UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the Fiscal Year Ended December 31, 2004

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 check mark 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. YES þ NO o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES o NO þ

     Aggregate market value of the voting Common Stock held by non-affiliates at June 30, 2004: $71,279,760

Number of shares of Common Stock outstanding as of February 28, 2005: 3,486,516

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the following documents are incorporated by reference into the identified parts of this Form 10-K:

2005 Annual Meeting Proxy Statement — Part III, Items 10, 11, 12, 13 and 14.

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SOUTHWEST COMMUNITY BANCORP
FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
TABLE OF CONTENTS

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     This Annual Report on Form 10-K (this “Annual 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 Annual 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 — BUSINESS — Material Risks Affecting the Company and Our Common Stock” herein. We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Annual 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 Annual Report are made only as of the date of this Annual Report. We have no intention, and do not assume any obligation, to update these forward-looking statements.

PART I

ITEM 1 — BUSINESS

Southwest Community Bancorp

     Southwest Community Bancorp is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Southwest Community’s principal business is to serve as a holding company for our banking subsidiary, Southwest Community Bank (“SWCB”), and our subsidiary services company, Financial Data Solutions, Inc. (“FDSI”). When we say “we,” “our” or the “Company,” we mean Southwest Community Bancorp on a consolidated basis with SWCB and FDSI. When we refer to “Southwest Community” or to the holding company, we are referring to the parent company on a stand-alone basis.

     Southwest Community was incorporated on December 4, 2002, under the laws of the State of California, at the direction of the Board of Directors of SWCB for the purpose of becoming SWCB’s holding company. The holding company reorganization was consummated on April 1, 2003, pursuant to a Plan of Reorganization and Merger Agreement dated December 18, 2002, and each outstanding share of SWCB common stock was converted into one share of Southwest Community’s common stock and all outstanding shares of SWCB’s common stock were transferred to Southwest Community. Further, each outstanding warrant to purchase SWCB’s common stock, issued in connection with SWCB’s 2002 Unit Offering, was converted into a warrant to purchase Southwest Community’s common stock.

     During the third quarter of 2004, we raised approximately $14.4 million in net proceeds from a best efforts offering of common stock. The offering resulted in the issuance of 483,867 shares of our common stock. We invested $9.5 million of the proceeds from the offering in SWCB and used $2.0 million to repay a short-term loan to an unrelated third party that we had used to purchase the outstanding minority interest in FDSI. The remainder of the proceeds were retained by the Company for general corporate purposes and working capital.

     In April 2003 Southwest Community raised approximately $8.0 million in net proceeds from the sale of “trust preferred” securities, due June 26, 2033. The holders of the trust preferred securities will be entitled to receive cumulative cash distributions at a variable annual rate, reset quarterly, equal to three month LIBOR plus 3.15%. The current rate is 5.70%. Southwest Community formed a wholly-owned business trust subsidiary, Southwest Community Statutory Trust I (the “Trust”), pursuant to the laws of the State of Connecticut, to facilitate the transaction. The offering was conducted as a private placement to accredited investors within the meaning and in accordance with the requirements of Regulation D and was therefore exempt under the Securities Act. The proceeds to Southwest Community are treated as Tier 1 capital by Southwest Community for regulatory purposes. (See “Supervision and Regulation — Southwest Community Bank — Risk-Based Capital Guidelines” herein.) Southwest Community is using the proceeds from the offering to fund SWCB’s growth. The interest paid by Southwest Community is deductible. Southwest Community has the right, assuming that no default has occurred, to defer interest payments at any time for a period of up to twenty consecutive calendar quarters. The “trust preferred” securities can be called on or after June 26, 2008 at their face value.

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     The Company consists of two business segments. The primary source of income comes from banking services provided by SWCB and to a lesser extent from item processing services provided by FDSI. SWCB derives its income primarily from interest received on loans and investment securities and from fees received from deposit services. The expenses of SWCB are the interest it pays on deposits and borrowings, salaries and benefits for employees, occupancy costs for its banking offices and general operating expenses. FDSI derives its income primarily from fees for 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 these business segments is summarized in the following table (see “ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” for more detailed information regarding lending, deposits and securities portfolios):

Southwest Community Bank

     SWCB commenced operations on December 1, 1997, as a California state-chartered bank. SWCB is authorized to engage in the general commercial banking business by the California Department of Financial Institutions (“DFI”) and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the applicable limits of the law. SWCB is not a member of the Federal Reserve System (“FRB”). Since opening its first office in Encinitas, California, SWCB has experienced continued growth in total assets and locations.

     In 1998 SWCB opened a Private Banking Office in downtown San Diego. During 2000, SWCB added offices in Escondido and El Cajon. In 2001, SWCB opened a fifth office in the Carlsbad commercial business district and relocated its administrative offices from Encinitas to the new Carlsbad office. During 2002, SWCB opened its sixth office in Murrieta, California. During 2003, SWCB opened a seventh office in Anaheim and a loan production office in Glendale, California. In May 2004 SWCB opened an eighth office in San Bernardino, California.

Financial Data Solutions, Inc.

     FDSI was established in November 1998 as a wholly-owned subsidiary of SWCB. FDSI, headquartered in Murrieta, California, is a technology related servicing company that was formed for the purpose of providing quality, state-of-the-art item processing and related services to the financial services community in Southern California. Shortly after establishing FDSI, SWCB sold a 49% interest in FDSI to another financial institution. In February 2001 FDSI opened its second processing center in El Monte, California, to expand its service area to Los Angeles and Orange Counties. In 2001, FDSI further expanded its product offering with automated remittance processing/lock box services. In January 2003 a third processing center in San Leandro, California, was opened, expanding FDSI’s market area to Northern California. In May 2003 SWCB transferred its 51% equity interest in FDSI to Southwest Community. In February 2004 pursuant to a Buy-Sell Agreement between FDSI and its two shareholders and following the acquisition of the minority shareholder by another financial institution, Southwest Community purchased the minority shareholder’s interest in FDSI for $3,350,000. The increase in earnings at FDSI in 2002 and subsequent decrease in 2003 was the result of the loss of an item processing customer in 2002 that resulted in payment of a contract termination fee followed by the loss of revenue from that customer in 2003 and increased expenses in 2003 that related to the opening of an additional processing center in January 2003.

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Business of the Company

     Banking

     SWCB offers a variety of checking, savings and money market accounts, sweep accounts, and time certificate of deposits, including IRA and KEOGH accounts. Depositors have the option of subscribing for a wide range of electronic services including ATM/debit card services, on-line banking, bill paying, cash management and a variety of electronic account statement options. In addition, we provide other incidental services customary to the banking industry such as courier service, coin and cash handling and notary services.

     SWCB makes a variety of loan products available, including commercial, real estate, construction, automobile and other installment and term loans. In May 1998 SWCB initiated an SBA lending program as a key aspect of its commercial client/small business focus. By mid-1999, SWCB received a “Preferred Lender” status from the San Diego Regional SBA office. The “Preferred Lender” status enabled SWCB to process loans in less time than before, which contributed to SWCB becoming San Diego County’s largest local SBA lender for the SBA’s fiscal years ending September 30, 2000, 2001, 2003 and 2004. SWCB’s “Preferred Lender” status was extended to the Santa Ana Region in August 2000, which provided expedited loan processing ability in Orange, Riverside and San Bernardino Counties, and was extended to the Sacramento and Fresno Districts in 2003.

     With the assistance of FDSI, SWCB has established itself as a niche player in the remittance or lock box processing arena, enabling SWCB to attract corporate relationships with larger than average balances that require specialized services. This has enabled SWCB to achieve a ratio of demand deposits to total deposits of 75% as of December 31, 2004, which has resulted in a lower cost of funds than most of our peers. Many of these deposits, however, require services that are included in noninterest expense.

     Through affiliations with third party vendors, SWCB also provides loans for single-family mortgages, merchant card services, and noninsured investment products.

     SWCB offers a variety of electronic banking services for corporate and individual customers, including ATMs, cash management and electronic bill payment. SWCB also has a “home page” address on the World Wide Web as an additional means of providing customer access to banking services. Our website address is: www.swcbank.com. These services are not a significant source of revenue and are provided primarily for customer convenience and operational efficiencies. SWCB does not make loans or open deposit accounts via the internet.

     Our business plan emphasizes providing highly specialized financial services in a professional and personalized manner to individuals and businesses in our service area. Our primary market area is San Diego County. We market certain services, such as construction and SBA loans, to an expanded market encompassing portions of Orange, Riverside and San Bernardino Counties. Since we are locally owned and operated, with a management team and Board of Directors charged with monitoring the financial needs of the communities we serve, we believe that we are in a position to respond promptly to the changing needs of customers.

     Also see “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” for additional information regarding SWCB’s loan and deposit products.

     Item Processing

     FDSI primarily offers first-pass item/imaging processing that transforms paper items/checks into digitized electronic form to provide efficient processing for financial institutions along with related back office support services such as data storage, research, reports and customer statements. FDSI also provides remittance processing or lockbox service for customers with high volume payment processing needs.

Business Concentrations

     Banking

     Except for the deposit relationships discussed below, no individual or single group of related customers is considered material in relation to the earnings assets or the sources of revenue of SWCB. However, we accept deposits and provide deposit services to real estate related service businesses, such as mortgage servicing, title and escrow and property management companies. Deposits from four of these businesses, whose aggregate average balances represented 1% or more of our total deposits, totaled $238 million in average balances during the month of December 2004. One of these relationships, a mortgage servicing company, substantially

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increased its deposit balances beginning in the fourth quarter of 2002 and accounted for approximately 65% of these deposits in December 2004. The increase in these deposit balances also increased the amount of funds in the process of collection included in the cash and due from banks accounts. Fluctuations in these deposit balances would primarily affect the balances of cash and due from banks, short-term investments and short-term borrowings. (See “ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Deposits” herein.)

     Moreover, our banking activities are currently focused primarily in Southern California, with the majority of our business concentrated in San Diego County. Consequently, our results of operations and financial condition are dependent upon the general trends in the Southern California economy and, in particular, the residential and commercial real estate markets in San Diego County. In addition, the concentration of our operations in Southern California exposes us to greater risk than other banking companies with a wider geographic base in the event of catastrophes, such as earthquakes, fires and floods, in this region, although we do not anticipate any adverse consequences as a result of the recent rains and flooding in Southern California.

     Item Processing

     FDSI’s five largest customers account for approximately 50% of 2003 and 2004 revenues, including approximately 14% and 13%, respectively, from its former minority shareholder. As a result of the acquisition of the minority shareholder by another financial institution in January 2004, services to the financial institution were terminated during 2004. The decrease in monthly revenue from the loss of this customer has been replaced with other new customers.

Market Area

     Banking

     SWCB’s primary market areas include the cities and surrounding communities of San Diego, Carlsbad, El Cajon, Escondido, Encinitas, Murrieta, Anaheim and San Bernardino, encompassing portions of San Diego, Riverside, San Bernardino and Orange Counties.

     The sixth-largest city in the United States, San Diego is the southern-most major metropolitan area in California. The city lies 125 miles south of Los Angeles and 500 miles south of San Francisco. The county covers 4,261 square miles, and borders Orange, Riverside and Imperial Counties to the north and east, and Baja California to the south.

     San Diego’s economy has undergone a remarkable transformation over the past decade. The severe recession in the first half of the 1990s was the longest and deepest of the past 60 years. The downturn, subsequent recovery and expansion were not mere business or cyclical adjustments, but an extensive overhauling and restructuring of the region’s basic economic drivers. SWCB, having commenced operations in late 1997, has been a beneficiary of the region’s economic growth and was not burdened by the economic downturn earlier in the decade. San Diego’s economic growth has enabled SWCB to expand from one office in 1997 to five offices in San Diego County.

     From an economy largely dominated by defense and military expenditures, San Diego industries transformed into a diversified mix of high-technology commercial endeavors. Some of these sectors were by-products of defense-based efforts, as well as capitalization of highly educated and skilled workers. Emerging growth areas include telecommunications, electronics, computers, software, and biotechnology.

     International trade also contributed to San Diego’s economic recovery and dynamic performance in recent years. San Diego’s cross border trade and interactions with Mexico provide tremendous economic advantages and opportunities, becoming an increasingly important facet of San Diego’s economic fortunes.

     Mexico and Canada, U.S. partners under the North American Free Trade Agreement (“NAFTA”), dominate San Diego’s export markets by far, accounting for more than one-half (55%) of all export production. San Diego clearly benefits from NAFTA, not only because the agreement further opened up the markets of the United States’ two largest customers, but also because Baja California was greatly benefited and stimulated by heightened trade and dollars flowing to the region.

     Mexico and NAFTA are key factors in San Diego’s continued economic prosperity, export production and growth. International trade accounts for more than one-third (37%) of San Diego manufacturing dollars. Manufacturing remains the largest economic sector for local dollars generated, with electronics, computers and industrial machinery, aerospace and shipbuilding, and instruments leading local production.

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     Specific products made and exported from San Diego, in addition to televisions, include other radio and broadcasting/communications equipment, cellular telephones, semiconductors, circuit boards, computers, and scientific, medical, and other measuring instruments.

     The transformation of the United States’ defense system from cold-war industrial buildup to modern high-tech military transformed San Diego’s military operations and defense contracting work. Despite past cutbacks and downsizing, the military’s presence and commitment to San Diego remains, if anything, greater than ever as the Navy’s principal location for West Coast and Pacific Ocean operations. San Diego is also home to the only few remaining shipyards on the West Coast able to build and repair large Navy ships.

     The San Diego-based Space & Naval Warfare Systems Command (SPAWAR) administers several billions of dollars in contract work for local companies. The command is primarily responsible for equipment needed for modern warfare and surveillance, including Naval space systems, communications and information technology.

     Although SWCB does not directly finance international trade, is not directly impacted by NAFTA, and does not provide banking services to the Navy, as noted, these factors have had a positive impact on the economy of San Diego, generally, and the industries and customers SWCB serves, indirectly.

     The multi-billion dollar visitor industry has also been an important sector of economic power and stability. The visitor industry is San Diego’s third largest economic sector, behind only manufacturing and military/defense.

     SWCB also operates branch offices in Orange, Riverside and San Bernardino Counties. The Anaheim office serves customers in Anaheim and neighboring Orange County communities. The Murrieta office extends SWCB’s service area to Riverside County. In May 2004 SWCB opened a new office in the City of San Bernardino, San Bernardino County, California.

     Item Processing

     FDSI’s services are primarily provided to financial institutions located in Southern California; however the opening of a processing facility in the San Francisco Bay area in January 2003 has expanded the market area to Northern California. The ability to efficiently provide item processing services is impacted by the proximity of the processing center to customers.

Competition

     Banking

     The banking business in California, generally, and in SWCB’s service areas, specifically, is highly competitive with respect to both loans and deposits and is dominated by a number of major banks that have many offices operating over wide geographic areas. SWCB competes for deposits and loans principally with these major banks, savings and loan associations, finance companies, credit unions and other financial institutions located in our market areas. Among the advantages that the major banks have over SWCB are their ability to finance extensive advertising campaigns and to allocate their investment assets to regions of highest yield and demand. Many of the major commercial banks operating in SWCB’s service areas offer certain services (such as trust and international banking services) that are not offered directly by SWCB and, by virtue of their greater total capitalization, such banks have substantially higher lending limits.

     As of June 30, 2004, the most recent period for which figures are available, data reported by state and federal agencies indicated that the 539 banks and savings and loan offices then open in SWCB’s primary market area, San Diego County, held approximately $43.8 billion in total deposits averaging approximately $81.3 million per banking office. SWCB’s total deposits ($345,830,000) in the San Diego market area constituted 0.79% of the total deposits in that market.

     Moreover, all banks face increasing competition for loans and deposits from non-bank financial intermediaries such as mortgage companies, insurance companies, and securities firms.

     In November 1999, the President signed the Gramm-Leach-Bliley Act, or the GLB Act, into law, which significantly changed the regulatory structure and oversight of the financial services industry. The GLB Act revised the Bank Holding Company Act of 1956 and repealed the affiliation prohibitions of the Glass-Steagall Act of 1933. Consequently, a qualifying holding company, called a financial holding company, can engage in a full range of financial activities, including banking, insurance, and securities activities, as well as merchant banking and additional activities that are “financial in nature” or “incidental” to those financial activities. Expanded financial affiliation opportunities for existing bank holding companies are now permitted. Moreover, various non-bank financial

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services providers can acquire banks while also offering services like securities underwriting and underwriting and brokering insurance products. The GLB Act also expanded passive investment activities by financial holding companies, permitting investments in any type of company, financial or non-financial, through acquisitions of merchant banking firms and insurance companies.

     Given that the traditional distinctions between banks and other providers of financial services have been effectively eliminated, SWCB will face additional competition from thrift institutions, insurance companies and securities firms. Additionally, their ability to cross-market banking products to their existing customers or the customers of affiliated companies may make it more difficult to compete. SWCB and many similarly situated institutions have not yet experienced the full impact of the GLB Act and therefore, it is not possible to determine the potential effects, if any, that the GLB Act will have on community banks in general, or on SWCB’s operations specifically.

     In order to compete, SWCB uses to the fullest extent possible the familiarity of its directors and officers with the market area and its residents and businesses and the flexibility that SWCB’s independent status will permit. This includes an emphasis on specialized services, local promotional activity, and personal contacts by directors, officers and other employees. SWCB uses advertising, including radio and newspaper ads and direct mail pieces, to inform the community of the services it offers. SWCB also utilizes emerging marketing techniques, such as the Internet, to reach target markets. In addition, directors and shareholders refer customers, as well as bring their own business. SWCB also has an active calling program where officers, including commissioned business development officers, contact targeted prospects to solicit both deposit and loan business.

     SWCB has developed programs that are specifically addressed to the needs of consumers, professionals and small-to medium-sized businesses. In the event there are customers whose loan demands exceed SWCB’s lending limits, it arranges for such loans on a participation basis with other financial institutions and intermediaries. SWCB also assists those customers requiring other services not offered by SWCB to obtain those services from correspondent banks. In addition, SWCB offers ATM services, including a drive-up ATM, a night depository, courier services, bank-by-mail services, merchant windows and direct deposit services.

     SWCB’s management believes that SWCB’s reputation in the communities served and personal service philosophy enhance the ability to compete favorably in attracting and retaining individual and business clients. SWCB also believes that it has an advantage over the larger national and “super regional” institutions because it is managed by well respected and experienced bankers.

     Mergers, acquisitions and downsizing have and will continue to foster impersonal banking relationships which, in turn, may cause dissatisfaction among SWCB’s targeted customer population. Moreover, larger competitors may not offer adequate personalized banking services, since their emphasis is on large volume and standardized retail products.

     SWCB faces growing competition from other community banks. These institutions have similar marketing strategies, have also been successful and are strong evidence regarding the potential success of the community banking sector.

     No assurance can be given that ongoing efforts to compete will continue to be successful.

     Item Processing

     FDSI generally competes with larger companies that have longer operating histories, larger customer bases and greater financial resources. Competitive factors affecting the market for FDSI’s services include comprehensive services, customization of applications, quickness to adapt to new technologies, customer service and support, references from existing customers and pricing. While FDSI has a short operating history, management personnel and employees have considerable experience in the industry. FDSI also partners with out of area data processing service companies to provide the local item processing services.

Employees

     At December 31, 2004, SWCB had 101 full-time and 11 part-time employees. In addition, FDSI, had 50 full-time and 50 part-time employees. Our employees are not represented by any union or other collective bargaining agreement and we consider our relations with our employees to be excellent.

Material Risks Affecting the Company and Our Common Stock

     The considerations listed below represent material factors we believe could cause our actual results of operations to differ materially from our expectations. These considerations are not intended to represent a complete list of the general or specific risks that may affect our future results of operations or stock price and should be considered carefully.

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     Risks Related to the Company

     We have a Limited Operating History. We have only been operating since December 1, 1997. Therefore, we have a limited operating history and we still remain subject to the risks inherently associated with a new business enterprise in general, and a new financial institution in particular, such as untested systems and management in a full range of economic conditions. Although we had increasing profits in each of the past five years, we cannot assure you that we will maintain our level of profitability in the future.

     We Face Limits on Our Ability to Lend. Our legal lending limit as of December 31, 2004, was approximately $10.3 million for secured loans and $6.2 million for unsecured loans. Accordingly, the size of the loans which we can offer to potential customers is less than the size of loans which many of our competitors with larger lending limits can offer. Our legal lending limit affects our ability to seek relationships with the region’s larger and more established businesses. Through our previous experience and relationships with a number of the region’s other financial institutions, we are generally able to accommodate loan amounts greater than our legal lending limit by selling participations in those loans to other banks. However, we cannot assure you of any success in attracting or retaining customers seeking larger loans or that we can engage in participations of those loans on terms favorable to us.

     Declines in Real Estate Values Could Materially Impair Our Profitability and Financial Condition. A significant proportion of our loan portfolio (65% of our loan portfolio) consists of commercial real estate and construction loans secured by real estate collateral. A substantial portion of the real estate securing these loans is located in San Diego and Riverside Counties. Real estate values are generally affected by factors such as:

	•	the socioeconomic conditions of the area where the real estate collateral is located;
	•	fluctuations in interest rates;
	•	property and income tax laws;
	•	local zoning ordinances governing the manner in which real estate may be used; and
	•	federal, state and local environmental regulations.

     Declines in real estate values could significantly reduce the value of the real estate securing our loans and could increase the likelihood of defaults. Moreover, if the value of real estate collateral declines to a level that is not sufficient to provide adequate security for the underlying loans, we will be required to make additional loan loss provisions which, in turn, will reduce our profits and could negatively affect our capital. Finally, if a borrower defaults on a loan secured by real estate, we may be forced to foreclose on the property and carry it as a nonperforming asset, which, in turn, reduces our net interest income.

     Changes in Economic Conditions, in Particular an Economic Slowdown in Southern California, Could Hurt our Business Materially. Our business is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control. Substantially all of our business comes from Southern California and particularly San Diego County. A deterioration in economic conditions, whether caused by national concerns or local concerns, in Southern California could result in the following consequences, any of which could hurt our business materially:

	•	loan delinquencies may increase;
	•	problem assets and foreclosures may increase;
	•	demand for our products and services may decline;
	•	low cost or noninterest bearing deposits may decrease; and
	•	collateral for loans made by us, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.

     Our Future Growth May Be Hindered If We Do Not Raise Additional Capital. Bank holding companies and banks are required by law and regulation to meet capital adequacy guidelines and maintain their capital to specified percentages of their assets. A failure to meet these guidelines will limit our ability to grow and could result in banking regulators requiring us to increase our

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capital or reduce our loans and other earning assets. Therefore, in order for us to continue to increase our earning assets and net income, we may be required, from time to time, to raise additional capital. We cannot assure you that additional sources of capital will be available or, if it is, that it will be available on terms reasonable to us.

     We Have a Continuing Need to Adapt to Technological Changes. The banking industry is undergoing rapid technological changes with frequent introductions ohnology-driven products and services. The effective use of technology allows us to:

	•	serve our customers better;
	•	increase our operating efficiency by reducing operating costs;
	•	provide a wider range of products and services to our customers; and
	•	attract new customers.

     Technological changes will also have a significant impact on FDSI, which provides technologically-driven services to the financial services industry. For example, “Check 21” may reduce the need for FDSI’s item processing services by reducing the flow of paper check clearings.

     Our future success will partially depend upon our ability to successfully use technology to provide products and services that will satisfy our customers’ demands for convenience, as well as to create additional operating efficiencies. Our larger competitors already have existing infrastructures or substantially greater resources to invest in technological improvements. We cannot assure you that we will be able to effectively implement new technology-driven products and services or be successful in marketing those products and services to our current and future customers.

     Our Growth Strategy Involves Risks That May Adversely Impact Our Net Income. 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 may not be able to sustain our planned growth without establishing additional new branches or more new products. Therefore, we may expand in our current market by opening or acquiring branch offices or we may expand into new markets or make strategic acquisitions of other financial institutions or branch offices. This expansion may require significant investments in equipment, technology, personnel and site locations. We cannot assure you of our success in implementing our growth strategy without corresponding increases in our non-interest expenses.

     We are Exposed to Risk of Environmental Liabilities With Respect to Properties to Which We Take Title. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.

     Our Ability to Pay Cash Dividends is Restricted by Law and Depends on Capital Distributions From SWCB; Our Debt Service Obligations Also Impair Our Ability to Pay Cash Dividends. Our ability to pay dividends to our shareholders is subject to the restrictions set forth in California law. We cannot assure you that we will meet the criteria specified under California law in the future. Even if we may legally declare and pay dividends, the amount and timing of those dividends will be at the discretion of our board of directors. The board of directors may, in its sole discretion, decide not to declare dividends. We do not plan to pay dividends on our common stock in the near future, although we have declared four stock splits since inception.

     As a bank holding company, substantially all of our operating assets are owned by SWCB and we rely upon receipt of sufficient funds from SWCB and FDSI, primarily in the form of cash dividends, to meet our obligations and corporate expenses, including our debt service obligations of approximately $470,000 annually pursuant to our trust preferred securities. The availability of cash dividends from SWCB and FDSI, however, is limited by various statutes and regulations. It is possible, depending upon the financial condition of SWCB, and other factors, that the DFI and/or the FDIC could assert that payment of dividends or other payments is an unsafe or unsound practice. In the event SWCB and/or FDSI are unable to pay dividends to us, we in turn may be unable to pay our

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debt service and other obligations or pay cash dividends on our common stock. As of December 31, 2004, SWCB was legally able to pay $8.2 million in cash dividends but FDSI was not legally able to pay any cash dividends.

     Our Allowance for Loan Losses May Not be Adequate to Cover Actual Losses. Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and non-performance. Our allowance for loan losses may not be adequate to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our operating results. Our allowance for loan losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. While we believe that our allowance for loan losses is adequate to cover potential losses, we cannot assure you that we will not further increase the allowance for loan losses or that regulators will not require us to increase this allowance. Either of these occurrences could materially adversely affect our earnings. (See “ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” herein.)

     Risks Relating to Our Common Stock and Warrants

     Only a Limited Trading Market Exists for Southwest Community Common Stock and Warrants Which Could Lead to Price Volatility. Only a limited trading market for our common stock and warrants exists on the OTC “Bulletin Board.” Although five dealers currently trade shares of our common stock and warrants, we cannot assure you that an active public market for our common stock or warrants will ever develop or the extent to which those dealers will continue trading our common stock and warrants. During the year 2004, the average daily volume of common shares traded was 1,403.

     Concentrated Ownership of Our Common Stock and Warrants By Directors and Executive Officers Creates a Risk of Sudden Changes in Our Share Price. As of December 31, 2004, directors and members of our executive management team owned or controlled approximately 27% of the total outstanding common stock, including warrants and vested stock options as if they were exercised and outstanding.

     Investors who purchase our common stock or warrants may be subject to certain risks due to the concentrated ownership of our common stock and warrants. The sale by any of our large shareholders of a significant portion of that shareholder’s holdings could have a material adverse effect on the market price of our common stock or warrants. In addition, the sale and issuance of any significant amount of additional shares of our common stock will have the immediate effect of increasing the public float of our common stock and any such increase may cause the market price of our common stock and warrants to decline or fluctuate significantly.

     Future Issuances or Sales of Shares of Our Common Stock Could Have an Adverse Effect on Our Stock Price. As of December 31, 2004, options to purchase 901,890 shares have been granted and are outstanding to directors, officers and employees under our 2002 Stock Option Plan, of which 535,769 are exercisable. In addition, 120,024 shares of our common stock are reserved for issuance upon exercise of our outstanding warrants. Future sales of a substantial of our common stock could adversely affect prevailing market prices for the shares of our common stock, including sales of shares acquired upon exercises of options or warrants.

     Risks Related to Our Industry

     Our Business is Subject to Interest Rate Risk and Variations in Interest Rates May Negatively Affect Our Financial Performance. Changes in the interest rate environment may reduce our profits. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. They are also affected by the proportion of interest-earning assets that are funded by interest-bearing liabilities. In general, over most time periods we have more assets than liabilities repricing and therefore generally benefit more in periods of rising interest rates than in periods of falling interest rates. This is primarily due to our relatively high ratio of interest-earning assets to interest-bearing liabilities. To mitigate the impact of declining interest rates we can extend the repricing maturities of our interest-earning assets and negotiate interest rate floor provisions into our longer term variable rate loans. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. We cannot assure you that we can minimize our interest rate risk. In addition, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, loan origination volume and overall profitability.

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     We Face Strong Competition From Financial Service Companies and Other Companies that Offer Banking Services that Could Hurt Our Business. We conduct our banking operations exclusively in Southern California. Increased competition in our market may result in reduced loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services that we offer in our service area. These competitors include national banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including without limitation, savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies to provide financial services. We also face competition from out-of-state financial intermediaries that have opened low-end production offices or that solicit deposits in our market areas. If we are unable to attract and retain banking customers, we may be unable to continue our loan growth and level of deposits and our results of operations and financial condition may otherwise be adversely affected.

     We are Subject to Extensive Regulation Which Could Adversely Affect Our Business. Our operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations applicable to us are subject to regular modification and change. There are currently proposed various laws, rules and regulations that, if adopted, would impact our operations. There can be no assurance that these proposed laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could make compliance much more difficult or expensive, restrict our ability to originate, broker or sell loans, further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by us or otherwise adversely affect our business or prospects.

Financial and Statistical Disclosure

     Certain of our statistical information is presented within “ITEM 6 — SELECTED FINANCIAL DATA,” “ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” and “ITEM 7A — QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK.” This information should be read in conjunction with the consolidated financial statements contained in “ITEM 8 — FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”

Supervision and Regulation

     Introduction

     Banking is a complex, highly regulated industry. The primary goals of the regulatory scheme are to maintain a safe and sound banking system, protect depositors and the Federal Deposition Insurance Corporation’s insurance fund, and facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the financial services industry. Consequently, our growth and earnings performance can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statues, regulations and the policies of various governmental regulatory authorities, including:

	•	the Board of Governors of the Federal Reserve System, or the FRB;
	•	the Federal Deposit Insurance Corporation, or the FDIC; and
	•	the California Department of Financial Institutions, or the DFI.

     The system of supervision and regulation applicable to us governs most aspects of our business, including:

•

the scope of permissible business;

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	•	investments;
	•	reserves that must be maintained against deposits;
	•	capital levels that must be maintained;
	•	the nature and amount of collateral that may be taken to secure loans;
	•	the establishment of new branches;
	•	mergers and consolidations with other financial institutions; and
	•	the payment of dividends.

     In general, the extensive system of regulation restricts our ability to implement our decisions, adds costs to our operations, and affects our ability to compete with non-bank financial institutions.

     The following summarizes the material elements of the regulatory framework that applies to us. It does not describe all of the statutes, regulations and regulatory policies that are applicable. Also, it does not restate all of the requirements of the statutes, regulations and regulatory policies that are described. Consequently, the following summary is qualified in its entirety by reference to the applicable statute, regulations and regulatory policies discussed in this Annual Report. Any change in these applicable laws, regulations or regulatory policies may have a material effect on our business.

     Southwest Community Bancorp

     General. Southwest Community, as a bank holding company registered under the Bank Holding Company Act of 1956, as amended, or BHCA, is subject to regulation by the FRB. According to FRB policy, Southwest Community is expected to act as a source of financial strength for SWCB, to commit resources to support it in circumstances where Southwest Community might not otherwise do so. Under the BHCA, Southwest Community, SWCB and any banks that Southwest Community may acquire in the future, are subject to periodic examination by the FRB. Southwest Community is also required to file periodic reports of its operations and any additional information regarding its activities and those of its subsidiaries with the FRB, as may be required.

     Southwest Community is also a bank holding company within the meaning of Section 3700 of the California Financial Code. Consequently, Southwest Community and SWCB are subject to examination by, and may be required to file reports with, the DFI. Regulations have not yet been proposed or adopted or steps otherwise taken to implement the DFI’s powers under this statute.

     The Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002, or the SOX, became effective on July 30, 2002, and represents the most far reaching corporate and accounting reform legislation since the enactment of the Securities Act of 1933 and the Exchange Act. The SOX is intended to provide a permanent framework that improves the quality of independent audits and accounting services, improves the quality of financial reporting, strengthens the independence of accounting firms and increases the responsibility of management for corporate disclosures and financial statements. It is intended that by addressing these weaknesses, public companies will be able to avoid the problems encountered by many notable companies in 2001-2002.

     The SOX’s provisions are significant to all companies that have a class of securities registered under Section 12 of the Exchange Act, including the Company, or are otherwise reporting to the SEC (or the appropriate federal banking agency) pursuant to Section 15(d) of the Exchange Act (collectively, “public companies”).

     The SOX’s provisions become effective at different times, ranging from immediately upon enactment to later dates specified in the SOX or the date on which the required implementing regulations become effective. In addition to SEC rulemaking to implement the SOX, NASDAQ and the New York Stock Exchange have adopted changes to their listing standards. Wide-ranging in scope, the SOX will have a direct and significant impact on banks and bank holding companies that are public companies, including us.

     The following briefly describes some of the key provisions of the SOX:

•

Section 301 establishes certain oversight, independence, funding and other requirements for the audit committees of public companies, and requires the SEC to issue rules that prohibit any national securities exchange or national securities association from listing the securities of a company that doesn’t comply with these audit committee requirements.

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	•	Section 302 mandates that the SEC adopt rules that require the principal executive officer(s) and principal financial officer(s) of public companies to include certain certifications in the company’s annual and quarterly reports filed under the Exchange Act.
	•	Section 906 includes another certification requirement that is separate from the certification requirements of Section 302. Section 906 provides that all periodic reports that contain financial statements and that are filed by public companies under Sections 13(a) or 15(d) of the Exchange Act must include a written certification by the CEO and CFO (or equivalent) that (1) the report complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and (2) the information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. Section 906 became effective on July 30, 2002, and persons who knowingly or willfully violate Section 906 are subject to specified criminal penalties.
	•	Section 303 which requires the SEC to issue rules prohibiting the officers and directors of public companies, and persons acting under their direction, from fraudulently influencing, coercing, manipulating, or misleading the company’s independent auditor in order to render the financial statements materially misleading.
	•	Section 304 requires the CEO and CFO of public companies to reimburse the company for certain compensation and profits received if the company is required to restate its financial reports due to material noncompliance resulting from misconduct, with the Federal securities laws.
	•	Section 306(a) prohibits the directors and executive officers of any public company from purchasing, selling or transferring any equity security acquired by the director or executive officer in connection with his or her service as a director or executive officer during any “blackout period” with respect to the company’s securities. Blackout periods refer to periods when most public company employees are not permitted to sell shares in their 401(k) plans.
	•	Section 401(b) requires the SEC to issue rules that prohibit issuers from including misleading pro forma financial information in their filings with the SEC or in any public release, and that requires issuers to reconcile any pro forma financial information included in such filings or public releases with their financial statements prepared in accordance with generally accepted accounting principles.
	•	Section 404 mandates that the SEC issue rules that require all annual reports filed under Sections 13(a) or 15(d) of the Exchange Act to include certain statements and assessments related to the issuer’s internal control structures and procedures for financial reporting.
	•	Section 406 mandates that the SEC adopt rules that require public companies to (1) disclose in their periodic reports filed under the Exchange Act whether the company has adopted a code of ethics for its senior financial officers and, if not, the reasons why; and (2) promptly disclose on Form 8-K any change to, or waiver of, the company’s code of ethics.
	•	Section 407 mandates that the SEC adopt rules that require public companies to disclose in their periodic reports filed under the Exchange Act whether the audit committee of the company includes at least one financial expert and, if not, the reasons why.

     In addition to the provisions discussed above, the SOX also includes a variety of other provisions that will affect all public companies.

     We cannot be certain of the effect, if any, of the foregoing legislation on our business. Future changes in the laws, regulation, or policies that impact us cannot necessarily be predicted and may have a material adverse effect on our business and earnings.

     The California Corporate Disclosure Act. On January 1, 2003, the California Corporate Disclosure Act, or the CCD, became effective. The CCD, also a reaction to the “Enron scandal,” increases the frequency and expands the scope of information required in filings by publicly traded companies with the California Secretary of State. Some of the new information required includes the following:

	•	The name of the independent auditor for the publicly traded company, a description of the services rendered by the auditor during the previous 24 months, the date of the last audit and a copy of the report;
	•	The annual compensation paid to each director and executive officer, including options or shares granted to them that were not available to other employees of the company;

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	•	A statement indicating whether any bankruptcy has been filed by the company’s executive officers or directors during the past 10 years; and
	•	A statement indicating whether any of the company’s executive officers or directors were convicted of fraud during the past 10 years.

     For purposes of the CCD, a “publicly traded company” is any company with securities that are listed on or admitted to trading on a national or foreign exchange, or is the subject of a two-way quotation, such as both “bid” and “asked” prices, that is regularly published by one or more broker-dealers in the National Daily Quotations Service or a similar service. Southwest Community is deemed to be a “publicly traded company” under the CCD.

     Bank Holding Company Liquidity. Southwest Community is a legal entity, separate and distinct from SWCB and FDSI. Southwest Community has the ability to raise capital on its own behalf or borrow from external sources. Southwest Community may also obtain additional funds from dividends paid by, and fees charged for services provided to, SWCB or FDSI. However, regulatory and statutory constraints may restrict or totally preclude SWCB or FDSI from paying dividends.

     Southwest Community is entitled to receive dividends, when and as declared by SWCB’s Board of Directors. Those dividends may come from funds legally available for those dividends, as specified and limited by the California Financial Code. Under the California Financial Code, funds available for cash dividends by a California-chartered bank are restricted to the lesser of: (i) the bank’s retained earnings; or (ii) the bank’s net income for its last three fiscal years (less any distributions to shareholders made during such period). With the prior approval of the DFI, cash dividends may also be paid out of the greater of: (a) the bank’s retained earnings; (b) net income for the bank’s last preceding fiscal year; or (c) net income or the bank’s current fiscal year. Based on these limitations, the amount available at SWCB for payment of dividends, without DFI approval, as of December 31, 2004 was approximately $8.2 million.

     If the DFI determines that the shareholders’ equity of the bank paying the dividend is not adequate or that the payment of the dividend would be unsafe or unsound for the bank, the DFI may order the bank not to pay the dividend.

     Since SWCB is an FDIC insured institution, it is also possible, depending upon its financial condition and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, constitute an unsafe or unsound practice and thereby prohibit such payments.

     Under California Corporations Code Section 500, FDSI may pay a cash dividend to Southwest Community only to the extent that FDSI has retained earnings and, after the dividend, FDSI’s:

	•	assets (exclusive of goodwill and other intangible assets) would be 1.25 times its liabilities (exclusive of deferred taxes, deferred income and other deferred credits); and
	•	current assets would be at least equal to current liabilities.

     As of December 31, 2004, FDSI had negative retained earnings and therefore could not pay a cash dividend.

     Transactions with Affiliates. Southwest Community and any subsidiaries it may purchase or organize are deemed to be affiliates of SWCB within the meaning of Sections 23A and 23B of the Federal Reserve Act and the FRB’s Regulation W, adopted effective April 2003, to implement those sections. Under Sections 23A and 23B and Regulation W, loans by SWCB to affiliates, investments by them in affiliates’ stock, and taking affiliates’ stock as collateral for loans to any borrower is limited to 10% of SWCB’s capital, in the case of any one affiliate, and is limited to 20% of the SWCB’s capital, in the case of all affiliates. In addition, transactions between SWCB and other affiliates must be on terms and conditions that are consistent with safe and sound banking practices; in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. These restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. Southwest Community and SWCB are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. (See “Supervision and Regulation — Southwest Community Bank — Significant Legislation” herein.)

     Limitations on Business and Investment Activities. Under the BHCA, a bank holding company must obtain the FRB’s approval before:

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	•	directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company;
	•	acquiring all or substantially all of the assets of another bank; or
	•	merging or consolidating with another bank holding company.

     The FRB may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, the FRB must give effect to applicable state laws limiting the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institutions in the state in which the target bank is located, provided that those limits do not discriminate against out-of-state depository institutions or their holding companies, and state laws which require that the target bank have been in existence for a minimum period of time, not to exceed five years, before being acquired by an out-of-state bank holding company.

     In addition to owning or managing banks, bank holding companies may own subsidiaries engaged in certain businesses that the FRB has determined to be “so closely related to banking as to be a proper incident thereto.” Southwest Community, therefore, is permitted to engage in a variety of banking-related businesses. Some of the activities that the FRB has determined, pursuant to its Regulation Y, to be related to banking are:

	•	making or acquiring loans or other extensions of credit for its own account or for the account of others;
	•	servicing loans and other extensions of credit;
	•	performing functions or activities that may be performed by a trust company in the manner authorized by federal or state law under certain circumstances;
	•	leasing personal and real property or acting as agent, broker, or adviser in leasing such property in accordance with various restrictions imposed by FRB regulations;
	•	acting as investment or financial advisor;
	•	providing management consulting advise under certain circumstances;
	•	providing support services, including courier services and printing and selling MICR-encoded items;
	•	acting as a principal, agent, or broker for insurance under certain circumstances;
	•	making equity and debt investments in corporations or projects designed primarily to promote community welfare or jobs for residents;
	•	providing financial, banking, or economic data processing and data transmission services;
	•	owning, controlling, or operating a savings association under certain circumstances;
	•	selling money orders, travelers’ checks and U.S. Savings Bonds;
	•	providing securities brokerage services, related securities credit activities pursuant to Regulation T, and other incidental activities; and
	•	underwriting dealing in obligations of the U.S., general obligations of states and their political subdivisions, and other obligations authorized for state member banks under federal law.

     Under the recently enacted Gramm-Leach-Bliley Act (discussed below in the section entitled “Supervision and Regulation — Southwest Community Bank — Significant Legislation”) qualifying bank holding companies making an appropriate election to the FRB may engage in a full range of financial activities, including insurance, securities and merchant banking. Southwest Community has not elected to qualify for these financial activities.

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     Generally, the BHCA does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.

     Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, SWCB may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that:

	•	the customer must obtain or provide some additional credit, property or services from or to SWCB other than a loan, discount, deposit or trust services;
	•	the customer must obtain or provide some additional credit, property or service from or to Southwest Community or any subsidiaries; or
	•	the customer must not obtain some other credit, property or services from competitors, except reasonable requirements to assure soundness of credit extended.

     Capital Adequacy. Bank holding companies must maintain minimum levels of capital under the FRB’s risk-based capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

     The FRB’s risk-based capital adequacy guidelines for bank holding companies and state member banks, discussed in more detail below in the section entitled “Supervision and Regulation — Southwest Community Bank — Risk-Based Capital Guidelines,” assign various risk percentages to different categories of assets, and capital is measured as a percentage of risk assets. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total risk assets and on total assets, without regard to risk weights.

     The risk-based guidelines are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual organizations. For example, the FRB’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Moreover, any banking organization experiencing or anticipating significant growth or expansion into new activities, particularly under the expanded powers under the Gramm-Leach-Bliley Act, would be expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.

     Limitations on Dividend Payments. California Corporations Code Section 500 allows Southwest Community to pay a dividend to its shareholders only to the extent that Southwest Community has retained earnings and, after the dividend, Southwest Community’s:

	•	assets (exclusive of goodwill and other intangible assets) would be 1.25 times its liabilities (exclusive of deferred taxes, deferred income and other deferred credits); and
	•	current assets would be at least equal to current liabilities.

     Additionally, the FRB’s policy regarding dividends provides that a bank holding company should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The FRB also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.

     Southwest Community Bank

     General. SWCB, as a California-chartered bank that is not a member of the Federal Reserve System, is subject to regulation, supervision, and regular examination by the DFI and the FDIC. SWCB’s deposits are insured by the FDIC up to the maximum extent provided by law. The regulations of these agencies govern most aspects of SWCB’s business and establish a comprehensive framework governing its operations. California law exempts all banks from usury limitations on interest rates.

     Significant Legislation. The laws, regulations and policies governing financial institutions are continuously under review by Congress, state legislatures and federal and state regulatory agencies. From time to time laws or regulations are enacted which have

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the effect of increasing the cost of doing business, limiting or expanding the scope of permissible activities, or changing the competitive balance between banks and other financial and non-financial institutions. Various federal laws enacted in recent years have expanded the lending authority and permissible activities of certain non-bank financial institutions, such as savings and loan associations and credit unions, and have given federal regulators increased enforcement authority. These laws have generally had the effect of altering competitive relationships existing among financial institutions, reducing the historical distinctions between the services offered by banks, savings and loan associations and other financial institutions, and increasing the cost of funds to banks and other depository institutions. Future changes in the laws, regulations or polices that impact SWCB cannot necessarily be predicted, but they may have a material effect on SWCB’s business and earnings.

     USA Patriot Act

     On October 26, 2001, the President signed into law comprehensive anti-terrorism legislation, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, known as the USA Patriot Act. Title III of the USA Patriot Act requires financial institutions, including SWCB, to help prevent, detect and prosecute international money laundering and the financing of terrorism. SWCB has augmented its systems and procedures to accomplish this requirement. We believe that the cost of compliance with Title III of the USA Patriot Act is not likely to be material to the Company.

     Gramm-Leach-Bliley Act

     In November 1999, the Gramm-Leach-Bliley Act, or the GLB Act, became law, significantly changing the regulatory structure and oversight of the financial services industry. The GLB Act repealed the provisions of the Glass-Steagall Act that restricted banks and securities firms from affiliating. It also revised the Bank Holding Company Act to permit a “qualifying” bank holding company, called a financial holding company, to engage in a full range of financial activities, including banking, insurance, securities, and merchant banking activities. It also permits qualifying bank holding companies to acquire many types of financial firms without the FRB’s prior approval.

     The GLB Act thus provides expanded financial affiliation opportunities for existing bank holding companies and permits other financial services providers to acquire banks and become bank holding companies without ceasing any existing financial activities. Previously, a bank holding company could only engage in activities that were “closely related to banking.” This limitation no longer applies to bank holding companies that qualify to be treated as financial holding companies. To qualify as a financial holding company, a bank holding company’s subsidiary depository institutions must be well-capitalized, well-managed and have at least a “satisfactory” Community Reinvestment Act examination rating. “Nonqualifying” bank holding companies are limited to activities that were permissible under the Bank Holding Company Act as of November 11, 1999.

     The GLB Act changed the powers of national banks and their subsidiaries, and made similar changes in the powers of state banks and their subsidiaries. National banks may now underwrite, deal in and purchase state and local revenue bonds. A subsidiary of a national bank may now engage in financial activities that the bank cannot itself engage in, except for general insurance underwriting and real estate development and investment. In order for a subsidiary of a national bank to engage in these new financial activities, the national bank and its depository institution affiliates must be “well capitalized,” have at least “satisfactory” general, managerial and Community Reinvestment Act examination ratings, and meet other qualification requirements relating to total assets, subordinated debt, capital, risk management, and affiliate transactions. Subsidiaries of state banks can exercise the same powers as national bank subsidiaries if they satisfy the same qualifying rules that apply to national banks, except that state-chartered banks do not have to satisfy the statutory managerial and debt rating-requirements of national banks.

     The GLB Act also reformed the overall regulatory framework of the financial services industry. In order to implement its underlying purposes, the GLB Act preempted state laws that would restrict the types of financial affiliations that are authorized or permitted under the GLB Act, subject to specified exceptions for state insurance laws and regulations. With regard to securities laws, the GLB Act removed the blanket exemption for banks from being considered brokers or dealers under the Exchange Act and replaced it with a number of more limited exemptions. Thus, previously exempted banks may become subject to the broker-dealer registration and supervision requirements of the Exchange Act. The exemption that prevented bank holding companies and banks that advise mutual funds from being considered investment advisers under the Investment Advisers Act of 1940 was also eliminated.

     Separately, the GLB Act imposes customer privacy requirements on any company engaged in financial activities. Under these requirements, a financial company is required to protect the security and confidentiality of customer nonpublic personal information. Also, for customers that obtain a financial product such as a loan for personal, family or household purposes, a financial company is required to disclose its privacy policy to the customer at the time the relationship is established and annually thereafter, including its policies concerning the sharing of the customer’s nonpublic personal information with affiliates and third parties. If an exemption is

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not available, a financial company must provide consumers with a notice of its information sharing practices that allows the consumer to reject the disclosure of its nonpublic personal information to third parties. Third parties that receive such information are subject to the same restrictions as the financial company on the reuse of the information. Finally, a financial company is prohibited from disclosing an account number or similar item to a third party for use in telemarketing, direct mail marketing or other marketing through electronic mail.

     Risk-Based Capital Guidelines

     General. The federal banking agencies have established minimum capital standards known as risk-based capital guidelines. These guidelines are intended to provide a measure of capital that reflects the degree of risk associated with a bank’s operations. The risk-based capital guidelines include both a new definition of capital and a framework for calculating the amount of capital that must be maintained against a bank’s assets and off-balance sheet items. The amount of capital required to be maintained is based upon the credit risks associated with the various types of a bank’s assets and off-balance sheet items. A bank’s assets and off-balance sheet items are classified under several risk categories, with each category assigned a particular risk weighting from 0% to 100%. A bank’s risk-based capital ratio is calculated by dividing its qualifying capital, which is the numerator of the ratio, by the combined risk weights of its assets and off-balance sheet items, which is the denominator of the ratio.

     Qualifying Capital. A bank’s total qualifying capital consists of two types of capital components: “core capital elements,” known as Tier 1 capital, and “supplementary capital elements,” known as Tier 2 capital. The Tier 1 component of a bank’s qualifying capital must represent at least 50% of total qualifying capital and may consist of the following items that are defined as core capital elements:

	•	common stockholders’ equity;
	•	qualifying noncumulative perpetual preferred stock (including related surplus); and
	•	minority interests in the equity accounts of consolidated subsidiaries.

     The Tier 2 component of a bank’s total qualifying capital may consist of the following items:

	•	a portion of the allowance for loan and lease losses;
	•	certain types of perpetual preferred stock and related surplus;
	•	certain types of hybrid capital instruments and mandatory convertible debt securities; and
	•	a portion of term subordinated debt and intermediate-term preferred stock, including related surplus.

     Risk Weighted Assets and Off-Balance Sheet Items. Assets and credit equivalent amounts of off-balance sheet items are assigned to one of several broad risk classifications, according to the obligor or, if relevant, the guarantor or the nature of the collateral. The aggregate dollar value of the amount in each risk classification is then multiplied by the risk weight associated with that classification. The resulting weighted values from each of the risk classifications are added together. This total is the bank’s total risk weighted assets.

     Risk weights for off-balance sheet items, such as unfunded loan commitments, letters of credit and recourse arrangements, are determined by a two-step process. First, the “credit equivalent amount” of the off-balance sheet items is determined, in most cases by multiplying the off-balance sheet item by a credit conversion factor. Second, the credit equivalent amount is treated like any balance sheet asset and is assigned to the appropriate risk category according to the obligor or, if relevant, the guarantor or the nature of the collateral. This result is added to the bank’s risk weighted assets and comprises the denominator of the risk-based capital ratio.

     Minimum Capital Standards. The supervisory standards set forth below specify minimum capital ratios based primarily on broad risk considerations. The risk-based ratios do not take explicit account of the quality of individual asset portfolios or the range of other types of risks to which banks may be exposed, such as interest rate, liquidity, market or operational risks. For this reason, banks are generally expected to operate with capital positions above the minimum ratios.

     All banks are required to meet a minimum ratio of qualifying total capital to risk weighted assets of 8%. At least 4% must be in the form of Tier 1 capital, net of goodwill. The maximum amount of supplementary capital elements that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill. In addition, the combined maximum amount of subordinated debt and intermediate-

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term preferred stock that qualifies as Tier 2 capital is limited to 50% of Tier 1 capital. The maximum amount of the allowance for loan and lease losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk weighted assets. The allowance for loan and lease losses in excess of this limit may, of course, be maintained, but would not be included in a bank’s risk-based capital calculation.

     The federal banking agencies also require all banks to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a bank rated in the highest of the five categories used by regulators to rate banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banks not rated in the highest category, the minimum leverage ratio must be at least 4% to 5%. These uniform risk-based capital guidelines and leverage ratios apply across the industry. Regulators, however, have the discretion to set minimum capital requirements for individual institutions which may be significantly above the minimum guidelines and ratios.

     The following table sets forth the Company’s and SWCB’s actual capital amounts and ratios and comparison to the minimum ratios:

     Other Factors Affecting Minimum Capital Standards. The federal banking agencies have established certain benchmark ratios of loan loss reserves to be held against classified assets. The benchmark ratio established by the federal banking agencies is the sum of:

	•	100% of assets classified loss;
	•	50% of assets classified doubtful;
	•	15% of assets classified substandard; and
	•	estimated credit losses on other assets over the upcoming twelve months.

     The risk-based capital rules adopted by the federal banking agencies take account of concentrations of credit and the risks of engaging in non-traditional activities. Concentrations of credit refers to situations where a lender has a relatively large proportion of loans involving a single borrower, industry, geographic location, collateral or loan type. Non-traditional activities are considered those that have not customarily been part of the banking business, but are conducted by a bank as a result of developments in, for example, technology, financial markets or other additional activities permitted by law or regulation. The regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards. The federal banking agencies also are authorized to

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review an institution’s management of concentrations of credit risk for adequacy and consistency with safety and soundness standards regarding internal controls, credit underwriting or other operational and managerial areas. We do not have any concentrations of credit or risk associated with non-traditional activities which would affect our capital ratios.

     The federal banking agencies also limit the amount of deferred tax assets that are allowable in computing a bank’s regulatory capital. Deferred tax assets that can be realized from taxes paid in prior carry-back years and from future reversals of existing taxable temporary differences are generally not limited. However, deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of:

	•	the amount of the deferred tax assets that can be realized within one year of the quarter-end report date; or
	•	10% of Tier 1 capital.

     The amount of any deferred tax in excess of this limit would be excluded from Tier 1 capital, total assets and regulatory capital calculations. We do not have any deferred tax assets in excess of the regulatory limits.

     The federal banking agencies have also adopted a joint agency policy statement which provides that the adequacy and effectiveness of a bank’s interest rate risk management process and the level of its interest rate exposures are critical factors in the evaluation of the bank’s capital adequacy. A bank with material weaknesses in its interest rate risk management process or high levels of interest rate exposure relative to its capital will be directed by the federal banking agencies to take corrective actions. Financial institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities, and who fail to adequately manage these risks, may be required to set aside capital in excess of the regulatory minimums.

     Prompt Corrective Action

     The federal banking agencies possess broad powers to take prompt corrective action to resolve the problems of insured banks. Each federal banking agency has issued regulations defining five capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Under the regulations, a bank shall be deemed to be:

	•	“well capitalized” if it has a total risk-based capital ratio of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a leverage capital ratio of 5.0% or more, and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure;
	•	“adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more, and a leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized”;
	•	“undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%, or a leverage capital ratio that is less than 4.0% (3.0% under certain circumstances);
	•	“significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a leverage capital ratio that is less than 3.0%; and
	•	“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.

     As of December 31, 2004, the most recent notification from the regulatory agencies categorized the Company and SWCB as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company’s or SWCB’s category.

     Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment the bank would be “undercapitalized,” that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to “undercapitalized” banks. Banks classified as “undercapitalized” are required to submit acceptable capital plans guaranteed by its holding company, if any. Broad regulatory authority was granted with respect to “significantly undercapitalized” banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to “critically undercapitalized” banks, those with capital at or less than 2%.

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Restrictions for these banks include the appointment of a receiver or conservator after 90 days, even if the bank is still solvent. All of the federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.

     A bank, based upon its capital levels, that is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. At each successive lower capital category, an insured bank is subject to more restrictions. The federal banking agencies, however, may not treat an institution as “critically undercapitalized” unless its capital ratios actually warrant such treatment.

     Deposit Insurance Assessments

     The FDIC has implemented a risk-based assessment system in which the deposit insurance premium relates to the probability that the deposit insurance fund will incur a loss. The FDIC sets semi-annual assessments in an amount necessary to maintain or increase the reserve ratio of the insurance fund to at least 1.25% of insured deposits or a higher percentage as determined to be justified by the FDIC.

     Under the risk-based assessment system adopted by the FDIC, banks are categorized into one of three capital categories (“well capitalized,” adequately capitalized,” and “undercapitalized”). Assignment of a bank into a particular capital category is based on supervisory evaluations by its primary federal regulator. After being assigned to a particular capital category, a bank is classified into one of three supervisory categories. The three supervisory categories are:

	•	Group A — financially sound with only a few minor weaknesses;
	•	Group B — demonstrates weaknesses that could result in significant deterioration; and
	•	Group C — poses a substantial probability of loss.

The capital ratios used by the FDIC to define “well-capitalized,” “adequately capitalized” and “undercapitalized” are the same as in the prompt corrective action regulations.

     Because of the FDIC’s favorable loss experience and a healthy reserve ratio in the Bank Insurance Fund, well-capitalized and well-managed banks have in recent years paid minimal premiums for FDIC Insurance. The amount of future premiums will depend on the outcome of legislative and regulatory initiatives as well as the Bank Insurance Fund loss experience and other factors, none of which we can predict.

     The current assessment rates are summarized below, expressed in terms of cents per $100 in insured deposits:

     Interstate Banking and Branching

     Bank holding companies from any state may generally acquire banks and bank holding companies located in any other state, subject in some cases to nationwide and state-imposed deposit concentration limits and limits on the acquisition of recently established banks. Banks also have the ability, subject to specific restrictions, to acquire by acquisition or merger branches located outside their home state. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to many of the laws of the states in which they are located.

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     California law authorizes out-of-state banks to enter California by the acquisition of or merger with a California bank that has been in existence for at least five years, unless the California bank is in danger of failing or in certain other emergency situations, but limits interstate branching into California to branching by acquisition of an existing bank.

     Enforcement Powers

     In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses, or for violation of any law, rule, regulation, condition imposed in writing by the regulatory agency, or term of a written agreement with the regulatory agency. Enforcement actions may include:

	•	the appointment of a conservator or receiver for the bank;
	•	the issuance of a cease and desist order that can be judicially enforced;
	•	the termination of the bank’s deposit insurance;
	•	the imposition of civil monetary penalties;
	•	the issuance of directives to increase capital;
	•	the issuance of formal and informal agreements;
	•	the issuance of removal and prohibition orders against officers, directors and other institution-affiliated parties; and
	•	the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the deposit insurance fund or the bank would be harmed if such equitable relief was not granted.

     The DFI, as the primary regulator for state-chartered banks, also has a broad range of enforcement measures, from cease and desist powers and the imposition of monetary penalties to the ability to take possession of a bank, including causing its liquidation.

     FDIC Receiverships

     The FDIC may be appointed conservator or receiver of any insured bank or savings association. In addition, the FDIC may appoint itself as sole conservator or receiver of any insured state bank or savings association for any, among others, of the following reasons:

	•	insolvency;
	•	substantial dissipation of assets or earnings due to any violation of law or regulation or any unsafe or unsound practice;
	•	an unsafe or unsound condition to transact business, including substantially insufficient capital or otherwise;
	•	any willful violation of a cease and desist order which has become final;
	•	any concealment of books, papers, records or assets of the institution;
	•	the likelihood that the institution will not be able to meet the demands of its depositors or pay its obligations in the normal course of business;
	•	the incurrence or likely incurrence of losses by the institution that will deplete all or substantially all of its capital with no reasonable prospect for the replenishment of the capital without federal assistance; or
	•	any violation of any law or regulation, or an unsafe or unsound practice or condition which is likely to cause insolvency or substantial dissipation of assets or earnings, or is likely to weaken the condition of the institution or otherwise seriously prejudice the interests of its depositors.

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     As a receiver of any insured depository institution, the FDIC may liquidate such institution in an orderly manner and dispose of any matter concerning such institution as the FDIC determines is in the best interests of such institution, its depositors and the FDIC. Further, the FDIC shall, as the conservator or receiver, by operation of law, succeed to all rights, titles, powers and privileges of the insured institution, and of any shareholder, member, account holder, depositor, officer or director of such institution with respect to the institution and the assets of the institution; may take over the assets of and operate such institution with all the powers of the members or shareholders, directors and the officers of the institution and conduct all business of the institution; collect all obligations and money due to the institution and preserve and conserve the assets and property of the institution.

     Safety and Soundness Guidelines

     The federal banking agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before capital becomes impaired. These guidelines establish operational and managerial standards relating to:

	•	internal controls, information systems and internal audit systems;
	•	loan documentation;
	•	credit underwriting;
	•	asset growth; and
	•	compensation, fees and benefits.

     Additionally, the federal banking agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action.

     The federal banking agencies have issued regulations prescribing uniform guidelines for real estate lending. The regulations require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations.

     Risk Management and Exposure

     The federal banking agencies have begun examining banks and bank holding companies with respect to their exposure to and management of different categories of risk, including: legal, operations, market, credit, interest rate, price, foreign exchange, transaction, compliance, strategic, credit, liquidity, and reputation risk. This examination approach causes bank regulators to focus on risk management procedures, rather than simply examining every asset and transaction. This approach supplements rather than replaces existing rating systems based on the evaluation of an institution’s capital, assets, management, earnings and liquidity.

     Money Laundering and Currency Controls

     Various federal statutory and regulatory provisions are designed to enhance recordkeeping and reporting of currency and foreign transactions. Pursuant to the Bank Secrecy Act, financial institutions must report high levels of currency transactions or face the imposition of civil monetary penalties for reporting violations. The Money Laundering Control Act imposes sanctions, including revocation of federal deposit insurance, for institutions convicted of money laundering.

     The International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”), a part of the USA Patriot Act, authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks and other financial institutions to enhance recordkeeping and reporting requirements for certain financial transactions that are of primary money laundering concern. Among its other provisions, IMLAFATA requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering, or managing correspondent accounts in the Untied States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLAFATA contains a provision encouraging cooperation

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among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.

     On April 30, 2003, the Treasury Department adopted final regulations, which became mandatory on October 1, 2003, implementing the IMLAFATA mandate that federally-insured banks and other financial institutions establish customer identification programs designed to verify the identity of persons opening new accounts, to maintain the records used for verification, and to determine whether the person appears on any list of known or suspected terrorists or terrorist organizations.

     Consumer Protection Laws and Regulations

     The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and implementing regulations. These laws and implementing regulations impact overall bank operations as well as specific consumer-oriented products and services. Examination and enforcement have become more intense in nature, and insured institutions have been advised to carefully monitor compliance with various consumer protection laws and implementing regulations. Banks are subject to many federal consumer protection laws and regulations, including:

	•	the Community Reinvestment Act, or the CRA;
	•	the Truth in Lending Act, or the TILA;
	•	the Fair Housing Act, or the FH Act;
	•	the Equal Credit Opportunity Act, or the ECOA;
	•	the Home Mortgage Disclosure Act, or the HMDA; and
	•	the Real Estate Settlement Procedures Act, or the RESPA.

     The CRA is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations.

     The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from “outstanding” to a low of “substantial noncompliance.”

     The ECOA prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act. In March 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination:

	•	overt evidence of discrimination;
	•	evidence of disparate treatment; and
	•	evidence of disparate impact.

This means that if a creditor’s actions have had the effect of discriminating, the creditor may be held liable — even when there is no intent to discriminate.

     The FH Act regulates many practices, including making it unlawful for any lender to discriminate against any person in its housing-related lending activities because of race, color, religion, national origin, sex, handicap, or familial status. The FH Act is

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broadly written and has been broadly interpreted by the courts. A number of lending practices have been found to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself. Among those practices that have been found to be, or may be considered, illegal under the FH Act are:

	•	declining a loan for the purposes of racial discrimination;
	•	making excessively low appraisals of property based on racial considerations;
	•	pressuring, discouraging, or denying applications for credit on a prohibited basis;
	•	using excessively burdensome qualifications standards for the purpose or with the effect of denying housing to minority applicants;
	•	imposing on minority loan applicants more onerous interest rates or other terms, conditions or requirements; and
	•	racial steering, or deliberately guiding potential purchasers to or away from certain areas because of race.

     The TILA is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology and expressions of rates, the annual percentage rate, the finance charge, the amount financed, the total payments and the payment schedule.

     HMDA grew out of public concern over credit shortages in certain urban neighborhoods. One purpose of HMDA is to provide public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. HMDA requires institutions to report data regarding applications for one-to-four family real estate loans, home improvement loans, and multifamily loans, as well as information concerning originations and purchases of those types of loans. Federal bank regulators rely, in part, upon data provided under HMDA to determine whether depository institutions engage in discriminatory lending practices.

     RESPA requires lenders to provide borrowers with disclosures regarding the nature and costs of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts.

     The GLB Act requires disclosure of our privacy policy at the time a customer relationship is established and annually thereafter. Under the provisions of the GLB Act, we must put systems in place to safeguard the non-public personal information of our customers.

     Violations of these various consumer protection laws and regulations can result in civil liability to the aggrieved party, regulatory enforcement including civil money penalties, and even punitive damages.

     Other Aspects of Banking Law

     We are also subject to federal statutory and regulatory provisions covering, among other things, security procedures, insider and affiliated party transactions, management interlocks, electronic funds transfers, funds availability, and truth-in-savings. There are also a variety of federal statutes which regulate acquisitions of control and the formation of bank holding companies.

     Impact of Monetary Policies

     Banking is a business which depends on rate differentials. In general, the difference between the interest rate paid by a bank on its deposits and its other borrowings and the interest rate earned by a bank on its loans, securities and other interest-earning assets comprises the major source of the bank’s earnings. These rates are highly sensitive to many factors which are beyond the bank’s control and, accordingly, the earnings and growth of the bank are subject to the influence of economic conditions generally, both domestic and foreign, including inflation, recession, and unemployment; and also to the influence of monetary and fiscal policies of the United States and its agencies, particularly the FRB. The FRB implements national monetary policy, such as seeking to curb inflation and combat recession, by:

•

its open-market dealings in United States government securities;

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	•	adjusting the required level of reserves for financial institutions subject to reserve requirements;
	•	placing limitations upon savings and time deposit interest rates; and
	•	adjustments to the discount rate applicable to borrowings by banks which are members of the Federal Reserve System.

     The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect market interest rates. Since January 2001 the FRB has decreased interest rates thirteen times, reducing the overnight “Federal Funds” rate from 6.50% to 1.00% through early 2004, the lowest level in over four decades. Since June 2004, the FRB has increased interest rates seven times to 2.75%. Additional increases are expected during 2005. The nature and timing of any future changes in such policies and their impact on us cannot be predicted; however, depending on the degree to which our interest-earning assets and interest-bearing liabilities are rate sensitive, increases in rates would have a temporary effect of increasing our net interest margin, while decreases in interest rates would have the opposite effect. In addition, adverse economic conditions, including a downturn in the local or regional economy and rising energy prices, could make a higher provision for loan losses a prudent course and could cause higher loan charge-offs, thus adversely affecting our net income or other operating costs.

     Conclusion

     As a result of the recent federal and California legislation, including the GLB Act, there has been a competitive impact on commercial banking. There has been a lessening of the historical distinction between the services offered by banks, savings associations, credit unions, securities dealers, insurance companies, and other financial institutions. Banks have also experienced increased competition for deposits and loans which may result in increases in their cost of funds, and banks have experienced increased overall costs. Further, the federal banking agencies have increased enforcement authority over banks and their directors and officers.

     Future legislation is also likely to impact our business. However, our management cannot predict what legislation might be enacted or what regulations might be adopted or the effects thereof.

ITEM 2 — PROPERTIES

     In January 2001 we moved our administrative headquarters to 5810 El Camino Real, Carlsbad, California 92008, Suites C and D, and in March 2001 we opened the Carlsbad Business Banking Center at the same location. The premises consist of a stand-alone building containing approximately 13,400 square feet of which we lease approximately 6,260 square feet from an unaffiliated third party. The lease provides for annual cost of living increases not to exceed 6%. The current monthly base rent amount is $8,158. The lease expires January 31, 2009 and provides a five-year option to extend. In May 2004 we entered into a new lease at 5650 El Camino Real, Suite 130, Carlsbad, California 92008, in the Carlsbad Gateway Center for the relocation of our Carlsbad Business Banking Center. The premises consist of a stand-alone building containing 50,071 square feet of which we lease approximately 3,260 square feet from an unaffiliated third party. The current monthly base rent is $5,053. The lease expires in October 2009 and provides two five-year options to extend.

     Our Encinitas Office is located at 277 North El Camino Real, Encinitas, California 92024, in the Villa Encinitas Plaza. These premises are leased from an unaffiliated third party. The premises consist of a stand-alone building having approximately 5,200 square feet. The building is located in a shopping center and has ample parking. The current monthly base rent amount is $11,598. The lease provides for bi-annual cost of living increases of not less than 8%. The lease expires in May 2008 and provides four five-year options to extend. We also lease the space for the drive-up ATM at this same location at the currently monthly rate of $800. The ATM lease expires in May 2008 with options to extend.

     Our downtown Private Banking Office is located at 600 “B” Street, Suite 2202, San Diego, California 92101. We sublease approximately 1,091 square feet from Fortuna Financial, Inc., of which our Chairman of the Board, Mr. Howard B. Levenson, serves as Chairman, President and sole stockholder. (See “ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” herein.) The original lease expired in September 2000 and was renewed. The current monthly base rent is $2,618. The new lease expires in September 2005 and provides a five-year option to extend. In December 2002 we entered into an agreement with an unaffiliated third party to lease approximately 373 square feet of additional space to expand the Private Banking Office. The current monthly base rent is $783. The lease expires in September 2005 and provides a five- year option to extend.

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     Our Escondido Office is located at 1146 West Valley Parkway, Suite 102, Escondido, California 92025, in Plaza Las Palmas. We lease these premises from an unaffiliated third party. The premises are located in a shopping center and we lease approximately 1,271 square feet. The lease provides for annual cost of living increases not to exceed 6%. The currently monthly base rent amount is $3,059. The lease has been extended and expires in March 2010 and provides for an additional five-year option to extend.

     Our El Cajon Office is located at 1235 Avocado Boulevard, El Cajon, California 92020. The premises consist of a stand-alone building having approximately 3,500 square feet. The building is located in a shopping center. The currently monthly base monthly rent amount is $4,859. The lease is with an unaffiliated third party and provides for annual cost of living increases not to exceed 5%. The lease expires in March 2011 and provides a five-year option to extend.

     Our Murrieta Office is located at 26755 Jefferson Avenue, Murrieta, California 92562. The premises consist of a stand-alone building containing approximately 43,200 square feet of which we lease approximately 3,013 square feet from an unaffiliated third party. The current monthly rent amount is $5,214. The lease expires in September 2007 and provides two five-year options to extend.

     Our Anaheim Office is located at 2401 E. Katella Avenue, Anaheim, California 92806. We have leased approximately 5,800 square feet on the ground floor of an existing multi-story/multi-tenant building from an unaffiliated third party. The currently monthly base rent is $10,652. The lease expires in April 2009 and provides a five-year option to extend.

     In April 2003 we leased approximately 5,013 square feet of administrative office space at 5611 Palmer Way, Suite G, Carlsbad, California 92008, from an unaffiliated third party. The currently monthly base rent amount is $4,912, plus common area charges, with annual step adjustments in the monthly rent of approximately 3%. The lease expires in August 2008 and provides a three-year option to extend.

     Our Glendale Loan Production Office is located at 330 North Brand Boulevard, Suite 525, Glendale, California 92103. We have leased approximately 2,096 in a multi-story/multi-tenant building from an unaffiliated third party. The current monthly base rent is $4,611, plus common area charges. The lease expires in December 2008 and provides a five-year option to extend.

     In March 2004 we leased approximately 5,386 square feet of office space at 599 North E. Street, San Bernardino, California 92401 from an unaffiliated third party for our San Bernardino Office. The basic monthly rent is $10,368, plus a pro rata share of common area charges and annual cost of living increases of not less that 2.5% and not more than 6.0%. The lease expires in July 2014 and provides a five-year option to extend.

     In July 1998 FDSI leased a free-standing industrial building with approximately 8,667 square feet of space for its item processing operations and related uses at 41188 Sandalwood Circle, Murrieta, California 92562, from an unaffiliated third party. The basic monthly rent is $4,967, plus common area expenses, with cost of living adjustments every 2 years not to exceed 7%. The lease expires in October 2008 and provides two five-year options to extend.

     FDSI also leases approximately 5,152 square feet of space for general office and processing services located at 9440 Telstar Avenue, Suite 6, El Monte, California 91731 from an unaffiliated third party. The current basic monthly rent is $4,225, plus common area charges. The lease expires in January 2006 and provides two five-year options to extend.

     FDSI leases approximately 4,916 square feet of office space located at 2235 Polvorosa Avenue, San Leandro, California 94577, from an unaffiliated third party. The basic monthly rent is $5,165, plus common area charges. The lease provides for annual step adjustments in the monthly rent of approximately 3%. The lease and expires in January 2010 and provides a five-year option to extend.

     FDSI leases warehouse space in Murrieta for storage and other uses at 41162 Sandalwood Circle, Unit “A,” Murrieta, California 92562, from an unaffiliated third party. The lease expires in September 2005 and is expected to be renewed. The basic monthly rent is $3,325, plus common area charges.

     During 2004 and 2003, our aggregate lease expense was approximately $1,041,000 and $833,000, respectively, on a consolidated basis.

     We believe that our existing premises are adequate for present and anticipated needs and do not contemplate any material capital expenditures. We also believe that we have adequate insurance to cover our interests in the premises we occupy.

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ITEM 3 — LEGAL PROCEEDINGS

     We may, from time to time, be involved in legal proceedings in the ordinary course of business. We are not currently involved in any pending legal proceedings that we believe, either individually or taken as a whole, could materially harm our business, financial position, results of operations or cash flows.

ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to the Company’s shareholders during the fourth quarter of 2004.

PART II

ITEM 5 — MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Equity Securities

     As of December 31, 2004, we had 3,484,266 shares of our common stock issued and outstanding and warrants outstanding to purchase 120,024 shares of our common stock. As of February 28, 2005, we had approximately 466 holders of record of our common stock, although we believe that there are an additional 400 shareholders who own their shares in “street name” through brokerage firms, and approximately 106 holders of record of our warrants, although we believe that there are additional holders who own their warrants in “street name” through brokerage firms.

Historical Market Prices

     There has been a limited trading market for our common stock on the OTC Bulletin Board (trading symbol “SWCB”). We are aware of only five market makers in our common stock. However, there are a number of other dealers who affect trades in our common stock through these market makers including Western Financial Corporation, an affiliated company of our Chairman, Howard S. Levenson. No assurance can be given that a more active public trading market for our common stock will develop in the future or the extent to which those dealers will continue to effect trades. Our common stock is not currently listed on any exchange or on the Nasdaq National Market.

     The information in the following table indicates the high and low sales prices and volume of trading for our common stock for each quarterly period since January 1, 2003, and is based upon information provided by the OTC Bulletin Board. Because of the limited market for our common stock, these prices may not be indicative of the fair market value of our common stock. The information does not include transactions for which no public records are available. The trading prices in such transactions may be higher or lower than the prices reported below. These prices do not include retail mark-ups, mark-downs, or commissions and have been adjusted for our 3-for-2 stock split in 2004 and our 2-for-1 stock split in 2003.

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Dividends

     To date, we have not paid any cash dividends. Payment of stock or cash dividends in the future will depend upon the Company’s earnings and financial condition and other factors deemed relevant by the Boards of Directors of Southwest Community and SWCB. It is our current intention to follow our strategic plan of retaining earnings to increase our capital and provide additional basis for growth. Accordingly, no assurance can be given that any cash dividends will be declared in the foreseeable future. On March 23, 2005, the Board of Directors approved a five percent stock dividend payable on May 18, 2005 to shareholders of record as of April 25, 2005.

Securities Authorized for Issuance Under Equity Compensation Plans

     The following table provides information as of December 31, 2004, with respect to the shares of Southwest Community common stock that may be issued under existing equity compensation plans:

Recent Sales of Unregistered Securities

     During 2004, we issued a total of 4,200 shares (as adjusted for stock splits) of our common stock pursuant to the exercise of warrants issued in our 2002 Unit Offering. The aggregate proceeds were $40,040. The issuances of common stock were exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(2). That section exempts from the registration requirements securities issued by a company not involving any public offering. The issuance of shares of common stock upon exercise of warrants did not involve any public offering in compliance with the requirements of Section 4(2) and, therefore, was exempt from registration.

     There were no discounts or commissions involved in the above transactions.

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ITEM 6 — SELECTED FINANCIAL DATA

ITEM 7 — 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.

FINANCIAL SUMMARY

     The primary source of the Company’s earnings comes from banking services provided by SWCB and to a lesser extent from item processing services provided by FDSI. Our financial condition and results of operations reflect the continued growth in earning assets,

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deposits, equity capital and net earnings. SWCB commenced operations in 1997 and opened branches in 1998, 2000, 2001, 2002, 2003 and 2004, for a total of 8 full-service banking offices and a loan production office. This contributed to our growth in loans and deposits, as well as the increases in noninterest expenses. In addition, FDSI, which commenced operations in 1998, opened a second processing center in 2001 and a third in 2003, which also resulted in increased revenues and expenses.

     Since the opening of SWCB, it has been our business plan to maximize growth in assets funded by growth in liabilities to enhance profitability and share value tempered by prudent underwriting of credit risk and management of interest rate and other operational risks. Consequently, our Board, management and staff have been dedicated to attracting new customers as SWCB has attempted to increase its market share and establish itself as a viable competitor in the North San Diego County market initially and the broader marketplace in which it now operates. Since December 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 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 years ended December 2004, 2003 and 2002 is summarized below and discussed in more detail in the following sections:

Year 2004 Compared to 2003

     The 62% increase in net income for the year ended December 31, 2004 as compared to the same period in 2003 was a result of several factors. Net interest income increased by $5,248,000, or 43%, due primarily to a 60% increase in average interest-earning assets; and noninterest income increased by $2,161,000, or 23%, due to increases in fees and service charges due to our overall growth, loan referral fees and in gains on sales of SBA loans at SWCB and item processing fees at FDSI. During 2004 we had a loss on sale of securities as compared to $288,000 in securities gains in 2003. Partially offsetting the increases in revenues, noninterest expense increased by $3,738,000, or 24%, and the provision for loan losses increased $675,000, or 84%. 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.

     The growth in revenues and earnings at FDSI is dependent upon acquiring new item processing customers, the growth of existing customers and the retention of existing customers. Management expects to benefit from the recent formation of new banks and the continuing growth of existing banks in our market area; however, an increase in merger and acquisition activity may cause the

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unplanned loss of existing customers and “Check 21” may reduce the need for item processing services by reducing the flow of paper check clearings.

     For the year 2004, the return on average assets was 1.18% and the return on average equity was 17.61%, as compared to 1.03% and 16.88%, respectively, for the year 2003.

     As of December 31, 2004 consolidated total assets were $532,874,000 as compared to $338,815,000 at December 31, 2003, a 57% increase. Total loans increased 50% to $283,600,000 and total deposits increased 57% to $482,762,000 as of December 31, 2004 as compared to December 31, 2003. Shareholders’ equity increased $19,926,000, to $38,888,000 at December 31, 2004 from $18,962,000 as of December 31, 2003. The increase included net income for the period and the $14,384,000 in net proceeds from the common stock offering that was completed during the third quarter.

Year 2003 Compared to 2002

     The 62% increase in net income for the year December 31, 2003 as compared to the same period in 2002 was a result of several factors. Net interest income increased by $4,203,000, or 52%, due primarily to a 48% increase in average interest-earning assets; and noninterest income increased by $979,000, or 12%, due to increases in fees and service charges due to our overall growth and in gains on sales of SBA loans at SWCB and item processing fees at FDSI. During 2003 we also had $288,000 in securities gains as securities were sold to fund loan growth. Partially offsetting the increases in revenues, noninterest expense increased by $2,989,000, or 23%, and the provision for loan losses increased $145,000, or 22%. 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.

     The increase in earnings at FDSI in 2002 and subsequent decrease in 2003 was the result of the loss of an item processing customer and increased expenses. During 2002 FDSI recognized a one-time increase in revenue from the former customer’s payment of a contract termination fee. The comparison of revenues from 2003 to 2002 is impacted by the 2002 one-time payment and the consequent loss of revenue from that customer in 2003. During 2003, FDSI also experienced increased expenses related to the opening of an additional processing center in January 2003. Although FDSI recognized an overall increase in revenues from 2002 to 2003, the rate of increase was impacted by the loss of the customer that merged into another institution and, as a result of increased expenses related to the new office, net income declined. The growth in revenues and earnings at FDSI is dependent upon acquiring new item processing customers, the growth of existing customers and the retention of existing customers.

     For the year 2003, the return on average assets was 1.03% and the return on average equity was 16.88%, as compared to 1.05% and 14.55%, respectively, for the year 2002.

     As of December 31, 2003 consolidated total assets were $338,815,000 as compared to $250,898,000 at December 31, 2002, a 35% increase. Total loans increased 48% to $190,640,000 and total deposits increased 33% to $308,379,000 as of December 31, 2003 as compared to December 31, 2002. Shareholders’ equity increased, primarily due to net income for the period, to $18,962,000 at December 31, 2003 from $16,177,000 as of December 31, 2002.

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 the notes to our consolidated financial statements. 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. These policies are summarized below.

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     Allowance for Loan Losses

     We maintain an allowance for loan losses at an amount which we believe is sufficient to provide adequate protection against losses in the loan portfolio. Our periodic evaluation of the adequacy of the allowance is based on such factors as our past loan loss experience, known and inherent risks in the portfolio, adverse situations that have occurred but are not yet known that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and economic conditions. As we utilize information currently available to evaluate the adequacy of the allowance for loan losses, the amount of the allowance for loan losses is subjective and may be adjusted in the future depending on changes in economic conditions or other factors. If our estimate of possible loan losses or an increase in actual loan losses required us to increase the allowance for loan losses, we would increase the allowance through an increase in the provision for loan losses taken as a charge against earnings. Conversely, if net loan losses are less that expected, we may be able to reduce our provision for loan losses in future periods.

     During the time we hold collateral, we are subject to credit risks, including risks of borrower defaults, bankruptcies and special hazard losses that are not covered by standard hazard insurance (such as those occurring from earthquakes or floods). Although we have established an allowance for loan losses that we consider adequate, there can be no assurance that the established allowance for loan losses will be sufficient to offset losses on loans in the future. See the notes to the consolidated financial statements for additional information regarding loans and the allowance for loan losses.

     Fair Value of Financial Instruments

     We estimate the fair value of financial instruments for purposes of preparing our financial statements. We assess the fair value of various items such as investment securities, loans, deposits, borrowings and commitments to extend credit. Fair value estimates are based on relevant market information and information about the financial instrument. Because there are no markets for a portion of our financial instruments, fair value estimates are based on management’s judgment regarding expected future cash flows, current economic conditions, risk characteristics of the instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. 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 charged against earnings. 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 charged against earnings. See the notes to the audited consolidated financial statements for additional information regarding the fair value of our financial instruments.

ANALYSIS OF RESULTS OF OPERATIONS

Distribution of Assets, Liabilities and Shareholders’ Equity; Net Interest Income and Net Yield

     Our earnings depend largely upon the difference between the income we receive from interest-earning assets, which are principally our loan portfolio and investment securities; and the interest paid on our interest-bearing liabilities, which consist of deposits and borrowings. 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 absolute difference between the rate earned on interest-earning assets and the rate paid on interest-bearing liabilities.

     The following table provides 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 yields and rates of interest earned or paid, net interest income and net interest spread:

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Analysis of Average Rates and Balances

     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 Analysis of Changes in Volume and Interest Rates table that follows:

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     Year 2004 compared to 2003

     For the year ended December 31, 2004, net interest income was $17,525,000, an increase of $5,248,000, or 43%, as compared to $12,277,000 for the year ended December 31, 2003. The increase in net interest income can be primarily attributed to the growth in the volume of loans, our highest yielding interest-earning assets, partially offset by lower yields on loans and the growth in the volume of interest-bearing liabilities. The increase in net interest income can also be attributed to the differential in the rate of growth in our interest-earning assets versus our interest-bearing liabilities. Average interest-earning assets increased $119,841,000, or 60%, versus an increase in average interest-bearing liabilities of $33,638,000, or 48%. The increase in average loans accounted for most of the increase in average interest-earning assets. Average loans increased by $66,690,000, or 43%. The increased volume of our interest-bearing assets contributed $6,204,000 towards the net increase in net interest income, of which the increased volume of loans contributed $5,024,000, offset by $344,000 due to the increased volume of interest-bearing liabilities. Interest rates had an overall negative impact of $612,000 on net interest income, of which $429,000 resulted from lower yields on interest-earning assets and $183,000 was due to in increased costs of interest-bearing liabilities. Lower loan yields contributed $649,000 of the overall decrease.

     The net interest margin for the year 2004 was 5.47%, a decrease of 66 basis points from 6.13% for the year 2003. The decrease in net interest margin was due to a decrease in the yield on interest-earning assets and an increase in the cost of interest-bearing liabilities partially offset by a continuing decrease in the proportion of interest-bearing liabilities to interest-earning assets. The yield on interest-earning assets was 5.95% for the year 2004, a decrease of 67 basis points as compared to 6.62% for the year 2003. The lower yield was primarily due to lower yields on loans. The lower yield on loans was due to the prime rate declining during 2003 to a low of 4.0% at mid-year and remaining there through the first half of 2004. While the average prime rate in 2004 increased to 4.34% as compared to 4.12% in 2003 loans added in 2003 and early 2004 continued to reduce the overall loan yield. The average cost of interest-bearing liabilities was 1.46% in 2004, an increase of 5 basis points from 1.41% in 2003. Most of our growth was supported by an increase in average noninterest-bearing deposits, which increased $76,641,000, or 39%. As a result, the ratio of interest-earning assets to interest-bearing liabilities increased from 2.84:1 to 3.07:1. No assurance can be given that this trend will continue.

     Year 2003 compared to 2002

     For the year ended December 31, 2003, net interest income was $12,277,000, an increase of $4,203,000, or 52%, as compared to $8,074,000 for the year ended December 31, 2002. The increase in net interest income can be primarily attributed to the growth in the volume of loans, our highest yielding interest-earning assets, partially offset by declining rates and the growth in the volume of interest-bearing liabilities. The increase in net interest income can also be attributed to the differential in the rate of growth in our interest-earning assets versus our interest-bearing liabilities. Average interest-earning assets increased $64,926,000, or 48%, versus an increase in average interest-bearing liabilities of $11,610,000, or 20%. The increase in average loans accounted for most of the increase in average interest-earning assets. Average loans increased by $53,950,000, or 53%. The increased volume of our interest-bearing assets contributed $4,702,000 towards the net increase in net interest income, of which the increased volume of loans contributed $4,262,000, offset by $307,000 due to the increased volume of interest-bearing liabilities. Declining rates had an overall negative impact of $192,000 on net interest income, of which $552,000 resulted from declining yields on interest-earning assets, offset by $360,000 in reduced costs of interest-bearing liabilities. Declining loan rates contributed $211,000 of the overall decrease.

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     The net interest margin for the year 2003 was 6.13%, an increase of 17 basis points from 5.96% for the year 2002. The increase in net interest margin was due to a smaller decrease in the yield on interest-earning assets than the decrease in the cost of interest-bearing liabilities and a continuing decrease in the proportion of interest-bearing liabilities to interest-earning assets. The yield on interest-earning assets was 6.62% for the year 2003, a decrease of 11 basis points as compared to 6.73% for the year 2002. The average cost of interest-bearing liabilities was 1.41% in 2003, a decrease of 37 basis points from 1.78% in 2002. The average prime rate in 2003 was 4.12% as compared to 4.68% in 2002. Most of our growth was supported by an increase in average noninterest-bearing deposits, which increased $94,570,000, or 94%. As a result, the ratio of interest-earning assets to interest-bearing liabilities increased from 2.30:1 to 2.84:1. No assurance can be given that this trend will continue.

Noninterest Income

     For the year ended December 31, 2004, noninterest income was $11,369,000, an increase of $2,161,000, or 23%, from the 2003 amount of $9,208,000. The major items contributing to the increase were fees and service charges, item processing income, loan referral fees and gains from the sale of SBA loans. Fees and service charges increased $295,000, or 12%, from 2003 to 2004, primarily as a result of an increasing deposit customer base. Item processing income, which is generated by FDSI, increased $590,000, or 13%, from 2003 to 2004, primarily as a result of an increased number of clients using the services of FDSI. Loan referral fees increased $750,000, or 235%, to $1,069,000 in 2004 due an increase in the volume of loans referred to a correspondent bank. Gains on sales of SBA loans increased $684,000, or 58%, due to increased loan originations.

     For the year ended December 31, 2003, noninterest income was $9,208,000, an increase of $979,000, or 12%, from $8,229,000 for the year 2002. The major items contributing to the increase were fees and service charges, item processing income, gains from sales of SBA loans and gains from sales of securities. Fees and service charges increased $146,000, or 6%, as a result of the growth in deposits. Item processing income, generated by FDSI, our item processing subsidiary, increased $320,000, or 7%, from 2002 to 2003. The slower growth in item processing income is partially due to the loss of a customer in 2002 for which FDSI received a termination fee in 2002. Gains on sales of SBA loans increased $214,000, or 22%, due to increased loan originations. Gains on sales of securities totaled $228,000 during the year 2003. There were no sales of securities during the same period in 2002.

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 following periods is consistent with our growth in earning assets and revenues.

     Noninterest expense for the year ended December 31, 2004, increased $3,738,000, or 24%, to $19,479,000 from $15,741,000 in 2003. The major items contributing to the increase were salaries and benefits increasing $2,089,000, or 24%, occupancy expense increasing $275,000, or 21%, data processing and equipment expense increasing $267,000, or 12%, and correspondent bank fees increasing $466,000, or 276%, to $635,000. The increases in all expense classifications were primarily attributable to the growth of both SWCB and FDSI, including increases in the number of employees and the number of offices. The increase in correspondent bank fees was due to higher fees for improved cash letter deferred funds availability.

     Noninterest expense for year ended December 31, 2003, was $15,741,000, an increase of $2,989,000, or 23%, from $12,752,000 for the year 2002. The major items contributing to the increase were salaries and benefits increasing $1,509,000, or 21%, occupancy expense increasing $348,000, or 36%, and data processing and equipment expense increasing $273,000, or 14%. The increases in all expense classifications are attributable to growth of SWCB as well as the growth of FDSI, including an increase the number of employees and in the number of offices. SWCB branch offices were opened in the fourth quarter of 2002 and the first quarter of 2003 and FDSI added an additional processing office in the first quarter of 2003 and expanded its main office in the fourth quarter of 2002.

Income Taxes

     Income taxes for the year ended December 31, 2004, totaled $3,195,000, or 40.2% of income before taxes, as compared to $2,009,000, or 40.6% of income before taxes, for 2003 and $1,079,000, or 37.2% of income before income taxes, for the year 2002. The increase in the effective tax rate in 2004 and 2003 as compared to 2002 and prior periods is due to a decrease in the proportion of consolidated net income coming from FDSI, which, prior to becoming a wholly-owned subsidiary in 2004, did not provide for income taxes due to unused net operating loss carry forwards.

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ANALYSIS OF FINANCIAL POSITION

Loans

     Loan Categories

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

Analysis of Loans

     Our loan portfolio has consistently increased since the opening of SWCB. Loan growth is the result of increased lending in our original market area and the addition of additional banking offices in the surrounding area. In addition, our increasing lending limits that result from the growth of our capital allows us to make larger loans. The size of a loan that a bank can make is limited by regulations to a percentage of the institution’s regulatory capital.

     Our real estate construction loans are primarily short-term loans made to finance the construction of commercial and single family residential property. The increase in construction loans reflects an increased emphasis by management as the result of increased construction activity in our market area resulting from the low interest rate environment and a favorable real estate market. 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.

     Our other real estate loans consist primarily of loans made based on the borrower’s cash flow, secured by deeds of trust on commercial and residential property to provide an additional source of repayment in the event of default. Maturities on these loans are generally for up to five years (on an amortization ranging from fifteen to twenty-five years with a balloon payment due at maturity) except for home equity line loans which have a ten year maturity and interest rates that float with changes in the prime rate. SBA and certain other real estate loans, which are generally saleable in the secondary market, are made for longer maturities. Any loans extended for greater than five years have re-pricing provisions that adjust the interest rate to market rates at times prior to maturity.

     Commercial loans secured by real estate are generally greater in amount, more difficult to evaluate and monitor and are often dependent on the successful operation and management of the properties. Repayment of such loans may be affected by adverse conditions in the real estate market or the economy. Poor location, special use characteristics and overall attractiveness of the properties may impair the value of properties in the event of foreclosure.

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     Our commercial and industrial loans are made for the purpose of providing working capital, financing the purchase of equipment or for other business purposes. Such loans include loans with maturities ranging from thirty days to one year and “term loans,” which are loans with maturities normally ranging from one to five years.

     We make SBA guaranteed loans, the guaranteed portion of which are generally sold in the secondary market. We retain the servicing rights for the sold portion of the SBA loans. The retained portions of SBA loans are categorized as either commercial or real estate loans depending on the underlying collateral.

     Commercial business loans may be unsecured or secured by special purpose or rapidly depreciating assets, such as equipment, inventory, receivables, junior liens on property or personal guarantees which may not provide an adequate source of repayment in the event of default. These loans may also have partial guarantees from the Small Business Administration. Commercial business loans are generally more dependent on the borrower’s continuing financial strength and management ability. The borrower’s cash flow and ability to service the debt from earnings is the primary source of repayment rather than the liquidation of any pledged collateral. Commercial business loans are generally for shorter terms and are often subject to annual review and generally require more administrative and management attention.

     Consumer loans are made for the purpose of financing automobiles, various types of consumer goods and other personal purposes. Consumer loans generally provide for the monthly payment of principal and interest.

     Consumer loans are often unsecured or secured by rapidly depreciating assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Also, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

     Outstanding loan commitments primarily consist of commercial, construction and equity lines of credit which have not been fully disbursed. Based upon our experience, the outstanding loan commitments and standby letters of credit are expected to increase in line with increase in loan demand, subject to economic conditions.

     We do not have any concentrations in our loan portfolio by industry or group of industries, except for the level of loans that are secured by real estate as presented in the table above. We have not made loans to any foreign entities. In addition, we have not made any loans to finance leveraged buyouts or for highly leveraged transactions.

     Loan Origination and Underwriting

     Our primary lending emphasis is in construction, commercial real estate and business loans, including SBA loans. Major credit risk factors for all categories of loans include: changes in national and local economic conditions; the experience, ability and depth of our lending staff; changes in the quality of our internal and external loan review systems; and the impact of certain external factors such as competition, legal and regulatory changes. For construction and other real estate related loans, additional major risk factors include: changes in the valuation of real property; increases in commercial, industrial and retail vacancy rates; market absorption levels; excess market supply; and rising interest rates. To address these credit risks, all loan requests require preparation of a credit commitment report that details the purpose of the loan, terms, repayment source, collateral, credit rating of the borrower and a general description of the borrower’s background and/or business. Current appraisals, insurance and perfected liens are generally required for any collateral taken on loans.

     Branch officers are assigned lending limits commensurate with their experience and skill and are capped at $50,000 for unsecured loans and $100,000 for secured loans. Loan requests exceeding branch officer limits are referred to Loan Administration for underwriting, review and approval. Lending limits for Loan Administration lenders are capped at $200,000 for unsecured requests and $500,000 for secured loans. The Chief Executive Officer and the President/Chief Operating Officer have combined lending limits when acting jointly of $750,000 unsecured and $1,500,000 secured. All requests exceeding the authority of the Chief Executive Officer and the President/Chief Operating Officer combined are submitted to the Board of Director’s Loan Committee for approval. Additionally, all new loans, regardless of amount, are reviewed by the Loan Committee monthly and all new loans of $500,000 or more or relationships that aggregate $500,000 or more are reported to the Board monthly. All processing, boarding and servicing of loans are performed by Loan Administration regardless of loan amount.

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     Construction loans for small tract projects or non-residential properties generally require a minimum of 15% equity contribution by the borrower and a maximum advance of 80% of current appraisal. Loan terms can range from 6 to 18 months depending on the nature of the project. We require a first lien position on the property to be constructed and often take a junior lien on other real estate property as well. Land draws are generally limited to 50% of cost. Pricing is generally in the range of Wall Street Journal Prime plus 1% to 2%, loan fees of 1% to 2% and a documentation fee of $500 to $1,000.

     Commercial real estate loans are generally underwritten at a maximum loan to appraised value of 75%; however, we will often advance up to 90% of the value when using the SBA 504 or 7a loan guarantee programs as part of the financing structure for owner-users. Income property loans generally require a debt service coverage ratio of 1.20:1 to 1.30:1 depending on the type of property. Loan terms can range from 3 to 15 years with pricing adjustments at 3 or 5 year intervals. We require a first lien position on the subject property and often take a junior lien on other real estate property as well. Pricing is generally in the range of Wall Street Journal Prime plus 1% to 2% with a negotiated floor rate, loan fees of 1% to 2% and a documentation fee of $500 to $1,000. We also offer short-term fixed rate loans when necessary.

     Commercial business loans and SBA 7a loans are offered to existing and start-up businesses for various purposes. Such loans are generally collateralized with assets of the business and junior liens on personal residences. Commercial business loans are underwritten on the basis of the borrower’s cash flow and ability to service the debt from earnings rather than on the basis of the underlying collateral value. We seek to structure these loans so that they have more than one source of repayment. The borrower is required to provide sufficient information to allow us to make an adequate credit evaluation. In most instances, this information consists of financial statements, tax returns, projected cash flows, current financial information on any guarantor and information about any collateral. Loans to closely held business borrowers typically require personal guarantees by the principals. Lines of credit and asset based loans are generally written for 12 months. SBA 7a loans can have terms of up to 25 years. Pricing is generally in the range of Wall Street Journal Prime plus 1% to 2.75% and a documentation fee of $500 to $1,000. Loan fees for non-SBA loans can range from 1% to 2%.

     Loan Maturities

     The following table sets forth the maturity distribution of our real estate-construction and commercial loans outstanding at December 31, 2004. In addition, the table shows the distribution of such loans between those loans with predetermined (fixed) interest rates and those with variable (floating) interest rates. Floating rate loans generally fluctuate with changes in the national prime rate or our Reference Rate. As of December 31, 2004, approximately 87% of our loan portfolio was comprised of floating interest rate loans. However, approximately 58% of the floating rate loans have interest rate floors. This offers rate protection in a downward rate environment as the loans continue to earn interest at the floor and not lower. As rates increase these loans will not reprice until rates exceed the floor, putting pressure on the interest rate margin in the short term. Non-performing loans are included in this schedule based on nominal maturities even though we may be unable to collect such loans at their maturity date.

Loans Repricing or Maturing as of December 31, 2004

40

     Non-Performing Assets

     Prior to classifying a loan as non-performing, we review each loan to determine the nature of the problem and the need to classify. Further, all non-performing loans are reviewed on a monthly basis to discern if there were changes to the value of the collateral or the ability of the borrower to repay. Interest on performing loans is accrued and taken into income daily. Loans over 90 days past due are deemed “non-performing” and are placed on a non-accrual status, unless the loan is well collateralized and in the process of collection. Interest received on non-accrual loans is credited to income only upon receipt and in certain circumstances may be applied to principal until the loan has been repaid in full, at which time the interest received is credited to income. Loans are restored to accrual status when the loans become both well-secured and are in the process of collection.

     When appropriate or necessary to protect our interests, real estate taken as collateral on a loan may be taken by us through foreclosure or a deed in lieu of foreclosure. Real property acquired in this manner is known as other real estate owned (“OREO”). OREO would be carried on our books as an asset, at the lesser of our recorded investment or the fair value less estimated costs to sell. OREO represents an additional category of “non-performing assets.” Since commencing operations we have not had any OREO.

     The following table provides information with respect to the components of our non-performing assets at the dates indicated. We have no loans past due 90 days or more still on accrual and we have no restructured loans.

Nonperforming Assets