporation reorganizations.

 

In 2001 and 2002, the Bank entered into Change in Control Employmentagreements with Executive Officers Demmin and Korsgaard, and also with four ofthe Bank’s Senior Vice Presidents, and in 2003 with two of the Bank’s SeniorVice Presidents, that will provide for severance benefits for termination aftera merger, change in control, or other defined corporate reorganizations equalto a lump sum amount equal to six months salary.

 

**Directors’Compensation**

 

During 2000, 2001 and part of 2002 the Bank’s directors were not paidfor attending meetings of the Board or the committees on which theyserved.  On April 22, 2002 the bank’sBoard of Directors approved a Director Compensation Program, which becameeffective on July 1, 2002, providing for outside directors to receive a monthlyretainer of $500 for each Board Meeting attended and a fee of $100 for eachDirector Committee meeting attended.  In2003, the Board received, on a cumulative basis, $61,700.00 in Director feesfor meetings attended in 2003.

 

There were no Stock Option grants to Directors during the year-endingDecember 31, 2003.

 

**Code of Ethics**

 

The Company has adopted a code of ethics that applies to its principalexecutive officer (President and Chief Executive Officer) and it principalfinancial officer (Executive Vice President and Chief Financial Officer.  This code is a written standard designed toreasonably deter wrongdoing and to promote:

 

•                  Honest andethical conduct, including the ethical handling of actual or apparent conflictsof interest between personal and professional relationships;

•                  Full, fair,accurate, timely, and understandable disclosure in reports and documents filedto the Commission and other public communications;

•                  The promptinternal reporting of violations of the code to an appropriate person orpersons identified in the code; and

•                  Accountabilityfor adherence to the code.

 

A copy of the code is filed as an exhibit to this annual report.

 

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

 

The following table sets forthcertain information as of December 31, 2003, concerning the beneficialownership of the Company’s outstanding Common Stock: (i) by each of thedirectors and executive officers; and (ii) by all directors and executiveofficers of the Company as a group. Management is not aware of any change in control of the Company whichhas occurred since January 1, 2004 or of any arrangement which may, at asubsequent date, result in such a change in control.

 

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 Trustbeneficially owns 41,634 shares of common stock, or 6.5% of total sharesoutstanding.

 

The U.S. Department of TreasuryCommunity Development Financial Institutions Fund holds the equivalent of100,000 shares Common Stock under their combined ownership of Series A andSeries C Convertible Preferred Stock.

 
| **Name and Position Held**                                         |   | **Common  Stock  Beneficially  Owned (1)** |   | **Shares  Subject to  Exercise(2)** |   | **Total  Shares  Beneficially  Owned** |   | **Percent  of Class** |   |
|--------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------|--------|----------------------------------------|--------|-----------------------|--------|
| Bruce M. Breault  Founding Chairman of the Board (Emeritus)        |   | 21,250                                     |   | 14,733                              |   | 35,983                                 |   | 5.5                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Roxanne M. Carr  Vice Chairman of the Board                        |   | 10,000                                     |   | 8,600                               |   | 18,600                                 |   | 2.9                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Karla S. Cool  Director                                            |   | 4,837                                      |   | 2,300                               |   | 7,137                                  |   | 1.1                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| William B. Coy  Chairman of the Board                              |   | 7,750                                      |   | 8,600                               |   | 16,350                                 |   | 2.5                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Erol F. Giray, M.D.(3)                                             |   | 7,330                                      |   | N/A                                 |   | 7,330                                  |   | 1.2                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Anita M. Robinson  Director, President and Chief Executive Officer |   | 18,609                                     |   | 23,000                              |   | 41,609                                 |   | 6.3                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Robin L. Rossi  Director                                           |   | 13,707                                     | (4)    | 12,600                              |   | 26,307                                 |   | 4.0                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Gary E. Stemper  Immediate Past Chairman of the Board              |   | 7,500                                      |   | 11,000                              |   | 18,500                                 |   | 2.9                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| Karl F. Wittstrom  Secretary                                       |   | 15,350                                     |   | 10,200                              |   | 25,550                                 |   | 3.9                   | %      |
|                                                               |   |                                       |   |                                |   |                                   |   |                  |   |
| All Directors and Executive Officers as a  Group (11)              |   | 106,333                                    |   | 94,433                              |   | 200,766                                |   | 27.4                  | %      |

 

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

 

(2)          Shares subject to options that were exercisablewithin 60 days of 12/31/03 are treated as issued and outstanding for thepurpose of computing the percent of class owned by such person but not for thepurpose of computing the percent of class owned by any other person.  Includes 2,400 shares subject to option heldby William C. Demmin and 1,000 shares subject to option held by RichardKorsgaard, exercisable within 60 days.

 

(3)          Erol F. Giray, M.D. resigned from the Board ofDirectors of the Company and Bank effective November 21, 2003.  Of his shares beneficially owned, 6,530 aresubject to Rule 144 restrictions until February 21, 2004.  The remaining 800 shares were obtainedthrough an exercise of Dr. Giray’s available stock options as of hisresignation date, with these shares not being subject to Rule 144 restrictions.

 

(4)          Includes 457 shares held in the name of The RossiFoundation, of which, Mr. Rossi holds no voting rights.

 

**ITEM 12.****  CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

**Certain Transactions**

 

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 directorsand executive officers and their immediate families, as well as the companieswith which such directors and executive officers are associated, are customersof, and have had banking transactions with the Bank in the ordinary course ofbusiness and anticipate having such banking transactions with such persons inthe future.  In the opinion ofManagement, all loans and commitments to lend included in such transactionswere made in compliance with applicable laws on substantially the same terms,including interest rates and collateral, as those prevailing at the time forcomparable transactions with other persons of similar creditworthiness and didnot involve more than a normal risk of collectibility or present otherunfavorable features.  As ofDecember 31, 2003, loans outstanding to the Bank’s directors and executiveofficers (including associated companies) totaled approximately $2.1 million.

 

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**ITEM 13.****  EXHIBITS ANDREPORTS ON FORM 8-K**

 

**Exhibits**

** **
| **Exhibit #** |   |                                                                                                                                                                                                                                                           |   |   |
|---------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| 2.1           |   | Plan of Reorganization and Agreement of Merger dated as of October 4,  2000 (A)                                                                                                                                                                                |   |   |
| 3.1           |   | Articles of Incorporation (A)                                                                                                                                                                                                                                  |   |   |
| 3.2           |   | Bylaws (A)                                                                                                                                                                                                                                                     |   |   |
| 4.1           |   | Certificate of Determination for Series A Non-Voting Convertible  Redeemable Preferred Stock (A)                                                                                                                                                               |   |   |
| 4.2           |   | Certificate of Determination for Series B Non-Voting Preferred Stock  (A)                                                                                                                                                                                      |   |   |
| 4.3           |   | Certificate of Determination for Class C Preferred Stock (B)                                                                                                                                                                                                   |   |   |
| 4.4           |   | Purchase Agreement dated October 10, 2003, by and among Registrant,  Mission Community Capital Trust 1, and Bear Stearns & Co., Inc. (C)                                                                                                                   |   |   |
| 4.5           |   | Indenture dated as of October 14, 2003 by and between the Registrant  and Wells Fargo Bank, National Association, as trustee (C)                                                                                                                               |   |   |
| 4.6           |   | Declaration of Trust Mission Community Capital Trust I dated as of  October 10, 2003 (C)                                                                                                                                                                       |   |   |
| 4.7           |   | Amended and Restated Declaration of Trust of Mission Community  Capital Trust I dated as of October 14, 2003 by and among the Registrant,  Wells Fargo Delaware Trust Company, as Trustee, and Anita M. Robinson and  William C. Demmin, as Administrators (C) |   |   |
| 4.8           |   | Guarantee Agreement dated October 14, 2003 between Registrant, as Guarantor,  and Wells Fargo Bank, National Association, as Guarantee Trustee (C)                                                                                                             |   |   |
| 4.9           |   | Fee Agreement dated October 14, 2003 by and among the Registrant,  Wells Fargo Delaware Trust Company, Bear Stearns & Co., Inc. and Mission  Community Capital Trust I (C)                                                                                 |   |   |
| 10.1          |   | Purchase and Sale Agreement and Lease dated January, 1997, as amended  (A)                                                                                                                                                                                     |   |   |
| 10.2          |   | Financial Facilities Purchase Agreement (A)                                                                                                                                                                                                                    |   |   |
| 10.3          |   | Employment Contract — Ms. Robinson (A)                                                                                                                                                                                                                    |   |   |
| 10.4          |   | Lease Agreement — Paso Robles (A)                                                                                                                                                                                                                         |   |   |
| 10.5          |   | Lease Agreement — San Luis Obispo (A)                                                                                                                                                                                                                     |   |   |
| 10.6          |   | Lease Agreement — Arroyo Grande (A)                                                                                                                                                                                                                       |   |   |
| 10.7          |   | 1998 Stock Option Plan (A)                                                                                                                                                                                                                                     |   |   |
| 10.8          |   | Lease Agreement — 569 Higuera, San Luis Obispo (B)                                                                                                                                                                                                        |   |   |
| 10.9          |   | Lease Agreement — 671 Tefft Street Nipomo CA (B)                                                                                                                                                                                                          |   |   |
| 10.10         |   | Employment Agreement — Ms. Robinson (D)                                                                                                                                                                                                                   |   |   |
| 14.0          |   | Code of Ethics                                                                                                                                                                                                                                                 |   |   |
| 21            |   | Subsidiaries of the registrant                                                                                                                                                                                                                                 |   |   |
| 23.1          |   | Independent Auditors’ Consent                                                                                                                                                                                                                             |   |   |

 

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(A)      Included in Form 10-KSB filed on March 28, 2002

(B)        Included in Form 10-QSB filed on June 12, 2002

(C)        Included in Form 8-K filed on October 21, 2003

(D)       Included in From 10-QSB filed on August 13, 2003

 
| 31.1 |   | Certification of CEO pursuant to Section 302 of Sarbanes Oxley Act |   |   |
|------|--------|--------------------------------------------------------------------|--------|--------|

 

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| **Exhibit #** |   |                                                                |   |   |
|---------------|--------|---------------------------------------------------------------------|--------|--------|
| 31.2          |   | Certification  of CFO pursuant to Section 302 of Sarbanes Oxley Act |   |   |
| 32.1          |   | Certification  of CEO pursuant to Section 906 of Sarbanes Oxley Act |   |   |
| 32.2          |   | Certification  of CFO pursuant to Section 906 of Sarbanes Oxley Act |   |   |

 

**Reports on Form 8-K:**

 

1.               OnOctober 20, 2003, the Company filed a Form 8-K announcing its completion of atrust preferred security offering.

 

2.               On November 24, 2003, the Company filed aForm 8-K announcing the payment of a dividend payable for 2003.

 

3.               On December 29, 2003, the Company filed aForm 8-K announcing the conversion of Mission Community Bank from a national toa state charter.

 

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**Item 14.             PrincipalAccountant Fees and Services**

 

The following table presentsfees for professional audit services rendered by Vavrinek, Trine, Day &Co., LLP for the audit of the Bank’s annual financial statements for the yearsended December31, 2003, and December 31, 2002, and fees billed for the other servicesrendered by Vavrinek, Trine, Day & Co., LLP during those periods.

 
| **(Amounts  in dollars)** |   | **2003** |   | **2002** |   |
|---------------------------|--------|----------|--------|----------|--------|
|                      |   |     |   |     |   |
| Audit Fees                |   | 31,500   |   | 25,300   |   |
|                      |   |     |   |     |   |
| Tax Fees                  |   | 2,500    |   | 2,500    |   |

 

Audit Fees consist of amountsbilled for professional services rendered by Vavrinek, Trine, Day & Co.,LLP for the audit of the Bank’s annual financial statements and the reviews ofthe financials statements included in the Bank’s Forms 10-QSB for theapplicable fiscal year.  Tax Fees consist of the aggregate fees billed forprofessional services rendered by Vavrinek, Trine, Day & Co., LLP for tax compliance,tax advice, and tax planning.  Before Vavrinek, Trine, Day & Co., LLPwas engaged by the Bank to render audit or non-audit services associated withthe fees discussed above, the engagement was approved by the Audit Committee ofthe Board of Directors.  The Board of Directors is of the opinion that allservice fees charged by Vavrinek, Trine, Day & Co., LLP are consistent withVavrinek, Trine, Day & Co., LLP maintaining its independence from the Bank.

 

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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, 2004                    |                  |
|                                                 |                  |
|                                                 |                  |
| By:                                                  | /s/ William C. Demmin |   |   |
| **WILLIAM C. DEMMIN**                                |                  |
| Executive Vice President and Chief Financial Officer |                  |
| Dated:   March 28, 2004                    |                  |

 

[Signatures continue on next page]

 

86

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

** **

** **
| ** /s/ Bruce  M. Breault** |   |                                                                                  |   |               |
|---------------------------------|--------|---------------------------------------------------------------------------------------|--------|--------------------|
| BRUCE M. BREAULT                |   | Founding Chairman of the Board  (Emeritus)                                            |   | **March 28, 2004** |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  Roxanne M. Carr      |   | Vice Chairman of the Board                                                            |   | March 28, 2004     |
| ROXANNE M. CARR                 |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  Karla S. Cool        |   | Director                                                                              |   | March 28, 2004     |
| KARLA S. COOL                   |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  William B. Coy       |   | Chairman of the Board                                                                 |   | March 28, 2004     |
| WILLIAM B. COY                  |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  William C. Demmin    |   | Executive Vice President and Chief  Financial Officer (Principal Accounting  Officer) |   | March 30, 2004     |
| WILLIAM C. DEMMIN               |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  Anita M. Robinson    |   | Director, President and Chief Executive                                               |   | March 30, 2004     |
| ANITA M. ROBINSON               |   | Officer                                                                               |   |               |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  Robin L. Rossi       |   | Director                                                                              |   | March 30, 2004     |
| ROBIN L. ROSSI                  |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  Gary E. Stemper      |   | Immediate Past Chairman of the Board                                                  |   | March 30, 2004     |
| GARY E. STEMPER                 |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|                            |   |                                                                                  |   |               |
|  /s/  Karl F. Wittstrom    |   | Director and Secretary                                                                |   | March 28, 2004     |
| KARL F. WITTSTROM               |   |                                                                                  |   |               |

 

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