**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-KSB**

 

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

 

**For the Fiscal Year ended December 31, 2005**

 

**OR**

 

**o****        ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**Commission file number 333-12892**

 

**MISSION COMMUNITY BANCORP**

(Exact name of registrant as specified in itscharter)

 

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

 

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

Securities registered pursuant to Section 12(g) of the Exchange 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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. Yes ý****No o

 

Check if disclosure of delinquent filers pursuant to Item 405 ofRegulation 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’srevenue for this year ended **December 31, 2005**was **$10,239,589.**

 

Statethe aggregate market value of the voting stock and non-voting common equityheld by non-affiliates computed by reference to the price at which the commonequity was sold, or the average bid and asked prices of such common equity; asof **March 27, 2006**such aggregate marketvalue was **$15,664,124.**

 

As of **March 27, 2006**, the Registrant had 665,999 shares of CommonStock outstanding.

 

Transitional Small Business Disclosure Format (check one) Yes o No ý

 

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 Bancorpfiled an 8-K Report with the Commission reporting that it had acquired MissionCommunity Bank, N.A. in a holding company formation transaction and that itwould thereafter file reports with the Commission pursuant toSection 15(d) of the Securities Exchange Act of 1934.

 

 

----

 

**Forward Looking Statements**

 

This Annual Report on Form10-KSB includes forward-looking information, which is subject to the “safeharbor” created by Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act ant the Private SecuritiesLitigation Reform Act of 1995. When 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. Suchstatements are subject to certain risks, uncertainties and assumptions,including those described in this Annual Report on Form 10-KSB. Should one ormore of these risks or uncertainties materialize, or should underlyingassumptions prove incorrect, actual results may vary materially from thoseanticipated, estimated, expected, projected, intended, committed or believed.Such risks and uncertainties include, but are not limited to, the followingfactors: (i) general economic conditions, whether national or regional, thatcould affect the demand for loans and other banking services or lead toincreased loan losses; (ii) competitive factors, including increasedcompetition with community, regional and national financial institutions thatmay lead to pricing pressures on rates the Bank charges on loans and pays ondeposits or reduce the value of real estate collateral securing the Bank’sloans; (iii) loss of customers of greatest value to the Bank or other losses;(iv) increasing or decreasing interest rate environments that could lead todecreased net interest margin and increased volatility of rate sensitive loansand deposits; (v) changing business conditions in the banking industry; (vi)changes in the regulatory environment or new legislation; (vii) changes intechnology or required investments in technology; (viii) credit qualitydeterioration which could cause an increase in the provision for loan losses;(ix) dividend restrictions; (x) the effects of the September 11, 2001 terroristattacks and their aftermath; (xi) continued tensions in Iraq and elsewhere inthe Middle East; and (xii) increased regulation of the securities markets,whether pursuant to the Sarbanes-Oxley Act of 2002 or otherwise.

 

Investors and other readers arecautioned not to place undue reliance on forward-looking statements, whichreflect management’s analysis only as of the date of the statement.

 

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

 

2

----

 

# **PART I**

 

## **Item1. Description of Business**

## ** **

**BUSINESS DEVELOPMENT**

 

**The Company**

 

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

 

As of December 31, 2005, theCompany had approximately $156 million in total assets and $11 million inshareholders’ equity.

 

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

 

The U.S. Department of theTreasury, Community Development Financial Institutions Fund, has certifiedBancorp 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 Bancorp. It also opensto the Bank and Bancorp various government sponsored programs, grants, andawards in which they may participate.

 

With its status as a CDFI, Bancorpcompleted the private placement of $500,000 in preferred stock during December2000 with the CDFI Fund. Bancorp also was awarded a second $500,000 Core Awardin 2001 from the CDFI Fund, which was funded in December 2002 in the form ofpreferred stock. This was matched with a combination of preferred and commonshares through an investment of $500,000 from the National Community InvestmentFund (“NCIF”). In 2004 the Bank received a $1,240,929 Bank Enterprise Award(“BEA”) from the CDFI Fund.  The award was made under the Fiscal Year 2004BEA Program, which provides an incentive for any FDIC insured bank to annuallyincrease the levels of financial services provided to economically distressedcommunities.  The Bank also received a similar award in 2001 of $990,000,but did not receive any grants or awards in 2003 or in 2005.  Bancorp received a $135,000 CDFI technicalassistance grant in 2005, which will be recognized in income as qualifyingexpenses are incurred.

 

**Mission Community Bank**

 

The Bank opened on December 18,1997, in San Luis Obispo, California, as a national bank chartered by theComptroller of the Currency and opened additional offices in San Luis ObispoCounty in the city of Paso Robles in 1998, Arroyo Grande and Nipomo in 2002. InJuly of 2005, the Nipomo office was closed. The Bank is authorized to engage inthe general commercial banking business, and its deposits are insured by theFederal Deposit Insurance Corporation up to the applicable limits of the law.At December 31, 2005, the Bank had approximately $156.3 million in assets,$119.5 million in loans, $127.6 million in deposits, and $11.0 million instockholders’ equity. The Bank does not offer trust services or internationalbanking services and does not plan to do so in the near future.

 

The Bank is also certified by theState of California Department of Insurance to accept deposits under theCalifornia Organized Investment Network (the “COIN”). The COIN program providesCalifornia tax credits and/or CRA credit to individuals, corporations, orpartnerships that invest in below market rate deposits or specified termcertificates of deposit.

 

On December 29, 2003, the CaliforniaDepartment of Financial Institutions (the “DFI”) approved the Bank’s conversionapplication to be chartered in the State of California as a Federal ReserveMember Bank and effective on this date, the Bank returned its national charterfrom the Comptroller of the Currency. The change in charter was completedprimarily to allow the Bank to benefit from the larger secured legal lendinglimit for banks chartered in California, specifically, increasing its legallending limit from 15% to 25% for certain real estate secured loans. The Bankis now supervised by the Federal Reserve and the DFI. Other than the change inlegal lending limit, no material changes have occurred or are anticipated tooccur in the future from the charter change.

 

3

----

 

**Mission Community DevelopmentCorporation (“MCDC”)**

 

Mission Community DevelopmentCorporation, a community development corporation which was incorporated inAugust 1997, is a wholly-owned subsidiary of the Bank. MCDC is a “for-profit”Community Development Corporation (“CDC”), which provides financing for smallbusinesses and low- to moderate-income area development and/or affordablehousing projects. Its purpose is to benefit small business and low- tomoderate-income areas/residents. The board of directors of MCDC consists offour members of the Board of Directors of the Bank and three outside memberswho are actively involved in representing and supporting the low incomecommunity.

 

At December 31, 2005, MCDC hadapproximately $200,000 in net loans and $292,000 in shareholder’s equity, andprovided loan accounting services for a very small pool of communitydevelopment micro loans which were funded by a group of banks through theEconomic Vitality Corporation, as well as management of an emergency assistanceloan pool created after the San Simeon earthquake of December 2003 and the SanLuis Obispo County Housing Trust Fund.

 

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

 

Bancorp and the Bank have anaffiliate relationship with, but no ownership of, MCSC, which was incorporatedin August 1997 and which was established in September 2003 as a“not-for-profit” public charitable corporation under Internal Revenue CodeSection 501(c)(3). MCSC’s primary focus is to provide technical support andtraining services to the community, including small business, minority andlow-income entrepreneurs. While MCSC has not engaged in any direct lending, itmay provide some lending in the future. The Board of Directors of MCSC includesrepresentatives from the Company, together with members representing thelow-income and business community. The accounts of MCSC are not included in theCompany’s consolidated financial statements or elsewhere in this Form 10-KSB.See also Note L to the Consolidated Financial Statements for additionalinformation regarding MCSC.

 

**The “Mission” Group**

 

Bancorp, the Bank and itssubsidiary MCDC, and MCSC form an organizational structure intended to providetraditional community bank financial services and to foster economicrevitalization 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 orOther Changes**

 

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

 

**BUSINESS OF ISSUER**

 

**Principal Products, Services, and Markets**

 

Other than holding the shares of the Bank, Bancorp conducts nosignificant activities. Bancorp is authorized with the prior approval of theBoard of Governors of the Federal Reserve System (the “Federal Reserve Board”),its principal regulator, to engage in a variety of activities which are deemedclosely related to the business of banking.

 

The Bank offers checking andsavings accounts, money market accounts and time certificates of deposits;offers commercial, agribusiness, government guaranteed, real estate, automobileand other installment and term loans and leases; issues drafts, sellstravelers’ checks and provides other customary banking services. Although theBank does not operate a trust department or provide international services, itmakes trust services or international services available through correspondentinstitutions.

 

The areas in which the Bank hasdirected virtually all of its lending activities are commercial loans(including government-guaranteed loans), agricultural loans, constructionloans, real estate loans, and consumer loans. As of December 31, 2005, thesefive categories accounted for approximately 12.6%, 0.1%, 25.0%, 60.2%, and 2.1%respectively, of the Bank’s gross loan portfolio. As of December 31, 2005,$101.8 million, or 85.2%, of the Bank’s loans consisted of interim constructionand 

 

4

----

 

real estate loans, for singlefamily residences or for commercial development. This represents an increase inconstruction and real estate loans from the prior year’s combined 82.1%. See *Loan Concentrations* in Managements’ Discussion and Analysisunder Item 6 of Part II of this report.

 

As of December 31, 2005, the Bankhad 4,106 deposit accounts, including 2,400 demand accounts totaling $32.0million; 1,185 savings accounts with balances totaling $35.2 million; and 521time certificates of deposit totaling $60.3 million.

 

The principal sources of the Bank’s revenues are interestand fees on loans, interest on investments including federal funds sold, gainon sale of loans, service charges on deposit accounts, and other charges andfees. For the year ended December 31, 2005, these sources comprised 84.2%,7.9%, 3.4%, 2.5%,and  2.0%, respectively,of the Bank’s total operating income.

 

**Distribution Methods of the Productsand Services**

 

The Bank’s primary service areaconsists of San Luis Obispo County and northern Santa Barbara County, which liecentrally within the State of California along the Pacific Ocean. Secondarymarket areas include cities and unincorporated areas in the neighboringcounties, including Kern, Kings, and Fresno.

 

The Bank operates out of three fullservice offices (in the cities of San Luis Obispo, Paso Robles and ArroyoGrande) plus a loan production office and an administrative facility, which areboth located in the city of San Luis Obispo. The Bank provides some financialservices through direct contact by calling officers who travel into theneighboring counties. Physical expansion into the neighboring counties wouldmost likely come from acquisitions or in the form of loan production officesalthough there are no immediate plans for acquisitions or loan productionoffices.

 

The Bank’s operating policy since its inception hasemphasized community development through small business, commercial and retailbanking. Most of the Bank’s customers are retail customers, farmers and smallto medium-sized businesses. As a CDFI, the Bank also emphasizes loans andfinancial 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 the Bankemphasizes providing highly specialized financial services in a professionaland personalized manner to individuals and businesses in its service area. Itskey strengths are customer service and an experienced management team familiarwith the community through the Bank’s involvement in various community lendingand development projects.

 

In 2004 and 2005, the Bank extended its use of Internettechnology as a distribution tool to improve its customer service by use ofInternet Banking, including bill pay, and ACH origination. While the Bankcontinues to focus on its local market areas, it has also been able to attractnon-local (“brokered”) certificates of deposit at market rates. Managementexpects that brokered deposits will be used from time to time in the future asan alternative source of funding loan growth.

 

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

 

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

 

The Bank has participated in a 3-year project (2002-2005)sponsored by NCIF to explore and develop a profitable range of retail financialproducts and services to low income and unbanked customers (“low incomecustomers”). NCIF is underwriting a majority of the costs associated with thisproject. The project seeks to develop replicable and profitable business modelsfor both particular products and services targeted at low income customers, andcoordinated suites of products that meet a range of needs. Product and servicespecifications, target market, cross selling and profitability data is beingtracked over a two- to three-year time horizon with the goal to develop suitesof products that meet household financial and asset building needs while beingprofitable for financial institutions. Expected products include FirstAccounts, Individual Development Accounts, and access to debit cards and otherelectronic services. The Bank expects to increase its focus on profitablefinancial services for the un- and under-banked customers in its market area,but does not expect these services will be a material percentage of its depositactivities.

 

The Company applied to the CDFI in 2004 for a technicalassistance grant to help offset any costs associated with providing additionalservices to the un- and under-banked in its market area, and received a grantof $134,935 in 2005. This grant was not recognized in income in 2005 as noqualifying expenses have been incurred to date.

 

5

----

 

**Competition**

 

The banking and financial servicesbusiness in the Bank’s market area is highly competitive. The increasinglycompetitive environment is a result primarily of changes in regulation, andchanges in technology and product delivery systems. In order to compete withother financial institutions in its service area, the Bank relies upon localadvertising programs; direct personal contact by officers, directors,employees, and shareholders; and specialized services such as courier pick-up.The Bank emphasizes to its customers the advantages of dealing with a locallyowned and community development oriented institution. Larger banks may have acompetitive advantage because of higher lending limits and major advertisingand marketing campaigns in addition to expanded products like trust services,international banking, discount brokerage and insurance services that the Bankdoes not offer. As a service to its customers, the Bank has made arrangementswith other financial service providers to extend such services to its customerswhere possible. For borrowers requiring loans in excess of the Bank’s legallending 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 utilizes technology toimprove its competitive advantages by use of ATMs, Internet Banking, ACHorigination, electronic bill pay, email, and credit card and merchant cardrelationships.

 

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

 

As a service organization, the Company is not dependent onraw materials.

 

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

 

The Bank is limited in the size ofloans it can make to any one individual borrower (in the aggregate), and it hasapproximately 700 loan customers. As of December 31, 2005, the Bank’s legallending limits to a single borrower, and such borrower’s related parties, on asecured basis (first trust deed) were approximately $3.4 million and $2.0million for unsecured loans, based on regulatory capital plus reserves ofapproximately $13.4 million.

 

A material portion of the Bank’s deposits have not beenobtained from a single person or a few persons, the loss of any one or more ofwhich would have a materially adverse effect on the business of the Bank. TheBank has a higher than average dependence (as measured by peer group analysis)on larger deposit balances, with a total of 173 depositors holding $35.2million in time deposits of $100,000 or more as of December 31, 2005. Includedin those totals are nine customers with deposits of $1 million or more totaling$24.7 million. These deposit balances have been reasonably stable during thepast several years and are consistent with the Bank’s deposit/funding strategy.

 

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

 

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

 

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

 

**Effect ofGovernment Policies and Regulations**

 

Banking is a business that dependson rate differentials. In general, the difference between the interest ratepaid by the Bank on its deposits and its other borrowings and the interest ratereceived by the Bank on loans extended to its customers and securities held inthe Bank’s portfolio comprise the major portion of the Bank’s earnings. Theserates are highly sensitive to many factors that are beyond the control of theBank. Accordingly, the earnings and growth of the Bank are subject to theinfluence of domestic and foreign economic conditions, including inflation, recessionand unemployment.

 

The commercial banking business isnot only affected by general economic conditions but is also influenced by themonetary and fiscal policies of the federal government and the policies ofregulatory agencies, particularly the Federal Reserve Board. The FederalReserve Board implements national monetary policies (with objectives such ascurbing inflation and combating recession) by its open-market operations inU.S. Government securities, by adjusting the required level of reserves forfinancial institutions subject to its reserve requirements and by varying thediscount rates applicable to borrowings by 

 

6

----

 

depository institutions. Theactions of the Federal Reserve Board in these areas influence the growth ofbank loans, investments and deposits and also affect interest rates charged onloans and paid on deposits. The nature and impact of any future changes inmonetary policies cannot be predicted.

 

From time to time, legislation isenacted which has the effect of increasing the cost of doing business, limitingor expanding permissible activities or affecting the competitive balancebetween banks and other financial institutions. Proposals to change the lawsand regulations governing the operations and taxation of banks, bank holdingcompanies and other financial institutions are frequently made in Congress, inthe California legislature and before various bank regulatory and otherprofessional agencies. For example, the Bank’s ability to originate and sellSBA loans would be severely impacted if federal appropriations for the SBAlending program were curtailed or eliminated.

 

**Supervisionand Regulation**

 

The Company and the Bank areextensively regulated under both federal and state law. Set forth below is asummary description of certain laws that relate to the regulation of Bancorpand the Bank. The description does not purport to be complete and is qualifiedin its entirety by reference to the applicable laws and regulations.

 

**Bancorp**

 

Bancorp is a bank holding companywithin the meaning of the Bank Holding Company Act of 1956, as amended (the“BHCA”), and is registered as such with, and subject to the supervision of, theFederal Reserve Board. Bancorp is required to file with the Federal ReserveBoard quarterly and annual reports and such additional information as theFederal Reserve Board may require pursuant to the BHCA. The Federal ReserveBoard may conduct examinations of bank holding companies and theirsubsidiaries.

 

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

 

Bancorp is prohibited by the BHCA,except in certain statutorily prescribed instances, from acquiring direct orindirect ownership or control of more than 5% of the outstanding voting sharesof any company that is not a bank or bank holding company and from engaging,directly or indirectly, in activities other than those of banking, managing orcontrolling banks or furnishing services to its subsidiaries. However, Bancorpmay, subject to the prior approval of the Federal Reserve Board, engage in, oracquire shares of companies engaged in, any activities that are deemed by theFederal Reserve Board to be so closely related to banking or managing orcontrolling banks as to be a proper incident thereto.

 

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

 

Under the Federal Reserve Board’sregulations, a bank holding company is required to serve as a source offinancial and managerial strength to its subsidiary banks and may not conductits operations in an unsafe and unsound manner. In addition, it is the 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 willgenerally be considered by the Federal Reserve Board to be an unsafe andunsound banking practice or a violation of the Federal Reserve Board’sregulations or both.

 

Bancorp is subject to the periodicreporting requirements of Section 15(d) of the Securities Exchange Act of 1934,as amended, and files reports pursuant to such Act with the Securities andExchange Commission (“SEC”).

 

7

----

 

**The Bank**

 

The Bank is chartered under thelaws of the State of California and its deposits are insured by the FDIC to theextent provided by law. Prior to December 2003 and its charter conversion, theBank was supervised by the Comptroller of the Currency. Following theconversion, the Bank is subject to the supervision of, and is regularlyexamined by, the Federal Reserve Bank of San Francisco (the “FRB”) and the DFI.Such supervision and regulation include comprehensive reviews of all majoraspects of the Bank’s business and condition.

 

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

 

If, as a result of an examinationof a bank, the FRB or DFI determines that the financial condition, capitalresources, asset quality, earnings prospects, management, liquidity, or otheraspects of the Bank’s operations are unsatisfactory or that the Bank or itsmanagement is violating or has violated any law or regulation, various remediesare available to such regulatory agency. Such remedies include the power toenjoin “unsafe or unsound” practices, to require affirmative action to correctany conditions resulting from any violation or practice, to issue anadministrative order that can be judicially enforced, to direct an increase incapital, to restrict the growth of the Bank, to assess civil monetarypenalties, to remove officers and directors, and ultimately to terminate theBank’s deposit insurance, which would result in a revocation of the Bank’scharter.

 

**CapitalStandards**

 

The Federal Reserve Board hasadopted risk-based minimum capital guidelines intended to provide a measure ofcapital that reflects the degree of risk associated with a 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, whichinclude off balance sheet items, against both Tier 1 capital and Totalqualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2capital). 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 the risked-basedguidelines, federal banking regulators require banking organizations tomaintain a minimum amount of Tier 1 capital to total assets (notrisk-adjusted), referred to as the leverage ratio. For a banking organizationrated in the highest of the five categories used by regulators to rate bankingorganizations, the minimum leverage ratio of Tier 1 capital to total assets is3%. For all banking organizations not rated in the highest category, includingthe Company and the Bank, the minimum leverage ratio must be at least 4%. Inaddition to these uniform risk-based capital guidelines and leverage ratiosthat apply across the industry, the regulators have the discretion to set individualminimum capital requirements for specific institutions at rates significantlyabove the minimum guidelines and ratios. Future changes in required capitalratios or regulations or practices could further reduce the amount of capitalrecognized for purposes of capital adequacy. Such a change could affect theability of the Bank to grow and could restrict the amount of profits, if any.

 

8

----

 

The following table presents theamounts of regulatory capital and the capital ratios for the Bank compared toits minimum regulatory capital requirements as of December 31, 2005:

 
| ** **                      | ** ** | **Bank  Actual** | ** ** | **Well-  Capitalized  Requirements** | ** ** | **Minimum  Capital  Requirements** | ** ** |
|---------------------------------|------------|------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| Total Risk-Based Capital Ratio  |       | 10.7             | %          | 10.0                                 | %          | 8.0                                | %          |
| Tier 1 Risk-Based Capital Ratio |       | 9.8              | %          | 6.0                                  | %          | 4.0                                | %          |
| Leverage Ratio                  |       | 9.2              | %          | 5.0                                  | %          | 4.0                                | %          |

 

Under applicable regulatory guidelines, the Bank wasconsidered “Well Capitalized” at December 31, 2005.

 

Under existing regulations of the Federal Reserve Board,the consolidated capital ratios of bank holding companies with total assets ofless than $150 million are deemed to be the same as those of the Bank. As ofDecember 31, 2005, the Company would be subject to similar regulatory capitalrequirements as the Bank because its consolidated assets first exceeded $150million on December 31, 2005. However, the Company has been notified by the FRBthat by March 31, 2006, the FRB expects to revise, from $150 million to $500million, the minimum asset size criteria for bank holding companies subject tothose requirements. Further, the FRB has notified the Company that it is notsubject to those additional requirements in the interim period from December31, 2005, to March 31, 2006.

 

**PromptCorrective Action and Other Enforcement Mechanisms**

 

Federal banking agencies possessbroad powers to take corrective and other supervisory action to resolve theproblems of insured depository institutions, including, but not limited to,those institutions that fall below one or more prescribed minimum capitalratios described above. An 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 measures taken underthe prompt corrective action provisions, commercial banking organizations maybe subject to potential enforcement actions by the federal regulators forunsafe or unsound practices in conducting their businesses or for violations ofany law, rule, regulation, or any condition imposed in writing by the agency orany written agreement with the agency.

 

**Safety and Soundness Standards**

 

The federal banking agencies haveadopted guidelines designed to assist the federal banking agencies inidentifying and addressing potential safety and soundness concerns beforecapital becomes impaired. The guidelines set forth operational and managerialstandards relating to internal controls, information systems and internal auditsystems, loan documentation, credit underwriting, asset growth, earnings, andcompensation, fees and benefits.

 

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

 

•                  conduct periodic asset-quality reviews to identifyproblem assets;

•                  estimate the inherent losses in problem assets andestablish reserves that are sufficient to absorb estimated losses;

•                  compare problem asset totals to capital;

•                  take appropriate corrective action to resolveproblem assets;

•                  consider the size and potential risks of materialasset concentrations; and

•                  provide periodic asset quality reports with adequateinformation for management and the board of directors to assess the level ofasset risk.

 

9

----

 

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

 

**Premiums forDeposit Insurance**

 

Through the Bank Insurance Fund(“BIF”), the FDIC insures the deposits of the Bank up to prescribed limits foreach depositor. The amount of FDIC assessments paid by each BIF memberinstitution is based on its relative risk of default as measured by regulatorycapital ratios and other factors. Specifically, the assessment rate is based onthe institution’s capitalization risk category and supervisory subgroupcategory. An institution’s capitalization risk category is based on the FDIC’sdetermination of whether the institution is well capitalized, adequatelycapitalized or less than adequately capitalized. An institution’s supervisorysubgroup category is based on the FDIC’s assessment of the financial conditionof the institution and the probability that FDIC intervention or othercorrective action will be required.

 

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

 

All FDIC-insured depositoryinstitutions must pay an annual assessment to provide funds for the payment ofinterest on bonds issued by the Financing Corporation, a federal corporationchartered under the authority of the Federal Housing Finance Board. The bonds,commonly referred to as FICO bonds, were issued to capitalize the FederalSavings and Loan Insurance Corporation. The FICO assessments are adjustedquarterly 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 to certain fairlending requirements and reporting obligations involving home mortgage lending operationsand Community Reinvestment Act (“CRA”) activities. The CRA generally requiresthe federal banking agencies to evaluate the record of a financial institutionin meeting the credit needs of their local communities, including low andmoderate income neighborhoods. In addition to substantial penalties andcorrective measures that may be required for a violation of certain fairlending laws, the federal banking agencies may take compliance with such lawsand CRA into account when regulating and supervising other activities. Inconnection with its assessment of CRA performance, the appropriate bankregulatory agency assigns a rating of “outstanding,” “satisfactory,” “needs toimprove” or “substantial noncompliance.”

 

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

 

**RecentLegislation**

 

**Financial Holding Companies**

 

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

 

**USA Patriot Act of 2001**

 

In October 2001, the USA Patriot Act of 2001 wasenacted in response to the terrorist attacks in New York, Pennsylvania andWashington, D.C., which occurred on September 11, 2001. The Patriot Act isintended to strengthen U.S. law enforcement’s and the intelligence community’sabilities to work cohesively to combat terrorism on a variety of fronts. Thepotential impact of the Patriot Act on financial institutions of all kinds issignificant and wide ranging. The Patriot Act contains sweeping anti-moneylaundering and financial transparency laws and imposes various regulations,including standards for verifying client identification at account opening, andrules to promote cooperation among financial institutions, regulators and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering.

 

10

----

 

**California Corporate Disclosure Act**

 

The California Corporate Disclosure Act, effective January1, 2003, amended the Corporations Code by requiring additional public disclosuresby “publicly traded companies,” including domestic and foreign corporations,qualified to transact intrastate business in California. The purpose of the newrequired disclosures is to help combat fraud and protect investors. “Publiclytraded company” means a company with securities listed or admitted to tradingon a national or foreign exchange, or which is the subject of two-wayquotations that are regularly published. Such companies must file with theSecretary of State a statement, in the form prescribed, including the followingadditional information:

 

•                  Name of independent auditor, description of otherservices provided as specified, and date of the last audit, including a copy ofthe report;

•                  Annual compensation paid to each director andexecutive officer;

•                  Description of any loans made to any director at apreferential loan rate;

•                  Statement indicating whether any bankruptcy has beenfiled by corporation executive officers or directors during the past 10 years;

•                  Statement indicating whether any member of the boardof directors or executive officer of the corporation was convicted of fraudduring the previous 10 years;

•                  Statement indicating whether the corporationviolated 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**

 

On July 30, 2002, President Bush signed into law theSarbanes-Oxley Act of 2002 (the “SOA”). The stated goals of the SOA are toincrease corporate responsibility, to provide for enhanced penalties foraccounting and auditing improprieties at publicly traded companies and toprotect investors by improving the accuracy and reliability of corporatedisclosures pursuant to the securities laws.

 

The SOA is the most far-reaching U.S. securitieslegislation 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 rolein implementing rules relating to many of the SOA’s new requirements, the finalscope of these requirements remains to be determined.

 

The SOA includes very specific additional disclosurerequirements and new corporate governance rules, requires the SEC andsecurities exchanges to adopt extensive additional disclosure, corporategovernance and other related rules and mandates further studies of certainissues by the SEC. The SOA represents significant federal involvement inmatters traditionally left to state regulatory systems, such as the regulationof the accounting profession, and to state corporate law, such as therelationship between a board of directors and management and between a board ofdirectors and its committees.

 

The SOA addresses, among other matters:

 

•                  the creation of an independent accounting oversightboard to oversee the audit of public companies and auditors who perform suchaudits;

•                  audit committees for all listed companies andexpansion of the power of the audit committee, including the requirements thatthe audit committee: (i) have direct control of the outside auditor; (ii) beable 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 the chiefexecutive officer and the chief financial officer;

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

•                  a prohibition on insider trading during pension planblack out periods;

•                  increased protection for whistleblowers andinformants;

•                  disclosure of off-balance sheet transactions;

•                  expedited filing requirements for ownership reportsby officers and directors;

 

11

----

 

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

•                  “real time” filing of periodic reports; and

•                  various increased criminal penalties for violationsof securities laws.

 

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

 

On September 21, 2005, the SEC extended thecompliance dates for non-accelerated filers, such as Bancorp, regarding rulespursuant to Section 404 of the Sarbanes-Oxley Act. The rules relate torequirements that companies include in annual reports a report by management onthe company’s internal control over financial reporting and an accompanyingauditor’s report. Under the latest extension, a company that is not required tofile its annual and quarterly reports on an accelerated basis (non-acceleratedfiler), must begin to comply with the internal control over financial reportingrequirements for its first fiscal year ending on or after July 15, 2007. Thisis a one-year extension from the previously established July 15, 2006,compliance date for non-accelerated filers. The SEC also has extended thecompliance date for non-accelerated filers relating to requirements regardingevaluation of internal control over financial reporting and managementcertification requirements.

 

**BudgetReconciliation Act**

 

On February 8, 2006, President Bush signed into lawthe Budget Reconciliation Act ("BRA") that is intended to reducefederal spending by $40 billion over five years.  The BRA included provisions that reformsdeposit insurance, including giving the FDIC broad authority to charge premiums,raises the deposit insurance limit for retirement accounts to $250,000, andbeginning in 2011, allows the FDIC to index the general $100,000 coverage limitevery five years to keep pace with inflation.

 

12

----

 

**Transactions Between Affiliates**

 

Transactions between a bank and its “affiliates” arequantitatively and qualitatively restricted under the Federal Reserve Act. TheFRB has also issued Regulation W, which codifies prior regulations underSections 23A and 23B of the Federal Reserve Act and interpretative guidancewith respect to affiliate transactions. Regulation W incorporates the exemptionfrom the affiliate transaction rules but expands the exemption to cover thepurchase of any type of loan or extension of credit from an affiliate.Affiliates of a bank include, among other entities, companies that are undercommon control with the bank. In general, subject to certain specifiedexemptions, a bank or its subsidiaries are limited in their ability to engagein “covered transactions” with affiliates:

 

•                  to an amount equal to 10% of the bank’s capital andsurplus, in the case of covered transactions with any one affiliate; and

•                  to an amount equal to 20% of the bank’s capital andsurplus, in the case of covered transactions with all affiliates.

 

In addition, a bank and its subsidiaries may engagein covered transactions and other specified transactions only on terms andunder circumstances that are substantially the same, or at least as favorableto the bank or its subsidiary, as those prevailing at the time for comparabletransactions with nonaffiliated companies. A “covered transaction” includes:

 

•                  a loan or extension of credit to an affiliate;

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

•                  a purchase of assets from an affiliate, with someexceptions;

•                  the acceptance of securities issued by an affiliateas collateral for a loan or extension of credit to any party; and

•                  the issuance of a guarantee, acceptance or letter ofcredit on behalf of an affiliate.

 

In addition, under Regulation W:

 

•                  a bank and its subsidiaries may not purchase alow-quality asset from an affiliate;

•                  covered transactions and other specifiedtransactions between a bank or its subsidiaries and an affiliate must be onterms and conditions that are consistent with safe and sound banking practices;and

•                  with some exceptions, each loan or extension ofcredit by a bank to an affiliate must be secured by collateral with a marketvalue ranging from 100% to 130%, depending on the type of collateral, of theamount of the loan or extension of credit.

 

Regulation Wgenerally 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.

 

**Environmental Regulations**

 

Management of the Bank is unaware of any material effectupon the Bank’s capital expenditures, earnings or competitive position as aresult of federal, state or local environmental regulation.

 

**Employees**

 

As of March 1, 2006 the Bank had a total of 50 employees. Themanagement of the Bank believes that its employee relations are satisfactory.Neither Bancorp nor MCDC have salaried employees; Bancorp’s officers all holdsimilar positions at the Bank. The Bank, under inter-company arrangements, maycharge Bancorp and/or MCDC for management, staff, and services; however, thetime and services are not material at this time.

 

13

----

 

**Certain Business Risk**

 

In addition to the other information contained in thisReport, the following risks may affect the Company. If any of these risksoccur, the Company’s business, financial condition or operating results couldbe adversely affected.

 

**Dependence on Real Estate**

 

A significant portion of the loanportfolio of the Bank is dependent on real estate. At December 31, 2005, realestate served as the principal source of collateral with respect to approximately85 percent of the Bank’s loan portfolio. A decline in current economicconditions or rising interest rates could have an adverse effect on the demandfor new loans, the ability of borrowers to repay outstanding loans, the valueof real estate and other collateral securing loans and the value of real estateowned by the Bank, as well as the Company’s financial condition and results ofoperations in general, and the market value of the Company’s common stock. Actsof nature, including earthquakes and floods, which may cause uninsured damageand other loss of value to real estate that secures these loans, may also negativelyimpact the Company’s financial condition. See*Loan**Concentrations* in Managements’Discussion and Analysis under Item 6 of Part II of this report.

 

**Interest Rate Changes**

 

The earnings of the Company and theBank are substantially affected by changes in prevailing interest rates.Changes in interest rates affect the demand for new loans, the credit profileof existing loans, the rates received on loans and securities and the rates theBank must pay on deposits and borrowings. The difference between the rates theBank receives on loans and securities and the rates it must pay on deposits andborrowings is known as the interest rate spread. Given the Bank’s currentvolume and mix of interest-bearing liabilities and interest-earning assets, theBank’s interest rate spread can be expected to increase when market interestrates are rising, and to decline when market interest rates are declining,i.e., the Bank is “asset sensitive.” Although the Bank believes its current level of interest ratesensitivity is reasonable, significant fluctuations in interest rates may havean adverse impact on the Company’s and the Bank’s business, financial conditionand results of operations. See *Asset and LiabilityManagement* in Management’s Discussion and Analysis under Item 6 ofPart II of this report.

 

**Competition**

 

Competition may adversely affectthe Bank’s performance. The financial services business in the Bank’s marketarea is highly competitive and becoming more so due to changes in regulation,technological advances and the accelerating pace of consolidation amongfinancial 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 industry may reduce the Bank’s market share, cause theprices it charges for its services to fall, or cause the rates it must pay toattract deposits to rise. The Company’s results may differ in future periodsdepending on the nature or level of competition by financial servicesproviders.

 

**Regulation**

 

Bancorp and the Bank are subject togovernment regulation that could limit or restrict their activities, adverselyaffecting operations. Federal and state banking regulation is designed toprotect the deposits of consumers, not to benefit shareholders. The regulationsimpose significant limitations on operations, and may be changed at any time toimpose significant new limitations, possibly causing the Company’s results tovary significantly from past results. Government policy and regulation,particularly as implemented through the Federal Reserve Board, significantlyaffects credit conditions for the Bank.

 

**Borrowers’ Failure to Perform**

 

A significant number of the Bank’sborrowers and guarantors may fail to perform their obligations as required bythe terms of their loans, resulting in losses for the Bank. The Bank hasadopted underwriting and credit policies, and loan monitoring procedures,including the establishment and monitoring of allowances for credit losses.Management believes these provisions are reasonable and adequate, and shouldkeep 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.

 

14

----

 

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

 

The Company’s common stock istraded over-the-counter and is not listed or quoted on any major exchange.Trading volume is modest and can cause fluctuations in the market value of theCompany’s stock. These fluctuations can be exaggerated, leading to pricevolatility in excess of other stocks which are more actively traded. Noassurances can be given concerning market value or the ability to sell sharesof the Company’s common stock.

 

**REPORTS TO SECURITY HOLDERS.**

 

**Annual Report**

 

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

 

Certain reports are filed by the Company with the SecuritiesExchange Commission pursuant to Section 13 or 15(d) of the Securities ExchangeAct of 1934. The SEC maintains an Internet site that contains reports and otherinformation statements. The Company files its reports electronically and theymay be viewed from the SEC’s Internet site http://www.sec.gov. The public mayalso 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. Informationregarding the operation of the Public Reference Room is available by callingthe SEC at 1-800-SEC-0300.

 

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

 

## **Item2. Description of Property**

## ** **

The Company occupies a propertyowned by the Bank at 581 Higuera Street, San Luis Obispo, California, where theBank’s main office is located. For its administration offices, the Bank hasbeen leasing approximately 2,950 square feet at 569 Higuera St. in San LuisObispo at a cost of approximately $5,400 per month. The lease expires on June 30,2006, with an option to renew for one five-year period. The administrationoffice is located next to the Bank’s main office.

 

The Bank also leases a branchoffice at 1226 Park Street, Paso Robles, California, at a cost of $5,125 permonth. The lease expires on July 31, 2008 and provides for one five-yearoption.

 

The Bank’s branch office at 154West Branch Street, Arroyo Grande, California, is leased at a cost of $3,324per month, plus common area operating expenses. The lease expires in September2010 and provides for one five-year option period.

 

The Bank’s Business Banking Centerat 3440 and 3480 S. Higuera Street, San Luis Obispo, is leased for a five-yearperiod expiring in 2009 at a cost of $6,240 per month. One five-year optionperiod is provided in the lease.

 

During 2005 the Bank closed itsbranch office in Nipomo, California, which had been leased. Although the leasehad nearly two years left at the time the office was closed, the Bank was ableto negotiate a buyout of the lease in exchange for five months’ rent, which isincluded in occupancy expense for 2005.

 

During 2005, the Bank purchased aparcel located near the intersection of 6th and Spring Streets inPaso Robles, where the Bank plans to build a branch office. This property willassist in the facilitation of that development.  No agreement to build hasbeen entered into to date.

 

For the years ended December 31,2005 and 2004, the Bank’s total occupancy costs were approximately $569,000 and$442,000, respectively. In the opinion of management, the premises are adequatefor the Bank’s purposes and the Bank has sufficient insurance to cover itsinterest in the premises. Note D to the Consolidated Financial Statementscontains additional information about properties.

 

Bancorp is restricted by the bankholding company regulations in its power to hold real estate property forinvestment.  The Company does not currently invest in real estate, otherthan for purposes of operations and mortgage interests in real estate securingloans made by the Bank in the ordinary course of business, and has no plans todo so in the future.

 

15

----

 

## **Item 3. Legal Proceedings**

## ** **

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

 

There are no material proceedingsadverse to the Company to which any director, officer, affiliate of the Companyor 5% shareholder of the Company, or any associate of any such director,officer, affiliate or 5% shareholder is a party, and none of the above personshas a material interest adverse to the Company.

 

## **Item 4. Submission of Matters to a Vote of SecurityHolders**

## ** **

No matters were submitted to a voteof security holders during the fourth quarter of 2005.

 

16

----

 

# **PART II**

# ** **

## **Item5. Market for Common Equity and Related Shareholder Matters**

 

**Market Information**

 

The Company’s common stock hastraded infrequently in the over-the-counter market under the symbol“MISS.”  The Company’s Common Stock isnot listed on any exchange or market. However, the Seidler Companies, MonroeSecurities, Wedbush Morgan Securities, UBS Capital Markets, Hill Thompson Magid& Co, and Hoefer & Arnett make a market in the Company’s Common Stock.Certain information concerning the Common Stock is reported on the Nasdaq OTCBulletin Board (www.otcbb.com).

 

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

 
| ** ** | ** **  | ** ** | **Bid Prices** | ** ** |
|------------|-------------|------------|---------------------|------------|
| ** ** | ** **  | ** ** | **Low**             | ** ** | **High** | ** ** |
| 2004       | 1st Quarter |       | $                   | 16.10      |   | $ | 20.00 |   |
|       | 2nd Quarter |       | 17.60               |       | 20.00 |   |
|       | 3rd Quarter |       | 17.55               |       | 18.30 |   |
|       | 4th Quarter |       | 18.35               |       | 23.00 |   |
| 2005       | 1st Quarter |       | 20.55               |       | 24.75 |   |
|       | 2nd Quarter |       | 22.00               |       | 24.00 |   |
|       | 3rd Quarter |       | 22.50               |       | 26.00 |   |
|       | 4th Quarter |       | 24.00               |       | 27.00 |   |
|            |             |            |                     |            |  |  |  |  |

 

**Holders**

 

As of March 1, 2006,there were 335 holders of record of Bancorp’s Common Stock.

 

**Dividends**

 

The Company’s shareholders are entitled to receivedividends, when and as declared by its Board of Directors, out of funds legallyavailable therefore, subject to the restrictions set forth in the in theCalifornia 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 also provides that, in the event thatsufficient retained earnings are not available for the proposed distribution, acorporation may nevertheless make a distribution to its shareholders if itmeets two conditions, which generally stated are as follows: (i) thecorporation’s assets equal at least 1.25 times its liabilities, and (ii) thecorporation’s current assets equal at least its current liabilities or, if theaverage of the corporation’s earnings before taxes on income and beforeinterest expenses for the two preceding fiscal years was less than the averageof the corporation’s interest expenses for such fiscal years, then thecorporation’s current assets must equal at least 1.25 times its currentliabilities. The Company was eligible to pay dividends at the end of 2004 and2005.

 

The availability of operating funds for the Company and theability of the Company to pay a cash dividend depends largely on the Bank’sability to pay a cash dividend to Bancorp. The payment of cash dividends by theBank is subject to restrictions. In general, dividends may not be paid from anyof the Bank’s capital. Dividends must be paid out of available net profits,after deduction of all current operating expenses, actual losses, accrueddividends on preferred stock, if any, and all federal and state taxes.Additionally, a bank is prohibited from declaring a dividend on its shares ofcommon stock until its surplus fund equals its common capital, or, if itssurplus fund does not equal its common capital, until at least one-tenth of thebank’s net profits, for the preceding half year in the case of quarterly orsemi-annual dividends, or the preceding full year in the case of an annualdividend, are transferred to its surplus fund each time dividends are declared.Regulatory approval is required if the total of all dividends declared by abank in any calendar year exceeds the total of its net profits for that yearcombined with its retained net profits of the two preceding years, less anyrequired transfers to surplus or a fund for the retirement of any preferredstock. Furthermore, bank regulators also have authority to prohibit the paymentof dividends by a bank when it determines such payment to be an unsafe andunsound banking practice.

 

17

----

 

Additionally, bank regulatory agencies have authority toprohibit banks from engaging in activities that, in their respective opinions,constitute unsafe and unsound practices in conducting its business. It ispossible, depending upon the financial condition of the bank in question andother factors, that the bank regulatory agencies could assert that the paymentof dividends or other payments might, under some circumstances, be an unsafe orunsound practice. Further, the bank regulatory agencies have establishedguidelines with respect to the maintenance of appropriate levels of capital bybanks or bank holding companies under their jurisdiction. Compliance with thestandards set forth in such guidelines and the restrictions that are or may beimposed under the prompt corrective action provisions of federal law couldlimit the amount of dividends which the Bank may pay.

 

Under these provisions and considering minimum regulatorycapital requirements, the Bank was eligible to pay dividends in 2004 and 2005.

 

The Company paid a $0.10 per share cash dividend onDecember 23, 2002 on its Common Stock, $0.05 per share on its 100,000 shares ofSeries A Preferred Stock outstanding, and $0.10 per share on its 20,500 sharesof Series B Preferred Stock outstanding, comprising a distribution in theaggregate amount of approximately $70,068.

 

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

 

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

 

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

 

The Bank paid a dividend to Bancorp in the amount of$70,068 in December 2002. In December 2005 the Bank paid a $90,085 dividend toBancorp. No dividend was paid from the Bank to Bancorp in 2003 or 2004.

 

Prior to the December 2002 dividends, no dividends had beenpaid by the Bank or the Company, and whether or not stock or cash dividendswill be paid in the future by the Company and/or the Bank will be determined bythe Board of Directors after consideration of various factors including, butnot limited to, profitability, regulatory capital ratios, and financialcondition. Additionally, certain provisions of the preferred stock issuancesrestrict the ability of the Company to pay cash dividends unless the requireddividends on the preferred stock are also paid.

 

**Trust Preferred Securities**

 

On October 10, 2003, Bancorp 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, Bancorp issued $3.093 million in Debentures to the Trust. Concurrently, the Trust issued $3.0 million of the Capital Securities to Bear, Stearns & Co., Inc., the initial purchaser, and $93,000 of Common Securities to Bancorp. 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 is treated as Tier 1 capital for regulatory purposes. The proceeds were used to increase the Bank’s capital by $2.0 million with the balance used for general corporate purposes.

 

The Debentures and Capital Securities mature in 2033 and bear a floating interest rate equal to the London Inter-Bank Offered Rate (“LIBOR”) plus 2.95%. The floating interest rate is adjustable quarterly with changes in LIBOR. The interest on the Debentures is tax 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.

 

18

----

 

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

 

**Equity Compensation Plans**

 

The following table shows, as of December 31, 2005, each category of equity compensation along with i) the number of securities to be issued upon the exercise of outstanding options, warrants and rights, ii) the weighted-average exercise price of the outstanding options, warrants and rights, and iii) the remaining number of securities available for future issuance under the plan, excluding stock options currently outstanding.

 

**Equity Compensation Plan Information**

 
| ** **                                                  | ** ** | **Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** | ** ** | **Weighted average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of  additional  securities available  for future grant   under the plan** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     |       | 143,233                                                                                                                                  |       | $                                                                                                            | 12.20      |                                                                                                                  | 7,134      |   |
|                                                        |       |                                                                                                                                     |       |                                                                                                         |       |                                                                                                                  |       |
| Equity compensation plans not approved by  security holders |       | —                                                                                                                                   |       | —                                                                                                       |       | —                                                                                                                |       |
|                                                        |       |                                                                                                                                     |       |                                                                                                         |       |                                                                                                                  |       |
| Total                                                       |       | 143,233                                                                                                                                  |       | $                                                                                                            | 12.20      |                                                                                                                  | 7,134      |   |

 

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

 

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

 

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

 

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

 

**Executive Summary**

 

At December 31, 2005, theCompany had total consolidated assets of $156.3 million, a 12% increase fromDecember 31, 2004. Total net loans increased 16%, to $118.3 million, over thatsame period. Deposits increased 13%, to $127.6 million and shareholders’ equityincreased 10%, to $11.0 million, over the past year.

 

The Company’s net income was$957 thousand, or $1.15 per diluted share, for the year ended December 31,2005. This compares with $1.49 million, or $1.84 per diluted share, in 2004.

 

The Company’s results for 2004included $1.333 million ($784 thousand after taxes) in grants received from theBank Enterprise Award (“BEA”) program sponsored by the U.S. TreasuryDepartment, Community Development Financial Institutions Fund. This award wasreceived in recognition of the increased levels of financial services the Bankhas provided to economically distressed communities. Negatively impactingearnings for 2004 was a $254 thousand ($149 thousand after taxes) provision forlosses on one of the Bank’s investment securities.

 

Excluding these unusualtransactions from the 2004 results, net income for 2005 would have been $100thousand higher than 2004 net income (as adjusted) and diluted earnings pershare would have increased by $0.10 over 2004’s diluted (adjusted) earnings pershare of $1.05.

 

19

----

 

 

The net interest margin for2005 was 5.02%, up 24 basis points from 2004. The Bank is asset sensitive (seethe *Asset and Liability Management* sectionof this discussion) and has benefited from the steady increase in short-terminterest rates over the past year and a half. Most economists expect short-terminterest rates to continue to rise during the first half of 2006, which wouldsuggest that further improvement in the interest margin would be likely in2006. However, in recent months the Bank has also experienced increasingpressure on the margin due to competition for deposits in the local market.Overall, the Bank expects to maintain its interest margin at approximately 5%,but does not expect to benefit significantly from increasing rates in 2006.

 

Due to a number of factors,including competition in the local market, SBA loans originated and sold weresignificantly lower in 2005 as compared to 2004. Gains on loan sales declined50% in 2005, from $685 thousand in 2004 to $344 thousand.

 

Credit quality remained high in2005, with non-performing loans decreasing by $130 thousand, or 63%, fromyear-end 2004, and $28 thousand of net charge-offs (0.03% of average loans) forthe year.

 

In 2006, management expects tocontinue to pursue the benefits related to CDFI products and services, althoughthere can be no assurance that any future BEA grants or awards will bereceived. In addition, appropriate opportunities for expansion will bedeveloped as they arise.

 

**Critical Accounting Policies**

** **

The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires the Company’s management to make estimates andassumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

A critical accounting policy isdefined as one that is both material to the presentation of the Company’sfinancial statements and requires management to make difficult, subjective orcomplex judgments that could have a material effect on the Company’s financialcondition and results of operations and may change in future periods. Note A tothe Consolidated Financial Statements describes the significant accountingpolicies used in the preparation of the Consolidated Financial Statements. Notall of these accounting policies require management to make difficult, subjectiveor complex judgments or estimates. However, management believes that thefollowing policies could be considered critical within the SEC’s definition.

 

*Reservesand Contingencies*

 

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

 

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

 

*Revenuerecognition*

 

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

 

The Company also records gainsin connection with the sale of the guaranteed portion of certain SBA-guaranteedloans for which the Bank retains the right to service the loans. Recording ofsuch gains involves the use of estimates and assumptions related to theexpected life of the loans and future cash flows. Notes A and C in the Notes tothe Consolidated Financial Statements contain additional information regardingthe Company’s accounting policy for revenue recorded in 

 

20

----

 

connection with the sale ofloans. SBA loan servicing rights are based upon estimates and are subject tothe risk of prepayments and market value fluctuation.

 

**SelectedFinancial Data**

 

The following is selectedconsolidated financial data with respect to the Company’s consolidatedfinancial statements for the two years ended December 31, 2005 and 2004. Theinformation presented has been derived from the audited consolidated financialstatements included in Item 7 of Part II of this Form 10-KSB. This informationshould be read in conjunction with such consolidated financial statements andthe notes thereto.

 
| ** **                                                                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **In thousands, except share and per share data** | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Interest income                                                                      |       | $                                          | 9,435      |   | $ | 7,425 |   |
| Interest expense                                                                     |       | 2,879                                      |       | 1,708 |   |
| Net interest income                                                                  |       | 6,556                                      |       | 5,717 |   |
| Provision for loan losses                                                            |       | 75                                         |       | 280 |   |
| Non-interest income                                                                  |       | 805                                        |       | 2,567 |   |
| Non-interest expense                                                                 |       | 5,714                                      |       | 5,494 |   |
| Income before income taxes                                                           |       | 1,572                                      |       | 2,510 |   |
| Income taxes                                                                         |       | 615                                        |       | 1,018 |   |
| Net income                                                                           |       | $                                          | 957        |   | $ | 1,492 |   |
|                                                                                 |       |                                       |       |   |   |
| **Balance Sheet Data at End of Year**                                                |       |                                       |       |   |   |
| Assets                                                                               |       | $                                          | 156,288    |   | $ | 139,249 |   |
| Earning assets                                                                       |       | 145,290                                    |       | 131,164 |   |
| Total loans                                                                          |       | 119,475                                    |       | 103,376 |   |
| Deposits                                                                             |       | 127,588                                    |       | 112,836 |   |
| Total shareholders’ equity                                                      |       | 10,981                                     |       | 10,027 |   |
| Preferred equity                                                                     |       | 1,084                                      |       | 1,084 |   |
| Common equity                                                                        |       | 9,897                                      |       | 8,943 |   |
| Number of common shares outstanding                                                  |       | 659,799                                    |       | 642,599 |   |
| **Average Balance Sheet Data**                                                       |       |                                       |       |   |   |
| Assets                                                                               |       | $                                          | 140,344    |   | $ | 129,022 |   |
| Earning assets                                                                       |       | 130,695                                    |       | 118,814 |   |
| Loans                                                                                |       | 108,289                                    |       | 95,205 |   |
| Deposits                                                                             |       | 115,016                                    |       | 108,644 |   |
| Shareholders’ equity                                                            |       | 10,451                                     |       | 9,240 |   |
| **Per Share Data**                                                                   |       |                                       |       |   |   |
| Basic earnings per share                                                             |       | $                                          | 1.25       |   | $ | 1.97 |   |
| Diluted earnings per share                                                           |       | 1.15                                       |       | 1.84 |   |
| Average number of shares outstanding -  basic                                        |       | 767,117                                    |       | 759,250 |   |
| Average number of shares outstanding -  diluted                                      |       | 828,576                                    |       | 812,979 |   |
| Book value per common share                                                          |       | $                                          | 15.00      |   | $ | 13.92 |   |
| Cash dividends declared                                                              |       | 0.12                                       |       | 0.12 |   |
| **Performance Ratios**                                                               |       |                                       |       |   |   |
| Return on average assets                                                             |       | 0.68                                       | %          | 1.16 | % |
| Return on average shareholders’ equity                                          |       | 9.16                                       | %          | 16.15 | % |
| Average equity to average assets                                                     |       | 7.45                                       | %          | 7.16 | % |
| Efficiency ratio                                                                     |       | 77.63                                      | %          | 65.76 | % |
| Leverage ratio                                                                       |       | 9.76                                       | %          | 9.62 | % |
| Net interest margin                                                                  |       | 5.02                                       | %          | 4.81 | % |
| Non-interest revenue to total revenue                                                |       | 10.94                                      | %          | 30.99 | % |
| **Asset Quality**                                                                    |       |                                       |       |   |   |
| Non-performing assets                                                                |       | $                                          | 76         |   | $ | 206 |   |
| Allowance for loan losses                                                            |       | 1,141                                      |       | 1,094 |   |
| Net charge-offs (recoveries)                                                         |       | 28                                         |       | (2 | ) |
| Non-performing assets to total assets                                                |       | 0.05                                       | %          | 0.15 | % |
| Allowance for loan losses to loans                                                   |       | 0.96                                       | %          | 1.06 | % |
| Net charge-offs to average loans                                                     |       | 0.03                                       | %          | 0.00 | % |

 

21

----

 

#### **Basis of Presentation**

#### ** **

The following discussion andanalysis is intended to assist in an understanding of the significant factorsthat affected our consolidated financial condition and results of operationsfor the years ended December 31, 2005 and 2004. This discussion, which refersto the Company on a consolidated basis, should be read in conjunction with theCompany’s consolidated financial statements and corresponding notes.

 

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

 

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

 

MCDC provides financing forsmall businesses and low- to moderate-income areas based on direct loans orfunding pools established in conjunction with others. MCDC currently providesloan servicing for the San Luis Obispo County Economic Vitality Corporation andhas one small community development loan outstanding. MCDC also services theSan Simeon Earthquake Recovery Loan Fund (the “Fund”), a loan pool funded bythe Bank and other local banks. This Fund is structured to provide low costfinancing to individuals and businesses in San Luis Obispo and northern SantaBarbara counties which experienced severe damage in the December 22, 2003, SanSimeon Earthquake. As of December 31, 2005, the Fund had $90,000 in loans outstandingand $317,000 available to lend. It is unlikely that the remainder of the Fundwill be used; no loans have been funded since October 2004.  In addition, MCDC services loans for the SanLuis Obispo County Housing Trust Fund.

 

MCSC provides technicalservices and training to the underserved segments of the community includingsmall businesses, minorities and low-income entrepreneurs, and providestechnical assistance to applicants for the Fund. As of December 31, 2005, theBank has had limited direct benefit from its association with MCSC. However,MCSC has received grants and loan funds and has developed a strategic plan toachieve its objectives.

 

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

 

The principal component ofearnings for most banks is net interest income. Net interest income is thedifference between the interest earned on loans and investments and theinterest paid on deposits and other interest-bearing liabilities.

 

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

 

22

----

 

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

 

***Net InterestAnalysis***

(dollars in thousands)

 
| ** **                                                                             | ** ** | **For the Years Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                             | ** ** | **December 31, 2005**        |       | **December 31, 2004** | ** ** |
| ** **                                                                             | ** ** | **Average**                            | ** ** | ** ** | ** ** | **Average** |   | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                                             | ** ** | **Balance**                            | ** ** | **Interest** | ** ** | **Rate** |   | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **Assets:**                                                                            |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                                               |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income                                                          |       | $                                      | 108,289    |   | $ | 8,625 |   | 7.96 | % | $ | 95,205 |   | $ | 6,685 |   | 7.02 | % |
| Investment securities                                                                  |       | 16,278                                 |       | 625 |   | 3.84 | % | 16,549 |   | 577 |   | 3.49 | % |
| Federal funds sold                                                                     |       | 4,429                                  |       | 137 |   | 3.09 | % | 5,043 |   | 71 |   | 1.41 | % |
| Interest-bearing deposits in other banks and  other interest income                    |       | 1,699                                  |       | 48 |   | 2.83 | % | 2,835 |   | 92 |   | 3.25 | % |
| **Total interest-earning assets / interest  income**                                   |       | 130,695                                |       | 9,435 |   | 7.22 | % | 119,632 |   | 7,425 |   | 6.21 | % |
| **Non-interest-earning assets:**                                                       |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan losses                                                              |       | (1,109                                 | )          |   |   |   |   | (960 | ) |   |   |   |   |
| Cash and due from banks                                                                |       | 3,321                                  |       |   |   |   |   | 3,942 |   |   |   |   |   |
| Premises and equipment                                                                 |       | 2,921                                  |       |   |   |   |   | 2,451 |   |   |   |   |   |
| Other assets                                                                           |       | 4,516                                  |       |   |   |   |   | 3,957 |   |   |   |   |   |
| **Total assets**                                                                       |       | $                                      | 140,344    |   |   |   |   |   | $ | 129,022 |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**                                          |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits:                                                             |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing demand accounts                                                       |       | $                                      | 4,851      |   | 57 |   | 1.18 | % | $ | 3,657 |   | 25 |   | 0.68 | % |
| Savings deposits                                                                       |       | 39,771                                 |       | 816 |   | 2.05 | % | 42,162 |   | 527 |   | 1.25 | % |
| Certificates of deposit                                                                |       | 47,001                                 |       | 1,365 |   | 2.90 | % | 41,101 |   | 745 |   | 1.81 | % |
| Total interest-bearing deposits                                                        |       | 91,623                                 |       | 2,238 |   | 2.44 | % | 86,920 |   | 1,297 |   | 1.49 | % |
| Federal funds purchased                                                                |       | 65                                     |       | 3 |   | 4.76 | % | 5 |   | 0 |   | 1.84 | % |
| Federal Home Loan Bank advances                                                        |       | 10,615                                 |       | 422 |   | 3.98 | % | 7,390 |   | 258 |   | 3.49 | % |
| Subordinated debt                                                                      |       | 3,093                                  |       | 216 |   | 6.98 | % | 3,093 |   | 153 |   | 4.94 | % |
| Total borrowed funds                                                                   |       | 13,773                                 |       | 641 |   | 4.65 | % | 10,488 |   | 411 |   | 3.92 | % |
| **Total interest-bearing liabilities / interest  expense**                             |       | 105,396                                |       | 2,879 |   | 2.73 | % | 97,408 |   | 1,708 |   | 1.75 | % |
| **Non-interest-bearing liabilities:**                                                  |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing deposits                                                          |       | 23,393                                 |       |   |   |   |   | 21,724 |   |   |   |   |   |
| Other liabilities                                                                      |       | 1,104                                  |       |   |   |   |   | 650 |   |   |   |   |   |
| Total liabilities                                                                      |       | 129,893                                |       |   |   |   |   | 119,782 |   |   |   |   |   |
| Stockholders’ equity                                                              |       | 10,451                                 |       |   |   |   |   | 9,240 |   |   |   |   |   |
| **Total liabilities and stockholders’ equity**                                    |       | $                                      | 140,344    |   |   |   |   |   | $ | 129,022 |   |   |   |   |   |
| **Net interest-rate spread**                                                           |       |                                   |       |   |   | 4.49 | % |   |   |   |   | 4.46 | % |
| Impact of non-interest-bearing sources and  other changes in balance sheet composition |       |                                   |       |   |   | 0.53 | % |   |   |   |   | 0.32 | % |
| **Net interest income / margin on  interest-earning assets**                           |       |                                   |       | $ | 6,556 |   | 5.02 | % |   |   | $ | 5,717 |   | 4.78 | % |

 

Nonaccrual loans are included in thecalculation of the average balances of loans; interest not accrued is excluded.Tax exempt income was not material for 2005 or 2004.

 

Net interest income is affectedby changes in the amount and mix of our interest-earning assets andinterest-bearing liabilities, referred to as the change due to *volume*. Average interest-earning assets grew by $11.1million in 2005 over 2004, primarily driven by loan volume—the most profitablecomponent of interest-earning assets. Interest-bearing liabilities increased$8.0 million over the past year. Net interest income is also affected bychanges in the yields we earn on interest-earning assets and the rates we payon interest-bearing deposits and borrowed funds, referred to as the change dueto *rate.*The average yield oninterest-earning assets increased by 101 basis points (1.01%) in 2005, whilethe average rate paid on interest-bearing liabilities increased by 98 basispoints.

 

23

----

 

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

 

***Rate / VolumeVariance Analysis***

(dollars in thousands)

 
| ** **                                     | ** ** | **Year Ended December 31, 2005**   | ** ** | **Year Ended December 31, 2004**   | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **Compared to 2004**               | ** ** | **Compared to 2003**               | ** ** |
| ** **                                     | ** ** | **Increase (Decrease)**            | ** ** | **Increase (Decrease)**            | ** ** |
| ** **                                     | ** ** | **in interest income and expense** | ** ** | **in interest income and expense** | ** ** |
| ** **                                     | ** ** | **due to changes in:**             | ** ** | **due to changes in:**             | ** ** |
| ** **                                     | ** ** | **Volume**                         | ** ** | **Rate**                           | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Interest-earning  assets:                      |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Loans, net of unearned income                  |       | $                                  | 981        |                               | $          | 959 |   | $ | 1,940 |   | $ | 2,020 |   | $ | (52 | ) | $ | 1,968 |   |
| Investment securities                          |       | (10                                | )          | 58                                 |       | 48 |   | 6 |   | (22 | ) | (16 | ) |
| Federal funds sold                             |       | (10                                | )          | 76                                 |       | 66 |   | (44 | ) | 25 |   | (19 | ) |
| Interest-bearing deposits in banks             |       | (33                                | )          | (11                                | )          | (44 | ) | (29 | ) | (23 | ) | (52 | ) |
| Total increase (decrease) in interest  income  |       | 928                                |       | 1,082                              |       | 2,010 |   | 1,953 |   | (72 | ) | 1,881 |   |
|                                           |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Transaction accounts                           |       | 10                                 |       | 22                                 |       | 32 |   | 5 |   | 10 |   | 15 |   |
| Savings deposits                               |       | (31                                | )          | 320                                |       | 289 |   | 72 |   | (26 | ) | 46 |   |
| Certificates of deposit                        |       | 119                                |       | 501                                |       | 620 |   | 133 |   | (86 | ) | 47 |   |
| Total interest-bearing deposits                |       | 98                                 |       | 843                                |       | 941 |   | 210 |   | (102 | ) | 108 |   |
| Federal funds purchased                        |       | 3                                  |       | —                             |       | 3 |   | — |   | — |   | — |   |
| FHLB advances                                  |       | 124                                |       | 40                                 |       | 164 |   | 192 |   | 16 |   | 208 |   |
| Other borrowings                               |       | —                             |       | 63                                 |       | 63 |   | 106 |   | — |   | 106 |   |
| Total borrowed funds                           |       | 127                                |       | 103                                |       | 230 |   | 298 |   | 16 |   | 314 |   |
| Total increase (decrease) in interest  expense |       | 225                                |       | 946                                |       | 1,171 |   | 508 |   | (86 | ) | 422 |   |
| Increase (decrease) in net interest income     |       | $                                  | 703        |                               | $          | 136 |   | $ | 839 |   | $ | 1,445 |   | $ | 14 |   | $ | 1,459 |   |

 

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

 

**Provisionfor Loan Losses**

 

The Bank makes provisions forloan losses when required to bring the total allowance for loan losses to alevel deemed appropriate. The determination of the appropriate level for theallowance is based on such factors as historical experience, the volume andtype of lending conducted, the amount of nonperforming loans, regulatorypolicies, general economic conditions, and other factors related to thecollectibility of loans in the portfolio. The provision for loan losses ischarged to earnings and totaled $75,000 for 2005, as compared to $280,000 for2004.

 

See *LendingActivities* and *Asset Quality*below for additional information on the provision and the allowance for loanlosses.

 

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

#### ** **

Non-interest income decreased$1.758 million in 2005 as compared to 2004, primarily due to a $1.241 millionBEA award received in the second half of 2004, and no similar awards receivedin 2005. The 2004 award was made in recognition of the Bank’s increased levelof lending activity in economically distressed communities in the Bank’s marketarea.  Because this award was based on past lending activity, the entireaward was recognized in non-interest income in 2004.

 

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

 

24

----

 

The Bank was awarded this cashpayment for investing $3 million in deposits in 2001 to 14 other certifiedCommunity Development Financial Institutions. The deposits were for 3 years andwere made at below market rates to assist the other CDFI’s to increase theirfinancing activities. The Bank recognized this award over the period from 2001through 2004, with the final $91,000 being taken into income in the first sixmonths of 2004.

 

In 2005 the Company received a$135,000 CDFI technical assistance grant to help offset any costs associatedwith providing additional services to the un- and under-banked in its marketarea. This grant is currently reflected in other liabilities in theconsolidated balance sheet and will be recognized in non-interest income asqualifying expenses are incurred. No such qualifying expenses had been incurredas of December 31, 2005. No assurance can be given that the Company willreceive any future BEA grants or awards.

 

The Bank derives a materialportion of its non-interest income from the sale of SBA guaranteed loans. Gainon Sale of SBA loans decreased by $321,000 in 2005 as compared to 2004. Due toa number of factors, including competition in the local market, SBA loansoriginated and sold were at a reduced level in 2005.

 

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

#### ** **

Non-interest expense increasedin 2005 by $220 thousand, or 4%.

 

Non-interest expenses that hadmaterial changes from 2004 to 2005 were:

•                  Salary andbenefits increased by $411 thousand, or 15%, due to a 13% increase in theaverage number of full-time-equivalent employees, normal salary increasesduring the year and increased employee benefit costs, particularly health careand workers’ compensation premiums.

•                  Occupancyexpenses increased by $127 thousand, or 29%. In January 2005, the Bank opened anew Business Banking Center in San Luis Obispo at a rental cost of $6,000 permonth, accounting for approximately $72 thousand of the increased occupancyexpense in 2005. Also contributing to the increase in occupancy expense was anadjustment to market value of the lease for the Paso Robles branch office,resulting in $44 thousand in additional rental payments in 2005.

•                  Furniture andequipment expense increased by $103 thousand, or 69%, due primarily todepreciation on computer hardware and software (up $51 thousand for the year)and on furniture and other equipment (an increase of $30 thousand from 2004 to2005).

•                  Marketing andbusiness development decreased by $127 thousand, or 32%. Included in marketingand business development for 2004 is a $250,000 grant to the non-profitaffiliate MCSC, to further MCSC’s mission of providing Central Coast andCentral California small businesses with technical assistance, counseling andtraining in finance, management, marketing procurement and access to the U. S.Small Business Administration’s programs and services. In 2005 the Companyrecognized a $75,000 contribution to MCSC related to its guarantee of MCSC’sborrowings (see Note L to the consolidated financial statements).

•                  The Bankrecognized in 2005 $45 thousand of direct costs related to the closing of theNipomo office. These costs included $30 thousand in losses on fixed assetsabandoned or sold, $13 thousand in lease exit costs and $2 thousand in movingand storage costs.

•                  2004’s resultsincluded a $254 thousand provision for losses on an impaired investmentsecurity. No additional provision was required for this security in 2005. SeeNote B to the consolidated financial statements for additional informationregarding investment securities.

 

#### **Income Taxes**

 

The Company’s combined federaland state effective income tax rate was 39.1% in 2005 and 40.6% in 2004. Thedecrease in the effective rate from 2004 to 2005 was primarily due to increasedtax-free income from bank-owned life insurance contracts. See Note H to theconsolidated financial statements for more information on income taxes.

 

#### **Liquidity Management**

 

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

 

The Bank’s liquidity, whichprimarily represents the ability to meet fluctuations in deposit levels andprovide for 

 

25

----

 

customers’ credit needs, ismanaged through various funding strategies that reflect the maturity structuresof the sources of funds and the assets being funded. The Bank’s liquidity isfurther augmented by payments of principal and interest on loans and increasesin short-term liabilities such as demand deposits and short-term certificatesof deposit. Short-term investments, primarily federal funds sold and federalfunds lines of credit provided by our correspondent banks, are the primarymeans for providing immediate liquidity. The Bank had $8.0 million in federalfunds sold on December 31, 2005, and $10.4 million on December 31, 2004.

 

In order to meet the Bank’sliquidity requirements, the Bank endeavors to maintain an appropriate liquidityratio. The liquidity ratio is the sum of cash and deposits at other banks,federal funds sold, and unpledged available-for-sale securities, divided bytotal deposits. As of December 31, 2005 and 2004, the Bank’s liquidity ratioswere 14.6% and 17.9%, respectively.

 

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

 

As of December 31, 2005, theBank had outstanding borrowings from the Federal Home Loan Bank of SanFrancisco (“FHLB”) of $13.4 million. Of the $13.4 million, $3 million wasborrowed for 10 years to offset a specific pool of the Bank’s fixed rate loansmaturing in 2013. Another $2.5 million was borrowed for five years to“match-fund” a pool of fixed rate loans maturing in 2009. Interest rates andterms for FHLB borrowings are generally more favorable than the rates forsimilar term certificates of deposit. The Bank has the potential (on a securedbasis) to borrow up to 20 percent of its total assets or an additional $18.3million from the FHLB. The Bank anticipates utilizing FHLB borrowings in 2006when needed as part of its normal liquidity management to fund asset growth ona cost-effective basis, and has more than adequate loans to pledge ascollateral should it need additional liquidity that cannot be funded bydeposits.

 

Following is a summary of theCompany’s contractual obligations extending beyond one year from December 31,2005:

 

**Long-Term Contractual Obligations**

 
| ** **                     | ** ** | **Less than**                   | ** ** | **1 thru 3** | ** ** | **3 thru 5** | ** ** | **More than** | ** ** | ** ** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|------------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **                     | ** ** | **1 year**                      | ** ** | **years**              | ** ** | **years**              | ** ** | **5 years**   | ** ** | **Total**  | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Borrowed funds                 |       | $                                    | 4,500      |                   | $          | 3,400                  |       | $                  | 2,000      |       | $          | 3,500 |   | $ | 13,400 |   |
| Junior subordinated debentures |       | —                               |       | —                 |       | —                 |       | 3,093              |       | 3,093      |       |
| Operating leases               |       | 210                                  |       | 330                    |       | 117                    |       | —             |       | 657        |       |
| Capital leases                 |       | —                               |       | —                 |       | —                 |       | —             |       | —     |       |
| Purchase obligations           |       | —                               |       | —                 |       | —                 |       | —             |       | —     |       |
| Other long-term liabilities    |       | —                               |       | 75                     |       | —                 |       | —             |       | 75         |       |
| Total contractual obligations  |       | $                                    | 4,710      |                   | $          | 3,805                  |       | $                  | 2,117      |       | $          | 6,593 |   | $ | 17,225 |   |

 

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

 

Bancorp is a company separateand apart from the Bank and must provide for its own liquidity. As of December31, 2005, Bancorp had no borrowings other than the junior subordinateddebentures reflected in the above table, and had approximately $261,000 inunrestricted cash. See Note Q to the consolidated financial statements foradditional financial information regarding Bancorp.

 

Substantially all of Bancorp’srevenues are obtained from dividends declared and paid by the Bank. There arestatutory and regulatory provisions that could limit the ability of the Bank topay dividends to Bancorp. See Note O to the consolidated financial statementsfor additional information regarding regulatory dividend and capitalrestrictions. Management believes that such restrictions will not have animpact on the ability of Bancorp to meet its ongoing cash obligations.

 

26

----

 

**InvestmentActivities**

 

Banks purchase and owninvestment securities for yield, to provide liquidity and to balance theoverall interest-rate sensitivity of its assets and liabilities. The Bank doesnot maintain a trading account.

 

Investment policies and limitshave been established by the board of directors. Investments can includefederally insured certificates of deposit, U.S. Treasury obligations and U.S.Government agency-backed securities, BBB-rated municipal bonds, AAA-ratedmortgage-backed and asset-backed securities, and A-rated corporate securities.Guidelines have been established for diversification of the portfolio amongthese investment categories and per-transaction limits as well. The Bank’s chieffinancial officer reports investment activity to the Board on a monthly basisand quarterly to the Investment Committee.

 

Investment goals are to obtainthe highest yield consistent with maintaining a stable overall asset andliability position while limiting economic risks. In accordance with thispolicy, management actively manages its investment portfolio between availablefor sale and held to maturity investments, the composition of which has shiftedover time. Due to a change in investment strategy in 2005, all securities inthe held-to-maturity category were reclassified to available-for-sale. Thischange in investment strategy is intended to improve the Bank’s financialflexibility.

 

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

 

**Investmentsecurities composition**

 
| ** **                                         | ** ** | **December 31, 2005**      | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | ** **                           | ** ** | **Approx.**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Approx.** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Amortized**                        | ** ** | **Market**                      | ** ** | **%** | ** ** | **Amortized** | ** ** | **Market** | ** ** | **%** | ** ** |
| ** **                                         | ** ** | **Cost**                             | ** ** | **Value**                       | ** ** | **Yield** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Yield** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands)** | ** ** |
| U.S. Government agencies:                          |       |                                 |       |                            |       |   |   |   |   |   |   |   |   |
| Within one year                                    |       | $                                    | —     |                            | $          | — |   |   |   | $ | — |   | $ | — |   |   |   |
| One to five years                                  |       | 4,499                                |       | 4,377                           |       | 3.63 | % | 4,000 |   | 3,959 |   | 3.24 | % |
| Five to ten years                                  |       | 1,500                                |       | 1,480                           |       | 4.32 | % | 1,500 |   | 1,500 |   | 4.15 | % |
| After 10 years                                     |       | 999                                  |       | 951                             |       | 4.31 | % | 1,498 |   | 1,460 |   | 4.21 | % |
| Total U.S. Government agencies                     |       | 6,998                                |       | 6,808                           |       | 3.87 | % | 6,998 |   | 6,919 |   | 3.64 | % |
| Mortgage-backed and asset-backed  securities:      |       |                                 |       |                            |       |   |   |   |   |   |   |   |   |
| Within one year                                    |       | —                               |       | —                          |       |   |   | — |   | — |   |   |   |
| One to five years                                  |       | 962                                  |       | 934                             |       | 3.72 | % | 1,272 |   | 1,265 |   | 3.59 | % |
| Five to ten years                                  |       | 426                                  |       | 419                             |       | 4.70 | % | 576 |   | 582 |   | 4.65 | % |
| After 10 years                                     |       | 7,756                                |       | 7,655                           |       | 4.20 | % | 6,950 |   | 6,966 |   | 3.76 | % |
| Total mortgage-backed and asset-backed  securities |       | 9,144                                |       | 9,008                           |       | 4.17 | % | 8,798 |   | 8,813 |   | 3.80 | % |
| Total investment securities                        |       | $                                    | 16,142     |                            | $          | 15,816 |   | 4.04 | % | $ | 15,796 |   | $ | 15,732 |   | 3.73 | % |

 

The nonaccrual security is included in theamortized cost and market value of securities. Yields reflect no interest incomeon the nonaccrual security. No tax equivalent adjustment has been made to theweighted average yields in the above table because the Bank did not have anytax-exempt investments and the end of 2004 or 2005.

 

During 2004, managementestablished a loss reserve for one of the Bank’s asset-backed securities afterconcluding it was “other than temporarily impaired.”  The security is in non-accrual status, withany interest payments received being credited to the reserve. As of December31, 2005, the gross book value of the security was $353,464 and the reserve was$237,500, for a net book value of $115,964.

 

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

 

27

----

** **

**Asset and 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. Even with perfectly matched repricing of assetsand liabilities, risks remain in the form of prepayment of assets, and timinglags in adjusting certain assets and liabilities that have varyingsensitivities to market interest rates.

 

The table below sets forth the interest rate sensitivity ofinterest-earning assets and interest-bearing liabilities as of December 31,2005. 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.

 
| **Interest  Sensitivity Gap**                | ** ** | ** **                                               | ** ** | ** **            | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|-----------------|------------|---------------|------------|
| ** **                                   | ** ** | ** **                                               | ** ** | ** **            | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| *December  31, 2005*                         | ** ** | ** **                                               | ** ** | ** **            | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    | ** ** |
| ** **                                   | ** ** | * *                                                 | ** ** | ** **            | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Sensitive to Rate Changes Within** | ** ** | ** **            | ** ** | ** **           | ** ** |
| ** **                                   | ** ** | **3**                                                    | ** ** | **4 to 12** | ** ** | **1 to 5** | ** ** | **Over 5** | ** ** | **Non-Rate-** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Months**                                               | ** ** | **Months**            | ** ** | **Years**            | ** ** | **Years**       | ** ** | **Sensitive** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)**                     | ** ** |
| **Earning  Assets:**                         | ** ** | ** **                                               | ** ** | ** **            | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| Loans, net of  unearned income               |       | $                                                        | 85,347     |                  | $          | 17,343               |       | $               | 16,343     |          | $          | 914 |   | $ | (472 | ) | $ | 119,475 |   |
| Investment  securities                       |       | 554                                                      |       | 2,736                 |       | 10,913               |       | 1,939           |       | (326          | )          | 15,816 |   |
| Other earning  assets                        |       | 9,524                                                    |       | 2,360                 |       | 250                  |       |            |       | —        |       | 12,134 |   |
| Non-interest-earning  assets                 |       | —                                                   |       | —                |       | —               |       | —          |       | 8,863         |       | 8,863 |   |
| Total assets                                 |       | 95,425                                                   |       | 22,439                |       | 27,506               |       | 2,853           |       | 8,065         |       | 156,288 |   |
|                                         |       |                                                     |       |                  |       |                 |       |            |       |          |       |   |   |
| **Interest-Bearing  Liabilities:**           |       |                                                     |       |                  |       |                 |       |            |       |          |       |   |   |
| Interest-bearing  deposits                   |       | 68,837                                                   |       | 29,127                |       | 1,654                |       | —          |       | —        |       | 99,618 |   |
| Borrowed funds                               |       | —                                                   |       | 4,500                 |       | 5,400                |       | 3,500           |       | —        |       | 13,400 |   |
| Junior  subrdinated debentures               |       | 3,093                                                    |       | —                |       | —               |       | —          |       | —        |       | 3,093 |   |
| Non-interest-bearing  liabilities and equity |       | —                                                   |       | —                |       | —               |       | —          |       | 40,177        |       | 40,177 |   |
| Total liabilities  and equity                |       | 71,930                                                   |       | 33,627                |       | 7,054                |       | 3,500           |       | 40,177        |       | 156,288 |   |
|                                         |       |                                                     |       |                  |       |                 |       |            |       |          |       |   |   |
| Interest rate  sensitivity gap               |       | $                                                        | 23,495     |                  | $          | (11,188              | )          | $               | 20,452     |          | $          | (647 | ) | $ | (32,112 | ) | $ | — |   |
|                                         |       |                                                     |       |                  |       |                 |       |            |       |          |       |   |   |
| Cumulative  interest rate sensitivity gap    |       | $                                                        | 23,495     |                  | $          | 12,307               |       | $               | 32,759     |          | $          | 32,112 |   | $ | — |   |   |   |
|                                         |       |                                                     |       |                  |       |                 |       |            |       |          |       |   |   |
| Cumulative gap to  total earning assets      |       | 15                                                       | %          | 8                     | %          | 21                   | %          | 21              | %          |          |       |   |   |

 

Gap analysis attempts to capture interest rate risk, which is attributableto the mismatching of interest rate sensitive assets and liabilities. Apositive cumulative gap, as shown in the table, means that over the periodsindicated our assets will reprice faster than our liabilities. During the firstyear $118 million of the interest earning assets are expected to reprice,compared with $106 million of interest bearing liabilities—a slightlyasset-sensitive structure. However, during the first three months $95 millionof interest earning assets will reprice, but only $72 million ofinterest-bearing liabilities—a higher degree of asset sensitivity in the firstfew months of a period of rate changes. In general, this means that in a risinginterest rate environment, with all other conditions remaining constant, netinterest income would be expected to increase, and in a declining interest rateenvironment net interest income would be expected to decrease.

 

The actual impact of interest rate movements on net interest income maydiffer from that implied by any gap measurement, depending on the direction andmagnitude of the interest rate movements, the repricing characteristics ofvarious on and off-balance sheet instruments, as well as competitive pressures.Changes in the mix of earning assets or supporting liabilities can eitherincrease or decrease the net interest margin without affecting interest ratesensitivity. In addition, varying interest rate environments can createunexpected changes in prepayment levels of assets and liabilities that are notreflected in the interest rate sensitivity analysis. Prepayments may havesignificant impact on our net interest margin. These factors are not fullyreflected in the foregoing gap analysis and, as a result, the gap report maynot provide a complete assessment of our interest rate risk.

 

Based on current economic forecasts, the Bank anticipates that interestrates will continue to rise in the first half of 2006, which would suggest thatimprovement in the interest margin would be likely in 2006. However, in recentmonths the Bank has also experienced increasing pressure on the net interestmargin due to competition for deposits in the local 

 

28

----

 

market. Overall, the Bank expects to maintain its net interest marginat approximately 5%, but does not expect to benefit significantly fromincreasing rates in 2006.

 

#### **Lending Activities**

#### ** **

The Bank originates loans, participates in loans from other banks andstructures loans for possible sale in the secondary market.

 

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

 
| **Loan  Portfolio Composition** | ** ** | ** **                            | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|----------------|------------|
| *(Dollars  in thousands)*       | ** ** | ** **                            | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** |
| * *                        | ** ** | ** **                            | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                      | ** ** | **As of December 31,** | ** ** |
| ** **                      | ** ** | **2005**                              | ** ** | **2004**       | ** ** |
| **Type of Loan**      | ** ** | **Amount**                            | ** ** | **Percentage** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Commercial                      |       | $                                     | 15,005     |           | 12.56      | %          | $          | 16,178         |       | 15.65 | % |
| Agricultural                    |       | 152                                   |       | 0.13           | %          | 774        |       | 0.75           | %          |
| Real estate                     |       | 71,878                                |       | 60.16          | %          | 60,445     |       | 58.47          | %          |
| Construction                    |       | 29,921                                |       | 25.04          | %          | 24,394     |       | 23.60          | %          |
| Consumer                        |       | 2,519                                 |       | 2.11           | %          | 1,585      |       | 1.53           | %          |
| Total loans                     |       | $                                     | 119,475    |           | 100.00     | %          | $          | 103,376        |       | 100.00 | % |
|                            |       |                                  |       |           |       |       |       |           |       |
| Off-balance-sheet commitments:  |       |                                  |       |           |       |       |       |           |       |
| Undisbursed loan commitments    |       | $                                     | 37,379     |           |       |       | $          | 29,793         |       |   |   |
| Standby letters of credit       |       | 203                                   |       |           |       | 123        |       |           |       |
|                                 |            |                                       |            |                |            |            |            |                |            |  |  |  |  |  |

 

The following table sets forth as of December 31, 2005, the maturitiesand sensitivities of loans to interest rate changes:

 

**Maturity and Rate Sensitivity of Loans**

*(Dollars in thousands)*

 
| ** **     | ** ** | ** **        | ** ** | ** **                                  | ** ** | ** **         | ** ** | ** ** | ** ** | **Rate Structure for Loans** | ** ** |
|----------------|------------|-------------------|------------|---------------------------------------------|------------|--------------------|------------|------------|------------|---------------------------------------------|------------|
| ** **     | ** ** | **Maturity**      | ** ** | **Maturing Beyond One Year** | ** ** |
| ** **     | ** ** | **One year** | ** ** | **One through**                        | ** ** | **Over five** | ** ** | ** ** | ** ** | **Fixed**                                   | ** ** | **Floating** | ** ** |
| ** **     | ** ** | **or less**  | ** ** | **five years**                         | ** ** | **years**          | ** ** | **Total**  | ** ** | **Rate**                                    | ** ** | **Rate** | ** ** |
| Commercial     |       | $                 | 10,530     |                                        | $          | 3,600              |       | $          | 875        |                                        | $          | 15,005 |   | $ | 4,475 |   | $ | — |   |
| Agricultural   |       | 152               |       | —                                      |       | —             |       | 152        |       | —                                      |       | — |   |
| Real estate    |       | 24,632            |       | 17,251                                      |       | 29,995             |       | 71,878     |       | 32,286                                      |       | 14,960 |   |
| Construction   |       | 28,596            |       | 850                                         |       | 475                |       | 29,921     |       | 708                                         |       | 617 |   |
| Consumer Loans |       | 509               |       | 648                                         |       | 1,362              |       | 2,519      |       | 2,010                                       |       | — |   |
| Total Loans    |       | $                 | 64,419     |                                        | $          | 22,349             |       | $          | 32,707     |                                        | $          | 119,475 |   | $ | 39,479 |   | $ | 15,577 |   |

 

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

 

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

 

The Bank is active in construction lending for interim loans to financethe construction of commercial and single family residential property. Constructionloans totaled $29.9 million as of December 31, 2005, a $5.5 million increasefrom a year earlier. These loans are typically extended for terms of no morethan 12 to 18 months. Generally, the Bank does not provide loans forspeculative purposes except to known builders who have a track record ofsuccessful projects and the expertise and financial strength for the particulartype of building.

 

Residential real estate loans are generally limited to home equityloans and home equity lines of credit. The Bank has not

 

29

----

 

been active in residential real estate lending.

 

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 and are secured by theproperty. The Bank offers both fixed and variable rate loans with maturitieswhich generally do not exceed 25 years. Exceptions are made for SBA-guaranteedloans secured by real estate, or for other commercial real estate loans whichcan be readily sold in the secondary market.

 

The Bank makes SBA-guaranteed loans and generally sells the guaranteedportion of the SBA loans in the secondary market while retaining the servicingrights for those loans. At December 31, 2005 and 2004, the Bank servicedapproximately $32.2 million and $33.0 million, respectively, in SBA loans.

 

#### **Asset Quality**

#### ** **

The risk of nonpayment of loans is inherent in the banking business.That risk varies with the type and purpose of the loan, the collateral which isutilized to secure payment and, ultimately, the creditworthiness of theborrower. In order to minimize this credit risk, all loans exceeding lendingofficers’ individual lending limits are reviewed and approved by a ManagementLoan Committee. Loans exceeding the Management Loan Committee’s authorizationare reviewed and approved by the Loan Committee of the board of directors. TheBoard Loan Committee is comprised of outside directors and the Bank’s chiefexecutive officer.

 

Loan grades are assigned based on a risk assessment of each loan. Loanswith minimum risk are graded as “pass,” with other classifications of “specialmention,” “substandard,” “doubtful” and “loss,” depending on credit quality. Loansgraded “substandard” or “doubtful” are considered “classified” loans, and loansgraded “loss” are charged off. As these loans are identified in our reviewprocess, they are added to the internal watch list and a loss allowance isestablished for them of at least the following amounts:  special mention – 5%, substandard – 15%, doubtful– 50%, and loss – 100%. These amounts are reduced only if circumstances for aparticular loan are such that the Bank is clearly insulated from loss. The Bankengages an outside firm to perform, at least quarterly, a review of the loanportfolio, and to test the adequacy of the allowance for loan losses. Inaddition, loans are examined periodically by the Bank’s federal and stateregulators.

 

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

 
| **Non-Performing  Assets**                               | ** ** | ** **                            | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|
| *(Dollars  in thousands)*                                | ** ** | ** **                            | ** ** | ** ** | ** ** |
|                                                     | ** ** | ** **                            | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **As of December 31,** | ** ** |
| ** **                                               | ** ** | **2005**                              | ** ** | **2004**   | ** ** |
| Loans on nonaccrual status                               |       | $                                     | 76         |       | $          | 206 |   |
| Loans past due 90 days or more and accruing              |       | —                                |       | —     |       |
| Restructured loans                                       |       | —                                |       | —     |       |
| Total nonperforming loans                                |       | 76                                    |       | 206        |       |
| Other real estate owned                                  |       | —                                |       | —     |       |
| Total nonperforming assets                               |       | $                                     | 76         |       | $          | 206 |   |
|                                                     |       |                                  |       |       |       |
| Allowance for loan losses                                |       | $                                     | 1,141      |       | $          | 1,094 |   |
|                                                     |       |                                  |       |       |       |
| Asset quality ratios:                                    |       |                                  |       |       |       |
| Non-performing assets to total assets                    |       | 0.05                                  | %          | 0.15       | %          |
| Non-performing loans to total loans                      |       | 0.06                                  | %          | 0.20       | %          |
| Allowance for loan losses to total loans                 |       | 0.96                                  | %          | 1.06       | %          |
| Allowance for loan losses to total non-performing  loans |       | 1501                                  | %          | 531        | %          |

 

Nonaccrual loans are loans which management believes may not be fullycollectible as to principal and interest. Generally, loans are placed innonaccrual status when they are 90 days or more past due. Restructured loansare those loans with concessions in interest rates or repayment terms due to adecline in the financial condition of the borrower. Other real estate owned isacquired in satisfaction of loans through foreclosure or other means and iscarried on an individual asset basis at the lower of the recorded investment inthe related loan or the estimated fair value of the property, less selling expenses.

 

30

----

 

 

 

Once placed in nonaccrual status, a loan is not returned to accrualstatus until it is brought current with respect to both principal and interestpayments, the loan is performing to current terms and conditions, the interestrate is commensurate with market interest rates and future principal andinterest payments are no longer in doubt, at which time a further review of theloan is conducted.

 

As of December 31,2005, 89% of the nonaccrual loans were SBA loans,with $58,000 of the total guaranteed by the SBA. At December 31, 2004, 93% ofthe Bank’s nonaccrual loans were SBA loans, and $159,000 of the total wasguaranteed by the SBA.

 

The Bank has no foreign loans.

 

**Potential Problem Loans**

 

At December 31, 2005, the Companyhad approximately $4.2 million of loans that were not classified asnon-performing but for which known information about the borrower’s financialcondition caused management to have concern about the ability of the borrowersto comply with the repayment terms of the loans. These loans were identifiedthrough the loan review process described above. Based on the evaluation ofcurrent market conditions, loan collateral, other secondary sources ofrepayment and cash flow generation, management does not anticipate anysignificant losses related to these loans. One of these potential problemloans, representing $1.8 million of the total, was paid in full during thefirst quarter of 2006. These loans are subject to continuing managementattention and are considered in the determination of the allowance for loanlosses.

 

While credit quality, as measuredby loan delinquencies and by the Bank’s internal risk grading system, appearsto be satisfactory as of December 31, 2005, there can be no assurances that newproblem loans will not develop in future periods. A decline in economicconditions in the Bank’s market area or other factors could adversely impactindividual borrowers or the loan portfolio in general. The Bank has well definedunderwriting standards and expects to continue with prompt collection efforts,but economic uncertainties or changes may cause one or more borrowers toexperience problems in the coming months.

 

**Loan Concentrations**

 

The Board of Directors has approved concentration levels (as apercentage of capital) for various loan types based on the Bank’s business planand historical loss experience. On a quarterly basis, management provides aloan concentration report to the board with information relating to concentrations.Management’s review of possible concentrations includes an assessment of loansto multiple borrowers engaged in similar activities which would cause them tobe similarly impacted by economic or other conditions. Management is not awareof any such concentrations in similar activities.

 

31

----

 

The following table reflects the major concentrations in the loanportfolio, by type of loan, as of December 31, 2005:

 
| **Loan Concentrations**                           |       |       |       |                                  |       |
|---------------------------------------------------|------------|------------|------------|---------------------------------------|------------|
| December 31, 2005                                 |       |       |       |                                  |       |
| *(Dollars in thousands)*                          |       |       |       |                                  |       |
| * *                                          |       |       |       |                                  |       |
| **Type of Loan**                        | ** ** | **Amount** | ** ** | **Percent of  Total Loans** | ** ** |
|                                              |       |       |       |                                  |       |
| Construction and land development                 |       | $          | 29,921     |                                  | 25.0       | % |
| Other real estate loans (by type of  collateral): |       |       |       |                                  |       |
| Non-farm, non-residential property                |       | 56,000     |       | 46.9                                  | %          |
| 1 to 4 family residential - 1st liens             |       | 1,190      |       | 1.0                                   | %          |
| 1 to 4 family residential - Jr. liens             |       | 8,528      |       | 7.1                                   | %          |
| Multi-family residential                          |       | 5,147      |       | 4.3                                   | %          |
| Farmland                                          |       | 1,013      |       | 0.8                                   | %          |
| Total real estate-secured loans                   |       | 101,799    |       | 85.1                                  | %          |
| Commercial loans and leases                       |       | 15,005     |       | 12.7                                  | %          |
| Agricultural loans                                |       | 152        |       | 0.1                                   | %          |
| Consumer loans                                    |       | 2,519      |       | 2.1                                   | %          |
| Total loans                                       |       | $          | 119,475    |                                  | 100.0      | % |

 

The table shows a concentration in commercial real estate loans(construction loans and loans secured by non-farm, non-residential and multi-familyresidential properties). However, these loans are well secured and the Bank hasexperienced no losses in real estate lending since the inception of the Bank.

 

The Bank’s analysis of loan concentrations compared to a Californiapeer group of 50 banks suggests that the Bank does not have an unusually highreal estate concentration compared to other similar sized banks in California. Banksin California typically are more prone than banks in other states to use realestate collateral for many commercial loans for business purposes wherecollateral is taken as an abundance of caution. In its analysis of real estateconcentrations, the Bank carefully considers economic trends and real estatevalues. The commercial real estate market in San Luis Obispo County remainsstrong, with good demand, limited vacancies and rising rents.

 

32

----

 

#### **Allowance for LoanLosses**

#### ** **

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

 
| **Summary of Loan Loss Experience**       |       |     |       |     |       |
|-------------------------------------------|------------|----------|------------|----------|------------|
| *(Dollars in thousands)*                  |       |     |       |     |       |
| * *                                  |       |     |       |     |       |
| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                      |       |     |       |     |       |
| Balance at beginning of year              |       | $        | 1,094      |     | $          | 812 |   |
| Loans charged off:                        |       |     |       |     |       |
| Real Estate                               |       | —   |       | —   |       |
| Commercial                                |       | (24      | )          | (1       | )          |
| Consumer                                  |       | (7       | )          | —   |       |
| Other                                     |       | —   |       | —   |       |
| Total loans charged off                   |       | (31      | )          | (1       | )          |
| Recoveries:                               |       |     |       |     |       |
| Real Estate                               |       | —   |       | —   |       |
| Commercial                                |       | 1        |       | 3        |       |
| Consumer                                  |       | 2        |       | —   |       |
| Other                                     |       | —   |       | —   |       |
| Total recoveries                          |       | 3        |       | 3        |       |
| Net recoveries (charge-offs)              |       | (28      | )          | 2        |       |
| Provision charged to operations           |       | 75       |       | 280      |       |
| Balance at end of year                    |       | $        | 1,141      |     | $          | 1,094 |   |
|                                      |       |     |       |     |       |
| Ratio of net charge-offs to average loans |       | 0.03     | %          | 0.00     | %          |
| Ratio of provision to average loans       |       | 0.07     | %          | 0.29     | %          |

 

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. Systematicreviews follow the methodology set forth by various regulatory policystatements on the allowance for loan losses.

 

A key element of the Bank’s methodology is the previously discussedcredit classification process. As of December 31, 2005, the Bank did notestablish special reserves for individual loans based on specific anticipationof loss to the portfolio. The inherent risk present in the “acceptable” portionof the loan portfolio is taken into consideration and adjustments made fortrends, changes in economic conditions and other relevant factors that mayaffect 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. Althoughmanagement uses available information to recognize losses on loans and leases,future additions to the allowance may be necessary based on changes in economicconditions. In addition, federal regulators periodically review our allowancefor loan losses and may recommend additions based upon their evaluation of theportfolio at the time of their examination. Accordingly, there can be noassurance that our allowance for loan losses will be adequate to cover futureloan losses or that significant additions to the allowance for loan losses willnot be required in the future. Material additions to the allowance for loanlosses would decrease earnings and capital and would thereby reduce the Bank’sability to pay dividends, among other adverse consequences.

 

The ratio of allowance for loan losses to total loans as of December31, 2005 was 0.96%. Management and the board consider this to be adequate basedon their analysis and reviews of the portfolio.

 

33

----

 

As part of the analysis of the allowance, the Bank assigns certain riskfactors to the entire loan portfolio in addition to the specific percentagesused for classified loans. The following table summarizes the allocation of theallowance for loan losses by general loan types based on collateral or securitytype as used internally by the Bank as of December 31, 2005 and 2004.

 
| ** **                           | ** ** | **December 31, 2005** | ** ** | **December 31, 2004**   | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-----------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Loans**                       | ** ** | **Percent  of Total  Loans** | ** ** | **Allowance  Allocation** | ** ** | **% of Total  Allowance** | ** ** | **Loans** | ** ** | **Percent  of Total  Loans** | ** ** | **Allowance  Allocation** | ** ** | **% of Total  Allowance** | ** ** |
| Unclassified  loans:                 |       |                            |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate                          |       | $                               | 93,588     |                              | 78.4       | % | $ | 431 |   | 37.8 | % | $ | 77,143 |   | 74.6 | % | $ | 309 |   | 28.2 | % |
| Other secured  loans                 |       | 20,649                          |       | 17.3                              | %          | 295 |   | 25.9 | % | 24,415 |   | 23.6 | % | 338 |   | 30.9 | % |
| Unsecured loans                      |       | 1,006                           |       | 0.8                               | %          | 21 |   | 1.8 | % | 623 |   | 0.6 | % | 14 |   | 1.3 | % |
| Total  unclassified loans            |       | 115,243                         |       | 96.5                              | %          | 747 |   | 65.5 | % | 102,181 |   | 98.8 | % | 661 |   | 60.4 | % |
| Classified loans                     |       | 4,232                           |       | 3.5                               | %          | 376 |   | 32.9 | % | 1,195 |   | 1.2 | % | 155 |   | 14.2 | % |
| Other economic  factors              |       |                            |       |                              |       | 18 |   | 1.6 | % |   |   |   |   | 278 |   | 25.4 | % |
| Totals                               |       | $                               | 119,475    |                              | 100.0      | % | $ | 1,141 |   | 100.0 | % | $ | 103,376 |   | 100.0 | % | $ | 1,094 |   | 100.0 | % |

 

**Deposits**

 

Deposits are the primary source of funding for lending and investingneeds. Total deposits were $127.6 million as of December 31, 2005, and $112.8million at December 31, 2004. Deposits increased by $14.8 million, or 13%,following a $16.5 million, or 17%, increase in 2004.

 

The Bank generally prices deposits at or above the median rate byclassification based on periodic interest rate surveys in the local market. Depositrates are then adjusted to balance the cost of funds versus funding needs andasset and liability considerations. The Bank has used and expects to continueto use an Investor Savings product that pays higher rates than normal savings,similar to money market accounts, as a special product unique in the Bank’smarket, but management also expects to see the relative percentage of InvestorSavings to total deposits to continue to decline. The *Net InterestAnalysis* and *Rate/Volume Analysis*earlier in this Discussion contains information regarding the average ratespaid on deposits for 2005 and 2004.

 

The following table reflects the maturity distribution of certificatesof deposit in the amounts of $100,000 or more as of December 31, 2005:

 
| **Maturities of Time Deposits of $100,000 or More** |   |   |   |
|-----------------------------------------------------|--------|--------|--------|
| *(Dollars in thousands)*                            |   |   |   |
|                                                |   |   |   |
| Three months or less                                |   | $      | 13,355 |   |
| Three months to six months                          |   | 14,022 |   |
| Six months to one year                              |   | 6,585  |   |
| Over one year                                       |   | 1,221  |   |
| Total time deposits of $100,000 or more             |   | $      | 35,183 |   |

#### ** **

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

#### ** **

As of December 31, 2005, the Bank had $13.4 million in outstandingborrowings from the Federal Home Loan Bank of San Francisco, $4.5 million ofwhich matures during 2006, and the balance matures on various dates from August2007 through December 2013. Note F to the consolidated financial statements containsadditional information regarding these borrowings.

 

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

#### ** **

In the normal course of business, the Bank enters into financialcommitments to customers, primarily to extend credit. Those instrumentsinvolve, to varying degrees, elements of credit and interest rate risk notrecognized in the statement of financial position. As of December 31, 2005, theBank had outstanding commitments to extend credit totaling $37.4 million andstandby letters of credit totaling approximately $200 thousand. See Note M tothe consolidated financial statements for additional information onoff-balance-sheet commitments and contingencies.

 

34

----

 

The Bank has not entered into any off-balance-sheet derivativefinancial instruments as of December 31, 2005.

 

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

#### ** **

A financial institution’s asset and liability structure issubstantially different from that of an industrial firm in that primarily allassets and liabilities of a bank are monetary in nature, with relatively littleinvestments in fixed assets or inventories. Inflation has an important impacton the growth of total assets and the resulting need to increase equity capitalat higher than normal rates in order to maintain an appropriate equity toassets ratio. Management believes that the impact of inflation on financialresults depends on the Company’s ability to react to changes in interest ratesand, by such reaction, reduce the inflationary impact on performance. Managementhas attempted to structure the mix of financial instruments and manage interestrate sensitivity in order to minimize the potential adverse effects ofinflation 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 noassurance that the economy will continue to improve and that real estate valueswill continue to increase in the short term. As such, the Bank closely monitorscredit quality, interest rate risk and operational expenses.

 

**Return on Equity and Assets**

 

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

 
| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Return on Average Assets |       | 0.68     | %          | 1.16     | %          |
| Return on Average Equity |       | 9.16     | %          | 16.15    | %          |

 

35

----

 

## **Item 7. FinancialStatements**

## ** **

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATED FINANCIAL STATEMENTS**

**WITH**

**INDEPENDENT AUDITORS’ REPORT**

 

**December 31, 2005 and 2004**

 

36

----

 

**CONTENTS**

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

 

37

----

 
|  | Vavrinek, Trine, Day & Co., LLP |  |
|--|-------------------------------------|--|

 

#### **REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

 

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, 2005 and 2004 and therelated consolidated statements of income, changes in shareholders’ equity, andcash flows of the years then ended. These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

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

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Mission Community Bancorp and Subsidiary as of December 31, 2005and December 31, 2004, and the results of its operations and its cash flows forthe years then ended, in conformity with accounting principles generallyaccepted in the United States of America.

 

 

 

Laguna Hills, California

February 2, 2006

 
|   25231 Paseo De Alicia, Suite 100  Laguna Hills, CA  92653   Tel: 949.768.0833  Fax:  949.768.8408  www.vtdcpa.com |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                   |
|   FRESNO  •  LAGUNA HILLS   •  PALO ALTO   •  PLEASANTON   •  RANCHO CUCAMONGA   |

 

38

----

** **

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

**December 31, 2005 and 2004**

 
| ** **                                             | ** ** | **2005** | ** **  | **2004**    | ** **  |
|--------------------------------------------------------|------------|----------|-------------|-------------|-------------|
| **ASSETS**                                             |       |     |        |        |        |
|                                                   |       |     |        |        |        |   |
| Cash and Due from Banks                                |       |     | $           | 4,432,733   |        | $ | 2,587,235 |   |
| Federal Funds Sold                                     |       |     | 7,950,000   |        | 10,385,000  |   |
| **TOTAL  CASH AND CASH EQUIVALENTS**                   | ** ** |     | 12,382,733  |        | 12,972,235  |   |
|                                                   |       |     |        |        |        |   |
| Certificates of Deposit in Other Banks                 |       |     | 550,000     |        | 550,000     |   |
|                                                   |       |     |        |        |        |   |
| Investment Securities:                                 |       |     |        |        |        |   |
| Investment Securities Available for Sale               |       |     | 15,815,704  |        | 6,727,055   |   |
| Investment Securities Held to Maturity                 |       |     | —      |        | 9,044,846   |   |
| **TOTAL  INVESTMENT SECURITIES**                       | ** ** |     | 15,815,704  |        | 15,771,901  |   |
|                                                   |       |     |        |        |        |   |
| Loans:                                                 |       |     |        |        |        |   |
| Commercial                                             |       |     | 15,004,679  |        | 16,178,184  |   |
| Agricultural                                           |       |     | 152,573     |        | 773,726     |   |
| Construction                                           |       |     | 29,920,948  |        | 24,394,027  |   |
| Real Estate                                            |       |     | 71,878,354  |        | 60,445,553  |   |
| Consumer                                               |       |     | 2,518,701   |        | 1,584,730   |   |
| **TOTAL  LOANS**                                       | ** ** |     | 119,475,255 |        | 103,376,220 |   |
|                                                   |       |     |        |        |        |   |
| Allowance for Loan Losses                              |       |     | (1,141,096  | )           | (1,093,838  | ) |
| **NET  LOANS**                                         | ** ** |     | 118,334,159 |        | 102,282,382 |   |
|                                                   |       |     |        |        |        |   |
| Federal Home Loan Bank Stock and Other  Stock, at Cost |       |     | 1,499,225   |        | 1,080,925   |   |
| Premises and Equipment                                 |       |     | 3,331,475   |        | 2,479,880   |   |
| Cash Surrender Value of Life Insurance                 |       |     | 2,134,526   |        | 2,059,805   |   |
| Accrued Interest and Other Assets                      |       |     | 2,239,784   |        | 2,052,093   |   |
|                                                   |       |     | $           | 156,287,606 |        | $ | 139,249,221 |   |

 

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

 

39

----

** **

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

**December 31, 2005 and 2004**

 
| ** **                                                                                                     | ** ** | ** ** | **2005**    | ** **  | **2004**    | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------|-------------|-------------|-------------|------------|
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                 |       |       |        |        |        |
|                                                                                                           |       |       |        |        |        |       |
| Deposits:                                                                                                      |       |       |        |        |        |       |
| Noninterest-Bearing Demand                                                                                     |       |       | $           | 27,969,486  |        | $          | 20,593,303 |   |
| Money Market, NOW and Savings                                                                                  |       |       | 39,280,290  |        | 46,972,959  |       |
| Time Deposits Under $100,000                                                                                   |       |       | 25,154,995  |        | 14,762,438  |       |
| Time Deposits $100,000 and Over                                                                                |       |       | 35,183,125  |        | 30,507,350  |       |
| **TOTAL  DEPOSITS**                                                                                            | ** ** |       | 127,587,896 |        | 112,836,050 |       |
|                                                                                                           |       |       |        |        |        |       |
| Other Borrowings                                                                                               |       |       | 13,400,000  |        | 12,500,000  |       |
| Junior Subordinated Debt Securities                                                                            |       |       | 3,093,000   |        | 3,093,000   |       |
| Accrued Interest and Other Liabilities                                                                         |       |       | 1,225,486   |        | 792,855     |       |
| **TOTAL  LIABILITIES**                                                                                         | ** ** |       | 145,306,382 |        | 129,221,905 |       |
|                                                                                                           |       |       |        |        |        |       |
| Commitments and Contingencies - Notes D and  M                                                                 |       |       | —      |        | —      |       |
|                                                                                                           |       |       |        |        |        |       |
| Shareholders’ Equity:                                                                                     |       |       |        |        |        |       |
| Preferred Stock - Authorized 1,000,000  Shares:                                                                |       |       |        |        |        |       |
| Series A - $5 Stated Value; 100,000 Issued  and Outstanding   Liquidation Value of $500,000                    |       |       | 392,194     |        | 392,194     |       |
| Series B - $10 Stated Value; 20,500 Issued  and Outstanding   Liquidation Value of $205,000                    |       |       | 191,606     |        | 191,606     |       |
| Series C - $10 Stated Value; 50,000 Issued  and Outstanding   Liquidation Value of $500,000                    |       |       | 500,000     |        | 500,000     |       |
| Common Stock - Authorized 1,000,000 Shares;  Issued and Outstanding: 659,799 in 2005 and 642,599 in 2004       |       |       | 6,655,784   |        | 6,387,326   |       |
| Retained Earnings                                                                                              |       |       | 3,434,081   |        | 2,570,697   |       |
| Accumulated Other Comprehensive Income -  Unrealized Depreciation on Available-for-Sale Securities, net of tax |       |       | (192,441    | )           | (14,507     | )          |
| **TOTAL  SHAREHOLDERS’ EQUITY**                                                                           | ** ** |       | 10,981,224  |        | 10,027,316  |       |
|                                                                                                           |       |       | $           | 156,287,606 |        | $          | 139,249,221 |   |

 

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

 

40

----

** **

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF INCOME**

**Years Ended December 31, 2005 and 2004**

 
| ** **                                          | ** ** | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------------------|------------|------------|-----------|------------|-----------|------------|
| **INTEREST INCOME**                                 | ** ** |       |      |       |      |       |
| Interest and Fees on Loans                          |       |       | $         | 8,624,700  |      | $          | 6,684,695 |   |
| Interest on Investment Securities                   |       |       | 624,902   |       | 577,088   |       |
| Other Interest Income                               |       |       | 185,640   |       | 163,107   |       |
| **TOTAL  INTEREST INCOME**                          | ** ** |       | 9,435,242 |       | 7,424,890 |       |
| **INTEREST EXPENSE**                                | ** ** |       |      |       |      |       |
| Interest on Money Market, NOW and Savings  Deposits |       |       | 875,083   |       | 552,232   |       |
| Interest on Time Deposits                           |       |       | 1,365,133 |       | 744,624   |       |
| Other Interest Expense                              |       |       | 638,668   |       | 410,699   |       |
| **TOTAL  INTEREST EXPENSE**                         | ** ** |       | 2,878,884 |       | 1,707,555 |       |
| **NET  INTEREST INCOME**                            | ** ** |       | 6,556,358 |       | 5,717,335 |       |
| Provision for Loan Losses                           |       |       | 75,000    |       | 280,000   |       |
| **NET  INTEREST INCOME AFTER**                      | ** ** |       |      |       |      |       |
| **PROVISION  FOR LOAN LOSSES**                      | ** ** |       | 6,481,358 |       | 5,437,335 |       |
| **NON-INTEREST INCOME**                             | ** ** |       |      |       |      |       |
| Service charges on deposit accounts                 |       |       | 256,109   |       | 249,321   |       |
| Gain on sale of loans                               |       |       | 344,490   |       | 684,514   |       |
| Loan servicing fees, net of amortization            |       |       | 15,627    |       | 165,612   |       |
| Bank Enterprise Awards                              |       |       | —    |       | 1,332,756 |       |
| Loss on sale of available-for-sale  securities      |       |       | —    |       | (71,281   | )          |
| Other income and fees                               |       |       | 188,121   |       | 205,453   |       |
| **TOTAL  NON-INTEREST INCOME**                      | ** ** |       | 804,347   |       | 2,566,375 |       |
| **NON-INTEREST EXPENSE**                            | ** ** |       |      |       |      |       |
| Salaries and employee benefits                      |       |       | 3,137,693 |       | 2,726,944 |       |
| Occupancy expenses                                  |       |       | 568,971   |       | 441,600   |       |
| Furniture and equipment                             |       |       | 254,272   |       | 150,861   |       |
| Data processing                                     |       |       | 403,440   |       | 370,328   |       |
| Professional fees                                   |       |       | 175,782   |       | 208,470   |       |
| Marketing and business development                  |       |       | 273,792   |       | 400,706   |       |
| Office supplies and expenses                        |       |       | 241,719   |       | 232,042   |       |
| Insurance and regulatory assessments                |       |       | 93,352    |       | 86,705    |       |
| Loan and lease expenses                             |       |       | 102,348   |       | 100,225   |       |
| Provision for unfunded commitments                  |       |       | 5,000     |       | 50,000    |       |
| Provision for securities losses                     |       |       | —    |       | 253,598   |       |
| Other expenses                                      |       |       | 457,961   |       | 472,534   |       |
| **TOTAL  NON-INTEREST EXPENSE**                     | ** ** |       | 5,714,330 |       | 5,494,013 |       |
| **INCOME  BEFORE INCOME TAXES**                     | ** ** |       | 1,571,375 |       | 2,509,697 |       |
| Income Tax Expense                                  |       |       | 614,847   |       | 1,017,766 |       |
| **NET  INCOME**                                     | ** ** |       | $         | 956,528    |      | $          | 1,491,931 |   |
|                                                |       |       |      |       |      |       |
| Per Share Data (Notes A and N):                     |       |       |      |       |      |       |
| Net Income - Basic                                  |       |       | $         | 1.25       |      | $          | 1.97 |   |
| Net Income - Diluted                                |       |       | $         | 1.15       |      | $          | 1.84 |   |

 

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

 

41

----

** **

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS’ EQUITY**

**Years Ended December 31, 2005 and 2004**

 
| ** **                                                                                                | ** ** | ** **    | ** ** | ** **            | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|---------------|------------|-----------------------|------------|-------------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                                | ** ** | ** **    | ** ** | ** **            | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | **Preferred** | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                                                | ** ** | **Stock**     | ** ** | **Shares**            | ** ** | **Amount**        | ** ** | **Income**   | ** ** | **Earnings**      | ** ** | **Income**      | ** ** | **Total**  | ** ** |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Balance  at January 1, 2004**                                                                           |       | $             | 1,083,800  |                  | 630,166    |              | $          | 6,273,101    |       |              |       | $               | 1,170,337  |       | $          | 18,288 |   | $ | 8,545,526 |   |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| Dividends paid                                                                                            |       |          |       |                  |       |              |       |         |       | (91,571           | )          |            |       | (91,571    | )          |
| Exercise of stock  options                                                                                |       |          |       | 12,433                |       | 114,225           |       |         |       |              |       |            |       | 114,225    |       |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Comprehensive  Income:**                                                                                |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| Net income                                                                                                |       |          |       |                  |       |              |       | $            | 1,491,931  |              | 1,491,931  |            |       |       | 1,491,931  |   |
| Net unrealized  loss on available-for-sale securities, net of taxes of $52,015                            |       |          |       |                  |       |              |       | (74,851      | )          |              |       | (74,851         | )          | (74,851    | )          |
| Less  reclassification adjustment for loss on securities included in net income,  net of taxes of $29,225 |       |          |       |                  |       |              |       | 42,056       |       |              |       | 42,056          |       | 42,056     |       |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Total  Comprehensive Income**                                                                           |       |          |       |                  |       |              |       | $            | 1,459,136  |              |       |            |       |       |       |   |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Balance  at December 31, 2004**                                                                         |       | 1,083,800     |       | 642,599               |       | 6,387,326         |       |         |       | 2,570,697         |       | (14,507         | )          | 10,027,316 |       |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| Dividends paid                                                                                            |       |          |       |                  |       |              |       |         |       | (93,144           | )          |            |       | (93,144    | )          |
| Exercise of stock  options, and related tax benefit of $107,170                                           |       |          |       | 17,200                |       | 268,458           |       |         |       |              |       |            |       | 268,458    |       |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Comprehensive  Income:**                                                                                |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| Net income                                                                                                |       |          |       |                  |       |              |       | $            | 956,528    |              | 956,528    |            |       |       | 956,528    |   |
| Net unrealized  loss on available-for-sale securities, net of taxes of $86,537                            |       |          |       |                  |       |              |       | (124,530     | )          |              |       | (124,530        | )          | (124,530   | )          |
| Net unrealized  loss on securities reclassified from held-to-maturity, net of taxes of  $37,111           |       |          |       |                  |       |              |       | (53,404      | )          |              |       | (53,404         | )          | (53,404    | )          |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Total  Comprehensive Income**                                                                           |       |          |       |                  |       |              |       | $            | 778,594    |              |       |            |       |       |       |   |
|                                                                                                      |       |          |       |                  |       |              |       |         |       |              |       |            |       |       |       |
| **Balance  at December 31, 2005**                                                                         |       | $             | 1,083,800  |                  | 659,799    |              | $          | 6,655,784    |       |              |       | $               | 3,434,081  |       | $          | (192,441 | ) | $ | 10,981,224 |   |
|                                                                                                           |            |               |            |                       |            |                   |            |              |            |                   |            |                 |            |            |            |  |  |  |  |  |  |  |

 

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

 

42

----

** **

**MISSION COMMUNITY BANCORP AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Years Ended December 31, 2005 and 2004**

 
| ** **                                                                         | ** ** | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------------------------------------------------------|------------|------------|-------------|------------|-------------|------------|
| **OPERATING ACTIVITIES**                                                           | ** ** |       |        |       |        |       |
| Net income                                                                         |       |       | $           | 956,528    |        | $          | 1,491,931 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |       |        |       |        |       |
| Provision for deferred income taxes                                                |       |       | (3,298      | )          | (39,538     | )          |
| Depreciation and amortization                                                      |       |       | 311,342     |       | 233,124     |       |
| Provision for credit losses                                                        |       |       | 75,000      |       | 280,000     |       |
| Provision for losses on unfunded loan  commitments                                 |       |       | 5,000       |       | 50,000      |       |
| Provision for securities losses                                                    |       |       | —      |       | 253,598     |       |
| Loss on sale of securities                                                         |       |       | —      |       | 71,281      |       |
| Loss on disposal of fixed assets                                                   |       |       | 30,262      |       | 17,528      |       |
| Gain on loan sales                                                                 |       |       | (344,490    | )          | (665,047    | )          |
| Proceeds from loan sales                                                           |       |       | 4,592,922   |       | 8,269,619   |       |
| Loans originated for sale                                                          |       |       | (4,073,364  | )          | (6,320,343  | )          |
| Increase in cash surrender value of life  insusance                                |       |       | (74,721     | )          | (59,805     | )          |
| Other, net                                                                         |       |       | 435,813     |       | 17,382      |       |
| **NET CASH  PROVIDED BY OPERATING ACTIVITIES**                                     | ** ** |       | 1,910,994   |       | 3,599,730   |       |
|                                                                               |       |       |        |       |        |       |
| **INVESTING ACTIVITIES**                                                           | ** ** |       |        |       |        |       |
| Purchases of Federal Home Loan Bank and  other stock                               |       |       | (418,300    | )          | (522,550    | )          |
| Net maturities of deposits in other banks                                          |       |       | —      |       | 3,000,000   |       |
| Purchase of available-for-sale securities                                          |       |       | (3,240,255  | )          | (10,514,498 | )          |
| Purchase of held-to-maturity securities                                            |       |       | —      |       | (500,000    | )          |
| Proceeds from maturities of  available-for-sale securities                         |       |       | 1,807,835   |       | 4,169,460   |       |
| Proceeds from maturities of  held-to-maturity securities                           |       |       | 1,055,446   |       | 2,481,076   |       |
| Proceeds from sales of available-for-sale  securities                              |       |       | —      |       | 6,428,719   |       |
| Net increase in loans                                                              |       |       | (16,263,602 | )          | (25,770,647 | )          |
| Purchase of bank-owned life insurance                                              |       |       | —      |       | (2,000,000  | )          |
| Proceeds from sale of fixed assets                                                 |       |       | 3,295       |       | —      |       |
| Purchases of premises and equipment                                                |       |       | (1,164,905  | )          | (265,396    | )          |
| **NET CASH  USED IN INVESTING ACTIVITIES**                                         | ** ** |       | (18,220,486 | )          | (23,493,836 | )          |
|                                                                               |       |       |        |       |        |       |
| **FINANCING ACTIVITIES**                                                           | ** ** |       |        |       |        |       |
| Net increase (decrease) in demand deposits  and savings accounts                   |       |       | (316,486    | )          | 6,264,485   |       |
| Net increase in time deposits                                                      |       |       | 15,068,332  |       | 10,286,027  |       |
| Net increase in other borrowings                                                   |       |       | 900,000     |       | 8,000,000   |       |
| Payment of dividends                                                               |       |       | (93,144     | )          | (91,571     | )          |
| Proceeds from exercise of stock options                                            |       |       | 161,288     |       | 114,225     |       |
| **NET CASH  PROVIDED BY FINANCING ACTIVITIES**                                     | ** ** |       | 15,719,990  |       | 24,573,166  |       |
|                                                                               |       |       |        |       |        |       |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                          | ** ** |       | (589,502    | )          | 4,679,060   |       |
| Cash and cash equivalents at beginning of  year                                    |       |       | 12,972,235  |       | 8,293,175   |       |
| **CASH AND  CASH EQUIVALENTS AT END OF YEAR**                                      | ** ** |       | $           | 12,382,733 |        | $          | 12,972,235 |   |
|                                                                               |       |       |        |       |        |       |
| **Supplemental Disclosures of Cash Flow  Information:**                            | ** ** |       |        |       |        |       |
| Interest paid                                                                      |       |       | $           | 2,798,589  |        | $          | 1,654,913 |   |
| Taxes paid                                                                         |       |       | 510,090     |       | 1,341,834   |       |
| Reclassification of securities from  held-to-maturity to available-for-sale        |       |       | 7,891,643   |       | —      |       |

 

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

 

43

----

** **

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

 

Principles of Consolidation

 

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

 

Nature of Operations

 

TheBank has been organized as a single reporting segment and operates threebranches in the Central Coast area of California (in the cities of San LuisObispo, Paso Robles and Arroyo Grande). On July 29, 2005 the Bank closed itsbranch office which was located in Nipomo, California. The deposit and loanbusiness of the Nipomo branch was transferred to the Arroyo Grande branch. Inconjunction with the branch consolidation, the Bank recognized $30 thousand inlosses and write-downs on fixed assets sold or abandoned and $15 thousand ofother expenses. These costs are included in non-interest expenses in theConsolidated Statements of Income for 2005. No additional costs are expected tobe incurred in connection with this branch consolidation.

 

TheBank’s primary source of revenue is providing real estate, commercial(including Small Business Administration (“SBA”) guaranteed loans) and consumerloans to customers, who are predominately small and middle-market businessesand individuals. The Company and the Bank are certified by the Department ofTreasury as Community Development Financial Institution(s) (“CDFI”) with acommitment to focus on providing financial services to low- and moderate-incomecommunities.

 

Mission Community Development Corporation

 

Mission Community Development Corporation (“MCDC”) is acommunity development corporation which provides financing for small businessesand projects in low- to moderate-income areas. The Board of Directors ofMission Community Development Corporation consists of four members of the Boardof Directors of the Company and three outside members who are actively involvedin supporting community affairs and activities. Community developmentinvestment is limited to 5% of the Bank’s capital and up to 10% with priorapproval by the Federal Reserve Board. Operations of MCDC were not material forthe years ended December 31, 2005 or 2004.

 

MissionCommunity Services Corporation

 

Mission Community Services Corporation (“MCSC”), an affiliateorganization, was organized in 1998 and the corporation was established as anot-for-profit company with Section 501(c)(3) status. This company’s primaryfocus is to provide technical support and training services to the underservedsegments of the community including small businesses, minorities and low-incomeentrepreneurs. The Board of Directors of Mission Community Services Corporationincludes representatives from the Company, together with members representingthe communities represented. The accounts of MCSC are not included in theCompany’s consolidated financial statements. See Note L for additionalinformation regarding MCSC.

 

44

----

** **

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 fromthose estimates.

 

Cash and Cash Equivalents

 

For purposes of reporting cash flows, cash and cash equivalents includecash, amounts due from other banks and federal funds sold. Generally, federalfunds 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 Reserve Bank(“FRB”). The Bank was in compliance with this requirement, which was $528,000as of December 31, 2005.

 

The Company maintains amounts due from other banks which exceedfederally insured limits. The Company has not experienced any losses in suchaccounts.

 

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. Unrealized gains or losses on available-for-salesecurities are excluded from net income and reported as an amount net of taxesas a separate component of comprehensive income included in shareholders’equity. Premiums or discounts are amortized or accreted into income using theinterest method. Realized gains or losses on sales of securities are recordedusing the specific identification method.

 

Other-than-temporary declines in the fair value of individualheld-to-maturity and available-for-sale securities below their cost result inwrite-downs of the individual securities to their fair value. The relatedwrite-downs are included in earnings as realized losses. In estimatingother-than-temporary impairment losses, management considers the length of timeand the extent to which the fair value has been less than cost, the financialcondition and near-term prospects of the issuer, and the intent and ability ofthe Bank to retain its investment in the issuer for a period of time sufficientto allow for any anticipated recovery in fair value.

 

45

----

** **

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 loanorigination fee income and direct loan origination costs are amortized tointerest income over the life of the loan using the interest method. Intereston loans is accrued to income daily based upon the outstanding principalbalances.

 

Loans for which the accrual of interest has been discontinued aredesignated as nonaccrual loans. Loans are classified as nonaccrual whenprincipal or interest is past due 90 days based on the contractual terms of theloan or when, in the opinion of management, there exists a reasonable doubt asto the full and timely collection of either principal or interest. Income onsuch loans is then only recognized to the extent that cash is received andwhere the future collection of principal is probable. Accrual of interest isresumed only when principal and interest are brought fully current and whensuch loans are considered to be collectible as to both principal and interest.

 

For impairment recognized in accordance with Financial AccountingStandards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”)No. 114, *“Accounting by Creditors for Impairment of a Loan,”*as amended by SFAS No. 118, the entire change in the present value of expectedcash flows is reported as either provision for credit losses in the same mannerin which impairment initially was recognized, or as a reduction in the amountof provision for credit losses that otherwise would be reported.

 

LoansHeld for Sale

 

Mortgage loans and SBA Loans originated and intended for sale in thesecondary market are carried at the lower of cost or estimated market value inthe aggregate. Net unrealized losses are recognized through a valuationallowance by charges to income. Gains or losses realized on the sales of loansare recognized at the time of sale and are determined by the difference betweenthe net sales proceeds and the carrying value of the loans sold, adjusted forany servicing asset or liability. Gains and losses on sales of loans areincluded in non-interest income.

 

The Bank has adopted SFAS No. 140, *“Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities.”*  The Statement provides accounting andreporting standards for transfers and servicing of financial assets andextinguishments of liabilities. Under this Statement, after a transfer offinancial assets, an entity recognizes the financial and servicing assets itcontrols and liabilities it has incurred, derecognizes financial assets whencontrol has been surrendered, and derecognizes 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. That portion of the excessservicing fees that represents contractually specified servicing fees(contractual servicing) is reflected as a servicing asset which is amortizedover an estimated life using a method approximating the level yield method. Theportion of excess servicing fees in excess of the contractual servicing fees isreflected as an interest-only (I/O) strip receivable, which is classified asavailable for sale and carried at fair value. The gain (loss) on the soldportion of the loan is recognized at the time of sale based on the differencebetween the sale proceeds and the allocated investment. As a result of therelative fair value allocation, the carrying value of the retained portion isdiscounted, with the discount accreted to interest income over the life of theloan.

 

46

----

** **

Allowance for Loan Losses

 

Theallowance for loan losses is increased by charges to income and decreased bycharge-offs (net of recoveries). Charge-offs are loans and leases deemeduncollectible, which are charged to the allowance. Management performs, atleast quarterly, an analysis of the allowance for loan losses to determine itsadequacy. In this analysis, all non-classified loans are segmented intocomponents by loan type and internal risk rating. Estimated loss factors areapplied to each loan pool based on historical losses as well as management’sassessment of current factors that may impact these historical factors, such aschanges in the local economy, changes in underwriting standards, changes inloans concentrations and trends in past due and non-performing loans. Significantloans classified as less than acceptable by management, the Bank’s regulatorsor external credit review consultants are evaluated separately in the process. Inthis evaluation, management reviews the borrower’s ability to repay as well asthe estimated value of any underlying collateral.

 

Premises and Equipment

 

Landis carried at cost. Premises and equipment are carried at cost less accumulateddepreciation and amortization. Depreciation is computed using the straight-linemethod over the estimated useful lives, which range from three to ten years forfurniture and fixtures and forty years for buildings. Leasehold improvementsare amortized using the straight-line method over the estimated useful lives ofthe improvements or the remaining lease term, whichever is shorter. Expendituresfor betterments or major repairs are capitalized and those for ordinary repairsand maintenance are charged to operations as incurred.

 

AdvertisingCosts

 

TheBank expenses the costs of advertising 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 orrates are enacted, deferred tax assets and liabilities are adjusted through theprovision for income taxes.

 

Comprehensive Income

 

SFAS No. 130, *“Reporting ComprehensiveIncome*,*”* requires the disclosure ofcomprehensive 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. Suchfinancial instruments are recorded in the financial statements when they arefunded or related fees are incurred or received.

 

47

----

** **

Earnings Per Share (“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 dilutionthat could occur if options or other contracts to issue common stock were exercisedor converted into common stock or resulted in the issuance of common stock thatthen shared in the earnings of the Company.

 

Stock-Based Compensation

 

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

 

Accordingly, compensation cost for stock options is measured as theexcess, if any, of the quoted market price of the Company’s stock at the dateof the grant over the amount an employee must pay to acquire the stock.

 

Had compensation cost for the Company’s stock option plans beendetermined based on the fair value at the grant dates for awards under thoseplans consistent with the method of SFAS No. 123, the Company’s net income andincome per share would have been reduced to the pro forma amounts indicatedbelow:

 
| ** **                                                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net Income:                                                                                     |       |     |       |     |       |
| As Reported                                                                                     |       | $        | 956,528    |     | $          | 1,491,931 |   |
| Stock-Based Compensation using the  Intrinsic Value Method                                      |       | —   |       | —   |       |
| Stock-Based Compensation that would have been  reported using the Fair Value Method of SFAS 123 |       | (60,012  | )          | (14,769  | )          |
| Pro Forma                                                                                       |       | $        | 896,516    |     | $          | 1,477,162 |   |
|                                                                                            |       |     |       |     |       |
| Basic Income Per Share:                                                                         |       |     |       |     |       |
| As Reported                                                                                     |       | $        | 1.25       |     | $          | 1.97 |   |
| Pro Forma                                                                                       |       | 1.17     |       | 1.95     |       |
|                                                                                            |       |     |       |     |       |
| Diluted Income Per Share:                                                                       |       |     |       |     |       |
| As Reported                                                                                     |       | 1.15     |       | 1.84     |       |
| Pro Forma                                                                                       |       | 1.08     |       | 1.82     |       |

 

48

----

 

RecentAccounting Announcements

 

In December 2004, FASB revised SFAS 123 and issued it under its newname, *“Share-Based Payment.” *This statement eliminates thealternative to use APB Opinion No. 25’s intrinsic value method of accountingdiscussed in the previous paragraph. Instead, this Statement generally requiresentities to recognize the cost of employee services received in exchange forawards of stock options, or other equity instruments, based on the grant-datefair value of those awards. This cost will be recognized over the period duringwhich an employee is required to provide service in exchange for the award,generally the vesting period.

 

The Company must adopt this Statement in 2006 for all new stock optionawards as well as any existing awards that are modified, repurchased orcancelled. In addition, the unvested portion of previously awarded options willalso be recognized as expense. The Company estimates that the adoption of thisStatement will result in a reduction in net income of approximately $59thousand in 2006, based on unvested options outstanding as of December 31, 2005.The decision to grant stock options is made annually on a case-by-case basisand, accordingly, the Company cannot estimate the amount or financial statementimpact of any stock options that might be granted in 2006.

 

Reclassifications

 

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

 

49

----

** **

**NOTE B - INVESTMENT SECURITIES**

 

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

 
| ** **                         | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                         | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market**    | ** ** |
| ** **                         | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**     | ** ** |
| **Available-for-Sale Securities:** |       |          |       |           |       |           |       |          |       |
| **December 31, 2005:**             |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies           |       | $             | 6,997,448  |           | $          | —         |       | $             | (189,423   | ) | $ | 6,808,025 |   |
| Mortgage-backed securities         |       | 8,828,346     |       | 7,565          |       | (191,575       | )          | 8,644,336     |       |
| Asset-backed securities            |       | 316,081       |       | 48,616         |       | (1,354         | )          | 363,343       |       |
|                               |       | $             | 16,141,875 |           | $          | 56,181         |       | $             | (382,352   | ) | $ | 15,815,704 |   |
|                               |       |          |       |           |       |           |       |          |       |
| **December 31, 2004:**             |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies           |       | $             | —     |           | $          | —         |       | $             | —     |   | $ | — |   |
| Mortgage-backed securities         |       | 6,695,720     |       | 3,480          |       | (29,270        | )          | 6,669,930     |       |
| Asset-backed securities            |       | 55,924        |       | 1,201          |       | —         |       | 57,125        |       |
|                               |       | $             | 6,751,644  |           | $          | 4,681          |       | $             | (29,270    | ) | $ | 6,727,055 |   |
|                               |       |          |       |           |       |           |       |          |       |
| **Held-to-Maturity Securities:**   |       |          |       |           |       |           |       |          |       |
| **December 31, 2004:**             |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies           |       | $             | 6,998,038  |           | $          | 6,875          |       | $             | (86,028    | ) | $ | 6,918,885 |   |
| Mortgage-backed securities         |       | 1,600,881     |       | 22,207         |       | (6,512         | )          | 1,616,576     |       |
| Asset-backed securities            |       | 445,927       |       | 23,132         |       | —         |       | 469,059       |       |
|                               |       | $             | 9,044,846  |           | $          | 52,214         |       | $             | (92,540    | ) | $ | 9,004,520 |   |

 

Duringthe first quarter of 2005, the Bank transferred one of its held-to-maturitysecurities to the available-for-sale category, due to management’s desire tosell the security in the event a suitable opportunity should arise. Thisdecision was based on a significant deterioration in the issuer’screditworthiness that has occurred subsequent to its original classification asa held-to-maturity security. During 2004, management established a loss reservefor this security after concluding it was “other than temporarily impaired.”  The security is in non-accrual status, withany interest payments received being credited to the reserve. As of March 31,2005, the date of transfer, the gross book value of the security was $391,000and the reserve was $250,000, for a net book value of $141,000. The fair valueon March 31, 2005, was $163,000, resulting in an unrealized gain of $22,000 onthe date of transfer. As of December 31, 2005, the gross book value ofthe security was $353,464 and the reserve was $237,500, for a net book value of$115,964.

 

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

 

50

----

 

Thescheduled maturities of investment securities at December 31, 2005, were asfollows. Actual maturities may differ from contractual maturities because someinvestment securities may allow the right to call or prepay the obligation withor without call or prepayment penalties.

 
| ** **                     | ** ** | **Amortized** | ** ** | **Fair**  | ** ** |
|--------------------------------|------------|---------------|------------|-----------|------------|
| ** **                     | ** ** | **Cost**      | ** ** | **Value** | ** ** |
|                           |       |          |       |      |       |
| Within one year                |       | $             | —     |      | $          | — |   |
| Due in one year to five years  |       | 5,461,297     |       | 5,311,458 |       |
| Due in five years to ten years |       | 1,926,311     |       | 1,898,601 |       |
| Due in greater than ten years  |       | 8,754,267     |       | 8,605,645 |       |
|                           |       | $             | 16,141,875 |      | $          | 15,815,704 |   |

 

Includedin accumulated other comprehensive income at December 31, 2005 were netunrealized losses on investment securities available for sale of $326,171 lessapplicable income taxes of $133,730. At December 31, 2004, accumulated othercomprehensive income included net unrealized losses on available-for-salesecurities of $24,589 less applicable income taxes of $10,082. During 2004, theBank realized $76,437 in losses and $5,156 in gains on sales of securitiesavailable for sale. No securities were sold in 2005.

 

Investment securities in a temporary unrealized loss position as ofDecember 31, 2005 and 2004 are shown in the following table, based on thelength of time they have been continuously in an unrealized loss position:

 
| ** **                         | ** ** | **Less than 12 Months** | ** ** | **12 Months or Longer** | ** ** | **Total** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------|------------|
| ** **                         | ** ** | **Fair**                               | ** ** | **Unrealized**                         | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                         | ** ** | **Value**                              | ** ** | **Losses**                             | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| **December 31, 2005:**             |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| **Available-for-Sale Securities:** |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies           |       | $                                      | 1,967,580  |                                   | $          | 31,298    |       | $ | 4,840,445 |   | $ | 158,125 |   | $ | 6,808,025 |   | $ | 189,423 |   |
| Mortgage-backed securities         |       | 3,918,662                              |       | 68,455                                 |       | 4,274,393 |       | 123,120 |   | 8,193,055 |   | 191,575 |   |
| Asset-backed securities            |       | 198,763                                |       | 1,354                                  |       | —    |       | — |   | 198,763 |   | 1,354 |   |
|                               |       | $                                      | 6,085,005  |                                   | $          | 101,107   |       | $ | 9,114,838 |   | $ | 281,245 |   | $ | 15,199,843 |   | $ | 382,352 |   |
|                               |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| **December 31, 2004:**             |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| **Available-for-Sale Securities:** |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies           |       | $                                      | —     |                                   | $          | —    |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Mortgage-backed securities         |       | 5,635,592                              |       | 29,270                                 |       | —    |       | — |   | 5,635,592 |   | 29,270 |   |
|                               |       | $                                      | 5,635,592  |                                   | $          | 29,270    |       | $ | — |   | $ | — |   | $ | 5,635,592 |   | $ | 29,270 |   |
|                               |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| **Held-to-Maturity Securities:**   |       |                                   |       |                                   |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies           |       | $                                      | 3,466,540  |                                   | $          | 33,460    |       | $ | 1,445,470 |   | $ | 52,568 |   | $ | 4,912,010 |   | $ | 86,028 |   |
| Mortgage-backed securities         |       | 602,471                                |       | 5,256                                  |       | 201,018   |       | 1,256 |   | 803,489 |   | 6,512 |   |
|                               |       | $                                      | 4,069,011  |                                   | $          | 38,716    |       | $ | 1,646,488 |   | $ | 53,824 |   | $ | 5,715,499 |   | $ | 92,540 |   |

 

51

----

** **

The unrealized losses on investments in U.S. Government agency andmortgage-backed securities which have been in an unrealized loss position forone year or longer as of December 31, 2005 (a total of 31 securities), werecaused by market interest rate increases subsequent to the purchase of thesecurities. Because the Bank has the ability to hold all these investmentsuntil a recovery in fair value, which may be maturity, the unrealized losses onthese investments are not considered to be other-than-temporarily impaired asof December 31, 2005. Other than the one impaired asset-backed securityfootnoted above, none of these securities has exhibited a decline in value as aresult of changes in credit risk.

 

Investments securities carried at $10,140,000 and $8,226,000 as ofDecember 31, 2005 and 2004, respectively, were pledged to secure publicdeposits as required by law.

 

**NOTE C- LOANS**

 

The Bank’s loan portfolio consists primarily of loans to borrowerswithin the Central Coast Area of California. Although the Bank seeks to avoidconcentrations of loans to a single industry or based upon a single class ofcollateral, real estate and real estate associated businesses are among theprincipal industries in the Bank’s market area and, as a result, the Bank’sloan and collateral portfolios are concentrated in those industries and in thatgeographic area. As of December 31, 2005, 76% of the loan portfolio was securedby commercial real estate (including construction and land development loans aswell as loans secured by non-farm, non-residential and multi-family residentialproperties).

 

The following is a summary of the investment in impaired loans as ofDecember 31, including the related allowance for loan losses and cash-basisincome recognized. Also shown are loans on nonaccrual and those that are pastdue and still accruing interest:

 
| ** **                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Impaired Loans:                                              |       |     |       |     |       |
| Recorded Investment in Impaired Loans                        |       | $        | 76,000     |     | $          | 206,000 |   |
| Related Allowance for Loan Losses                            |       | 9,000    |       | 17,000   |       |
| Average Recorded Investment in Impaired  Loans               |       | 130,000  |       | 333,000  |       |
| Interest Income Recognized for Cash  Payments While Impaired |       | —   |       | —   |       |
| Total Loans on Nonaccrual                                    |       | 76,000   |       | 206,000  |       |
| Total Loans Past Due 90 Days or More and  Still Accruing     |       | —   |       | —   |       |
|                                                              |            |          |            |          |            |  |  |

 

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

 
| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Balance at Beginning of Year                     |       | $        | 1,093,838  |     | $          | 811,925 |   |
| Additions to the Allowance Charged to  Expense   |       | 75,000   |       | 280,000  |       |
| Less Loans Charged Off                           |       | (30,402  | )          | (1,230   | )          |
| Plus Recoveries on Loans Previously Charged  Off |       | 2,660    |       | 3,143    |       |
| Balance at End of Year                           |       | $        | 1,141,096  |     | $          | 1,093,838 |   |

 

52

----

 

The Bank also originates SBA-guaranteed loans for sale to institutionalinvestors. At December 31, 2005 and 2004 the Bank was servicing$32,205,000 and $33,030,000, respectively, in loans previously sold orparticipated. The Bank has recorded servicing assets related to these loanstotaling $458,000 and $636,000 at December 31, 2005 and 2004,respectively. The estimated fair value of the servicing assets approximated thecarrying amount at December 31, 2005 and 2004.

 

Following is a summary of the changes in the balances of the SBA loanservicing asset and I/O strip for 2005 and 2004:

 
| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Servicing  Asset:             |       |     |       |     |       |
| Balance at  Beginning of Year |       | $        | 636,102    |     | $          | 606,698 |   |
| Additions to  the Asset       |       | 77,293   |       | 138,670  |       |
| Less  amortization            |       | (255,551 | )          | (109,266 | )          |
| Balance at  End of Year       |       | $        | 457,844    |     | $          | 636,102 |   |
|                          |       |     |       |     |       |
| I/O Strip:                    |       |     |       |     |       |
| Balance at  Beginning of Year |       | $        | 114,132    |     | $          | — |   |
| Additions to  the Asset       |       | 53,141   |       | 123,060  |       |
| Less  amortization            |       | (50,815  | )          | (8,928   | )          |
| Balance at  End of Year       |       | $        | 116,458    |     | $          | 114,132 |   |

 

These assets are included in accrued interest and other assets in theconsolidated balance sheets. Amortization of these assets is netted againstloan servicing fees in the consolidated statements of income.

 

Included in total loans are net deferred loan fees of $297,000 anddiscounts related to the retained portion of SBA loans of $549,000 at December 31,2005. At December 31, 2004, the Bank had net deferred loan fees of $70,000and discounts of $720,000 related to the retained portion of SBA loans.

 

53

----

 

**NOTE D - PREMISES AND EQUIPMENT**

 

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

 
| ** **                                 | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
|                                       |       |       |       |       |       |
| Land                                       |       | $          | 1,678,180  |       | $          | 976,498 |   |
| Buildings                                  |       | 722,333    |       | 722,333    |       |
| Leasehold  improvements                    |       | 344,245    |       | 346,788    |       |
| Furniture,  fixtures, and equipment        |       | 2,021,678  |       | 1,612,965  |       |
|                                       |       | 4,766,436  |       | 3,658,584  |       |
| Accumulated  depreciation and amortization |       | (1,434,961 | )          | (1,178,704 | )          |
| Net premises  and equipment                |       | $          | 3,331,475  |       | $          | 2,479,880 |   |

 

The Bank has entered into operating leases for its branches andoperating facilities, which expire at various dates through 2010. These leasesinclude provisions for periodic rent increases as well as payment by the lesseeof certain operating expenses. Rental expense relating to these leases was$282,000 in 2005 and $170,000 in 2004.

 

At December 31, 2005, theapproximate future minimum annual payments under these leases for the next fiveyears are as follows:

 
| 2006   |   | $       | 209,500 |   |
|--------|--------|---------|---------|--------|
| 2007   |   | 178,023 |    |
| 2008   |   | 152,095 |    |
| 2009   |   | 77,330  |    |
| 2010   |   | 39,890  |    |
|   |   | $       | 656,838 |   |

 

The minimum rental payments shown above are given for the existing leaseobligations and do not reflect any increases in rent unless the increases arescheduled and currently determinable. It does not represent a forecast offuture rental expenses.

 

**NOTE E - DEPOSITS**

 

At December 31, 2005, the scheduled maturities of time depositsare as follows:

 
| Due in one  year         |   | $         | 58,589,510 |   |
|--------------------------|--------|-----------|------------|--------|
| Due in one to five years |   | 1,748,610 |       |
|                     |   | $         | 60,338,120 |   |

 

Ninedeposit customers comprised $24.7 million, or 19.4%, of the Bank’s totaldeposits as of December 31, 2005.

 

54

----

 

**NOTE F - OTHER BORROWINGS**

 

Otherborrowings at December 31, 2005 are comprised of the following advancesfrom the Federal Home Loan Bank of San Francisco:

 
| **Maturity  Date** | ** ** | **Interest  Rate** | ** ** | **Amount** | ** ** |
|--------------------|------------|--------------------|------------|------------|------------|
| 6/5/2006           |       |               | 1.76       | %          | $          | 500,000 |   |
| 8/11/2006          |       |               | 4.17       | %          | 2,000,000  |   |
| 11/13/2006         |       |               | 4.24       | %          | 2,000,000  |   |
| 8/13/2007          |       |               | 4.37       | %          | 2,000,000  |   |
| 3/31/2008          |       |               | 4.34       | %          | 1,400,000  |   |
| 3/30/2009          |       |               | 3.19       | %          | 2,000,000  |   |
| 5/13/2009          |       |               | 4.48       | %          | 500,000    |   |
| 11/19/2013         |       |               | 4.82       | %          | 1,000,000  |   |
| 12/11/2013         |       |               | 4.98       | %          | 1,000,000  |   |
| 12/16/2013         |       |               | 4.88       | %          | 1,000,000  |   |
|               |       |               |       |       | $          | 13,400,000 |   |

 

Theseadvances are secured by loans of approximately $54 million. As of December 31,2005, the Bank had a borrowing capacity of approximately $18.3 million with theFederal Home Loan Bank of San Francisco in addition to the borrowings listedabove.

 

TheBank also has unsecured borrowing lines with correspondent banks totaling $6.5million. As of December 31, 2005, there were no balances outstanding onthese lines.

 

**NOTE G - JUNIOR SUBORDINATED DEBT SECURITIES**

 

On October 14, 2003, the Company issued $3,093,000 of juniorsubordinated debt securities (the “debt securities”) to Mission CommunityCapital Trust, a statutory trust created under the laws of the State ofDelaware. These debt securities are subordinated to effectively all borrowingsof the Company and are due and payable on October 7, 2033. Interest ispayable quarterly on these debt securities at LIBOR plus 2.95% for an effectiverate of 7.10% as of December 31, 2005. The debt securities can be redeemedfor 105% of the principal balance through October 7, 2008 and at parthereafter; they can also be redeemed at par if certain events occur thatimpact the tax treatment or the capital treatment of the issuance.

 

The Company also purchased a 3% minority interest in Mission CommunityCapital Trust. The balance of the equity of Mission Community Capital Trust iscomprised of mandatorily redeemable preferred securities. Under FASBInterpretation No. 46 (FIN 46), “*Consolidationof Variable Interest Entities, an interpretation of ARB No. 51,”*MissionCommunity Capital Trust is not consolidated into the Company’s financialstatements. Prior to the issuance of FIN 46, bank holding companies typicallyconsolidated these entities. The Federal Reserve Board has ruled thatsubordinated notes payable to unconsolidated special purpose entities (“SPE’s”)such as Mission Community Capital Trust, net of the bank holding company’sinvestment in the SPE, qualify as Tier 1 Capital, subject to certain limits.

 

55

----

 

**NOTE H - INCOME TAXES**

 

The income tax expense for the years ended December 31, 2005 and2004 is comprised of the following:

 
| ** **     | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------|------------|----------|------------|-----------|------------|
| Current Taxes: |       |     |       |      |       |
| Federal        |       | $        | 475,707    |      | $          | 825,390 |   |
| State          |       | 142,438  |       | 231,914   |       |
|           |       | 618,145  |       | 1,057,304 |       |
| Deferred       |       | (3,298   | )          | (39,538   | )          |
|           |       | $        | 614,847    |      | $          | 1,017,766 |   |

 

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

 
| ** **                                                     | ** ** | **2005**   | ** ** | **2004** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|----------|------------|
| ** **                                                     | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
|                                                           |       |       |       |     |       |   |   |   |   |
| Federal tax  rate                                              |       | $          | 534,268    |     | 34.0       | % | $ | 853,297 |   | 34.0 | % |
| California  franchise taxes, net of federal tax benefit        |       | 107,430    |       | 6.8      | %          | 175,726 |   | 7.0 | % |
| Increase in  cash surrender value of bank-owned life insurance |       | (25,405    | )          | (1.6     | )%         | (20,334 | ) | (0.8 | )% |
| Other items  - net                                             |       | (1,446     | )          | (0.1     | )%         | 9,077 |   | 0.4 | % |
|                                                           |       | $          | 614,847    |     | 39.1       | % | $ | 1,017,766 |   | 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’s principal timing differences are fromthe cash basis of tax reporting and the allowance for loan and lease losses.

 

56

----

 

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

 
| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred Tax Assets:                             |       |     |       |     |       |
| Allowance for Loan Losses Due to Tax Limitations |       | $        | 432,375    |     | $          | 410,075 |   |
| Unrealized Loss on Available-for-Sale Securities |       | 133,730  |       | 10,082   |       |
| Other                                            |       | 216,372  |       | 149,512  |       |
|                                             |       | 782,477  |       | 569,669  |       |
| Deferred Tax Liabilities:                        |       |     |       |     |       |
| Deferred loan costs                              |       | (141,296 | )          | —   |       |
| Cash Basis of Tax Reporting                      |       | —   |       | (47,784  | )          |
| Depreciation Differences                         |       | (96,043  | )          | (113,757 | )          |
| Other                                            |       | (26,606  | )          | (16,542  | )          |
|                                             |       | (263,945 | )          | (178,083 | )          |
| Net Deferred Tax Assets                          |       | $        | 518,532    |     | $          | 391,586 |   |

 

**NOTE I - STOCK OPTION PLAN**

 

During 1998, the Board ofDirectors adopted a stock option plan, which was approved by the shareholders,under which 180,000 shares of the Company’s common stock may be issued. Optionsare generally granted for a term of ten years, with vesting occurring ratablyover five years. The Company applies APB Opinion No. 25 and relatedinterpretations in accounting for its plan. Accordingly, no compensation costhas been recognized for its fixed stock option plan.

 

The fair value of each optiongranted in 2005 was estimated on the date of grant using the Black-Scholesoption pricing model with the following assumptions:  risk-free rate of 4.41%, expected lives ofsix years, no dividend payments and 35.4% stock price volatility. No optionswere granted in 2004.

 

57

----

 

A summary of the statusof the Company’s fixed stock option plan as of December 31, 2005 and 2004and changes during the years is presented below:

 
| ** **                                                      | ** ** | **2005**   | ** ** | **2004**      | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|---------------|------------|
| ** **                                                      | ** ** | ** ** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                                      | ** ** | ** ** | ** ** | **Average**   | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                      | ** ** | ** ** | ** ** | **Exercise**  | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                                      | ** ** | **Shares** | ** ** | **Price**     | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding at Beginning of Year                                |       | 138,933    |       | $             | 9.73       |   | 154,966 |   | $ | 9.66 |   |
| Granted                                                         |       | 25,500     |       | 25.50         |       | — |   | — |   |
| Exercised                                                       |       | (17,200    | )          | 9.38          |       | (12,433 | ) | 9.19 |   |
| Forfeited                                                       |       | (4,000     | )          | 23.27         |       | (3,600 | ) | 9.47 |   |
| Outstanding at End of Year                                      |       | 143,233    |       | $             | 12.20      |   | 138,933 |   | $ | 9.73 |   |
|                                                            |       |       |       |          |       |   |   |   |   |
| Options Exercisable at Year-End                                 |       | 110,133    |       | $             | 9.77       |   | 118,733 |   | $ | 9.76 |   |
|                                                            |       |       |       |          |       |   |   |   |   |
| Weighted-Average Fair Value of Options Granted During  the Year |       |       |       | $             | 10.77      |   |   |   | N/A |   |

 

The following tablesummarizes information about fixed options outstanding at December 31,2005:

 
| ** **         | ** ** | **Options Outstanding** | ** ** | ** **    | ** ** | ** **           | ** **           |
|--------------------|------------|------------------------------|------------|---------------|------------|----------------------|----------------------|
| ** **         | ** ** | ** **                   | ** ** | ** **    | ** ** | **Weighted-**        | ** **           | **Options Exercisable** | ** ** |
| ** **         | ** ** | ** **                   | ** ** | **Weighted-** | ** ** | **Average**          | ** **           | ** ** | ** ** | **Weighted-** | ** ** |
| ** **         | ** ** | ** **                   | ** ** | **Average**   | ** ** | **Remaining**        | ** **           | ** ** | ** ** | **Average** | ** ** |
| **Exercise**       | ** ** | **Number**                   | ** ** | **Exercise**  | ** ** | **Contractual**      | ** **           | **Number** | ** ** | **Exercise** | ** ** |
| **Price**          | ** ** | **Outstanding**              | ** ** | **Price**     | ** ** | **Life**             | ** **           | **Exercisable** | ** ** | **Price** | ** ** |
| $7.50              |       | 10,400                       |       | $             | 7.50       |                 | 5.6  Years |   | 8,000 |   | $ | 7.50 |   |
| $8.19              |       | 2,500                        |       | 8.19          |       | 4.6  Years |                 | 2,500 |   | 8.19 |   |
| $8.25              |       | 8,400                        |       | 8.25          |       | 5.2  Years |                 | 6,500 |   | 8.25 |   |
| $10.00             |       | 84,933                       |       | 10.00         |       | 2.1  Years |                 | 84,933 |   | 10.00 |   |
| $11.30             |       | 15,000                       |       | 11.30         |       | 6.7  Years |                 | 8,200 |   | 11.30 |   |
| $25.50             |       | 22,000                       |       | 25.50         |       | 9.2  Years |                 | — |   | 25.50 |   |
| Total / Wgtd. Ave. |       | 143,233                      |       | $             | 12.20      |                 | 4.1  Years |   | 110,133 |   | $ | 9.77 |   |

 

**NOTE J – DEFINED CONTRIBUTIONPLAN**

 

The Company has adopted adefined contribution plan, the Mission Community Bank 401k Profit Sharing Plan(“the 401k Plan”), covering substantially all employees fulfilling minimum ageand service requirements. Matching and discretionary employer contributions tothe 401k Plan are determined annually by the Board of Directors. The expensefor the 401k Plan was approximately $124,000 in 2005 and $123,000 in 2004.

 

58

----

 

**NOTE K - PREFERRED STOCK**

 

Series A – the Series APreferred Stock has a $5.00 stated value and is non-voting, convertible andredeemable. Each share is convertible into one-half share of voting commonstock of the Company. Series A shares are not entitled to any fixed rateof return, but do participate on the same basis (as if converted on atwo-for-one exchange) in any dividends declared on the Company’s common stock. Series Ashares may be redeemed upon request of the holder at their stated value ifthe Bank is found to be in default under any Community Development FinancialInstitutions Program Assistance Agreement for Equity Investments in RegulatedInstitutions, or any successor agreement. In the event of liquidation, theholders of Series A shares will be entitled to a liquidation preference of$5.00 per share before the holders of common stock receive any distributionsand after the holders of common stock receive distributions of $10.00 pershare, all distributions will be on the same basis (as if converted on aone-for-two exchange). These shares were issued for $392,194 (net of issuancecosts of $107,806) pursuant to an award from the Community DevelopmentFinancial Institutions Fund of the Department of the Treasury.

 

Series B – the Series BPreferred Stock has a $10.00 stated value and is non-voting, non-convertibleand non-redeemable. Series B shares are not entitled to any fixed rate ofreturn but do participate on the same basis in any dividends declared on theCompany’s common stock. In the event of liquidation, the holders of Series Bshares will be entitled to a liquidation preference of $10.00 per share beforethe holders of common stock receive any distributions. Additionally, in theevent of a specified “change in control event” (including certain mergers orsales of assets), holders of the Series B Preferred Stock shall beentitled to receive payment on the same basis as the holders of the commonstock of the Company. These shares were issued for $191,606 (net of issuancecosts of $13,394) pursuant to an investment from the National CommunityInvestment Fund (“NCIF”). In connection with this investment, NCIF alsopurchased 29,500 shares of the Company’s common stock for $10.00 per share. As part ofthe investment agreement, the Company by covenant agreed that so long as NCIFor any successor owns and holds any of the Shares to remain a CDFI and to meetcertain reporting requirements.

 

Series C – the Series CPreferred Stock has $10.00 stated value and is non-voting, convertible andredeemable. Each share is convertible into one share of voting common stock ofthe Company. Series C shares are not entitled to any fixed rate of return,but do participate on the same basis (as if converted on a one-to-one exchange)in any dividends declared on the Company’s common stock. Series C shares may beredeemed upon request of the holder at their stated value if the Bank is foundto be in default under any Community Development Financial Institutions ProgramAssistance Agreement for Equity Investments in Regulated Institutions, or anysuccessor agreement. In the event of liquidation, the holders of Series Cshares will be entitled to a liquidation preference of $10.00 per share (asadjusted for any stock dividends, combinations or splits with respect to suchshares) before the holders of common stock receive any distributions. Theseshares were issued for $500,000 pursuant to an award from the CommunityDevelopment Financial Institutions Fund of the Department of the Treasury.

 

59

----

 

**NOTE L- RELATED PARTY TRANSACTIONS**

 

Inthe ordinary course of business, the Bank has granted loans to certaindirectors and the companies with which they are associated. In the Bank’sopinion, 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.

 

Thefollowing is a summary of the activity in these loans:

 
| ** **                                                        | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                              |       |      |       |      |       |
| Balance at the beginning of the year                              |       | $         | 3,417,952  |      | $          | 2,124,738 |   |
| New loans and advances                                            |       | 1,581,015 |       | 1,983,301 |       |
| Repayments                                                        |       | (658,847  | )          | (690,087  | )          |
| Reclassifications (persons no longer considered  related parties) |       | (991,265  | )          | —    |       |
| Balance at the end of the year                                    |       | $         | 3,348,855  |      | $          | 3,417,952 |   |

 

Deposits from relatedparties held by the Bank totaled approximately $2,809,000 at December 31,2005, and $2,894,000 at December 31, 2004.

 

During 2003, Bancorppledged a $250,000 certificate of deposit in an unaffiliated bank as collateralfor borrowings of MCSC. As of December 31, 2005, MCSC had drawn $75,000 onits line of credit with the unaffiliated bank, and Bancorp recognized a $75,000contribution to MCSC related to its potential liability for this borrowing. In2004 Bancorp contributed $250,000 to MCSC to continue providing Central Coastand Central California small businesses with technical assistance, counselingand training in finance, management, marketing procurement and access to the U.S. Small Business Administration’s programs and services. This grant isincluded in marketing and business development expenses in the consolidatedstatements of income.

 

60

----

 

**NOTE M - COMMITMENTS ANDCONTINGENCIES**

 

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

 

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

 

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

 
| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Commitments to Extend Credit |       | $        | 37,379,000 |     | $          | 29,793,000 |   |
| Standby Letters of Credit    |       | 203,000  |       | 123,000  |       |
|                         |       | $        | 37,582,000 |     | $          | 29,916,000 |   |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Standby letters of credit areconditional commitments to guarantee the performance of a Bank customer to athird party. Since many of the commitments and standby letters of credit areexpected to expire without being drawn upon, the total amounts do notnecessarily represent future cash requirements. The Bank evaluates eachcustomer’s creditworthiness on a case-by-case basis. The amount of collateralobtained if deemed necessary by the Bank is based on management’s creditevaluation of the customer.

 

During 2004, the Bankestablished an allowance for possible losses on unfunded loan commitments inthe amount of $50,000, through a charge to non-interest expense. This allowancewas increased by $5,000 in 2005. No losses were charged against this allowancein 2005 or 2004. The balance of the allowance was $55,000 as of December 31,2005. This allowance is included in other liabilities in the consolidatedstatements of condition.

 

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

 

61

----

 

**NOTE N- EARNINGS PER SHARE**

 

Thefollowing is a reconciliation of net income and shares outstanding to theincome and number of shares used in the computation of earnings per share:

 
| ** **                                                                       | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                       | ** ** | **Income** | ** ** | **Shares** | ** ** | **Income** | ** ** | **Shares** | ** ** |
|                                                                             |       |       |       |       |       |   |   |   |   |
| Net income                                                                       |       | $          | 956,528    |       |       |   | $ | 1,491,931 |   |   |   |
| Average common shares outstanding during the year                                |       |       |       | 646,617    |       |   |   | 638,750 |   |
| Preferred shares participating in net income with  common shareholders - average |       |       |       | 120,500    |       |   |   | 120,500 |   |
| Used  in Basic EPS                                                               |       | $          | 956,528    |       | 767,117    |   | $ | 1,491,931 |   | 759,250 |   |
| Dilutive effect of outstanding stock options                                     |       |       |       | 61,459     |       |   |   | 53,729 |   |
| Used  in Dilutive EPS                                                            |       | $          | 956,528    |       | 828,576    |   | $ | 1,491,931 |   | 812,979 |   |

 

Preferredshares are included in the computation of basic earnings per share because theyshare equally with common shares in the distribution of net income and they donot have a stated dividend rate.

 

**NOTE O - REGULATORY MATTERS**

 

The Bank is subject tovarious regulatory capital requirements administered by the federal bankregulatory agencies. Failure to meet minimum capital requirements can initiatecertain mandatory, and possibly discretionary, actions by regulators that, ifundertaken, could have a direct material effect on the Bank’s financial statements.Under capital adequacy guidelines and the regulatory framework for promptcorrective action, the Bank must meet specific capital guidelines that involvequantitative measures of the Bank’s assets, liabilities, and certainoff-balance-sheet items as calculated under regulatory accounting practices. TheBank’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the table below) of Total andTier 1 capital (as defined in the regulations) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to average assets (as defined). Managementbelieves, as of December 31, 2005, that the Bank meets all capitaladequacy requirements to which it is subject.

 

62

----

 

As of December 31,2005 and 2004, the most recent notification from the Federal Reserve Boardcategorized the Bank as well-capitalized under the regulatory framework forprompt corrective action. There are no conditions or events since thatnotification that management believes have changed the Bank’s category. To becategorized as well-capitalized, the Bank must maintain minimum ratios as setforth in the table below. The following table also sets forth the Bank’s actualcapital amounts and ratios (dollar amounts in thousands):

 
| ** **                               | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of December 31, 2005:**        |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 14,599     |                 | 10.69      | %                                             | $          | 13,651 |   | 10.0 | % | $ | 10,920 |   | 8.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 13,403     |                 | 9.82       | %                                             | $          | 8,190 |   | 6.0 | % | $ | 5,460 |   | 4.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $          | 13,403     |                 | 9.23       | %                                             | $          | 7,263 |   | 5.0 | % | $ | 5,810 |   | 4.0 | % |
|                                     |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31, 2004:**        |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 13,461     |                 | 11.54      | %                                             | $          | 11,667 |   | 10.0 | % | $ | 9,333 |   | 8.0 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 12,317     |                 | 10.56      | %                                             | $          | 7,000 |   | 6.0 | % | $ | 4,667 |   | 4.0 | % |
| Tier 1 Capital (to Average Assets)       |       | $          | 12,317     |                 | 9.05       | %                                             | $          | 6,802 |   | 5.0 | % | $ | 5,442 |   | 4.0 | % |

 

Under existingregulations, the Company would be subject to similar requirements because itsconsolidated assets exceeded $150 million on December 31, 2005. However,the Company has been notified by the FRB that by March 31, 2006, the FRBexpects to revise, from $150 million to $500 million, the minimum asset sizecriteria for bank holding companies subject to those requirements. Further, theFRB has notified the Company that it is not subject to those additionalrequirements in the interim period from December 31, 2005, to March 31,2006.

 

Banking regulations limitthe amount of cash dividends that may be paid without prior approval ofthe Bank’s primary regulatory agency. Cash dividends are limited by theCalifornia Financial Code to the lesser of the Bank’s retained earnings or itsnet income for the last three fiscal years, net of the amount of any dividendsor other capital distributions made during those periods. As of December 31,2005, $3,578,000 was available for cash dividend distributions from the Bank toBancorp without prior regulatory approval. However, dividend distributions fromthe Bank in excess of $948,000 would change the Bank’s prompt corrective actionstatus from well-capitalized to adequately-capitalized.

 

63

----

 

**NOTE P- BANK ENTERPRISE AWARDS**

 

During2001, the Bank received a $990,000 award under the Fiscal Year 2001 BankEnterprise Award Program. The program is sponsored by the Department ofTreasury, Community Development Financial Institutions (CDFI) Fund. The Bankreceived the award for making a total of $3,000,000 in deposits with certifiedCommunity Development Financial Institutions.

 

TheBank deferred approximately $452,000 of the award to increase the future earningson the deposits to market rates, recognizing $181,000 of this deferred amountin 2003, and the balance of $92,000 was recognized in 2004.

 

TheBank received a $1,241,000 Bank Enterprise Award from the CDFI Fund in 2004. Theaward was made under the Fiscal Year 2004 Bank Enterprise Award (BEA) Program,which provides an incentive for any FDIC insured bank to annually increase thelevels of financial services provided to economically distressed communities. Becausethis award was based on past lending activity, the entire award was recognizedin non-interest income in 2004.

 

During2005 the Company received a $135,000 technical assistance grant from theCommunity Development Financial Institutions Fund. This grant is currentlyreflected in other liabilities in the consolidated balance sheet and will berecognized in non-interest income as qualifying expenses are incurred. No suchqualifying expenses had been incurred as of December 31, 2005. Althoughthe Bank is a certified CDFI bank and expects to continue to apply for variousgrants and awards, there can be no assurance that it will receive similarfuture grants or awards.

 

64

----

 

**NOTE Q - MISSION COMMUNITYBANCORP (Parent Company Only)**

 

On December 15, 2000,Mission Community Bancorp acquired Mission Community Bank by issuing 600,566shares of common stock in exchange for all outstanding shares of the Bank’scommon stock. There was no cash involved in this transaction.

 

Following are theseparate financial statements for Mission Community Bancorp (parent companyonly):

 

**MissionCommunity Bancorp (Parent Company Only)**

 

**CONDENSED BALANCE SHEETS**

 
| ** **                                     | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                     |       |       |       |       |       |
| Cash                                           |       | $          | 396,217    |       | $          | 35,479 |   |
| Interest-bearing deposits in other banks       |       | 250,000    |       | 250,000    |       |
| Investment in subsidiary bank                  |       | 13,256,705 |       | 12,366,327 |       |
| Loans receivable                               |       | —     |       | 150,000    |       |
| Other assets                                   |       | 437,887    |       | 356,996    |       |
| **TOTAL ASSETS**                               |       | $          | 14,340,809 |       | $          | 13,158,802 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY** |       |       |       |       |       |
| Junior subordinated debentures                 |       | $          | 3,093,000  |       | $          | 3,093,000 |   |
| Other liabilities                              |       | 266,585    |       | 38,486     |       |
| **TOTAL LIABILITIES**                          |       | 3,359,585  |       | 3,131,486  |       |
| **TOTAL SHAREHOLDERS’ EQUITY**            |       | 10,981,224 |       | 10,027,316 |       |
|                                           |       | $          | 14,340,809 |       | $          | 13,158,802 |   |

 

**CONDENSED STATEMENTS OF INCOME**

 
| ** **                                                | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Interest income                                           |       | $         | 6,389      |      | $          | 6,155 |   |
| Interest expense                                          |       | 216,115   |       | 152,482   |       |
| Net interest (expense)                                    |       | (209,726  | )          | (146,327  | )          |
| Dividends received from subsidiary                        |       | 90,085    |       | —    |       |
| Contribution to Mission Community Services Corp.          |       | 75,000    |       | 250,000   |       |
| Other expenses                                            |       | 57,424    |       | 46,493    |       |
| Loss before taxes                                         |       | (252,065  | )          | (442,820  | )          |
| Income taxes expense (benefit)                            |       | (140,282  | )          | (178,712  | )          |
| Loss before equity in undistributed income of  subsidiary |       | (111,783  | )          | (264,108  | )          |
| Equity in undistributed income of subsidiary              |       | 1,068,311 |       | 1,756,039 |       |
| Net income                                                |       | $         | 956,528    |      | $          | 1,491,931 |   |

 

65

----

 

**CONDENSED STATEMENTS CASH FLOWS**

 
| ** **                                                                                   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Operating activities:**                                                                    |       |       |       |       |       |
| Net income                                                                                   |       | $          | 956,528    |       | $          | 1,491,931 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |       |       |       |       |
| Income of subsidiary                                                                         |       | (1,158,396 | )          | (1,756,039 | )          |
| Amortization expense                                                                         |       | 17,232     |       | 17,232     |       |
| Other, net                                                                                   |       | 237,145    |       | (161,894   | )          |
| Net cash provided by (used in) operating activities                                          |       | 52,509     |       | (408,770   | )          |
| **Investing activities:**                                                                    |       |       |       |       |       |
| Loans repaid (advanced)                                                                      |       | 150,000    |       | (150,000   | )          |
| Dividends received from subsidiary                                                           |       | 90,085     |       | —     |       |
| Net cash provided by (used in) investing activities                                          |       | 240,085    |       | (150,000   | )          |
| **Financing activities:**                                                                    |       |       |       |       |       |
| Proceeds from issuance of common stock                                                       |       | 161,288    |       | 114,225    |       |
| Cash dividends paid                                                                          |       | (93,144    | )          | (91,572    | )          |
| Net cash provided by financing activities                                                    |       | 68,144     |       | 22,653     |       |
| Net increase (decrease) in cash                                                              |       | 360,738    |       | (536,117   | )          |
| Cash at beginning of year                                                                    |       | 35,479     |       | 571,596    |       |
| Cash at end of year                                                                          |       | $          | 396,217    |       | $          | 35,479 |   |

 

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

 

Thefair value of a financial instrument is the amount at which the asset orobligation could be exchanged in a current transaction between willing parties,other than in a forced or liquidation sale. Fair value estimates are made at aspecific point in time based on relevant market information and informationabout the financial instrument. These estimates do not reflect any premium ordiscount that could result from offering for sale at one time the entireholdings of a particular financial instrument. Because no market value existsfor a significant portion of the financial instruments, fair value estimatesare based on judgments regarding future expected loss experience, currenteconomic conditions, risk characteristics of various financial instruments, andother factors. These estimates are subjective in nature, involve uncertaintiesand matters of judgment and, therefore, cannot be determined with precision. Changesin assumptions could significantly affect the estimates.

 

Fairvalue estimates are based on financial instruments both on and off the balancesheet without attempting to estimate the value of anticipated future businessand the value of assets and liabilities that are not considered financialinstruments. Additionally, tax consequences related to the realization of theunrealized gains and losses can have a potential effect on fair value estimatesand have not been considered in many of the estimates.

 

66

----

## ** **

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

 

## **FinancialAssets**

## ** **

Thecarrying amounts of cash and short-term investments are considered toapproximate fair value. Short-term investments include federal funds sold andinterest bearing deposits with Banks. The fair values of investment securities,including available-for-sale, are generally based on quoted market prices. Thefair value of loans are estimated using a combination of techniques, includingdiscounting estimated future cash flows and quoted market prices of similarinstruments, where available.

 

## **FinancialLiabilities**

## ** **

The carrying amounts ofdeposit liabilities payable on demand and short-term borrowed funds areconsidered to approximate fair value. For fixed maturity deposits, fair valueis estimated by discounting estimated future cash flows using currently offeredrates for deposits of similar remaining maturities. The fair value of long-termdebt is based on rates currently available to the Bank for debt with similarterms and remaining maturities.

 

## **Off-BalanceSheet Financial Instruments**

## ** **

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

 

The estimated fair valueof financial instruments is summarized as follows:

 
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **Carrying**          | ** ** | **Fair** | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                               | ** ** | **Value**             | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| **Financial Assets:**                    |       |                  |       |   |   |   |   |   |   |
| Cash and due from banks                  |       | $                     | 4,433,000  |   | $ | 4,433,000 |   | $ | 2,587,000 |   | $ | 2,587,000 |   |
| Federal funds sold                       |       | 7,950,000             |       | 7,950,000 |   | 10,385,000 |   | 10,385,000 |   |
| Interest-bearing deposits in other banks |       | 550,000               |       | 550,000 |   | 550,000 |   | 550,000 |   |
| Investment securities                    |       | 15,816,000            |       | 15,816,000 |   | 15,772,000 |   | 15,732,000 |   |
| Loans, net                               |       | 118,334,000           |       | 118,205,000 |   | 102,282,000 |   | 102,224,000 |   |
| Federal Home Loan Bank and other stocks  |       | 1,499,000             |       | 1,499,000 |   | 1,081,000 |   | 1,081,000 |   |
| Accrued interest receivable              |       | 622,000               |       | 622,000 |   | 431,000 |   | 431,000 |   |
|                                     |       |                  |       |   |   |   |   |   |   |
| **Financial Liabilities:**               |       |                  |       |   |   |   |   |   |   |
| Deposits                                 |       | 127,588,000           |       | 127,569,000 |   | 112,836,000 |   | 112,653,000 |   |
| Other borrowings                         |       | 13,400,000            |       | 13,166,000 |   | 12,500,000 |   | 12,460,000 |   |
| Junior subordinated debt securities      |       | 3,093,000             |       | 3,727,000 |   | 3,093,000 |   | 3,093,000 |   |
| Accrued interest and other liabilities   |       | 1,225,000             |       | 1,225,000 |   | 793,000 |   | 793,000 |   |
|                                          |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

67

----

 

**Item 8. Changes In andDisagreements With Accountants on Accounting and Financial Disclosure**

 

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

 

**Item 8A. Controls and Procedures**

 

Within the 90 days prior tothe date of this report, our Chief Executive Officer and our Chief FinancialOfficer carried out an evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures pursuant to Exchange Act Rule 15a-15.Based upon that evaluation, the Chief Executive Officer and the Chief FinancialOfficer concluded that current disclosure controls and procedures are effectivein timely 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 is responsiblefor establishing and maintaining adequate internal control over financialreporting for the Company and the Bank including periodic filings with theSecurities Exchange Commission, the Federal Deposit Insurance Corporation (“FDIC”),the Federal Reserve Bank of San Francisco (“FRBSF”) and the CaliforniaDepartment of Financial Institutions (“DFI”). Such periodic financial reportsare prepared internally and reviewed by management prior to filing. Thesefinancial reports are also reviewed for timely filing, completeness andaccuracy with possible civil monetary penalties for late filing and intentionalinaccurate reporting by the various agencies where the reports are filed.

 

Internal controls overthe Bank’s operational, lending procedures and underwriting, financial systemsand other systems are reviewed by internal auditors, holding company and/orbank examiners, and by registered public accountants. At present, Bancorp,based on its asset size and lack of activity other than banking, is notindependently examined by the FRB.

 

Bancorp and the Bank haveelected to outsource the internal audit function to firms who specialize inperforming such auditing functions for community banks. During 2005, the Bankhad internal audits or reviews performed for operations and finance and theBank has contracted for several years for an independent loan review functionwhich reviews loans and lending activity once every two months. Each of theinternal audits, along with management’s response to any observations, arecompleted in writing and presented to the Board Audit Committee. Management isthen responsible to take any corrective action required to modify procedures orpolicies to improve internal controls and procedures. Internal auditengagements are in writing, including the anticipated scope, and are generallyfor 18 to 24 months with interim auditing during the term of the engagement. Engagementsare presented to and approved by the Board Audit Committee. Based on internalaudits performed in 2005, neither management nor the Board Audit Committee hasbeen informed of any material weaknesses in internal controls over financial reporting.

 

Internal controls, lending,and financial reporting are also periodically reviewed by bank and bank holdingcompany examiners. As a state charted bank, the Bank is examined by the FRBSFand the DFI. Prior to the December 2003 charter conversion, the Bank wasperiodically examined by the Comptroller of the Currency (OCC) as required bylaw, including examinations for safety and soundness, lending, compliance,Community Reinvestment Act, and information technology. Written reports ofexamination by state or federal regulators are provided to the Bank, reviewedby management and by the Board Audit Committee. If an examination revealedmaterial 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 event of material exceptions, a bank could berequired to enter into a formal agreement (such as a Memorandum of Understandingor Cease and Desist Order) which would document the specific weaknesses andcorrective action that must be taken. These formal agreements are generallyrequired to be disclosed to the public. As of December 2005, the Bank isnot operating under any formal or informal agreement with the FRB, DFI or OCCnor is any such agreement pending or anticipated.

 

Finally, internal controlsand financial reporting is reviewed by independent registered publicaccountants on an annual basis. These audited reports, including anyrecommendations for improvements in accounting or internal controls, arepresented to management and the Board’s Audit Committee. As of December 31,2005, the audited financial statements of the Company have been certified bythe Company’s independent registered public accountants with no materialweaknesses identified in internal controls or financial reporting. Beginning in2007, the Company will be required to have its registered public accountantsprovide an attestation of management’s assessment of internal controls overfinancial reporting.

 

No material changes havebeen made in internal controls during the past year. However, the Bank didincrease its budget and expenses for internal control reviews and internalauditing in 2004. It also engaged a firm to perform a specific internalassessment of the Bank’s information technology and information securitysystems for a three-year period beginning in

 

68

----

 

2006. It has made minorstaffing changes to improve internal controls based on recommendations madeduring the internal auditing process.

 

**Item 8B. Other Information**

 

All information requiredto be reported on a Form 8-K during the fourth quarter of 2005 has been soreported.

 

69

----

 

# **PART III**

# ** **

**Item 9. Directors,Executive Officers, Promoters and Controlled Persons; Compliance With Section 16(a) ofthe Exchange Act.**

 

Thefollowing table lists the names and certain information as of December 31,2005, concerning all directors and executive officers of the Company and theBank. The Company and the Bank have no “significant employees” (as defined)except its executive officers.

 
| **Name and Title**                                             | ** ** | **Age** | ** ** | **Business Experience for the Past Five Years**                                                                                                                                    | ** ** | **Year First Elected or  Appointed Director*** |
|--------------------------------------------------------------------------|------------|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|
|                                                                     |       |    |       |                                                                                                                                                                                                             |       |                                                               |
| Bruce  M. Breault  Founding Chairman  of the Board (Emeritus)            |       | 63      |       | Partner and Owner, F.  McLintocks, Inc. (restaurants) (1973-present)                                                                                                                                        |       | 1996                                                               |
| Roxanne  M. Carr  Vice Chairman of the Board                             |       | 68      |       | Division President and  Corporate Senior Vice President, The Mortgage House, Inc.  (1995-present); Regional Vice President, ARCS Mortgage, Inc. (1973-1995)                                            |       | 1997                                                               |
| William  B. Coy  Chairman of the Board                                   |       | 68      |       | Owner and Manager,  Rancho Rio Conejo (citrus and avocados) (1979-present); Corporate Marketing  Manager, San Luis Obispo County Farm Supply Company (1991-2001)                                                 |       | 1996                                                               |
| James  M. Judge  Executive Vice President and  Chief Credit Officer      |       | 61      |       | Chief Credit Officer  (3)                                                                                                                                                                                        |       | —                                                             |
| Richard  Korsgaard   Director                                            |       | 64      |       | Retired; Executive Vice  President and Chief Credit Officer, Mission Community Bank, 2002-2005 (1)                                                                                                               |       | 2005                                                               |
| Ronald  B. Pigeon  Executive Vice President and  Chief Financial Officer |       | 56      |       | Chief Financial Officer  and Controller (4)                                                                                                                                                                      |       | —                                                             |
| Anita  M. Robinson  Director, President and  Chief Executive Officer     |       | 53      |       | President and Chief  Executive Officer of the Bank and the Company  (2)                                                                                                                                     |       | 1996                                                               |
| Robin  L. Rossi 

Director                                               |       | 58      |       | President, Rossi  Enterprises (property management) (1991-present); President, Infinite  Horizons, Inc. (Manager of Avila Beach Resort and Blacklake Resort –  Real estate investments) (1979-present) |       | 1996                                                               |
| Gary  E. Stemper  Immediate Past Chairman  Of the Board                  |       | 63      |       | Manager, Eagle Castle  Winery, LLC, (2000-present); Partner, Eberle Winery of Paso Robles  (1982-2005); Owner, Gary Stemper Construction Co. (1967-present); Partner,  Mill Road Vineyard (1994-present)         |       | 1996                                                               |
| Karl F. Wittstrom 

Secretary                                            |       | 52      |       | Self-employed—real  estate development, construction, vineyards, ranching and investments,  (1996-present)                                                                                                  |       | 1997                                                               |

 

----

* Refers to year firstelected or appointed to Board of the Bank

 

(1)          Mr. Korsgaard joinedthe Bank on July 22, 2002 and served as the Executive Vice President andChief Credit Officer until his retirement on March 31, 2005. He wasappointed to the Board of Directors effective January 1, 2005, andcontinues to serve as a Director following his retirement. Mr. Korsgaardhas 40 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.

(2)          Ms. Robinson has been the Bank’s President and Chief ExecutiveOfficer since its formation in 1996. She has over 33 years of bankingexperience.

(3)          On February 16, 2005, James M. Judge joined theBank as its Executive Vice President/Chief Credit Officer, replacing RichardKorsgaard, who retired on March 31, 2005. Mr. Judge has over 43 yearsof banking and finance experience, recently serving as Executive VicePresident/Chief Credit Officer for Cerritos Valley Bank in Artesia, California(2001-2002).

(4)          On January 18, 2005, Ronald B. Pigeon joined theBank as its Executive Vice President and Chief Financial Officer, replacingWilliam Demmin, who left the Bank on July 29, 2004, to accept a position withanother firm. Mr. Pigeon was also appointed by the Company’sBoard of Directors to serve as Chief Financial Officer for Bancorp. During thepast five years, Mr. Pigeon held the positions of Senior Vice Presidentand Controller with Humboldt Bancorp located in Roseville, California (2003 to2004); and Controller and Chief Financial Officer for 722 Redemption Funding, Inc.located in Cincinnati, Ohio (1999 to 2003). He also served as the Controllerfor Trans Financial, Inc., located in Bowling Green, Kentucky, from 1993to 1998. Mr. Pigeon is a certified public accountant.

 

70

----

 

Inaddition, separate Salary Protection Agreements (“the Agreements”) have beenentered into by the Bank with Mr. Pigeon and Mr. Judge, which providefor salary continuation benefits for a period of six months in the event ofapplicable occurrences as specified within the Agreements.

 

None of the Bank’sdirectors or executive officers was selected pursuant to any arrangement orunderstanding, other than with the directors and executive officers of theBank, acting within their capacities as such. There are no family relationshipsbetween the directors or executive officers of the Bank and none serve asdirectors of any other company which has a class of securities registeredunder, or which is subject to the periodic reporting requirements of, theSecurities Exchange Act of 1934 or any investment company registered under theInvestment Company Act of 1940.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

 

The Company does not have a class of equitysecurities registered pursuant to Section 12 of the Securities Exchange Actof 1934 (the “Exchange Act”). Therefore, the Company’s officers and directors,and persons who own more than 10% of the Company’s Common Stock, are notsubject to the reporting requirements under Section 16(a) of theExchange Act.

 

**The Board of Directors andCommittees**

 

Regular meetings of the Board of Directors of the Company are notscheduled and are held as needed throughout the year, as virtually all of theCompany’s business is conducted through the Bank. The Board of Directors of theCompany has established an Audit Committee and an Executive Committee. In 2005,the Board of Directors met seven times, the Audit Committee met four times, andthe Executive Committee met one time. The Company also established a CorporateGovernance Committee in January 2006.

 

In addition to serving on the Board of Directors of the Company, eachof the directors serves on the Board of Directors of the Bank. The Bank’s Boardof Directors held twelve regular meetings and three special meetings in 2005. Allof the Bank’s directors attended at least 75% of all Board and assignedcommittee meetings held in 2005, with the exception of Director Karl F.Wittstrom who attended 70% of all meetings held.

 

In addition to meeting as a group to review the business of the Companyand the Bank, certain members of the Board of Directors also devote their timeand talents to certain various standing committees of either the Company or theBank. The Bank did not have a Compensation Committee in 2005; however, one wasformed in January 2006.

 

Executive Committee. The Executive Committee, consisting of DirectorsBreault, Carr, Coy, Robinson, Stemper and Wittstrom sets policies andsupervises the Company’s management between regular Board meetings. TheExecutive Committee held one meeting during 2005.

 

Audit Committee. The Audit Committee, consisting of DirectorsBreault, Carr, Coy, Korsgaard, Stemper and Wittstrom, reviews all internal andexternal examination reports and selects the Company’s independent accountants.The Audit Committee met four times in 2005. 

 

Investment Committee. The Investment Committee, consisting of DirectorsBreault, Carr, Korsgaard, Rossi, Robinson and Wittstrom, monitors the Bank’sinvestment portfolio, reviews interest rate exposure and liquidity, andestablishes investment policy. The Investment Committee met four times in 2005.

 

Loan Committee. The Loan Committee, consisting of Directors Breault,Coy, Korsgaard, Robinson, Stemper and Wittstrom, reviews loan policy andapproves loans in excess of individual loan officers’ lending authority. TheLoan Committee met 32 times in 2005.

 

71

----

 

Personnel Committee. The Personnel Committee, consisting of DirectorsBreault,  Coy, Robinson and Wittstrom,reviews and recommends for Board approval the Bank’s compensation, benefit andhealth insurance packages for senior management and employees. The PersonnelCommittee met once in 2005.

 

Technology Committee. The Technology Committee, consisting of DirectorsBreault, Coy, Stemper and Robinson oversees the Bank’s electronicbanking and information systems and assists management with technologicalchanges in the banking and business environment. The Technology Committee metonce in 2005.

 

Nominating Committee. The Companydid not have a standing Nominating Committee in 2005; however, one was formedin January 2006. In connection with selecting candidates for nomination tothe Board of Directors, including any nominees recommended by security holders,the Board of Directors (i) reviews compliance by the security holders withthe Company’s nominating procedures contained in the Bylaws and summarized inthe Notice of Annual Meeting; (ii) reviews information assembled for thepurpose of selecting candidates for nomination to membership on the Board ofDirectors; and (iii) following appropriate investigation, ascertains thewillingness of selected candidates to serve and extends on behalf of the Boardof Directors, invitations to become candidates.

 

**Item 10. Executive Compensation**

 

**Summary Compensation Table**

 

The followingtable sets forth a summary of annual and long-term compensation for services inall capacities to the Company for the Company’s executive officers who werepaid more than $100,000 during 2005.

 
| ** **                  | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Long-Term  Compensation  Awards** | ** ** | ** **                     | ** ** |
|-----------------------------|------------|------------|------------|-------------------------|------------|-------------------------------------|------------|--------------------------------|------------|
| **Name and Position**       | ** ** | **Year**   | ** ** | **Salary/Benefits**     | ** ** | **Bonus**                           | ** ** | **Other Annual  Compensation** | ** ** | **Securities  Underlying Options** | ** ** | **All Other  Compensation (1)** | ** ** |
|                        |       |       |       |                    |       |                                |       |                           |       |   |   |   |   |
| **Anita  M. Robinson**      |       | 2005       |       | $                       | 163,795    |                                | $          | 6,145                          |       | $ | 18,758 |   | — |   | — |   |
| President and  Chief        |       | 2004       |       | $                       | 140,400    |                                | $          | 18,428                         |       | $ | 18,166 |   | — |   | — |   |
| Executive  Officer (2)      |       | 2003       |       | $                       | 134,550    |                                | —     |                           | $          | 10,418 |   | — |   | — |   |
|                        |       |       |       |                    |       |                                |       |                           |       |   |   |   |   |
| **Ronald  B. Pigeon**  |       | 2005       |       | $                       | 103,615    |                                | $          | 3,073                          |       | $ | 10,879 |   | 3,000 |   | $ | 3,438 |   |
| Executive Vice              |       | 2004       |       | —                  |       | —                              |       | —                         |       | — |   | — |   |
| President and  Chief        |       | 2003       |       | —                  |       | —                              |       | —                         |       | — |   | — |   |
| Financial  Officer (3)      |       |       |       |                    |       |                                |       |                           |       |   |   |   |   |
|                        |       |       |       |                    |       |                                |       |                           |       |   |   |   |   |
| **James  M. Judge**         |       | 2005       |       | $                       | 95,833     |                                | $          | 2,677                          |       | $ | 6,949 |   | 3,000 |   | $ | 5,000 |   |
| Executive Vice              |       | 2004       |       | —                  |       | —                              |       | —                         |       | — |   | — |   |
| President  and Chief   |       | 2003       |       | —                  |       | —                              |       | —                         |       | — |   | — |   |
| Credit Officer  (4)         |       |       |       |                    |       |                                |       |                           |       |   |   |   |   |

 
| (1) “All Other Compensation” represents relocation  costs paid in 2005 for each executive officer as per terms of their  employment.                                                                                                                                                                                                                    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) “Other Annual Compensation” for Ms. Robinson  represents automobile allowances paid ($7,800 for each of 2005, 2004 and  2003), Company contributions to the 401(k) and Profit Sharing Plan ($10,385  for 2005, $9,891 for 2004 and $2,143 for 2003) and premiums for supplemental  life insurance ($573 for 2005, $475 for 2004 and $475 for 2003). |
| (3) “Other Annual Compensation” for Mr. Pigeon  represents automobile allowances paid ($4,800) and Company contributions to  the 401(k) and Profit Sharing Plan ($6,079).   Mr. Pigeon, who was hired January 18, 2005, did not receive any  compensation in 2003 or 2004.                                                                         |
| (4) “Other Annual Compensation” for Mr. Judge  represents automobile allowances paid ($4,400) and Company contributions to  the 401(k) and Profit Sharing Plan ($2,549).   Mr. Judge, who was hired February 16, 2005, did not receive any  compensation in 2003 or 2004.                                                                          |

 

No other officer receivedannual compensation of $100,000 or more in 2005. The Company currently pays nosalaries to its directors who are not officers.

 

72

----

 

In 2004 the Bankinitiated an incentive compensation plan covering Ms. Robinson and allother bank officers. No payments were made under this plan in 2004. Incentivecompensation payments to all participants in 2005, based on 2004 results,totaled approximately $57,000.  Incentivecompensation paid to all participants in the first quarter of 2006, based on2005 results, totaled approximately $46,000.

 

**Option/SAR Grants**

 

On January 20, 1998the Bank’s Board of Directors adopted the 1998 Stock Option Plan, pursuant toapproval by the Bank’s shareholders prior to January 20, 1999.

 

In 2005, a total of25,500 stock options were granted, 4,000 incentive stock options were retired,and 17,200 stock options were exercised.

 

See Note I - Stock OptionPlan in the consolidated financial statements for additional information onstock options issued and outstanding.

 

**Long Term Incentive Plan Awards**

 

There were no long-termincentive plan awards in 2004 or 2005.

 

**Employment Contracts**

 

On February 25,2002, the Board of Directors approved a new employment contract for Ms. Robinson,effective for a five year term beginning on January 1, 2002, whichprovided for a base salary of $10,833 per month, an automobile allowance of$650 per month, expense reimbursement, $250,000 of life insurance, standard andcustomary medical and dental insurance benefits, and a non-recurring bonus of$10,000. The five-year agreement provides for an annual review by the Board ofDirectors of the base salary provided to Ms. Robinson, which shall not beless than $10,833 per month during the life of the agreement. Ms. Robinson’sbase salary was increased to $11,700 per month effective January 1, 2003,and to $13,750 per month effective January 1, 2005. In 2005 her lifeinsurance coverage was increased to $550,000. The contract provides forseverance benefits of six months base salary for termination without cause, andseverance benefits of sixty months base salary, from the date of event, fortermination after a merger, change in control, or other defined corporatereorganizations.

 

On January 18, 2005and February 1, 2005, the Bank entered into Salary Protection Agreementswith Ronald B. Pigeon, Executive Vice President/Chief Financial Officer, andJames M. Judge, Executive Vice President/Chief Credit Officer, respectively. Since2001, the Bank has also entered into Salary Protection Agreements with thoseofficers holding the position of Senior Vice President and above. The SalaryProtection Agreements provide for severance benefits for termination after amerger, change in control, or other defined corporate reorganizations. The Bankhas not entered into any other employment contracts or severance agreements.

 

**Directors’ Compensation**

 

Prior to 2002 the Bank’sdirectors were not paid for attending meetings of the Board or the committeeson which they served. On April 22, 2002 the bank’s Board of Directorsapproved a Director Compensation Program, which became effective on July 1,2002, providing for outside directors to receive a monthly retainer of $500 foreach Board Meeting attended and a fee of $100 for each Director Committeemeeting attended. In 2005, the Board received, on a cumulative basis, $60,100in director fees for meetings attended in 2005.

 

There were no StockOption grants to Directors during the year ended December 31, 2005.

 

73

----

 

**Item 11.****   ****Security Ownership of Certain BeneficialOwners and Management and Related Shareholder Matters**

 

The followingtable sets forth certain information as of March 27, 2006, concerning thebeneficial ownership of the Company’s outstanding Common Stock: (i) byeach of the directors and executive officers; and (ii) by all directorsand executive officers of the Company as a group. Management is not aware ofany change in control of the Company which has occurred since January 1,2006 or of any arrangement which may, at a subsequent date, result in such achange in control.

 

 
| **Name and Position Held**                                   | ** ** | **Common  Stock  Beneficially  Owned (1)** | ** ** | **Shares  Subject  to  Exercise** | ** ** | **Total Shares  Beneficially  Owned** | ** ** | **Percent  of Class** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|
|                                                                        |       |                                            |       |                              |       |                                       |       |                       |       |
| Bruce  M. Breault  Founding Chairman of the Board  (Emeritus)               |       | 21,250                                          |       | 15,533                            |       | 36,783                                     |       | 5.4                        | %          |
| Roxanne  M. Carr  Vice Chairman of the Board                                |       | 19,400                                          |       | —                            |       | 19,400                                     |       | 2.9                        | %          |
| William  B. Coy  Chairman of the Board                                      |       | 7,750                                           |       | 9,400                             |       | 17,150                                     |       | 2.5                        | %          |
| James  M. Judge  Executive Vice President and  Chief Credit Officer         |       | —                                          |       | 600                               |       | 600                                        |       | 0.1                        | %          |
| Richard  Korsgaard  Director                                                |       | 3,000                                           |       | 1,000                             |       | 4,000                                      |       | 0.6                        | %          |
| Ronald  B. Pigeon  Executive Vice President and  Chief Financial Officer    |       | —                                          |       | 600                               |       | 600                                        |       | 0.1                        | %          |
| Anita  M. Robinson  Director, President and  Chief Executive Officer        |       | 18,609                                          |       | 25,000                            |       | 43,609                                     |       | 6.3                        | %          |
| Robin  L. Rossi  Director                                                   |       | 13,707(2                                        | )          | 13,400                            |       | 27,107                                     |       | 4.0                        | %          |
| Gary  E. Stemper  Immediate Past Chairman of the Board                      |       | 7,500                                           |       | 11,800                            |       | 19,300                                     |       | 2.8                        | %          |
| Karl  F. Wittstrom  Secretary                                               |       | 15,350                                          |       | 11,000                            |       | 26,350                                     |       | 3.9                        | %          |
| All  Directors and Executive Officers as a  Group, consisting of 10 persons |       | 106,566                                         |       | 88,333                            |       | 194,899                                    |       | 25.8                       | %          |

 

----

(1)          Includes shares beneficially owned, directly or indirectly, together withassociates. Also includes shares held as trustee and held by or as custodianfor minor children, by a closely held business or other associate. Unlessotherwise indicated, all shares are held as community property under Californialaw or with sole voting and investment power.

(2)          Mr. Rossi’s beneficially-owned shares include 457 shares held in thename of The Rossi Foundation, of which Mr. Rossi holds no voting power.

 

Management of theCompany is aware of one person who owns, beneficially or of record, more than5% of the Company’s outstanding Common Stock:

 

ThePatrick W. Hopper Trust beneficially owns 41,634 shares of common stock, or6.3% of total shares outstanding.

 

The U.S.Department of Treasury, Community Development Financial Institutions Fund,holds the equivalent of 100,000 shares Common Stock under its combinedownership of Series A and Series C Convertible Preferred Stock.

 

74

----

 

**Item 12. Certain Relationshipsand Related Transactions**

 

**Certain Transactions**

 

There are no materialexisting or proposed transactions between Bancorp or the Bank and any of itsexecutive officers, directors, or beneficial owners of 5% or more of the CommonStock, or the immediate family or associates of any of the foregoing persons,except as indicated below.

 

Some of the Bank’sdirectors and executive officers and their immediate families, as well as thecompanies with which such directors and executive officers are associated, arecustomers of, and have had banking transactions with the Bank in the ordinarycourse of business and anticipate having such banking transactions with suchpersons in the future. In the opinion of Management, all loans and commitmentsto lend included in such transactions were made in compliance with applicablelaws on substantially the same terms, including interest rates and collateral,as those prevailing at the time for comparable transactions with other personsof similar creditworthiness and did not involve more than a normal risk ofcollectibility or present other unfavorable features. As of December 31,2005, loans outstanding to the Bank’s directors and executive officers(including associated companies) totaled approximately $3,349,000.

 

75

----

 

## **Item13. Exhibits**

## ** **

**Exhibit Index:**

 
| **Exhibit #** | ** ** | ** **                                                                                                                                                                                                                                                    | ** ** | **Page**   |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 2.1                |       | Plan of Reorganization and  Agreement of Merger dated as of October 4, 2000 (A)                                                                                                                                                                          |       |       |
| 3.1                |       | Articles of Incorporation  (B)(G)                                                                                                                                                                                                                             | ** ** | ** ** |
| 3.2                |       | Bylaws (B)                                                                                                                                                                                                                                                    |       |       |
| 4.1                |       | Certificate of Determination  for Series A Non-Voting Preferred Stock (B)                                                                                                                                                                                |       |       |
| 4.2                |       | Certificate of  Determination for Series B Non-Voting Preferred Stock (B)                                                                                                                                                                                |       |       |
| 4.3                |       | Certificate of  Determination for Series C Non-Voting Preferred Stock (D)                                                                                                                                                                                |       |       |
| 4.4                |       | Purchase Agreement dated October 10,  2003, by and among Registrant, Mission Community Capital Trust I, and Bear  Stearns & Co., Inc. (F)                                                                                                  |       |       |
| 4.5                |       | Indenture dated as of October 14,  2003 by and between Registrant and Wells Fargo Bank, National Association, as  trustee (F)                                                                                                                            |       |       |
| 4.6                |       | Declaration of Trust of Mission  Community Capital Trust I dated October 10, 2003 (F)                                                                                                                                                                    |       |       |
| 4.7                |       | Amended and Restated  Declaration of Trust of Mission Community Capital Trust I dated October 14,  2003 by and among the Registrant, Wells Fargo Delaware Trust Company, as  Trustee, and Anita M. Robinson and William C. Demmin, as Administrators (F) |       |       |
| 4.8                |       | Guarantee Agreement dated October 14,  2003 between Registrant, as Guarantor, and Wells Fargo Bank, National  Association, as Guarantee Trustee (F)                                                                                                      |       |       |
| 4.9                |       | Fee Agreement dated October 14,  2003 by and among the Registrant, Wells Fargo Delaware Trust Co., Bear  Stearns & Co., Inc. and Mission Community Capital Trust I (F)                                                                     |       |       |
| 10.1               |       | Purchase and Sale Agreement  and Lease dated January, 1997, as amended (B)                                                                                                                                                                                    |       |       |
| 10.2               |       | Employment Contract – Ms. Robinson  (B)                                                                                                                                                                                                             |       |       |
| 10.3               |       | Lease Agreement – Paso  Robles (B)                                                                                                                                                                                                                       |       |       |
| 10.4               |       | Lease Agreement – San Luis  Obispo (B)                                                                                                                                                                                                                   |       |       |
| 10.5               |       | Lease Agreement – Arroyo  Grande (B)                                                                                                                                                                                                                     |       |       |
| 10.6               |       | 1998 Stock Option Plan, as  amended (B)                                                                                                                                                                                                                       |       |       |
| 10.7               |       | Lease Agreement – 569  Higuera, San Luis Obispo (D)                                                                                                                                                                                                      |       |       |
| 10.8               |       | Lease Agreement – 671 Tefft  Street Nipomo CA (C)                                                                                                                                                                                                        |       |       |
| 10.9               |       | Employment Agreement – Ms. Robinson  (E)                                                                                                                                                                                                            |       |       |
| 10.10              |       | Lease Agreement – 3480 S.  Higuera, San Luis Obispo (G)                                                                                                                                                                                                  |       |       |
| 10.11              |       | Salary Protection Agreement  – Mr. Pigeon (H)                                                                                                                                                                                                       |       |       |
| 10.12              |       | Salary Protection Agreement  – Mr. Judge (I)                                                                                                                                                                                                        |       |       |
| 21                 |       | Subsidiaries of the  registrant                                                                                                                                                                                                                               |       | 80         |
| 23.1               |       | Independent Auditors’  Consent                                                                                                                                                                                                                           |       | 81         |
| 31.1               |       | Certification of CEO  pursuant to Section 302 of Sarbanes Oxley Act                                                                                                                                                                                      |       | 82         |
| 31.2               |       | Certification of CFO  pursuant to Section 302 of Sarbanes Oxley Act                                                                                                                                                                                      |       | 83         |
| 32.1               |       | Certification of CEO  pursuant to Section 906 of Sarbanes Oxley Act                                                                                                                                                                                      |       | 84         |
| 32.2               |       | Certification of CFO  pursuant to Section 906 of Sarbanes Oxley Act                                                                                                                                                                                      |       | 85         |

 

----

(A)                              Included in the Company’s Form 8-K filedon December 18, 2000

(B)                                Included in the Company’s Form 10-KSBfiled on April 2, 2001

(C)                                Included in the Company’s Form 10-QSBfiled August 12, 2002

(D)                               Included in the Company’s Form 10-QSBfiled on November 12, 2002

(E)                                 Included in the Company’s Form 10-QSBfiled on August 13, 2003

(F)                                 Included in the Company’s Form 8-K filedon October 21, 2003

(G)                                Amendment included in the Company’s Form 10-QSBfiled on August 10, 2004

(H)                               Included in the Company’s Form 8-K filedon January 19, 2005

(I)                                    Included in the Company’s Form 8-K filedon February 17, 2005

 

76

----

 

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

 

The following table presentsfees for professional audit services rendered by Vavrinek, Trine, Day &Co., LLP for the audit of the Company’s annual financial statements for theyears ended December 31, 2005, and December 31, 2004, and fees billedfor the other services rendered by Vavrinek, Trine, Day & Co., LLPduring those periods.

 

| **(Amounts in dollars)** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Audit Fees                         |       | $        | 42,000     |     | $          | 37,000 |   |
| Tax Fees                           |       | 5,000    |       | 4,000    |       |
|                                    |            |          |            |          |            |  |  |

 

Audit Fees consist of amountsbilled for professional services rendered by Vavrinek, Trine, Day &Co., LLP for the audit of the Company’s annual financial statements and thereviews of the financials statements included in the Company’s Forms 10-QSB forthe applicable fiscal year. Tax Fees consist of the aggregate fees billed forprofessional services rendered by Vavrinek, Trine, Day & Co., LLP fortax compliance, tax advice, and tax planning. Before Vavrinek, Trine, Day &Co., LLP was engaged by the Bank to render audit or non-audit servicesassociated with the fees discussed above, the engagement was approved by theAudit Committee of the Board of Directors. The Board of Directors is of theopinion that all service fees charged by Vavrinek, Trine, Day & Co.,LLP are consistent with Vavrinek, Trine, Day & Co., LLP maintainingits independence from the Company.

 

77

----

 

**Signatures**

 

Pursuant to therequirements of Section 13 of the Securities Exchange Act of 1934, theCompany has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| **MISSION COMMUNITY BANCORP**                         |                  |
|-------------------------------------------------------|-----------------------|
|                                                  |                  |
|                                                  |                  |
|                                                  |                  |
| By:                                                   | /s/ Anita M. Robinson |   |   |
| ANITA M. ROBINSON                                     |                  |
| President and Chief  Executive Officer                |                  |
| Dated:                                                | March 29, 2006   |   |
|                                                  |                  |
|                                                  |                  |
|                                                  |                  |
| By:                                                   | /s/ Ronald B. Pigeon  |   |   |
| RONALD B. PIGEON                                      |                  |
| Executive Vice  President and Chief Financial Officer |                  |
| Dated:                                                | March 29, 2006   |   |
|                                                  |                  |
|                                                  |                  |
| [Signatures continue on  next page]                   |                  |
|                                                       |                       |  |  |  |

 

78

----

 

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

 
| **/s/ Bruce M. Breault** | ** ** | ** **                               | ** ** | ** **          |
|--------------------------|------------|------------------------------------------|------------|---------------------|
| BRUCE M. BREAULT         |       | Founding Chairman of  the Board          |       | March 27, 2006 |
|                     |       | (Emeritus)                               |       |                |
| /s/ Roxanne M. Carr      |       |                                     |       |                |
| ROXANNE M. CARR          |       | Vice Chairman of the  Board              |       | March 27, 2006 |
|                     |       |                                     |       |                |
| /s/ William B. Coy       |       |                                     |       |                |
| WILLIAM B. COY           |       | Chairman of the Board                    |       | March 27, 2006 |
|                     |       |                                     |       |                |
|                     |       |                                     |       |                |
| RICHARD KORSGAARD        |       | Director                                 |       |                |
|                     |       |                                     |       |                |
| /s/ Ronald B. Pigeon     |       |                                     |       |                |
| RONALD B. PIGEON         |       | Executive Vice  President and Chief      |       | March 27, 2006 |
|                     |       | Financial Officer                        |       |                |
|                     |       | (Principal Accounting  Officer)          |       |                |
| /s/ Anita M. Robinson    |       |                                     |       |                |
| ANITA M. ROBINSON        |       | Director, President and  Chief Executive |       |                |
|                     |       | Officer                                  |       | March 27, 2006 |
|                     |       |                                     |       |                |
| /s/ Robin L. Rossi       |       |                                     |       |                |
| ROBIN L. ROSSI           |       | Director                                 |       | March 27, 2006 |
|                     |       |                                     |       |                |
|                     |       |                                     |       |                |
| /s/ Gary E. Stemper      |       |                                     |       |                |
| GARY E. STEMPER          |       | Immediate Past Chairman  of the Board    |       | March 27, 2006 |
|                     |       |                                     |       |                |
| /s/ Karl F. Wittstrom    |       |                                     |       |                |
| KARL F. WITTSTROM        |       | Director and Secretary                   |       | March 27, 2006 |

 

79

----