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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10–Q

(Mark One)

For the quarterly period ended March 31, 2005

OR

For the transition period from                      to                     

Commission file number 0–30777

PACIFIC MERCANTILE BANCORP

(Exact name of Registrant as specified in its charter)

(714) 438–2500

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed, since last year)

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 x     No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x     No ¨

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

10,160,977 shares of Common Stock as of May 3, 2005

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PACIFIC MERCANTILE BANCORP

QUARTERLY REPORT ON FORM 10Q

FOR

THE QUARTER ENDED March 31, 2005

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PART I. – FINANCIAL INFORMATION

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)

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

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Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except for per share data)

(Unaudited)

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

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Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)

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

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Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(unaudited)

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

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Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

The consolidated financial statements include the accounts of Pacific Mercantile Bancorp (“PMBC”) and its wholly owned subsidiaries, which are Pacific Mercantile Bank (the “Bank”) and PMB Securities Corp. (which, together with PMBC, shall be referred to as the “Company” or as “we”, “us” or “our”). The Bank is chartered by the California Department of Financial Institutions (the “DFI”) and is a member of the Federal Reserve Bank of San Francisco (“FRB”). In addition, the deposit accounts of the Bank’s customers are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum amount allowed by law.

Substantially all of our operations are conducted and substantially all our assets are owned by the Bank, which accounts for substantially all of our consolidated revenues and expenses, and earnings. The Bank provides a full range of banking services to small and medium-size businesses, professionals and the general public in Orange, Los Angeles and San Diego Counties of California and is subject to competition from other financial institutions conducting operations in those same markets.

PMB Securities Corp. commenced operations in June 2002 as an SEC registered securities broker–dealer that is engaged in the retail securities brokerage business and is a member firm of the National Association of Securities Dealers.

During 2002, we organized three business trusts, under the names Pacific Mercantile Capital Trust I, PMB Capital Trust I, and PMB Statutory Trust III, respectively, to facilitate our issuance of $17 million principal amount of junior subordinated debentures, all with maturity dates in 2032. In October 2004, we organized PMB Capital Trust III to facilitate our issuance of $10 million principal amount of junior subordinated debentures, with a maturity date in 2034. In accordance with applicable accounting standards, the financial statements of these trusts are not included into the Company’s consolidated financial statements. See Note 2: “Significant Accounting Policies — Principles of Consolidation” below.

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10–Q and, therefore, do not include all footnotes that would be necessary for a fair presentation of financial position, results of operations, changes in cash flows and comprehensive income (loss) in accordance with generally accepted accounting principles in the United States (“GAAP”). However, these interim financial statements reflect all adjustments (consisting of normal recurring adjustments and accruals) which, in the opinion of our management, are necessary for a fair presentation of our results for the interim periods presented. These unaudited consolidated financial statements have been prepared in accordance with a basis consistent with prior periods, and should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2004 and the notes thereto included in our Annual Report on Form 10–K for the fiscal year ended December 31, 2004, as filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934.

However, our consolidated financial position at March 31, 2005, and the consolidated results of our operations for the three month period ended March 31, 2005, are not necessarily indicative of what our financial position will be as of the end of, or the results of operations that may be expected for any other interim period during or the full year ending December 31, 2005.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

Use of Estimates

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

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries Pacific Mercantile Bank and PMB Securities Corp. All significant intercompany accounts and transactions have been eliminated in consolidation. Our wholly owned trust subsidiaries, Pacific Mercantile Capital Trust I, PMB Capital Trust I, PMB Statutory Trust III, and PMB Capital Trust III (the “Trust Subsidiaries”), are not included in our consolidated financial statements, in accordance with Financial Interpretation Number (FIN) 46 issued by the Financial Accounting Standards Board (“FASB”).

Nonperforming Loans and Other Assets

At March 31, 2005, we had $11,000 in nonaccrual and impaired loans and had no restructured loans and no loans that were past due as to principal for 90 days or more that were still accruing interest.

Income Per Share

Basic income per share for any fiscal period is computed by dividing net income for such period by the weighted average number of common shares outstanding during that period. Fully diluted income per share reflects the potential dilution that could have occurred assuming all outstanding options or warrants to purchase our shares of common stock at exercise prices that were less than the market price of our shares were exercised into common stock, thereby increasing the number of shares outstanding during the period.

Stock-Based Employee Compensation Plans

The Company accounts for stock-based employee compensation as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure provisions of Statements of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock Based Compensation.” SFAS No. 123 requires pro-forma disclosures of the Company’s net income and net income per share as if the fair value based method of accounting for stock based awards had been applied. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the employee’s period of service with the Company. The Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment” in December 2004, which requires entities that grant stock options and shares to employees to recognize the fair value of those options and shares as compensation cost over the service (vesting) period in their financial statements. Public entities effective date for SFAS No. 123(R) is the first annual reporting period beginning after December 31, 2005. The Company will adopt SFAS No. 123(R) as of January 1, 2006, as required.

Effective March 2, 1999, our Board of Directors adopted, and in January 2000 our shareholders approved, the 1999 Stock Option Plan (the “1999 Option Plan”). That Plan authorizes the granting of options to directors, officers and other key employees that entitle them to purchase shares of common stock of the Company at a price per share equal to or above the fair market value of the Company’s shares on the date the option is granted. Options may vest immediately or over various periods of up to five years, determined by the Company’s Compensation Committee at the time it approves the grant of options under the 1999 Option Plan. Options may be granted for terms up to 10 years, or following termination of service, if sooner. A total of 1,248,230 shares were authorized for issuance under the 1999 Option Plan (which number has been adjusted for stock splits effectuated subsequent to the Plan’s adoption).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

Effective February 17, 2004, the Board of Directors adopted the Pacific Mercantile Bancorp 2004 Stock Incentive Plan (the “2004 Plan”), which was approved by the Company’s shareholders in May 2004. That Plan authorizes the granting of options and rights to purchase restricted stock to directors, officers and other key employees, that entitle them to purchase shares of common stock of the Company at a price per share equal to or above the fair market value of the Company’s shares on the date the option is granted or the stock purchase rights are awarded. Options and restricted stock purchase rights may vest immediately or over various periods of up to five years, determined by the Company’s Compensation Committee at the time the options are granted or the stock purchase rights are awarded. Options may be granted under the 2004 Plan for up to 10 years after the grant date, or following termination of service, if sooner. In the case of restricted stock purchase rights, they generally will expire, if not exercised, within 15 days of the date of the award. Any unvested shares, subject to restricted purchase rights, will become subject to repurchase by the Company in the event of a termination of employment or service of the holder of the stock purchase right. A total of 400,000 shares were authorized for issuance under the 2004 Plan.

The Company continues to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” under which no compensation cost for stock options is recognized in the accompanying financial statements for stock option or stock purchase awards granted at or above fair market value. Had compensation expense for the Company’s 1999 and 2004 Option Plans been determined based upon the fair value at the grant date for awards under those Plans in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and income per share would have been reduced to the pro forma amounts indicated below:

The fair values of the options that were outstanding under the 1999 and 2004 Plans as of March 31, 2005 and 2004 were estimated as of their respective dates of grant using the Black-Scholes option-pricing model. The following table summarizes the weighted average assumptions used for grants in the three month periods ended March 31:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of the equity section of the balance sheet net of income taxes, such items, along with net income, are components of comprehensive income.

Recent Accounting Pronouncements

In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123, (revised 2004), “Share-Based Payment”. SFAS No. 123R, which supersedes Accounting Principle Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, requires entities that grant stock options and shares to employees to recognize the fair value of those options and shares as compensation over the service (vesting) period in their financial statements; pro forma disclosure will no longer be permitted. The cost of the equity instruments is to be measured based on the fair value of the instruments on the date they are granted and is required to be recognized over the period during which the employees are required to provide services in exchange for the equity instruments. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. This statement becomes applicable for public entities on the first day of the first annual reporting period beginning after December 31, 2005, which in our case will be January 1, 2006.

The impact of adopting SFAS No. 123R cannot be accurately estimated at this time, as it will depend on the market value and the amount of share based awards granted in future periods.

Reclassification

Certain amounts in the accompanying 2004 consolidated financial statements have been reclassified to conform to 2005 presentation.

Commitments and Contingencies

To meet the financing needs of its customers in the normal course of business, the Company is party to financial instruments with off–balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. At March 31, 2005, the Company was committed to fund loans totaling approximately $163 million (inclusive of mortgage loans that, if funded, will be held for sale). The contractual amounts of credit-related financial instruments such as commitments to extend credit, credit-card arrangements, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.

The Company uses the same credit policies in making commitments to extend credit and conditional obligations as it does for on–balance sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case–by–case basis, using the same credit underwriting standards that are employed in making commercial loans. The amount of collateral obtained, if deemed necessary by the Company upon an extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, residential real estate and income–producing commercial properties.

In the ordinary course of business, we are subject to legal actions normally associated with financial institutions. At March 31, 2005, we were not a party to any pending legal action that is expected to be material to our consolidated financial condition or results of operations.

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OVERVIEW

Pacific Mercantile Bancorp is a bank holding company that owns all of the stock of Pacific Mercantile Bank (the “Bank”), which is a commercial bank that provides a full range of banking services to small and medium-size businesses and to professionals and the general public in Orange, Los Angeles and San Diego counties, in Southern California. Substantially all of our operations are conducted and substantially all of our assets are owned by the Bank, which accounts for substantially all of our consolidated revenues and operating costs.

The following discussion presents information about our consolidated results of operations for the three month periods ended March 31, 2005 and 2004 and our consolidated financial condition, liquidity and capital resources at March 31, 2005 and should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Report.

Forward–Looking Information

Statements contained in this Report that are not historical facts or that discuss our expectations or beliefs regarding our future operations or future financial performance, or financial or other trends in our business, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “project,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.” The information contained in such forward-looking statements is based on current information and assumptions about future events over which we do not have control and our business is subject to a number of risks and uncertainties that could cause our financial condition or actual operating results in the future to differ significantly from our expected financial condition or operating results that are set forth in those statements. Those risks and uncertainties are described in this Section of this Report, including in the subsection below entitled “Risks and Uncertainties That Could Affect Our Future Financial Performance” and readers of this Report are urged to read this Section in its entirety, including that subsection.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and general practices in the banking industry. The accounting policies we follow in determining the sufficiency of our allowance for loan losses and the fair value of derivative financial instruments involve judgments and assumptions which can have a material impact on the carrying value of our loans and those financial instruments, respectively, and, as a result, we consider these accounting policies to be critical accounting policies.

Allowance for Loan Losses. The accounting policies and practices we follow in determining the sufficiency of the allowance we establish for possible loan losses require us to make judgments and assumptions about economic and market trends that can affect the ability of our borrowers to meet their loan payment obligations. Accordingly, we use historical loss factors, adjusted for current economic market conditions and other economic indicators, to determine the losses inherent in our loan portfolio and the sufficiency of our allowance for loan losses. The actual loan losses could be greater than that predicted by those loss factors and our current assessments of current conditions and economic trends if unanticipated changes were to occur in those conditions. In such an event, it would be necessary for us to increase the allowance for loan losses by means of a charge to income referred to in our financial statements as the “provision for loan losses.” Such an increase would reduce the carrying value of our loans on our balance sheet, and the additional provision for loan losses taken to increase that allowance would reduce our income, in the period when it is determined that an increase in the allowance for loan losses is necessary. See the discussion in the subsections below entitled “—Provision for Loan Losses” and “—Allowance for Loan Losses and Nonperforming Loans” below.

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Derivative Financial Instruments. The derivative financial instruments that we enter into consist primarily of interest rate lock commitments that are designed to hedge mortgage loans held for sale. At March 31, 2005, approximately $25 million, or 83%, of mortgage loans held for sale were hedged. We estimate the fair value of mortgage loans held for sale based on period end market interest rates obtained from various mortgage investors. The fluctuations in the fair values of the mortgage loans held for sale are reflected in our consolidated statements of financial condition and, correspondingly, as adjustments to our noninterest income. We also enter into non-designated derivative instruments relating to mortgage loan interest rate lock commitments with borrowers and investors in order to reduce our exposure to adverse fluctuations in interest rates. At March 31, 2005 we had $2 million of mortgage loan commitments identified as non-designated derivative instruments. We did not have any significant ineffective hedges at March 31, 2005.

Overview of Operating Results in the Three Months ended March 31, 2005

The following table sets forth information regarding the interest income that we generated, the interest expense that we incurred, our net interest income, noninterest income, noninterest expense, and our net income and net income per share for the three months ended March 31, 2005 and 2004.

Key Factors Affecting Operating Results in the Three Months Ended March 31, 2005

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Set forth below are certain key financial performance ratios and other financial data for the periods indicated:

Results of Operations

Net Interest Income

One of the principal determinants of a bank’s income is its net interest income, which is the difference between (i) the interest that a bank earns on loans, investment securities and other interest earning assets, on the one hand, and (ii) its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest that it pays on borrowings and other interest-bearing liabilities, on the other hand. A bank’s interest income and interest expense are, in turn, affected by a number of factors, some of which are outside of its control, including national and local economic conditions and the FRB’s monetary policies, which affect interest rates, the demand for loans, and the ability of borrowers to meet their loan payment obligations.

The following table sets forth our interest income, interest expense, net interest income and net interest margin in the three month periods ended March 31, 2005 and March 31, 2004, respectively:

As the table above indicates, net interest income increased by $1.4 million, or 26.8%, in the first quarter of 2005 as compared to the first quarter of 2004. That increase was attributable to increases in interest income of $2.3 million, or 28.5%, which more than offset an increase in our interest expense of $871,000, or 31.6%, in the three month period ended March 31, 2005, as compared to the same period in 2004.

The increase in interest income in the quarter ended March 31, 2005, was primarily attributable to an increase in the volume of average interest earning assets, including a $169 million increase in the average volume of outstanding loans (exclusive of mortgages held for sale) over the corresponding quarter of 2004. That increase more than offset an $81 million reduction in average investment securities in the first quarter of 2005 as compared to the first quarter last year.

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The increase in interest expense in the quarter ended March 31, 2005, as compared to the same quarter last year, was primarily attributable to increases of $28 million and $46 million in the average volumes of interest bearing deposits and Federal Home Loan Bank borrowings, respectively, which were the primary sources of funding for our loan growth.

Our net interest margin improved to 3.26% in the first quarter of 2005 from 2.99% in the first quarter ended March 31, 2004. In the three months ended March 31, 2005 the yield on interest earning assets improved to 5.06%, while the average rate of interest paid on our interest bearing liabilities increased to 2.49%, as compared to a yield on interest earning assets of 4.58% and an average rate of interest paid on interest bearing liabilities of 2.18%, in the same three months of 2004.

This improvement in the average yield on interest earning assets was due primarily to the substantial increase in the volume of core loans on which we generate greater yields than on our other interest earning assets.

The following table sets forth changes in interest income, including loan fees, and interest paid in the three month period ended March 31, 2005, as compared to the same period in 2004 and the extent to which those changes were attributable to changes in the volume and of rates of interest earned on interest earning assets and in the volume of and rates of interest paid on interest-bearing liabilities.

Changes in interest earned and interest paid due to changes in the mix of interest earning assets and interest bearing liabilities have been allocated to the change due to volume and the change due to interest rates in proportion to the relationship of the absolute dollar amounts of the changes in each.

The above table indicates that the increase of $1.4 million in our net interest income in the three months ended March 31, 2005, as compared to the like period in 2004, was the result of a $960,000 increase in the volume variance and by a $429,000 increase in the rate variance for the three months ended March 31, 2005, as compared to the same period in 2004. The increase in the volume variance reflects the increases in average earning assets and in average interest-bearing liabilities of $119 million and $85 million, respectively, in the three month period ended March 31, 2005, as compared to the corresponding period of 2004.

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Provision for Loan Losses

Like virtually all banks and other financial institutions, we follow the practice of maintaining a reserve or allowance (the “Allowance”) for possible loan losses that occur from time to time as an incidental part of the banking business. When it is determined that the payment in full of a loan has become unlikely, the carrying value of the loan is reduced to what management believes is its realizable value. This reduction, which is referred to as a loan “charge-off,” or “write-down” is charged against that Allowance. The amount of the Allowance for Loan Losses is increased periodically (i) to replenish the Allowance after it has been reduced due to loan charge-offs, (ii) to reflect changes in the volume of outstanding loans, and (iii) to take account of changes in the risk of potential losses due to a deterioration in the condition of borrowers or in the value of property securing non–performing loans or changes in economic conditions. See “—Financial Condition—Allowance for Loan Losses and Nonperforming Loans” below in this Section of this Report. Increases in the Allowance for Loan Losses are made through a charge, recorded as an expense in the statement of income referred to as the “provision for loan losses.” Recoveries of loans previously charged-off are added back to the Allowance and, therefore, have the effect of increasing the Allowance for Loan Losses and reducing the amount of the provision that might otherwise be made to replenish or increase the Allowance.

Although we employ economic models that are based on bank regulatory guidelines, industry standards and historical loss experience to evaluate and determine the sufficiency of the Allowance for Loan Losses and, thereby, the amount of the provisions required to be made for potential loan losses, those determinations involve judgments about trends in current economic conditions and other events that can affect the ability of borrowers to meet their loan obligations. The duration and effects of current economic trends are subject to a number of uncertainties and changes that are outside of our ability to control. See the discussion below in this Section under the caption “Risks and Uncertainties That Could Affect our Future Financial Performance — we could incur losses on the loans we make.” In the event of unexpected subsequent events or changes in circumstances, it could become necessary in the future to incur additional charges to increase the Allowance, which would have the effect of reducing our income or could cause us to incur losses.

In addition, the Federal Reserve Board and the California Department of Financial Institutions, as an integral part of their examination processes, periodically review the Bank’s Allowance for Loan Losses. These agencies may require the Bank to make additional provisions, over and above that which we have already made, the effect of which would be to reduce our income.

Noninterest Income

Noninterest income consists primarily of mortgage banking income (which includes loan origination and processing fees, yield spread premium and service released premiums) and net gains on sales of loans held for sale, which are generated by our mortgage loan division. That division, which we established during fiscal 2001, originates conforming and non-conforming, agency quality, residential first and second lien and home equity mortgage loans.

The volume of residential mortgage refinancings is subject to significant fluctuations in response to changes in prevailing mortgage interest rates. Such interest rate changes can impact the volume of mortgage loan originations which, in turn, affects the loan processing fees and yield spread premiums we are able to realize on the mortgage loans we originate. For example, the decline in mortgage rates which began in 2002 and continued until June 2004, increased the demand for mortgage loan refinancings, which led to increases in our noninterest income during that period. Conversely, an increasing interest rate environment, or even the prospect of increasing interest rates, which has occurred since June 2004, generally causes a decline in mortgage loan refinancings and, therefore, corresponding declines in the volume of mortgage loan originations and in the income that the mortgage banking division is able to generate. We seek to manage the impact of changes in interest rates by seeking to originate mortgages for home purchases which are not as interest rate sensitive as mortgage loan refinancings. Mortgage loans for home purchases accounted for approximately 41% of our mortgage loan fundings in the quarter ended March 31, 2005, as compared to approximately 27% in the quarter ended March 31, 2004.

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The following table identifies the components of and the percentage changes in noninterest income in the three month period of 2005, as compared to the same period in 2004.

The decrease in noninterest income in the three months ended March 31, 2005, over the like period in 2004, was primarily attributable to a decline of $319,000 in net gains on securities (which consisted primarily of mortgage backed securities) available for sale.

Noninterest Expense

The following table sets forth the principal components of noninterest expense and the amounts thereof, incurred in the three month periods ended March 31, 2005 and 2004.

The increase of $771,000, or 17%, in noninterest expense in the three months ended March 31, 2005, as compared to the same three months of 2004, was primarily attributable to staff increases necessitated by increased loan demand and deposit activity at our existing Financial Centers, the opening, in September 2004, of our new Long Beach Financial Center, and costs associated with the transitioning of the mortgage banking division’s focus from mortgage refinancings to home purchase financings.

A measure of our ability to control noninterest expense in relation to the level of our net revenue (net interest income plus noninterest income) is our efficiency ratio, which is the ratio of noninterest expense to net revenue. As a general rule, all other things being equal, a lower efficiency ratio indicates an ability to generate increased revenue without a commensurate increase in the staffing and equipment and third party services and, therefore, would indicate greater efficiencies in our operations. However, a bank’s efficiency ratio can be adversely affected by factors such as the opening of new banking offices, the revenues of which usually lag behind the expenses that a bank must incur to staff and open the new offices.

        Notwithstanding the increase in the dollar amount of our noninterest expense in the first quarter this year, as compared to the first quarter last year, we were able to keep our efficiency ratio essentially unchanged, at 70.4% for the first quarter this year, as compared to 70.2% in the first quarter last year, largely because we were able to increase our net interest income by increasing the volume of loans we generated at our existing Financial Centers. That increase in net interest income more than offset the decline in noninterest income and largely offset the increases in noninterest expense that were attributable not only to increased lending and deposit activity at our existing Financial Centers, but also the costs associated with the opening of our new Long Beach Financial Center in September 2004.

Due largely to the opening of our new Ontario Financial Center, which is currently scheduled for late spring of 2005, we expect noninterest expense to increase during the balance of 2005, which could also cause our efficiency ratio to increase during that period.

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Asset/Liability Management

The primary objective of asset/liability management is to reduce our exposure to interest rate fluctuations, which can affect our net interest margins and, therefore, our net interest income and net earnings. We seek to achieve this objective by matching interest rate sensitive assets and liabilities, and maintaining the maturities and the repricing of these assets and liabilities at appropriate levels in response to the changes in the interest rate environment. Generally, if rate sensitive assets exceed rate sensitive liabilities, net interest income will be positively impacted during a rising interest rate environment and negatively impacted during a declining interest rate environment. When rate sensitive liabilities exceed rate sensitive assets, net interest income generally will be positively impacted during a declining interest rate environment and negatively impacted during a rising interest rate environment. However, because interest rates for different asset and liability products offered by depository institutions respond differently to changes in the interest rate environment, the relationship or “gap” between interest sensitive assets and interest sensitive liabilities is only a general indicator of interest rate sensitivity and how our net interest income might be affected by changing rates of interest.

For example, rates on certain assets or liabilities typically lag behind changes in market rates of interest. Additionally, prepayments of loans and securities available for sale, and early withdrawals of certificates of deposit, could cause the interest sensitivities to vary.

The table below sets forth information concerning our rate sensitive assets and liabilities at March 31, 2005. The assets and liabilities are classified by the earlier of maturity or repricing dates in accordance with their contractual terms. As is described above, certain shortcomings are inherent in the method of analysis presented in this table.

At March 31, 2005, our rate sensitive balance sheet was shown to be in a negative twelve-month gap position. This implies that our net interest margin would decrease in the short–term if interest rates rise and would increase in the

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short-term if interest rates were to fall. However, as noted above, the extent to which our net interest margin will be impacted by changes in prevailing interests rates will depend on a number of factors, including how quickly rate sensitive assets and liabilities react to interest rate changes, the mix of our interest earning assets (loans versus other lower yielding interest earning assets, such as securities) and the mix of our interest bearing deposits (between for example, lower interest core deposits and higher cost time certificates of deposit) and our other interest bearing liabilities.

Derivative Financial Instruments

We use derivative instruments to reduce our exposure to adverse fluctuations in interest rates in accordance with our risk management policy. Generally, if interest rates increase, the value of our mortgage loan commitments to borrowers and mortgage loans held for sale are adversely impacted. We attempt to economically hedge 100% of the risk of the overall change in the fair value of loan commitments to borrowers and mortgage loans held for sale by entering into rate lock commitments with investors in mortgage loans at the date loan commitments are made to the individual borrowers. These rate lock commitments are entered into at the same terms as those extended to borrowers to be delivered to the investors at a future date.

Mortgage loan commitments to borrowers and rate lock commitments with investors in mortgage loans are non-designated as derivative instruments and are included in mortgage loans held for sale in our balance sheets, and gains and losses resulting from these derivative instruments are included in gains on sales of loans in the Company’s consolidated statements of income.

Financial Condition

Assets

Our total consolidated assets increased by $48 million, or 6%, to $894 million at March 31, 2005 from $846 million at December 31, 2004, primarily as a result of increases in loan volume. That increase was funded by increases in borrowings and, to a lesser extent, increases in deposits.

The following table sets forth the composition of our interest earning assets at:

Loans Held for Sale

Loans held for sale in the secondary market, which consist primarily of mortgage loans, totaled $30 million at March 31, 2005, a decrease of $12 million from $42 million at December 31, 2004. Loans held for sale are carried at the lower of cost or estimated fair value in the aggregate except for those designated as fair value hedges, which are carried at fair value. There were $25 million of loans held for sale designated as fair value hedges at March 31, 2005, and there were no ineffective hedges. Net unrealized losses on loans held for sale, if any, are recognized through a valuation allowance by charges to income. As of March 31, 2005, we had a valuation allowance of approximately $35,000 representing net unrealized losses related to these loans held for sale and unfunded commitments to make such loans.

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Loans

The following table sets forth the composition, by loan category, of our loan portfolio, excluding mortgage loans held for sale, at March 31, 2005 and December 31, 2004: