UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004

OR

[  ]       Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                                        to                                       

COMMISSION FILE No.: 000-50545

SOUTHWEST COMMUNITY BANCORP

Incorporated Under the Laws of the State of California

I.R.S. EMPLOYER IDENTIFICATION NO.: 30-0136231

5810 EL CAMINO REAL
CARLSBAD, CALIFORNIA 92008
TELEPHONE: (760) 918-2616

     Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

     Number of shares of Common Stock outstanding as of July 31, 2004: 2,996,762

INDEX

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PART I – Financial Information

SOUTHWEST COMMUNITY BANCORP AND SUBSIDIARIES

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

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SOUTHWEST COMMUNITY BANCORP AND SUBSIDIARIES

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

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SOUTHWEST COMMUNITY BANCORP AND SUBSIDIARIES

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

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SOUTHWEST COMMUNITY BANCORP AND SUBSIDIARIES

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

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SOUTHWEST COMMUNITY BANCORP

Note 1 – Summary of Significant Accounting Policies

     The accounting and reporting policies of Southwest Community Bancorp and subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices followed by the banking industry. In the opinion of management, the unaudited consolidated financial statements contain all (consisting of only normal recurring adjustments) adjustments necessary to present fairly the Company’s consolidated financial position at June 30, 2004 and results of operations for the three and six month periods ended June 30, 2004 and 2003 and changes in cash flows for the six month periods ended June 30, 2004 and 2003.

     Certain information and footnote disclosures normally presented in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended December 31, 2003 included in the Company’s Annual Report on Form 10-K.

Nature of Operations

     Southwest Community Bancorp (“Southwest Community” or “holding company” on a parent –only basis and the “Company” “we” or “our” on a consolidated basis) is a bank holding company that was incorporated on December 4, 2002, under the laws of the State of California for the purpose of becoming the holding company for Southwest Community Bank (the “Bank”) and the Bank’s majority-owned subsidiary, Financial Data Solutions, Inc. (“FDSI”). The holding company reorganization was consummated on April 1, 2003.

     The Bank began operations on December 1, 1997, as a state-chartered bank and currently operates eight branch offices within San Diego, Orange, Riverside and San Bernardino Counties and a loan production office in Los Angeles County. The Bank’s primary source of revenue is from providing loans to customers who are predominately small and middle-market businesses. In November 1998, the Bank began a subsidiary operation, FDSI, which provides a variety of data processing services to the financial services industry. In May 2003, the Bank transferred its 51% equity interest in FDSI to the holding company. In February 2004, the holding company acquired the 49% minority interest.

Principles of Consolidation

     The accompanying consolidated financial statements include the accounts of the Company, the Bank and FDSI. All material intercompany balances and transactions have been eliminated in consolidation. Minority interest in prior periods represented a minority shareholder’s 49% share of the equity of FDSI. On February 26, 2004, the Company purchased the minority interest for $3,350,000 in cash. The consolidated financial statements do not include the accounts of Southwest Community Statutory Trust I (the “Trust”), a business trust formed to issue trust preferred securities. The Company’s investment in the Trust is carried as an investment in other assets and the funds borrowed from the Trust are presented as junior subordinated debt. For regulatory purposes the proceeds from issuance of the junior subordinated debt, subject to percentage limitations, are considered Tier 1 capital.

Use of Estimates in the Preparation of Financial Statements

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

     Material estimates that are subject to change include the carrying value of financial instruments such as investment securities, loans, deposits, borrowings and commitments to extend credit. Material estimates

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that are subject to change also include the allowance for loan losses and the valuation of loan collateral and any foreclosed assets.

     If the values of financial instruments carried as assets become impaired due to the fair value declining below the recorded value, we may be required to provide an allowance for loss or write off the instrument by an expense charge in our income statement. Also, if our obligations to third parties increased above our recorded liabilities, we may have to increase the carrying value of those liabilities by an expense charge in our income statement.

Allowance for Loan Losses

     The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The allowance is based on management’s continuing review and evaluation of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. While management uses available information to provide for an allowance for loan losses, additional provisions to the allowance may be necessary based on future changes in the factors used to evaluate the loan portfolio.

Note 2 – Earnings Per Share

     The following is a reconciliation of net income and shares outstanding to the income and number of shares used to compute net income per share for the periods presented:

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Note 3 – Stock-Based Compensation

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

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

Note 4 – Recent Accounting Pronouncements

     In March 2004, the Financial Accounting Standards Board (“FASB”) issued an exposure draft entitled “Share-Based Payment, an amendment of FASB Statements No. 123 and 95.” This proposed statement would eliminate the ability to account for stock-based compensation using APB 25 and require such transactions be recognized as compensation expense in the income statement based on their fair values at the date of grant. Companies transitioning to fair value based accounting for stock-based compensation will be required to use the “modified prospective” method whereby companies must recognize equity compensation cost from the beginning of the year in which the recognition provisions are first applied as if the fair value method had been used to account for all equity compensation awards granted, modified, or settled in fiscal years beginning after December 31, 1994. As proposed, this statement would be effective for the Company on January 1, 2005. The proposal is controversial and subject to public comment. Accordingly, the provisions of the final statement, which the FASB expects to issue in late 2004, could significantly differ from those proposed in the exposure draft.

Note 5 – Stock Split

     On April 21, 2004, the Board of Directors declared a three-for-two split of the Company’s common shares to shareholders of record as of May 20, 2004 and paid on June 4, 2004. All outstanding shares, stock options and related per share earnings calculations in this report have been retroactively adjusted for this stock split.

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Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     Management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes in trends relating to our financial condition, results of operations, liquidity and interest rate sensitivity. The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto, included elsewhere herein, and our Annual Report on Form 10-K.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     This Quarterly Report on Form 10-Q (this “Quarterly Report”) includes “forward-looking statements,” as that term is used in the securities laws. All statements regarding our expected financial position, business and strategies are forward-looking statements. In addition, throughout this Quarterly Report the words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends” and similar expressions, as they relate to us, Southwest Community Bancorp, Southwest Community Bank, Financial Data Solutions, Inc., or our management, are intended to identify forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, and we have based these expectations on our beliefs as well as the assumptions we have made, those expectations may prove to be incorrect. Important factors that could cause actual results to differ materially from our expectations include, without limitation, failure of a significant number of borrowers to repay their loans, failure of our community banking strategy, changes in general economic conditions or the economic conditions in Southern California, the monetary policies of the Federal Reserve, changes in interest rates, and restrictions imposed on us by regulations or the banking industry regulators.

     For information about factors that could cause our actual results to differ from our expectations, you should carefully read “ITEM 1 – DESCRIPTION OF BUSINESS – Material Risks Affecting the Company and our Common Stock” included in our Annual Report on Form 10-K. We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report. All future written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report. We have no intention, and do not assume any obligation, to update these forward-looking statements.

FINANCIAL SUMMARY

     On July 8, 2004, we commenced a “best-efforts” offering of our common stock to raise an aggregate of $15,000,000 to fund our continued growth.

     The primary source of the Company’s earnings comes from banking services provided by SWCB and to a lesser extent from data processing services provided by FDSI.

     Since the opening of SWCB in 1997, we have experienced continued growth in assets and earnings. We have pursued and continue to pursue a growth strategy which depends primarily on generating an increasing level of loans and deposits at acceptable risk levels. We have also pursued growth through new branches and by expanding real estate and small business lending. We believe that our continued growth results from the level of services we provide, as well as favorable pricing for our banking products and services and the overall growth in the local economy in which we operate. We cannot assure you of our success in implementing our growth strategy without corresponding increases in our non-interest expenses.

     SWCB derives its income primarily from interest received on loans and investment securities and from fees received from providing deposit services. SWCB’s expenses are the interest it pays on deposits and borrowings, salaries and benefits for employees, occupancy costs for its banking offices and general

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operating expenses. FDSI derives its income primarily from fees for item processing services. The expenses of FDSI are salaries and benefits for employees, occupancy and equipment costs for its processing facilities and general operating expenses. The assets of the Company are primarily those of SWCB.

     The growth in Company assets and earnings and the contribution to earnings from our business segments for the three and six month periods ended June 30, 2004 and 2003 is summarized below and discussed in more detail in the following sections:

Results of Operations for the Three Months Ended June 30, 2004 Compared to 2003

     The 92% increase in net income for the three months ended June 30, 2004 as compared to the same period in 2003 was a result of several factors. Net interest income increased by $1,112,000, or 38%, due primarily to a 59% increase in average interest-earning assets; and noninterest income increased by $717,000, or 31%, due to increases in fees and service charges related to the overall growth at SWCB and data processing fees at FDSI. Partially offsetting the increases in revenues, noninterest expense increased by $775,000, or 20%, and the provision for loan losses increased $15,000, or 7%. The increase in noninterest expenses was primarily due to increases in salaries and employee benefits, occupancy, and equipment and data processing that were related to our growth in offices. The increase in the provision for loan losses was primarily due to the increase in outstanding loans.

Results of Operations for the Six Months Ended June 30, 2004 Compared to 2003

     The 78% increase in net income for the six months ended June 30, 2004 as compared to the same period in 2003 was a result of several factors. Net interest income increased by $2,152,000, or 38%, due primarily to a 51% increase in average interest-earning assets; and noninterest income increased by $1,107,000, or 24%, due to increases in fees and service charges related to the overall growth at SWCB and data processing fees at FDSI. Partially offsetting the increases in revenues, noninterest expense increased by $1,392,000, or 18%, and the provision for loan losses increased $125,000, or 31%. The increase in

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noninterest expenses was primarily due to increases in salaries and employee benefits, occupancy, and equipment and data processing that were related to our growth in offices. The increase in the provision for loan losses was primarily due to the increase in outstanding loans.

Balance Sheet as of June 30, 2004 compared to December 31, 2003

     As of June 30, 2004 consolidated total assets increased $78,338,000, or 23%, to $417,153,000 as compared to $338,815,000 at December 31, 2003. The increase in assets included a $31,726,000, or 28%, increase in cash and cash equivalents, a $21,334,000, or 92%, increase in investment securities available-for-sale and a $22,743,000, or 12%, increase in total loans to $211,458,000. The increase in assets was funded primarily by the $75,097,000, or 24%, increase in total deposits to $383,476,000 as of June 30, 2004 as compared to $308,379,000 at December 31, 2003. Shareholders’ equity increased, primarily due to net income for the period, to $21,339,000 at June 30, 2004 from $18,962,000 as of December 31, 2003.

Critical Accounting Policies That May Affect Our Reported Income

     Our consolidated financial statements and the notes thereto have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and other factors and circumstances. We believe that our estimates are reasonable; however, actual results may differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

     Our significant accounting policies and practices are described in Note 1 to our Consolidated Financial Statements and in Management’s Discussion and Analysis of Financial Condition and Results of Operation that are included our Annual Report on Form 10-K for the year ended December 31, 2003. The accounting policies that involve our significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, are considered critical accounting policies. We have identified our policies for allowance for loan losses and fair value of financial instruments as critical accounting policies.

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RESULTS OF OPERATIONS

Net Interest Income

     Our earnings depend largely upon the difference between the income we receive from interest-earning assets and the interest paid on our interest-bearing liabilities. This difference is net interest income. Net interest margin is net interest income expressed as a percentage of average total interest-earning assets. Net interest spread is the difference between the rate earned on interest earning assets and the rate paid on interest-bearing liabilities.

     The following tables provide information, for the periods indicated, on the average amounts outstanding for the major categories of interest-earning assets and interest-bearing liabilities, the amount of interest earned or paid, the annualized yields and rates, net interest income, net interest margin and net interest spread:

(1)		The yield for investment securities reflects that securities totaling $29,832,000 in 2004 and 20,635,000 in 2003 were classified as available-for-sale and carried at market value while $481,000 in 2004 and $1,170,000 in 2003 were classified as held-to-maturity and carried at cost.
(2)		Loans, net of unearned income, include non-accrual loans, but do not reflect average allowances for loan losses. Interest income from loans includes loan fees of $513,000 in 2004 and $326,000 in 2003.
(3)		The ratios have been annualized.

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(1)		The yield for investment securities reflects that securities totaling $26,215,000 in 2004 and $17,168,000 in 2003 were classified as available-for-sale and carried at market value while $535,000 in 2004 and $1,302,000 in 2003 were classified as held-to-maturity and carried at cost.
(2)		Loans, net of unearned income, include non-accrual loans, but do not reflect average allowances for loan losses. Interest income from loans includes loan fees of $944,000 in 2004 and $616,000 in 2003.
(3)		The ratios have been annualized.

     Net interest income is affected by changes in the level and the mix of interest-earning assets and interest-bearing liabilities. The changes between periods in these assets and liabilities are referred to as volume changes. The impact on net interest income of changes in average volume is measured by multiplying the change in volume between the current period and the prior period by the prior period rate.

     Net interest income is also affected by changes in the yields earned on assets and rates paid on liabilities. These are referred to as rate changes and the impact on net interest income of these changes is measured by multiplying the change in rate between the current and prior period by the average volume of the prior period. Changes in rate-volume between periods, which is measured by the change in rate multiplied by the change in volume, are allocated on a pro rata basis between the volume and the rate changes in the table that follows:

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Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

     For the three months ended June 30, 2004, net interest income was $4,080,000, an increase of $1,112,000, or 38%, as compared to $2,968,000 for the three months ended June 30, 2003. The increase in net interest income was primarily due to the increase in average loans, our highest yielding interest-earning assets. The increase in net interest income can also be attributed to the differential in the amount of growth in our interest-earning assets versus our interest-bearing liabilities. Average interest-earning assets increased $114,191,000, versus an increase in average interest-bearing liabilities of $32,827,000. Most of the earning asset growth was supported by the $69,565,000, or 37%, growth in average noninterest-bearing demand deposits. The increased volume of our interest-earning assets contributed $1,378,000 towards the increase in net interest income. The $59,062,000, or 39%, increase in average loans contributed $1,120,000 to the increase in interest income. The increase in interest income from the increased volume of interest-earning assets was partially offset by the $74,000 increase in interest expense due to the increased volume of interest-bearing liabilities.

     Lower interest rates had an overall negative impact of $192,000 on net interest income. The average prime rate during the second quarter of 2004 was 4.00% as compared to 4.23% during the second quarter of 2003. The decrease was primarily due to $177,000 from lower yields on interest-earning assets. In addition, interest expense increased $15,000 as lower rates on time deposits were offset by higher rates on borrowings. The overall decrease included $105,000 due to lower loan yields and $74,000 due to lower yields on Federal funds sold and other.

     The net interest margin for the three months ended June 30, 2004 was 5.30%, a decrease of 83 basis points from 6.13% for the same period in 2003. The decrease in net interest margin was due to a larger decrease in the yield on interest-earning assets than the decrease in the cost of interest-bearing liabilities. .

     The yield on interest-earning assets was 5.75% for the second quarter of 2004, a decrease of 92 basis points as compared to 6.67% for the second quarter of 2003. The decrease in the yield on interest-earning assets was due to lower yields on earnings assets and a change in the mix of earnings assets. Despite the 39% increase in average loans, the percentage of loans to average interest-earning assets decreased from 78% for the second quarter of 2003 to 68% for the second quarter of 2004.

     The average cost of total interest-bearing liabilities was 1.38% in the second quarter of 2004, a decrease of 14 basis points from 1.52% for the same period in 2003. The overall decrease in the average cost was primarily due to a change in mix. The net increase in average interest-bearing liabilities was primarily due to the increase in the lower cost savings & money market deposits while the average balances of the higher cost time deposits and borrowings decreased.

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Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

     For the six months ended June 30, 2004, net interest income was $7,840,000, an increase of $2,152,000, or 38%, as compared to $5,688,000 for the six months ended June 30, 2003. The increase in net interest income was primarily due to the increase in average loans, our highest yielding interest-earning assets. The increase in net interest income can also be attributed to the differential in the amount of growth in our interest-earning assets versus our interest-bearing liabilities. Average interest-earning assets increased $92,900,000, versus an increase in average interest-bearing liabilities of $30,361,000. Most of the earning asset growth was supported by the $56,054,000, or 31%, growth in average noninterest-bearing demand deposits. The increased volume of our interest-earning assets contributed $2,715,000 towards the increase in net interest income. The $65,636,000, or 46%, increase in average loans contributed $2,458,000 to the increase in interest income. The increase in interest income from the increased volume of interest-earning assets was partially offset by the $216,000 increase in interest expense due to the increased volume of interest-bearing liabilities.

     Lower interest rates had an overall negative impact of $347,000 on net interest income. The average prime rate during the first six months of 2004 was 4.00% as compared to 4.25% during the same period in 2003. A decrease of $373,000 from lower yields on interest-earning assets was partially offset by a $26,000 decrease in interest expense due to lower rates on interest-bearing liabilities. Decreased loan yields account for $303,000 of the overall decrease.

     The net interest margin for the six months ended June 30, 2004 was 5.67%, a decrease of 53 basis points from 6.20% for the same period in 2003. The decrease in net interest margin was due to a larger decrease in the yield on interest-earning assets than the decrease in the cost of interest-bearing liabilities.

     The yield on interest-earning assets was 6.12% for the first six months of 2004, a decrease of 55 basis points as compared to 6.67% for the same period in 2003. The decrease in the yield on interest-earning assets was due to lower yields on earnings assets and a change in the mix of earnings assets. Despite the 46% increase in average loans, the percentage of loans to average interest-earning assets decreased from 78% in 2003 to 75% in 2004.

     The average cost of total interest-bearing liabilities was 1.37% for the six months ended June 30, 2004, a decrease of 6 basis points from 1.43% for the same period in 2003. The overall decrease in the average cost was primarily due to a change in mix. The net increase in average interest-bearing liabilities was primarily due to the increase in the lower cost savings & money market deposits.

Noninterest Income

     For the three months ended June 30, 2004, noninterest income was $3,051,000, an increase of $717,000, or 31%, from $2,334,000 for the three months ended June 30, 2003. The major items contributing to the increase were fees and service charges and data processing income. Fees and service charges increased $380,000, or 60%, as a result of the growth in deposits. Data processing income from FDSI, our data processing subsidiary, increased $353,000, or 30% to $1,524,000 for the three months ended June 30, 2004 due to increased processing volumes. Gains on sales of securities totaled $154,000 during the second quarter of 2003. There were no sales of securities during the second quarter of 2004.

     For the six months ended June 30, 2004, noninterest income was $5,681,000, an increase of $1,107,000, or 24%, from $4,574,000 for the six months ended June 30, 2003. The major items contributing to the increase were fees and service charges and data processing income. Fees and service charges increased $644,000, or 47%, as a result of the growth in deposits. Data processing income from FDSI, our data processing subsidiary, increased $492,000, or 22% to $2,766,000 for the six months ended June 30, 2004 due to increased processing volumes. Gains on sales of securities totaled $228,000 during the first six months of 2003. There were no sales of securities during the same period of 2004.

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Noninterest Expense

     The major expense categories are for employees’ salaries and benefits and for occupancy and equipment expense in our facilities. Together, these expenses constitute over 75% of total noninterest expense. Growth in these expenses during the periods presented is consistent with our growth in earning assets and revenues.

     Noninterest expense for the three months ended June 30, 2004, was $4,738,000, an increase of $775,000, or 20%, from $3,963,000 for the second quarter of 2003. The major items contributing to the increase were salaries and benefits increasing $328,000, or 14%, and occupancy expense and equipment expense increasing $120,000, or 14%. The increases in all expense classifications are attributable to growth of SWCB as well as the growth of FDSI, including increases in the number of employees and in the number of offices. During the second quarter of 2004, SWCB opened a branch office in San Bernardino.

     Noninterest expense for the six months ended June 30, 2004, was $9,004,000, an increase of $1,392,000, or 18%, from $7,612,000 for the first six months of 2003. The major items contributing to the increase were salaries and benefits increasing $597,000, or 14%, and occupancy expense and equipment expense increasing $258,000, or 16%. The increases in all expense classifications are attributable to growth of SWCB as well as the growth of FDSI, including increases in the number of employees and in the number of offices.

FINANCIAL POSITION

     Our total assets increased $78,338,000, or 23%, to $417,153,000 at June 30, 2004 from $338,815,000 at December 31, 2003. The increase in assets is primarily due to a $22,161,000 increase in net loans. The decrease in cash and due from banks and increase in Federal funds sold at June 30, 2004, as compared to December 31, 2003, is due to the increase in deposits and the timing in the collection process of checks deposited by our customers. The increase in assets was funded primarily by a $75,097,000 increase in deposits, which included a $39,920,000 increase in noninterest-bearing demand deposits and a $35,795,000 increase in money market and NOW account deposits. We emphasize seeking demand deposits from business customers in our market area. In addition, we opened a new branch office in San Bernardino in May 2004. The $2,377,000 increase in shareholders’ equity was primarily from our earnings for the first six months of 2004.

Loans

     The following table sets forth the components of net loans outstanding in each category at the dates indicated:

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     The growth in loans was primarily in commercial real estate loans as construction loans decreased due to loan payoffs as a result of completion of the construction projects. Construction activity and real estate investment have remained strong in our market area due to continued economic growth and continuing low interest rates.

     Construction lending is generally considered to involve a higher degree of risk than permanent mortgage lending because of the inherent difficulty in estimating both a property’s value at completion of the project and the cost of the project. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, we may be confronted with a project the value of which is insufficient to assure full repayment. Disagreements between borrowers and builders and the failure of builders to pay subcontractors may also jeopardize projects. Loans to builders to construct projects for which no purchaser has been identified carry additional risk because the payoff for the loan may be dependent on the contractor’s ability to sell the property prior to the due date of the loan. We address these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices.

Capital Resources and Regulatory Requirements

     Under regulatory capital adequacy guidelines, capital adequacy is measured as a percentage of risk-adjusted assets in which risk percentages are applied to assets on the balance sheet as well as off-balance sheet, such as unused loan commitments and standby letters of credit. The guidelines require that a portion of total capital be core, or Tier 1, capital consisting of common shareholders’ equity and perpetual preferred stock, less goodwill and certain other deductions. Tier 2 capital consists of other elements, primarily non-perpetual preferred stock, subordinated debt and mandatory convertible debt, plus the allowance for loan losses, subject to certain limitations. The guidelines also evaluate the leverage ratio, which is Tier I capital divided by average assets.

     At June 30, 2004, our capital exceeded the minimum regulatory requirements and we were considered to be “well capitalized,” as defined in the regulations issued by our regulatory agencies. Our capital ratios, shown below for both the Company and SWCB, have been computed in accordance with regulatory accounting guidelines.

     During the six months ended June 30, 2004 shareholders’ equity increased $2,377,000 to $21,339,000. The net increase included net income of $2,382,000, $209,000 from the exercise of stock options and warrants and a $214,000 decrease in the unrealized gain on available-for-sale securities.

     Effective July 8, 2004 we began an offering to raise up to $15,000,000 in equity through the sale of 500,000 additional common shares of the Company to fund the continuing expansion of our subsidiaries. For additional information, please refer to our Registration Statement on Form S-1 declared effective by the Securities and Exchange Commission on that date.

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Liquidity and Liability Management

     Liquidity management for banks requires that funds always be available to pay anticipated deposit withdrawals and maturing financial obligations in accordance with their terms and to meet customer requests for loans.

     The acquisition of deposits has been our primary source of funds used to invest in earning assets. Other sources of funds have been the cash provided from operations, the proceeds of common stock sales and from borrowings. We expect that deposits will continue to be the primary source of funds in future periods. We emphasize seeking demand deposits from business customers in our market area.

     To meet liquidity needs, we maintain a portion of our funds in cash deposits in other banks, Federal Funds sold, and investment securities. These funds are invested in financial instruments over various maturities to insure that funds are readily available to fund loans or meet deposit withdrawals. As of June 30, 2004, liquid assets (cash, Federal funds sold, interest bearing deposits in other financial institutions and investment securities available-for-sale) as a percentage of deposits were 50% as compared to 45% at December 31, 2003. The relatively high proportion of demand deposits in SWCB, versus total deposits, requires that we maintain higher levels of liquidity than might be required by other financial institutions. The demand deposits are primarily from businesses and are not expected to be significantly affected by a sudden change in the local housing market.

     Short term management of liquidity requires managing the daily fluctuations in deposits along with the net change in loans. To manage these fluctuations we invest in short term investments such as Federal funds and maintain borrowing facilities that we can access on a daily basis.

     SWCB maintains lines of credit of $8,000,000 with correspondent banks for the purchase of overnight Federal funds. The lines are subject to availability of funds and have restrictions as to the number of days used during a month. SWCB also has a credit line with the Federal Home Loan Bank of San Francisco which would allow SWCB to borrow up to 20% of its assets ($67,000,000 as of June 30, 2004) on a collateralized basis. As of June 30, 2004, loans and securities pledged as collateral for this facility would have allowed SWCB to borrow up to approximately $60,000,000. These facilities have been used infrequently.

     The primary sources of liquidity for the Company, on a stand alone basis, include the receipt of dividends from the subsidiaries and our ability to raise capital. The ability of the Company to obtain funds for the payment of dividends is dependent upon the subsidiaries’ earnings. The availability of dividends from the subsidiaries is also limited by various state and federal statutes and regulations.

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

     Our market risk arises primarily from credit risk and interest rate risk inherent in our lending and deposit taking activities. Risk management is an important part of our operations and a key element of our overall financial results.

Credit Risk

     Credit risk generally arises as a result of our lending activities and may be present with our investment activities. To manage the credit risk inherent in our lending activities, we rely on adherence to underwriting standards and loan policies as well as our allowance for loan losses. We employ frequent monitoring procedures and take prompt corrective action when necessary. Additionally, our loans are examined regularly by internal auditors and regulatory agencies.

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Interest Rate Risk

     Interest rate risk is the exposure of a bank’s financial condition, both earnings and the market value of assets and liabilities, to adverse movements in interest rates. The potential impact of interest rate risk is significant because of the liquidity and capital adequacy consequences that reduced earnings or losses could imply. We recognize and accept that interest rate risks are a routine part of bank operations and will from time to time impact our profits and capital position. The objective of interest rate risk management is to control exposure of net interest income to risks associated with interest rate movements in the market, to achieve consistent growth in net interest income and to profit from favorable market opportunities.

     Changes in interest rates can affect the value of assets, liabilities and equity in a variety of ways. Assets and liabilities with longer repricing characteristics may increase or decrease in economic value as interest rates change. Assets with fixed interest rates and longer repricing terms generally increase in value as interest rates decline and decrease in value as interest rates increase. Conversely, liabilities with fixed interest rates and longer repricing terms generally increase in value as interest rates increase and decline in value as interest rates decrease.

     Changes in interest rates may also affect customer behavior, such as by increasing or decreasing loan prepayments, which can affect the economic value of a loan or investment security. Because our earning assets have relatively short repricing terms and most of our liabilities are non rate sensitive or have very short repricing terms, we do not expect significant changes in the economic value of our assets, liabilities or net equity from changing interest rates.

     Since interest rate changes do not affect all categories of assets and liabilities equally or simultaneously, we perform simulation modeling to estimate the potential effects of changing interest rates. The process allows us to explore the complex relationships within the gap over time and various interest rate environments. The following table summarizes the sensitivity of net interest income to change over a one year period under alternative scenarios. Our policy is to manage the interest rate risk exposure to less than a 15% decline in net interest income assuming a 200 basis point change in rates over a one year time period. At current interest rate levels, we do not believe the down 200 and 300 basis point simulations to be realistic scenarios.

Sensitivity of Net Interest Income