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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

For the fiscal year ended December 31, 2002

For the transition period from              to             .

Commission File No. 000-26505

COMMUNITY BANCORP INC.

(Name of Issuer in its charter)

Issuer’s telephone number:    (760) 432-1100

Securities registered under Section 12(b) of the Act:    None

Securities registered under Section 12(g) of the Act:

Common Stock, $0.625 par value per share

(Title of class)

Check whether the Company (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or 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    x        No    ¨

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained in this form, and no disclosure will be contained, to the best of the Company’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.    ¨

Check whether or not the Company is an accelerated filer as defined in Exchange Rule Act 12b-2.

Yes    ¨        No    x

As of February 14, 2003, the aggregate market value of the common stock held by non-affiliates of the Company was: $29,996,000.

Number of shares of common stock of the Company outstanding as of February 14, 2003: 3,542,307 shares

Portions of the definitive proxy statement for the 2003 Annual Meeting of the Company’s shareholders are incorporated into Part III of this Report by reference.

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FORWARD-LOOKING INFORMATION

Certain statements contained in this Annual Report on Form 10 (“Report”), including, without limitation, statements containing the words “believes”, “anticipates”, “intends”, “expects”, and words of similar import, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in those areas in which the Company operates, demographic changes, competition, fluctuations in interest rates, changes in business strategy or development plans, changes in governmental regulation, credit quality, the availability of capital to fund the expansion of the Company’s business, economic, political and global changes arising from the terrorist attacks of September 11, 2001, the potential conflict with Iraq and their aftermath, and other factors referenced in this report, including in “Item 1. BUSINESS—Factors that May Affect Future Results of Operations.” When relying on forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

This discussion should be read in conjunction with the financial statements of the Company, including the notes thereto, appearing elsewhere in this report.

PART I

ITEM 1.    BUSINESS

WHERE YOU CAN FIND MORE INFORMATION

Under the Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current reports must be filed with the SEC. The Company electronically files the following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly Report), Form 11-K (Annual Report for Employees Stock Purchase and Savings Plans), Form 8-K (Report of Unscheduled Material Events), and Form DEF 14A (Proxy Statement). The Company may file additional forms. The SEC maintains an Internet site, www.sec.gov, in which all forms filed electronically may be accessed. Additionally, all forms filed with the SEC and additional shareholder information is available free of charge on the Company’s website: www.comnb.com. The Company posts these reports to its website as soon as reasonably practicable after filing them with the SEC. None of this information on or hyperlinked from the Company’s website is incorporated into this Annual Report on Form 10-K.

Community Bancorp Inc.

Community Bancorp Inc. (the “Company”) is a Delaware corporation organized to act as the bank holding company for Community National Bank, formerly Fallbrook National Bank, (the “Bank”) (unless the context requires otherwise, the term “Company” includes the “Bank”). Other than holding the shares of the Bank, the Company conducts no significant activities, although it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the Company’s principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. See “Item 1. Business Supervision and Regulation.” At December 31, 2002, the Company had approximately $415.7 million in consolidated assets, $339.5 million in consolidated net loans, $364.0 million in consolidated deposits, and $20.6 million in consolidated equity.

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The Company was formed through a holding company reorganization of the Bank, wherein the Bank became the wholly owned subsidiary of the Company as of June 25, 1999. The transaction was based on an exchange of shares in which shareholders of the Bank exchanged their shares of the Bank for shares of the common stock of the Company on a one share for one share basis. The transaction was not considered a taxable event for federal income tax purposes. At the same time, the Company was listed on the Nasdaq National Market under the symbol of CMBC, and the Bank’s stock was removed from public trading.

Community National Bank

The Bank was licensed by the Comptroller of the Currency (the “Comptroller”) on September 5, 1985 and commenced operation as a national banking association on the same day. As a national banking association, the Bank is subject to primary supervision, examination and regulation by the Comptroller. The Bank is also subject to certain other federal laws and regulations. In addition, the Bank is subject to applicable provisions of California law insofar as such provisions do not conflict with or are not preempted by federal banking laws. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the applicable limits thereof, and like all national banks, the Bank is a member of the Federal Reserve System. The Bank presently has no subsidiaries.

General Business Strategy

The Company’s strategy is to be a high performing bank holding company targeting small to medium sized businesses with sales up to $25 million annually. This strategy is being executed through a combination of Real Estate, Small Business Administration (“SBA”), Commercial, Construction and small Aircraft lending, combined with a retail banking network located in northern San Diego County and southwestern Riverside County. While most of the lending is concentrated in San Diego and Riverside Counties, the SBA division operates with nine loan production offices located throughout the state of California, and also originates loans in Nevada and Arizona through a network of brokers. In addition to California, the Company, through its contacts with brokers in other states, originates small Aircraft loans in Arizona, Nevada, New Mexico and Washington.

The Board has established three major goals for the Company: i) enhance profitability and core earnings, ii) maintain high credit quality, and iii) improve core deposit growth.

Enhance profitability and core earnings.    The Company has improved core earnings by focusing on net interest income, non-interest income and controlling expenses. This has resulted in record earnings for 2002 of $3.0 million, compared to $1.1 million in 2001 and $1.0 million in 2000. The efficiency ratio has declined (improved) to 70.25% for 2002, compared to 78.59% in 2001 and 81.32% in 2000. Return on Equity increased to 16.0% for 2002, compared to 7.8% in 2001 and 8.6% in 2000.

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Maintain high credit quality.    Oversight of the Company’s lending portfolio has been performed by individuals with extensive experience in commercial lending, and who have been with the Company for a significant period of time. The President, Thomas E. Swanson, was hired as Sr. Vice President, Chief Credit Officer of the Company in 1992. In 1996, Mr. Swanson was promoted to President and Chief Executive Officer. Mr. Swanson has in excess of 30 years experience as a commercial lending officer. Donald W. Murray, Executive Vice President, Chief Credit Officer was originally hired as the Vice President, SBA Department Manager in 1994, and was promoted to Sr. Vice President, Sr. Credit Officer in 1996, and was subsequently promoted to Executive Vice President, Chief Credit Officer in January 2001. Mr. Murray has 17 years experience

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in commercial and SBA lending. Gary M. Youmans was hired in 1991 as Sr. Vice President from another bank that specialized in SBA lending to develop the Company’s SBA lending operation. In 1996 Mr. Youmans was promoted to Executive Vice President. In addition, the Company’s other non-SBA commercial lending officers have an average tenure with the Company of 5 years, and have experience in excess of 15 years on average in commercial lending. The Company’s consistent lending quality and underwriting expertise is the result of experienced lenders and sound underwriting practices. Net charge offs to average loans outstanding has averaged 0.14% for the five years ending December 31, 2002. For the year ended December 31, 2002, the net charge offs to average loans outstanding was 0.16%. Non-accrual loans to total loans have averaged 0.76% of total loans for the five years ending December 31, 2002. With the exception of December 31, 2000, when the Company had an unusually low delinquency ratio of only 0.02%, the ratio of non-accrual loans to total loans of 0.65% at December 31, 2002 is the lowest in five years.

Improve core deposit growth.    In 2000, Michael Patterson, Sr. Vice President, Chief Administrative Officer, was hired to oversee the retail banking side of the Company. Mr. Patterson, with 19 years experience as a regional retail banking manager for major bank’s and thrifts, brought new focus to both core deposit and fee generation in the deposit side of the Banking division. In addition, Mr. Patterson expanded the branch operation by adding two new branches in 2001, with an additional branch planned for 2003. As a result, transaction accounts (checking, savings and money market accounts) increased 10% to $139.4 million as of December 31, 2002, compared to $126.2 million as of December 31, 2001, and were $101.2 million as of December 31, 2000. In addition, customer service charges increased to $614,000 for the year ended December 31, 2002 compared to $533,000 for the year ended December 31, 2001 and $394,000 for the year ended December 31, 2000.

With the continued expansion of the retail banking operations, wholesale deposits as a percentage of total deposits are expected to continue to decline in 2003. Wholesale deposits decreased from $81.7 million as of December 31, 2001 to $63.7 million as of December 31, 2002. Since the Company will no longer need to compete for the higher volume and higher cost Certificates of Deposits (“CD”) required to support the rapid growth of the Company, the Company has been able to price its CD products more in line with the average price of the competition. This has contributed to the improved interest margin. This repricing coupled with more attention on core deposit growth is intended to continue to improve the net interest margin through lowering the cost of funds.

Market Area and Competition

The Company’s primary market area is San Diego County consisting of the communities of Bonsall/Fallbrook, Escondido, Vista, and the Inland Empire in the community of Temecula. In 2000, the most recent census information available, the populations of Bonsall/Fallbrook, Escondido, Temecula and Vista were approximately, 43,000, 134,000, 67,000 and 86,000, respectively. During that same year, the average household incomes for Bonsall/Fallbrook, Escondido, Temecula and Vista were $38,000, $43,000, $62,000 and $44,000, respectively. The combined population growth rate for the San Diego County and the Inland Empire was approximately 18% and 12% per annum, respectively.

The banking and financial services business in California generally, and in the Company’s primary market area specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. As a result of this consolidation, there were 19 community banks located in the Company’s primary market area as of December 31, 2002.

The Company competes for loans, deposits and customers for financial services with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other non-bank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than the Company. In order to compete with the

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other financial services providers, the Company principally relies upon local promotional activities, personal relationships established by officers, directors and employees with its customers, and specialized services tailored to meet its customers’ needs.

The financial services industry is undergoing rapid technological changes involving frequent introductions of new technology-driven products and services which have further increased competition. There can also be no assurance that these technological improvements, if made, will increase the Company’s operational efficiency or that the Company will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

There were approximately $4.1 billion in deposits in the Company’s primary market areas as of June 30, 2002, the most recent data available. At that time, the Company maintained five full service banking offices in Bonsall, Escondido, Fallbrook, Temecula and Vista, California. As of June 30, 2002, the Escondido Office deposit market share of the Escondido market was approximately 5%, the Fallbrook/Bonsall Offices deposit market share of the Fallbrook/Bonsall market was approximately 27%, the Temecula Office deposit market share of the Temecula market was approximately 7%, and the Vista Office was approximately 5%.

The Company is a “Preferred Lender” and has authority throughout the states of California, Arizona, Nevada and Oregon to originate SBA loans. For the SBA’s fiscal year ended September 30, 2002, $3.2 billion of SBA guaranteed loans were originated in the State of California, of which $63.2 million were originated by the Company. The Company’s typical small business customer is a small to mid-sized business with annual sales between $1 million and $10 million. See “GENERAL BUSINESS STRATEGY—DIVISIONS OF THE COMPANY—SBA DIVISION.”

Divisions of the Company

In order to better present and monitor the performance of the Company, management has separated the Company into two distinct divisions, Banking (including Mortgage Banking) and SBA. The separation of income and expenses, as well as assets and liabilities allows management and investors to better understand the performance of the Company.

Each Division has somewhat different ways of measuring performance. For example, the SBA Division is focused on annual production of SBA loans, while the Banking Division is focused on building more long term relationships, servicing the entire banking relationship of the customer. The Company’s SBA Division also operates in territories throughout the state of California, as well as Nevada, Oregon and Arizona, making it difficult to service the entire banking relationship of the customer.

Banking Division

Performance in the Banking Division is measured in terms of profitability, asset growth, asset quality, deposit growth, market share and other standards. For the year ended December 31, 2000, the Banking Division had a pre-tax profit of $1.9 million, with net interest income of $9.7 million. Other operating income was $1.2 million, and other operating expenses were $8.1 million for the year ended December 31, 2000. Total assets of the Banking Division were $203.5 million as of December 31, 2000. For the year ended December 31, 2001, net interest income before provision for loan losses declined to $8.9 million as a result of the 4.75% decline in interest rates in 2001 and the corresponding margin compression. However, other operating income increased to $1.6 million for the year ended December 31, 2001, an increase of $401,000 over the year ended December 31, 2000. Due to the addition of two branches in 2001, operating expenses increased to $8.9 million for the year ended December 31, 2001. The decline in net interest income and the additional expense of the two new branches resulted in a decline in income before income taxes for the Banking Division to $488,000 for the year ended December 31, 2001. For the year ended December 31, 2002, the Banking Division had a pre-tax profit of $1.2 million, with net interest income of $12.6 million. Other operating income was $1.5 million, and other operating

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expenses were $11.9 million for the year ended December 31, 2002. The increase in income before income taxes of $744,000 in 2002 when compared with 2001 is due to the increase in the net interest income and decrease in provision for loan losses, partially offset by the increase in operating expenses. Net interest income increased due to higher volume of interest earning assets and lower cost of funds in 2002 when compared with 2001. Other operating expenses increased in 2002 as a result of the opening of the Corporate headquarters in March 2002, certain nonrecurring expenses incurred as a result of the relocation, and increased salaries and employee benefits as a result of increased performance based incentives and loan officer commissions, combined with additions to staff due to the expansion of the Company. Total assets of the Banking Division increased to $321.8 million as of December 31, 2002, compared to $270.2 million as of December 31, 2001. The Company added two branches during 2001, which, combined with normal expansion of the Company, resulted in the 19% increase in total assets of the Banking Division. The closure of the Mortgage Banking department in January 2003 is anticipated to have minimal impact on the Banking Division.

The rapidly falling interest rates in 2001 resulted in a rapid decline in the Company’s net interest margin. The Company’s assets adjust to changes in interest rates faster than its liabilities. With the constant declining interest rate environment experienced in 2001, the yield on interest earning assets declined rapidly, while the cost of liabilities decreased at a much slower pace. Certificates of Deposits have terms of 3 to 12 months, and therefore do not adjust as quickly as interest earning assets tied to the prime rate. In addition, 38% of the average deposits in 2001 were either non-interest bearing or had minimal interest paid (approximately 2.16% for interest bearing savings and checking accounts in 2001), and therefore resulted in minimal adjustments as interest rates have declined. As a result, the interest margin has declined from 5.20% in 2000 to 4.18% in 2001. The net interest margin improved in 2002 as a result of the increase in interest earning assets, combined with continued declines in the cost of deposits and an improvement in the net interest margin to 4.40%. The cost of interest bearing deposits declined 50 basis points to 4.35% in 2001 compared to 4.85% in 2000. The cost of interest bearing deposits declined 194 basis points to 2.41% in 2002 compared to 4.35% in 2001. Further declines in market rates would result in further margin shrinkage. However, a rising interest rate environment should have a positive impact on the net interest margin. See “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—INTEREST RATE SENSITIVITY.”

The following table shows the total assets and results of operations for the Banking Division as of and for the five years indicated.

SBA Division

The SBA Division performance is measured in terms of profitability, asset quality, asset size and loan production. The Company did not sell any SBA 7a loans in 2000 or the first half of 2001. Assets totaled $76.9 million for the SBA Division as of December 31, 2000. The Division had a loss of $206,000 before income taxes for the year ended December 31, 2000. Other operating income was $1.0 million for the year ended

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December 31, 2000. Interest income before provision for loan losses was $1.7 million for the year ended December 31, 2000, and operating expenses totaled $2.9 million. Due to the retention of the SBA 7a loans during the first half of 2001, total assets increased to $100.0 million as of December 31, 2001. As a result, net interest income increased to $3.8 million for the year ended December 31, 2001, exceeding operating expenses of $3.5 million for the same period. Operating expenses increased when compared to the year ended December 31, 2000 due to the increase in SBA loan originations. Other operating income increased to $1.4 million for the year ended December 31, 2001 due to the increase in loan sales. Due to the retention of SBA loans and the resultant increase in net interest income, the SBA Division had a pretax profit of $1.4 million for the year ended December 31, 2001. As of December 31, 2002, total assets decreased to $93.9 million. As a result, interest income decreased to $3.5 million for the year ended December 31, 2002, and operating expenses were $4.0 million for the same period. Operating expenses increased when compared to the year ended December 31, 2001 due to the increase in SBA loan originations. Other operating income increased to $5.0 million for the year ended December 31, 2002 due to the increase in SBA loan sales. Due to the increased SBA loan sales and the resultant increase in other operating income, the SBA Division had a pretax profit of $3.9 million for the year ended December 31, 2002.

The Company sold 75% of its SBA loans originated in 2002, compared to 52% of SBA loans originated in 2001. The Company anticipates that it will decrease the percentage of SBA loans sold of those originated in 2003 to approximately 60%, which should result in a slight decrease in other operating income and a slight increase in net interest income due to the higher retention rate of loans originated.

The loan origination process is somewhat different from that of the Bank Division due to the fact that there are limitations as to structure and types of loans in order to meet the SBA guidelines. Since full banking relationships are difficult to develop on SBA loans outside of the Company’s retail banking operating areas, the Company has utilized wholesale certificates of deposit as a funding source for the SBA Division. Retail certificates of deposit are utilized as well, and as the Banking Division continues to expand the ultimate goal will be to reduce the use of wholesale deposits as a funding source. This should have the added effect of expanding the Company’s margin as interest rates stabilize. The SBA Division has not been affected as dramatically as the Banking Division by the 4.75% decline in interest rates in 2001. This is due to i) SBA 7a loans adjust on the first of each quarter to changes in rates for the prior quarter, rather than immediately, and ii) the use of certificates of deposit as its funding source. Although the certificates have terms ranging from 3 to 12 months, the rates offered on new and rollover certificates declined significantly over the two years ended December 31, 2002. The market rates for wholesale certificates of deposit also tend to move immediately as market rates change, as opposed to retail certificates of deposit, which tend to lag in terms of market rate changes.

The following chart illustrates the earnings, asset and loan origination growth of the SBA Division for each of the five years ended December 31, 2002.

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Lending

The following is a discussion of the various lending functions of the Company, including those of both the Banking and the SBA Divisions.

Underwriting Process

The lending activities of the Company are guided by the basic lending policies established by the Board of Directors. Each loan must meet minimum underwriting criteria established in the Company’s lending policies and must fit within the Company’s strategies for yield and portfolio enhancement.

For all newly originated loans, upon receipt of a completed loan application from a prospective borrower, a credit report is ordered and, if necessary, additional financial information is requested. An independent appraisal is required on every property securing a Company loan in excess of $200,000. In addition, the loan officer conducts a review of these appraisals for accuracy, reasonableness and conformance to the Company’s lending policy on all applications. All revisions to the Company’s approved appraiser list must be approved by the President.

Credit approval authority is segregated into three distinct levels, namely the Directors’ Loan Committee, Officers’ Loan Committee and the individual lending limits of loan officers. The limits for the various levels are determined by the Board of Directors and/or the President and reviewed periodically. The Directors’ Loan Committee consists of the President, who is the Chairman, and at least three outside directors of the Company. The committee meets at least once a month or more frequently as needed. The Officers’ Loan Committee consists of the President, Executive Vice President, the Chief Credit Officer/Executive Vice President, the Senior Vice President—Credit Administration, Vice President/SBA Manager and the First Vice President, Corporate lending. The committee is chaired by the Chief Credit Officer and meets twice a week or more frequently as needed.

The Board has established loan authority guidelines, which in general state that all loans to borrowing relationships where the aggregate amount of secured credit is $500,000 or more, or the aggregate amount of unsecured credit is $250,000 or more must be submitted to the Officers’ Loan Committee for approval. The President and Chief Credit Officer, together, may approve secured credits in an aggregate amount not to exceed $2,000,000, and may approve unsecured credits in an aggregate amount not to exceed $1,750,000. The Officers’ Loan Committee has authority to approve loans up to $3.5 million. The Directors’ Loan Committee approves all loans over $3.5 million, and reviews all secured loans originated of $500,000 or more and all other loans of $100,000 or more, as well as classification of assets, delinquencies and the current status of the loan portfolio. See “Concentrations of Credit”

If the loan is approved, the loan commitment specifies the terms and conditions of the proposed loan including the amount, interest rate, amortization term, a brief description of the required collateral, and the required insurance coverage. Generally, the borrower must provide proof of fire, flood (if applicable) and casualty insurance on the property serving as collateral, which insurance must be maintained during the full term of the loan. Also, generally, title insurance endorsed to the Company is required on all first mortgage loans.

The Company maintains nine loan production offices located throughout the state of California. The loan production offices are typically staffed with a loan officer who prepares the loan applications and compiles the necessary information regarding the applicant. The completed loan file is then sent to the Company’s main office where the credit decision is made. The loan production offices not associated with the retail branches predominantly originate loans guaranteed by the SBA. The retail branches may include both SBA loan officers as well as non-SBA commercial loan officers.

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SBA Lending Programs

The SBA lending programs are designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loan. The Company is a “Preferred Lender” with the SBA. As a “Preferred Lender,” the Company can approve a loan within the authority given it by the SBA without prior approval from the SBA. “Preferred Lenders” approve, package, fund and service SBA loans within a range of authority that is not available to other SBA lenders without the “Preferred Lender” designation. The Company has been a “Preferred Lender” since 1992 and has this authority throughout the states of California, Arizona, Oregon and Nevada.

The Company’s SBA loans fall into two categories, loans originated under the SBA’s 7a Program (“7a Loans”) and loans originated under the SBA’s 504 Program (“504 Loans”). Historically, 7a Loans have represented approximately 80% of the SBA Loans originated by the Company while 504 Loans have represented the balance. During the year ended December 31, 2002, 504 Loans constituted approximately 28% of all SBA loans originated. Of all SBA loans originated, approximately 98% are collateralized by commercial real estate, while the balance are commercial business loans generally for the purpose of funding working capital, equipment purchases and accounts receivable. See “Commercial Real Estate Lending” and “General Business Lending.”

Under the SBA’s 7a Program, loans in excess of $150,000 are guaranteed 75% by the SBA. Generally, this guarantee may become invalid only if the loan does not meet the SBA documentation guidelines.

In general the Company’s policy permits SBA 7a Loans in amounts up to $1.33 million. Under certain circumstances when the borrowing needs exceed $1.33 million, the Company makes a SBA guaranteed second trust deed loan and a second financial institution makes a first trust deed loan. Loans collateralized by real estate have terms of up to 25 years, while loans collateralized by equipment and working capital have terms of up to 10 years and 7 years, respectively. The Company requires a 10% down payment on most 7a Loans, with a 15% to 20% down payment on loans collateralized by hotels, motels and service stations.

As part of its strategy to stabilize and enhance earnings, during 2000 and the first half of 2001 the Company retained the guaranteed portion of most of the SBA loans it originated. This assisted the SBA Division in developing interest income which would offset the Division’s operating expenses. The Company returned to selling SBA 7a loans in the latter half of 2001 in order to manage its balance sheet and capital levels. The Company sold 75% of the SBA loans originated in 2002, and anticipates selling up to 60% of SBA loans originated in 2003. While the reduction in sales will have a slightly negative impact on non-interest income, the growth in loans from the increased retention rate will result in a slightly increased net interest income. Funding for these loans has come from a mix of wholesale and retail deposit sources. Management’s goal is to match the interest rate sensitivity of these loans, which adjust on a quarterly basis, with deposits that also adjust or mature with approximately the same duration. The SBA loans generally have an interest rate of 1.5% to 2.75% over prime, while the wholesale 90 day CD rates are approximately 2.25% to 2.75% under prime.

The Company periodically sells the guaranteed and unguaranteed portions of SBA loans it originates. The Company retains the servicing on such loans. This strategy allows the Company to manage its capital levels and to ensure that funding is always available to meet the local community loan demand. Upon sale in the secondary market, the purchaser of the guaranteed portion of 7a Loans pays a premium to the Company which, generally, is between 6% and 10% of the guaranteed amount. The Company also receives a servicing fee equal to 1% to 2% of the amount sold in the secondary market. In the event that a 7a Loan goes into default within 270 days of its sale, or prepays within 90 days, the Company is required to repurchase the loan and refund the premium to the purchaser. In the past three years, the Company has repurchased 17 loans, however only 2 of these repurchased loans required refunds of premiums. No refunds were owed on the other 15 loans repurchased. A reserve has not been deemed necessary as the likelihood of a refund is considered remote.

Under the SBA’s 504 Program, the Company requires a 10% down payment. The Company then enters into a 50% first trust loan to the borrower and an interim 40% second trust loan. The first trust has a term of 20 years.

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The second trust is for a term of 120 days. Within the 120 day period of entering into the loan, the second trust deed loans are refinanced by SBA certified development companies and used as collateral for SBA guaranteed debentures. For 504 construction loans, the 120 day period does not commence until the notice of completion is filed. The first trust deed loans may be pre-sold by the Company with no recourse, prior to releasing the funds to the purchaser. The Company retains no servicing on 504 Loans after they are sold.

In addition to SBA lending, the Company makes a limited number of building and industrial loans (“B&I Loans”) guaranteed by the Farmers Home Administration (“FmHA”). The FmHA guarantee program for B&I Loans generally provides for an 80% guarantee of the loan amount with no maximum loan amount limitations. This program is generally available for businesses located in rural market areas. There were no B&I Loans or FmHA Loans originated in 2002.

The Company’s SBA lending program and portions of its real estate lending are dependent on the continual funding and programs of certain federal agencies or quasi-government corporations including the SBA, the Federal Home Loan Mortgage Corporation (the “FHLMC”), and the Federal National Mortgage Association (the “FNMA”). The guaranteed portion of an SBA loan does not count towards the Company’s loans-to-one-borrower limitation which, at December 31, 2002 was $5.4 million.

SBA lending is a federal government created and administered program. As such, legislative and regulatory developments can affect the availability and funding of the program. This dependence on legislative funding and regulatory restrictions from time to time causes limitations and uncertainties with regard to the continued funding of such loans, with a resulting potential adverse financial impact on the Company’s business. For example, during late 2002 and early 2003 the maximum limit of individual 7a loans which the SBA would permit was substantially reduced to $500,000. This reduction in loan amount, which was in place for only a few months and which has now been removed, could have, had it remained in place for a longer period of time, had a negative impact on the Company’s business. Since the SBA Division of the Company constitutes a significant portion of the Company’s lending business, this dependence on this government program and its periodic uncertainty with availability and amounts of funding creates greater risk for the Company’s business than does other parts of its business.

Total Loan Portfolio Composition

The following table sets forth information concerning the composition of the Company’s loan portfolio at the dates indicated:

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Loan Maturity

The following table sets forth the contractual maturities of the Company’s gross loans at December 31, 2002.

The following table sets forth, as of December 31, 2002, the dollar amounts of gross loans outstanding that are contractually due after December 31, 2003 and whether such loans have fixed or adjustable rates.

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Loan Origination and Sale

The following table sets forth the Company’s loan originations by category and purchases, sales and principal repayments of loans for the periods indicated:

Commercial Real Estate Lending

The Company focuses on originating loans secured by commercial real estate, such as retail centers, small office and light industrial buildings and other mixed use commercial properties. The Company will make loans secured by special purpose properties such as motels, and, from time-to-time, restaurants. Pursuant to the Company’s underwriting policies, commercial real estate loans, which are not SBA loans, may be made in amounts up to the lesser of 75% of the appraised value of the property or the sales price. These loans may be made with terms up to 10 years and are either adjustable rate loans or fixed with a maximum term of 5 years. The Company generally requires a minimum debt service ratio (the ratio of net earnings on a property to debt service) of 1.25 to 1 or more. In addition to commercial real estate lending, and to a much lesser extent, the Company originates loans secured by multi-family residential properties.

Loans secured by commercial real estate and multi-family residential properties are generally larger and involve a greater degree of risk than one- to four-family residential loans. The liquidation value of commercial and multi-family properties may be adversely affected by risks generally incident to interests in real property, including changes or continued weakness in general or local economic conditions and/or specific industry segments; declines in real estate values; declines in rental room or occupancy rates; increases in interest rates, real estate and personal property tax rates and other operating expenses (including energy costs); the availability of refinancing; changes in governmental rules, regulations and fiscal policies, including rent control ordinances, environmental legislation, taxation and other factors beyond the control of the borrower or the lender. Because of

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this, the Company considers the borrower’s experience in owning and managing similar properties and the Company’s lending experience with the borrower.

General business lending

The Company offers commercial business loans to businesses operating in the Company’s primary market area. The Company’s commercial business loans consist of lines of credit which require annual renewals, adjustable-rate loans with terms of five to seven years, and short term fixed-rate loans with terms of up to three years. Such loans are made up to $5.4 million, the Company’s loans-to-one-borrower limit at December 31, 2002. The Company will also enter into commercial loans in excess of $5.4 million but will participate out that portion in excess of its legal lending limit.

Aircraft lending

The Company’s commercial loan portfolio also includes loans secured by new and used aircraft. These loans range in size from $25,000 to $1,586,000, have 15 or 20 year terms and are offered at variable or fixed interest rates. The market for loans secured by used aircraft is dominated by a few larger financial institutions. Typically these loans have maturities of 15 to 20 years but are refinanced approximately every three to four years. Lenders rely on relationships with aircraft dealers to compete for aircraft loans. In April 1998, the Company hired a loan officer with 16 years experience in aircraft lending and relationships with several aircraft dealers.

Aircraft loan customers are generally professionals and other high net worth individuals. The primary consideration on a loan application for an aircraft loan is the credit worthiness of the borrower and ability to repay the loan amount. The Company’s loan officers consider the costs of tie down space or hanger rental, maintenance requirements and insurance coverage in assessing the cash flow analysis of the borrower as such expenses can be substantial. In addition to the credit worthiness of the borrower, the Company will review the wholesale value of the aircraft. For loans over $200,000, an appraisal is performed on the aircraft which provides both a wholesale value and a retail value of the aircraft. Generally speaking, the wholesale value approximates 70% of the retail value. The Company generally will finance up to the lesser of 85% of the purchase price or 100% of the wholesale value of the aircraft. As the purchase price of the aircraft increases, the down payment required increases. A title search is conducted on all aircraft loans. In addition, appropriate ground and air coverage insurance and title insurance must be obtained by the borrower. The term of the loans are generally no more than 20 years. At December 31, 2002, the Company had $29.5 million of aircraft loans in its commercial loan portfolio with an average size of $130,000. Aircraft loans are based on the ability of the borrower to repay the loan, and not necessarily on the cash flows generated from the use of the aircraft. Impairment is measured at the time of repossession based on an appraisal performed within 60 days of repossession, and any impairment is then charged to the allowance for loan losses. Subsequent to repossession, the Company periodically will re-evaluate the change in market value of the repossessed aircraft, with any losses being charged against the income of the Company.

Construction Lending

The Company originates construction loans on both one- to four-family residences and on commercial real estate properties. The Company originates two types of residential construction loans, consumer and builder. The Company originates consumer construction loans to build single family residences. The Company will originate builder construction loans to companies engaged in the business of constructing homes for resale. These loans may be for homes currently under contract for sale or homes built for speculative purposes to be marketed for sale during construction. For owner occupied single family residences, the borrower and the property must qualify for permanent financing. Prequalification for owner occupied single family residences is required. For commercial property, the borrower must qualify for permanent financing and the debt service coverage must be 1.25 to 1 or more. Qualification for commercial properties can be determined by the loan officer as part of the

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credit presentation. Absent such prequalification, a construction loan will not be approved by the Company. The Company originates land acquisition and development loans with the source of repayment being either the sale of finished lots or the sale of homes to be constructed on the finished lots. Construction loans are generally offered with terms up to twelve months.

Construction loans are generally made in amounts up to 75% of the value of the security property for “spec” single family residences and commercial properties and up to 80% for owner-occupied single family residences. During construction, loan proceeds are disbursed in draws as construction progresses based upon inspections of work in place by independent construction inspectors. At December 31, 2002, the Company had construction loans, including land acquisition and development loans totaling $67.4 million or 20% of the Company’s total loan portfolio.

Construction loans are generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property’s value upon completion of construction as compared to the estimated costs of construction, including interest. Also, the Company assumes certain risks associated with the borrower’s ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or accurately, the Company may be confronted with a project which, when completed, has a value which is insufficient to assure full repayment.

Consumer Lending

The Company’s portfolio of consumer loans primarily consists of adjustable-rate home equity lines of credit and installment loans secured by new or used automobiles and loans secured by deposit accounts. Unsecured consumer loans are made with a maximum term of three years and a maximum loan amount of $5,000. At December 31, 2002, consumer loans totaled $7.3 million.

As of December 31, 2002, home equity loans totaled $3.4 million, or 0.98% of the Company’s gross loan portfolio. The Company’s home equity loans are adjustable-rate and reprice with changes in the Wall Street Journal prime rate. Adjustable-rate home equity lines of credit are offered in amounts up to 75% of the appraised value. Home equity lines of credit are offered with terms up to ten years.

One- to Four-Family Residential Lending

Up until January 31, 2003, the Company offered adjustable-rate mortgage (“ARM”) loans secured by one- to four-family residences, substantially all of which are owner-occupied, with loan maturities of up to 30 years. The Company’s policy was to originate one- to four-family residential loans in amounts generally up to 80% of the lower of the appraised value or the selling price of the property securing the loan, although this percentage is generally lower and varies depending upon an internal credit rating of the proposed loan and borrower, which is based upon a credit scoring matrix.

The majority of the one- to four-family loans originated by the Company were originated to FNMA or FHLMC standards except in the case of certain loans, as to size. Such loans are entered into only when the Company has a firm commitment from a purchaser to acquire the loans prior to settlement. The loans are recorded on the Company’s books for a limited period of two to three days. The Company generally sells these loans into the secondary market without recourse, servicing released. Many of these mortgage loans are the result of earlier interim construction financing by the Company. The Company also originates a limited number of one-to four-family loans in its immediate market area which it retains in its portfolio.

The Company’s one- to four-family residential loan portfolio at December 31, 2002, was $16.9 million. As of December 31, 2002, the average loan size for one- to four-family residential loans was $286,000, the average maturity was 13 years, the average interest rate was 6.15%, and the average loan-to-value ratio was 57.9%. The

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Company discontinued its mortgage banking operation as of January 31, 2003, and therefore the one- to four-family residential loan portfolio will decline from the December 31, 2002 level as the remaining loans are sold or paid in full.

Loan Servicing

Loans are serviced by the Company’s Note department except for loans secured by single family residences. The loan officer is responsible for the day to day relationship with the customer, unless the loan becomes delinquent, at which time the responsibilities are reassigned to credit administration. The Company outsources loan servicing on loans secured by first trust deeds on single family residences. Loan servicing is centralized at the Company’s corporate headquarters. As of December 31, 2002, the Company was servicing $117.2 million of loans originated by the Company but subsequently sold to other investors.

The Company’s loan servicing operations performed by the Note department are intended to provide prompt customer service and accurate and timely information for account follow-up, financial reporting and management review. Following the funding of an approved loan, all pertinent loan data is entered into the Company’s data processing system, which provides monthly billing statements, tracks payment performance, and effects agreed upon interest rate adjustments on loans. Regular loan service efforts include payment processing and collection notices, as well as tracking the performance of additional borrower obligations with respect to the maintenance of casualty insurance coverage, payment of property taxes and senior liens. When payments are not received by their contractual due date, collection efforts begin on the tenth day of delinquency with a telephone contact. If the borrower is non-responsive or the loan officer feels more stringent action may be required, the Chief Credit Officer is consulted. Notices of default are generally filed when the loan has become 30-90 days past due.

Credit Risk and Loan Review

Credit risk represents the possibility that a customer or counter-party may not perform in accordance with contractual terms. The Company incurs credit risk whenever it extends credit to, or enters into other transactions with, its customers. The risks associated with extensions of credit include general risk, which is inherent in the lending business, and risk specific to individual borrowers. Loan review and other loan monitoring practices provide a means for the Company’s management to ascertain whether proper credit, underwriting and loan documentation policies, procedures and practices are being followed by the Company’s loan officers and are being applied uniformly throughout the Company. Implementation and daily administration of loan review rests with the Chief Credit Officer and the President who approve loan officer requests for changes in risk ratings. Loan officers are responsible for continually grading their loans so that individual credits properly reflect the risk inherent therein. On an annual basis, the Board of Directors provides for a third-party outside loan review of all loans that meet certain criteria originated since the previous review. While the Company continues to review these and other related functional areas, there can be no assurance that the steps the Company has taken to date will be sufficient to enable it to identify, measure, monitor and control all credit risk.

Concentrations of Credit

The Company’s primary investment is in loans, 84.6% of which are secured by real estate. Therefore, although the Company monitors the real estate loan portfolio on a regular basis to avoid undue concentrations to a single borrower or type of real estate collateral, real estate in general is considered a concentration of investment. The Company seeks to mitigate this risk by requiring each borrower to have a certain amount of equity in the real estate at the time of origination, depending on the type of real estate and the credit quality of the borrower. Trends in the market are monitored closely by management on a regular basis.

Under federal law, the Company’s ability to make aggregate loans-to-one-borrower is limited to 15% of unimpaired capital and surplus (as of December 31, 2002, this amount was $5.4 million) plus an additional 10% of unimpaired capital and surplus if a loan is secured by readily-marketable collateral (defined to include only certain financial instruments and gold bullion).

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Investment Activities

The investment policy of the Company, as established by the Board of Directors, attempts to provide for and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement the Company’s lending activities. Specifically, the Company’s policies generally limit investments to government and federal agency-backed securities and other non-government guaranteed securities, including corporate debt obligations, that are investment grade. The Company’s policies provide the authority to invest in mortgage-backed securities guaranteed by the U.S. government and agencies thereof. The Company’s policies provide that all investment purchases which individually exceed $2 million, or that are outside the policy guidelines, be approved by the Board of Directors or committee thereof. Purchases and sales under this limitation and within the guidelines of the policies may be done at the discretion of the President, the Chief Financial Officer or the Controller. At December 31, 2002, the Company had $21.3 million in U.S. Treasury and agency securities, federal funds sold of $9.7 million, trading securities of $16.1 million and had interest bearing deposits in financial institutions totaling $99,000.

The Company has invested in a limited partnership that was formed to develop and operate six properties with a total of 352 affordable housing units for lower income tenants throughout the state of California. The Company’s ownership in the limited partnership is 6.4%. The cost of the investment is being amortized on a level-yield method over the life of the related tax credits. The partnership must meet the regulatory requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnership ceases to qualify during the compliance period, the credits may be denied for any period in which the projects are not in compliance and a portion of the credits previously taken is subject to recapture with interest.

The remaining federal tax credits to be utilized over a multiple-year period are $1.1 million as of December 31, 2002. The Company’s usage of tax credits approximated $5,000 during 2002. Investment amortization amounted to $11,000 for the year ended December 31, 2002.

The Company has an obligation to purchase $462,000 of additional interests in such investments, which is expected to be made in 2003. The balance of the investment as of December 31, 2002 was $527,000, net.

The following table sets forth the carrying values and estimated fair values of the Company’s held to maturity investment portfolio at the dates indicated.

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The contractual maturities of securities held to maturity at December 31, 2002 were as follows:

Sources of Funds

General

Deposits, loan repayments and prepayments, proceeds from the sales of loans, cash flows generated from operations and Federal Reserve borrowings are the primary sources of the Company’s funds for use in lending, investing and for other general purposes.

Deposits

The Company offers a variety of deposit accounts with a range of interest rates and terms. The Company’s deposits consist of checking accounts, money market accounts, passbook accounts and certificates of deposit. As of December 31, 2002, core deposits constituted 62.4% of total deposits. As of December 31, 2002, the average deposit account was $20,000. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Company’s deposits are attracted primarily from individuals and small and medium-sized businesses.

The Company relies primarily on customer service, aggressive marketing and cross-selling to customers and prospects to attract and retain deposits. However, market interest rates and products, and rates offered by competing financial institutions significantly affect the Company’s ability to grow and retain deposits.

In order to develop interest income for the SBA Division, during 2000 and the first half of 2001 the Company began retaining the guaranteed portion of SBA loans until it met certain concentrations of SBA loans (See “BUSINESS—SBA DIVISION” and —“SBA LENDING PROGRAMS”). In order to fund these retained assets, the Company began a program of originating wholesale deposits. While the Company intends to continue funding these loans using wholesale sources of funds, it is management’s intent to expand its retail deposit base through the development of its existing five branch network, and will consider the acquisition of branches of other institutions and/or through the addition of de novo branches as opportunities present themselves, which is expected to reduce the reliance on wholesale deposits as a funding source. There is one additional branch planned for 2003.

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The following table sets forth the distribution of the Company’s average deposit accounts for the periods indicated and the weighted average interest rates for each category of deposits presented: