<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
--------- -------
COMMISSION FILE NO. 0-25020
-------
HERITAGE OAKS BANCORP
- ------------------------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
STATE OF CALIFORNIA
- ------------------------------------------------------------------------------
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)
77-0388249
- ------------------------------------------------------------------------------
(I.R.S. EMPLOYER IDENTIFICATION CODE)
545 12TH STREET, PASO ROBLES, CA 93446
- ------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL OFFICE)
(805) 239-5200
- ------------------------------------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 TWELVE (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 NINETY (90) DAYS.
YES X NO
----- -----
AGGREGATE MARKET VALUE OF COMMON STOCK OF HERITAGE OAKS BANCORP AT
JULY 9, 1999: $18,134,188.
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
NO PAR VALUE COMMON STOCK - 1,115,950 SHARES OUTSTANDING AT JULY 9, 1999.
1
<PAGE>
HERITAGE OAKS BANCORP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
06/30/99 12/31/98
ASSETS (UNAUDITED) (1)
----------- -----------
<S> <C> <C>
Cash and due from banks $16,997,472 $17,239,179
Federal funds sold 2,500,000 7,700,000
----------- -----------
Total cash and cash equivalents 19,497,472 24,939,179
Interest bearing deposits other banks 670,124 666,975
Securities Available for sale 7,594,929 12,863,106
Securities held to maturity (see note 2) 13,265,772 15,758,151
Loans Held For Sale 328,389 1,654,765
Loans, net (see note 3) 84,454,494 69,803,041
Property, premises and equipment, net 3,122,263 2,447,385
Other real estate owned 0 0
Cash surrender value life insurance 1,273,984 1,020,576
Other assets 2,054,075 2,015,320
------------ ------------
TOTAL ASSETS $132,261,502 $131,168,498
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand, non-interest bearing $39,886,715 $38,672,576
Savings, NOW, and money market deposits 54,291,228 51,604,881
Time deposits of $100,000 or more 4,298,339 4,673,298
Time deposits under $100,000 22,294,511 24,456,951
------------ ------------
Total deposits 120,770,793 119,407,706
Other borrowed money 350,000 750,000
Other liabilities 1,292,815 1,574,122
------------ ------------
Total liabilities 122,413,608 121,731,828
Stockholders' equity
Common stock, no par value;
20,000,000 shares authorized; issued and outstanding
1,115,950 and 1,112,390 for June 30, 1999,
and December 31, 1998, respectively. 4,506,694 4,470,170
Accumulated other comprehensive income (331,510) (188,166)
Retained earnings 5,672,710 5,154,666
------------ ------------
Total stockholders' equity 9,847,894 9,436,670
------------ ------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $132,261,502 $131,168,498
============ ============
</TABLE>
(1) These numbers have been derived from the audited financial statements. See
notes to condensed financial statements
2
<PAGE>
HERITAGE OAKS BANCORP
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED JUNE 30,
<TABLE>
<CAPTION>
1999 1998
(UNAUDITED) (UNAUDITED)
----------- -----------
<S> <C> <C>
Interest Income:
Interest and fees on loans $1,966,207 $1,554,310
Investment securities 341,944 283,531
Federal funds sold and commercial paper 55,016 42,173
Time certificates of deposit 7,120 3,407
--------- ---------
Total interest income 2,370,287 1,883,421
Interest Expense:
Now accounts 165,764 203,460
MMDA accounts 53,972 25,365
Savings accounts 65,760 65,896
Time deposits of $100,000 or more 52,550 65,628
Other time deposits 239,910 240,237
Other borrowed funds 26,050 27,744
--------- ---------
Total interest expense 604,006 628,330
Net Interest Income Before Prov. for Possible Loan Losses 1,766,281 1,255,091
Provision for loan losses 39,500 25,000
--------- ---------
Net interest income after provision for loan losses 1,726,781 1,230,091
Non-interest Income:
Service charges on deposit accounts 181,143 181,729
Investment securities gains (losses), net 0 10,429
Other income 1,258,876 1,451,640
--------- ---------
Total Non-interest Income 1,440,019 1,643,798
Non-interest Expense:
Salaries and employee benefits 884,259 719,019
Occupancy and equipment 404,845 259,959
Other expenses 1,408,239 1,381,777
--------- ---------
Total Noninterest Expenses 2,697,343 2,360,755
Income before provision for income taxes 469,457 513,134
Provision for applicable income taxes 137,839 180,176
--------- ---------
Net Income $ 331,618 $ 332,958
========= =========
Earnings per share: (See note #4)
Basic $0.30 $0.32
Fully Diluted $0.27 $0.30
</TABLE>
See notes to condensed financial statements
3
<PAGE>
HERITAGE OAKS BANCORP
CONSOLIDATED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30,
<TABLE>
<CAPTION>
1999 1998
(UNAUDITED) (UNAUDITED)
----------- -----------
<S> <C> <C>
Interest Income:
Interest and fees on loans $3,734,411 $3,014,814
Investment securities 699,017 565,324
Federal funds sold and commercial paper 128,389 60,407
Time certificates of deposit 13,729 10,021
---------- ----------
Total interest income 4,575,546 3,650,566
Interest Expense:
Now accounts 320,493 373,815
MMDA accounts 97,710 78,921
Savings accounts 128,244 130,084
Time deposits of $100,000 or more 98,669 89,730
Other time deposits 522,101 451,603
Other borrowed funds 46,352 51,048
---------- ----------
Total interest expense 1,213,569 1,175,201
Net Interest Income Before Prov. for Possible Loan Losses 3,361,977 2,475,365
Provision for loan losses 81,500 46,000
---------- ----------
Net interest income after provision for loan losses 3,280,477 2,429,365
Non-interest Income:
Service charges on deposit accounts 354,591 328,633
Investment securities gains (losses), net 0 8,588
Other income 2,286,316 2,887,944
---------- ----------
Total Non-interest Income 2,640,907 3,225,165
Non-interest Expense:
Salaries and employee benefits 1,754,977 1,402,702
Occupancy and equipment 747,255 530,027
Other expenses 2,637,811 2,689,209
---------- ----------
Total Noninterest Expenses 5,140,043 4,621,938
Income before provision for income taxes 781,341 1,032,592
Provision for applicable income taxes 260,415 371,226
---------- ----------
Net Income $ 520,926 $ 661,366
========== ==========
Earnings per share: (See note #4)
Basic $0.47 $0.63
Fully Diluted $0.42 $0.60
</TABLE>
See notes to condensed financial statements
4
<PAGE>
HERITAGE OAKS BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED JUNE 30, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
(UNAUDITED) (UNAUDITED)
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
(dollars in thousands)
Net Income $520,926 $661,366
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 298,528 196,596
Provision for possible loan loss 81,500 46,000
Increase (decrease) in deferred loan fees (48,024) 136,870
Net loss on sales of investment securities - (8,588)
Amortization of premiums (Discount accretion)
on investment securities, net (166,920) (53,893)
Loss on sale of other real estate owned - -
Gain on sale of property, premises, and equipment - (8,093)
Decrease (increase) in other assets (38,755) (37,113)
Increase (decrease) in other liabilities (291,207) (190,315)
Net cash used in operating activities 356,048 742,830
Cash flows from investing activities:
Purchase of investment securities (16,472,098) (9,414,447)
Proceeds from sales, price reductions and maturities
from investment securities 24,229,505 8,265,688
Increase in time deposits with other banks - 343,443
Net additions to real estate acquired in settlement of loans - -
Purchase of insurance policies (253,408) (24,458)
Increase in loans, net (13,325,077) (9,022,969)
Purchase of property, premises and equipment, net (973,406) (178,758)
Net cash used in investing activities (6,794,484) (10,031,501)
Cash flows from financing activities:
Increase (decrease) in deposits, net 1,363,087 12,771,510
Net (decrease) increase in other borrowings (400,000) -
Proceeds from exercise of stock options 36,524 18,644
Cash paid in lieu of fractional shares (2,882) (519,717)
Net cash provided by (used in) financing activities 996,729 12,270,437
Net increase (decrease) in cash and cash equivalents (5,441,707) 2,981,766
Cash and cash equivalents at beginning of year 24,939,179 12,991,388
Cash and cash equivalents at end of period $19,497,472 $15,973,154
</TABLE>
See notes to condensed financial statements
5
<PAGE>
HERITAGE OAKS BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
JUNE 30, 1999 AND JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
SHARES COMMON RETAINED COMPREHENSIVE STOCKHOLDERS'
OUTSTANDING STOCK EARNINGS INCOME EQUITY
----------- ---------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
Balance January 1, 1999 1,069,791 $4,470,170 5,154,666 (188,166) 9,436,670
Exercise of Stock Options 3,500 36,524 0 36,524
Cash dividends paid 0 0 0 0
Stock dividend- 4% 42,659 0
Cash paid to Shareholders' in Lieu of
fractional shares on 4% Stock Dividend (2,882) (2,882)
Comprehensive Income
Net Income 520,926 520,926
Unrealized Security Holding Gains
(net of $38,021 tax) (54,121) (54,121)
Less Reclassification Adjustment for
Losses (net of $59,510 tax) (89,223) (89,223)
-------- --------
Total Other Comprehensive Income
Total comprehensive Income 377,582
BALANCE JUNE 30, 1999 1,115,950 $4,506,694 $5,672,710 (331,510) 9,847,894
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
SHARES COMMON RETAINED COMPREHENSIVE STOCKHOLDERS'
OUTSTANDING STOCK EARNINGS INCOME EQUITY
----------- ---------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
JANUARY 1, 1998 1,036,626 $4,180,486 $4,327,921 ($381,329) $8,127,078
Exercise of Stock Options 4,868 18,644 0 $18,644
Cash dividends paid - $.50 per share 0 0 (519,716) ($519,716)
Comprehensive Income
Net Income 661,366 $661,366
Unrealized Security Holding Gains 49,551
49,551
Total Other Comprehensive Income
Total comprehensive Income $710,917
BALANCE JUNE 30, 1998 1,041,494 $4,199,130 $4,469,571 ($331,778) $8,336,923
</TABLE>
6
<PAGE>
NOTES TO CONSOLIDATED CONDENSED FINANACIAL STATEMENTS
Note 1: CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of Management, the unaudited consolidated condensed financial
statements contain all (consisting of only normal recurring adjustments)
adjustments necessary to present fairly the Company's consolidated financial
position at June 30, 1999 and December 31, 1998 and the results of cash flows
for the six months ended June 30, 1999 and 1998 and the results of operations
for the three and six months ended June 30, 1999 and 1998.
Certain information and footnote disclosures normally presented in financial
statements prepared in accordance with generally accepted accounting
principles have been omitted. These interim consolidated condensed financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's 1998 Annual Report to
shareholders. The results for the three and six months ended June 30, 1999
and 1998 may not necessarily be indicative of the operating results for the
full year.
Note 2: INVESTMENT SECURITIES
The Company adopted SFAS No. 115 "Accounting for Certain Investments in Debt
and Equity Securities" on January 1, 1994, which addresses the accounting for
investments in equity securities that have readily determinable fair values
and for investments in all debt securities. Securities are classified in
three categories and accounted for as follows: debit and equity securities
that the company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and are measured at amortized cost; debt and
equity securities bought and held principally for the purpose of selling in
the near term are classified as trading securities and are measured at fair
value, with unrealized gains and losses included in earnings;, debt and
equity securities not classified as either held-to-maturity or trading
securities are deemed as available-for-sale and are measured at fair value,
with unrealized gains and losses, net of applicable taxes, reported in a
separate component of stockholders' equity. Any gains and losses on sales of
investments are computed on a specific identification basis.
The amortized cost and fair values of investment securities available for
sale at June 30, 1999 and December 31, 1998 were:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
JUNE 30, 1999 COST GAINS LOSSES VALUE
----- ------ ------ -----
<S> <C> <C> <C> <C>
Obligations of U.S. government agencies and corporations $4,171,247 $1,779 $281,068 $3,891,958
Mortgage-backed securities 3,356,754 8,152 131,243 3,233,663
Commercial Paper 0 0 0 0
Obligations of State and Political Subdivisions 497,554 0 28,246 469,308
TOTAL $8,025,555 $9,931 $440,557 $7,594,929
---------- ------ -------- ----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998 GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----- ------ ------ -----
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 0 $ 0 $ 0 $ 0
Obligations of U.S. government agencies and corporations 1,650,875 163,545 0 1,814,420
Mortgage-backed securities 3,286,605 2,903 214,455 3,075,053
Commercial Paper 7,969,833 0 0 7,969,833
Obligations of State and Political Subdivisions 0 0 0 0
Other Securities 3,800 0 0 3,800
---------- ------- ------- ----------
TOTAL $12,911,113 $166,448 $214,455 $12,863,106
----------- -------- -------- ----------
</TABLE>
7
<PAGE>
Note 2: INVESTMENT SECURITIES (continued)
The amortized cost and fair values of investment securities held to maturity
at June 30, 1999 and December 31, 1998 were:
<TABLE>
<CAPTION>
GROSS GROSS
JUNE 30, 1999 AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 0 $ 0 $ 0
Obligations of U.S. government agencies and corporations 6,010,447 10,543 226,139 $ 5,794,851
Mortgage-backed securities 668,719 3,553 16,191 656,081
Obligations of State and political subdivisions 6,191,406 16,537 125,726 6,082,217
Other securities 395,200 0 0 395,200
---------- ------ ------- ----------
TOTAL $13,265,772 $30,633 $368,056 $12,928,349
----------- ------- -------- -----------
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
----- ------ ------- -----
<S> <C> <C> <C> <C>
U.S. Treasury securities $98,777 $ 0 $ 777 $ 98,000
Obligations of U.S. government agencies and corporations 1,235,905 25,798 132 1,261,571
Mortgage-backed securities 8,168,695 283,004 12,759 8,438,940
Obligations of state and political subdivisions 6,254,774 14,059 8,337 6,260,496
----------- ------- ------ ----------
TOTAL $15,758,151 $322,861 $22,005 $16,059,007
----------- -------- ------- -----------
</TABLE>
Note 3: Loans and Reserve for Possible Loan Losses
<TABLE>
<CAPTION>
Major classifications of loans were:
June 30, December 31,
1999 1998
---- ----
<S> <C> <C>
Commercial, financial, and agricultural $40,623,886 $38,220,932
Real estate-construction 11,463,689 8,357,701
Real estate-mortgage 31,011,432 21,672,158
Installment loans to individuals 2,192,743 2,611,325
All other loans (including overdrafts) 678,833 323,493
---------- ----------
85,970,583 71,185,609
Less - deferred loan fees (361,057) (313,033)
Less - reserve for possible loan losses (1,155,032) (1,069,535)
---------- -----------
Total loans $84,454,494 $69,803,041
----------- -----------
Loans Held For Sale $328,389 $1,654,765
</TABLE>
Concentration of Credit Risk
At June 30, 1999, approximately $42,475,121 of the Bank's loan portfolio was
collateralized by various forms of real estate. Such loans are generally made
to borrowers located in San Luis Obispo County. The Bank attempts to reduce
its concentration of credit risk by making loans which are diversified by
project type. While management believes that the collateral presently
securing this portfolio is adequate, there can be no assurances that
significant deterioration in the California real estate market would not
expose the Bank to significantly greater credit risk.
Loans on nonaccrual status totaled $931,000 and $934,389 at June 30, 1999 and
December 31, 1998, respectively. Interest income that would have been
recognized on non-accrual loans if they had performed in accordance with the
terms of the loans was approximately $54,898 and $103,164 for the period
ended June 30, 1999 and December 31, 1998, respectively.
8
<PAGE>
Note 3: Loans and Reserve for Possible Loan Losses (continued)
An analysis of the changes in the reserve for possible loan losses is as
follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---- ----
<S> <C> <C>
Balance at beginning of year $1,069,535 $930,284
Additions charged to operating expense 81,500 164,000
Loans charged off (6,018) (45,277)
Recoveries of loans previously charged off 10,015 20,528
--------- ---------
Balance at end of year $1,155,032 $1,069,535
</TABLE>
At June 30, 1999, the Bank was contingently liable for letters of credit
accommodations made to its customers totaling $935,904 and undisbursed loan
commitments in the amount of $30,613,742. The Bank makes commitments to
extend credit in the normal course of business to meet the financing needs of
its customers. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
outstanding commitment amount does not necessarily represent future cash
requirements. Standby letters of credit written are conditional commitments
issued by the Bank to guarantee the performance of a customer to a third
party. The credit risk involved in issuing letters of credit is essentially
the same as that involved in extending loan facilities to customers. The Bank
anticipates no losses as a result of such transactions.
In accordance with Financial Accounting Standards Board (FASB) Statement No.
114, Accounting by Creditors for Impairment of a Loan. Allowance for credit
losses related to loans that are identified for evaluation in accordance with
Statement 114 is based on discounted cash flows using the loan's initial
effect interest rate or the fair value of the collateral for certain
collateral dependent loans.
Management believes that the allowance for credit losses at June 30, 1999 is
prudent and warranted, based on information currently available. However, no
prediction of the ultimate level of loans charged-off in future years can be
made any certainty.
Note 4: Earnings Per Share:
Basic earnings per share are based on the weighted average number of shares
outstanding before any dilution from common stock equivalents. Diluted
earnings per share includes common stock equivalents from the effect of the
exercise of stock options. The total number of share used for calculating
basic and diluted for June 30, 1999 was 1,116,143 and 1,243,082,
respectively. The total number of shares used for calculating basic and
diluted for June 30, 1998 was 1,082,473 and 1,151,650, respectively.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
HERITAGE OAKS BANCORP (THE "COMPANY") COMMENCED OPERATIONS ON NOVEMBER 15,
1994 WITH THE ACQUISITION OF HERITAGE OAKS BANK (THE "BANK"). EACH
SHAREHOLDER OF THE BANK RECEIVED ONE SHARE OF STOCK IN THE COMPANY IN
EXCHANGE FOR EACH SHARE OF HERITAGE OAKS BANK STOCK OWNED. THE BANK BECAME A
WHOLLY OWNED SUBSIDIARY OF THE COMPANY. THE BANK IS THE ONLY ACTIVE
SUBSIDIARY OWNED BY THE COMPANY.
SUMMARY OF FINANCIAL RESULTS
AS OF JUNE 30, 1999, TOTAL CONSOLIDATED ASSETS OF HERITAGE OAKS BANCORP WERE
$132,261,502 COMPARED TO $131,168,498 AT DECEMBER 31, 1998. THIS REFLECTS AN
INCREASE OF ONLY 0.83%, HOWEVER, TOTAL ASSETS AT DECEMBER 31, 1998 INCLUDED A
DEPOSIT OF APPROXIMATELY $5 MILLION FROM ONE PARTICULAR CUSTOMER ON DECEMBER
31, 1998 THAT REMAINED ON DEPOSIT FOR ONLY ONE WEEK. TAKING THAT ADJUSTMENT
INTO CONSIDERATION, TOTAL ASSETS HAVE GROWN BY 4.8% FROM YEAREND. THIS GROWTH
IS ATTRIBUTABLE TO TWO DE NOVO BRANCH OFFICES IN SANTA MARIA AND ATASCADERO
THAT OPENED ON FEBRUARY 1, 1999 AND MARCH 15, 1999, RESPECTIVELY.
TOTAL CASH AT JUNE 30, 1999 WAS $16,997,472. THE LARGE CASH BALANCE REFLECTS
THE INCREASED NUMBER OF BRANCH OFFICES AND CASH NEEDED TO FUND THE BANK'S
AUTOMATIC TELLER MACHINE ("ATM") NETWORK. AS OF JUNE 30, 1999, THE BANK WAS
OPERATING APPROXIMATELY 80 ATMS.
TOTAL NET LOANS AT JUNE 30, 1999 WERE $84,454,494 COMPARED TO $69,803,041 AT
DECEMBER 31, 1998. THIS INCREASE FROM YEAREND IS THE RESULT OF EXPANSION IN
THE NUMBER OF BRANCHES AND THE REPUTATION OUR BANK HAS ESTABLISHED IN OUR NEW
AND EXISTING MARKET AREA. MANAGEMENT INTENDS TO CONTINUE ITS AGGRESSIVE
INCREASE IN THE LEVEL OF LOANS OUTSTANDING WHILE NOT COMPROMISING
UNDERWRITING STANDARDS.
SECURITIES AVAILABLE FOR SALE, WHICH ARE CARRIED AT MARKET VALUE, WERE
$7,594,929 AT JUNE 30, 1999 COMPARED TO $12,863,106 AT DECEMBER 31, 1998.
SECURITIES HELD TO MATURITY, WHICH ARE CARRIED AT THEIR AMORTIZED COST, WERE
$13,265,772 AT JUNE 30, 1999 COMPARED TO $15,758,151 AT DECEMBER 31, 1998.
BOTH CATEGORIES HAVE DECREASED THROUGH SECURITY MATURITY AND PRINCIPAL CASH
FLOW PAY DOWN TO SUPPLY FUNDS FOR LOAN DEMAND.
FEDERAL FUNDS SOLD WERE $2,500,000 AT JUNE 30, 1999 AND $7,700,000 AT
DECEMBER 31, 1998.
10
<PAGE>
TOTAL DEPOSITS WERE $120,770,793 AT JUNE 30, 1999 COMPARED TO $119,407,706 AT
DECEMBER 31, 1998, WHICH REPRESENTS AN INCREASE OF ONLY 1.14%. HOWEVER, THE
IMPACT OF THE DEPOSIT TRANSACTION ON DECEMBER 31, 1998 THAT IS NOTED ABOVE,
DISTORTS THE REAL GROWTH OF APPROXIMATELY 5.3%. THE INCREASE IN TOTAL
DEPOSITS IS PRIMARILY ATTRIBUTABLE TO THE TWO NEW BRANCH OFFICES AND DEPOSITS
OBTAINED IN RELATIONSHIPS AS THE RESULT OF NEW LOANS.
CORE DEPOSITS (TIME DEPOSITS LESS THAN $100,000, DEMAND, AND SAVINGS)
GATHERED IN THE LOCAL COMMUNITIES SERVED BY THE BANK CONTINUE TO BE THE
BANK'S PRIMARY SOURCE OF FUNDS FOR LOANS AND INVESTMENTS. CORE DEPOSITS OF
$116,472,454 REPRESENTED 96.4% OF TOTAL DEPOSITS AT JUNE 30, 1999. THE
COMPANY DOES NOT PURCHASE FUNDS THROUGH DEPOSIT BROKERS.
THE COMPANY HAS A $2 MILLION REVOLVING LINE OF CREDIT AVAILABLE WITH PACIFIC
COAST BANKERS BANK. AT JUNE 30, 1999, THE BALANCE OF BORROWED FUNDS ON THIS
LINE WAS $350,000 COMPARED TO $750,000 AT DECEMBER 31, 1998.
RESULTS OF OPERATIONS
THE COMPANY REPORTED NET INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 OF
$520,926 COMPARED TO $661,366 FOR THE SAME PERIOD IN 1998. PER SHARE EARNINGS
ON A DILUTED BASIS FOR JUNE 30, 1999 AND JUNE 30, 1998 WERE $0.42 AND $0.60,
RESPECTIVELY. BASIC PER SHARE EARNINGS FOR JUNE 30, 1999 AND JUNE 30, 1998
WERE $0.47 AND $0.63, RESPECTIVELY.
NET INCOME FOR THE THREE MONTHS ENDED JUNE 30, 1999 WAS $331,618, COMPARED TO
$332,958 FOR THE SAME PERIOD IN 1998.
REDUCED EARNINGS ARE THE DIRECT RESULT OF THE BANK'S EXPANSION INTO SANTA
MARIA AND ATASCADERO. MANAGEMENT'S 1999 BUDGET REFLECTED THIS DECREASE IN
EARNINGS FROM THE SAME PERIOD IN 1998.
THE FOLLOWING DISCUSSION HIGHLIGHTS CHANGES IN CERTAIN ITEMS IN THE
CONSOLIDATED STATEMENTS OF INCOME.
11
<PAGE>
NET INTEREST INCOME
NET INTEREST INCOME, THE PRIMARY COMPONENT OF THE NET EARNINGS OF A FINANCIAL
INSTITUTION, REFERS TO THE DIFFERENCE BETWEEN THE INTEREST PAID ON DEPOSITS
AND BORROWINGS, AND THE INTEREST EARNED ON LOANS AND INVESTMENTS. THE NET
INTEREST MARGIN IS THE AMOUNT OF NET INTEREST INCOME EXPRESSED AS A
PERCENTAGE OF AVERAGE EARNING ASSETS. FACTORS CONSIDERED IN THE ANALYSIS OF
NET INTEREST INCOME ARE THE COMPOSITION AND VOLUME OF EARNING ASSETS AND
INTEREST-BEARING LIABILITIES, THE AMOUNT OF NON-INTEREST BEARING LIABILITIES
AND NON-ACCRUAL LOANS, AND CHANGES IN MARKET INTEREST RATES.
NET INTEREST INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 WAS $3,361,977 AS
COMPARED TO $2,475,365 FOR THE SAME PERIOD IN 1998. THIS REPRESENTS AN
IMPROVEMENT OF $886,612 OR 35.8%. AS A PERCENTAGE OF AVERAGE EARNING ASSETS,
THE NET INTEREST MARGIN FOR THE FIRST SIX MONTHS OF 1999 INCREASED TO 6.20%
FROM 6.03% FROM THE SAME PERIOD ONE YEAR EARLIER. THE INCREASE IN NET
INTEREST MARGIN IS PRIMARILY DUE TO AN $26,390,000 INCREASE IN AVERAGE
INTEREST EARNING ASSETS AND AN INCREASE OF ONLY $11,897,000 IN INTEREST
BEARING LIABILITIES. THIS IMPROVEMENT WAS THE RESULT OF THE BANK'S MARKETING
EFFORTS TO ATTRACT NON-INTEREST BEARING DEMAND DEPOSIT ACCOUNTS. THE AVERAGE
BALANCE OF DEMAND DEPOSITS AT JUNE 30, 1999 WAS $34,850,000 COMPARED TO
$18,485,000 AT JUNE 30, 1998.
NET INTEREST INCOME FOR THE THREE MONTHS ENDED JUNE 30, 1999 WAS $1,766,281
COMPARED TO $1,265,091 FOR THE SAME PERIOD IN 1998. THIS REPRESENTS AN
INCREASE OF 40.7%. INTEREST EXPENSE FOR THIS THREE MONTH PERIOD WAS $604,006
AT JUNE 30, 1999 COMPARED TO $628,330 AT JUNE 30, 1999.
AVERAGE INTEREST EARNING ASSETS WERE $108,518 AT JUNE 30, 1999 COMPARED TO
$82,128,000 AT JUNE 30, 1998. AVERAGE INTEREST-BEARING LIABILITIES INCREASED
TO $81,727,000 AT JUNE 30, 1999 FROM $69,830,000 AT JUNE 30, 1998. AVERAGE
INTEREST RATES ON INTEREST-BEARING LIABILITIES DROPPED FROM 3.39% FOR THE
FIRST SIX MONTHS OF 1998 TO 2.97% FOR THE FIRST SIX MONTHS OF 1999.
12
<PAGE>
AVERAGE BALANCE SHEET INFORMATION FOR JUNE 30,
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1999 1998
--------------------------------- ---------------------------------
AVERAGE AVERAGE YIELD AMOUNT AVERAGE AVERAGE YIELD AMOUNT
BALANCE RATE PAID INTEREST BALANCE RATE PAID INTEREST
-------- ------- ------ ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Interest Earning Assets:
Time deposits with other banks $495 5.66% $14 $224 6.30% $7
Investment securities taxable 18,252 5.98% 546 15,150 6.10% 458
Investment securities non-taxable 6,478 4.72% 153 4,313 5.00% 107
Federal funds sold 5,237 4.89% 128 2,261 5.35% 60
Loans (1) (2) 78,056 9.57% 3,734 60,180 10.11% 3,018
-------- ------ ------- ------
Total interest earning assets 108,518 8.43% 4,575 82,128 8.96% 3,650
-------- ------ ------- ------
Allowance for possible loan losses -1,106 (937)
Non-earning assets:
Cash and due from banks 14,091 10,806
Property, premises and equipment 2,839 2,058
Other assets 3,443 4,238
----- -------
TOTAL ASSETS $127,785 $98,293
-------- -------
Interest -bearing liabilities:
Savings/NOW/money market 53,444 2.04% 546 46,618 2.52% 583
Time deposits 26,926 4.61% 621 21,470 5.08% 541
Other borrowings 1,357 6.63% 45 1,742 5.90% 51
----- ------ ------- ------
Total interest-bearing liabilities 81,727 2.97% 1,212 69,830 3.39% 1,175
-------- ------ ------- ------
Non-interest bearing liabilities:
Demand deposits 34,850 18,485
Other liabilities 1,324 1,770
-------- -------
Total liabilities 117,901 90,085
-------- -------
Stockholders' equity
Common stock 4,500 4,190
Retained earnings 5,608 4,399
Valuation Allowance Investments (224) (381)
-------- -------
Total stockholders' equity 9,884 8,208
-------- -------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $127,785 $98,293
-------- -------
Net Interest Income $3,363 $2,475
------ ------
Net Interest Margin (3) 6.20% 6.03%
</TABLE>
(1)NONACCRUAL LOANS HAVE BEEN INCLUDED IN TOTAL LOANS.
(2)LOAN FEES OF $213,454 AND $131,600 FOR 1999 AND 1998,
RESPECTIVELY, HAVE BEEN INCLUDED IN THE INTEREST INCOME
COMPUTATION.
(3)NET INTEREST INCOME HAS BEEN CALCULATED BY DIVIDING THE NET
INTEREST INCOME BY TOTAL EARNING ASSETS.
13
<PAGE>
THE PRECEDING TABLE SETS FORTH AVERAGE BALANCE SHEET INFORMATION, INTEREST
INCOME AND EXPENSE, AVERAGE YIELDS AND RATES AND NET INTEREST INCOME AND MARGIN
FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998.
NON-INTEREST INCOME
NON-INTEREST INCOME CONSISTS OF BANKCARD MERCHANT FEES, AUTOMATIC TELLER
MACHINE ("ATM") TRANSACTIONS, AND OTHER FEES, SERVICE CHARGES, AND GAINS ON
OTHER REAL ESTATE OWNED. NON-INTEREST INCOME FOR THE SIX MONTHS ENDED JUNE
30, 1999 WAS $2,640,907 COMPARED TO $3,225,165 FOR THE SAME PERIOD IN 1998.
THAT REPRESENTS A DECREASE OF $584,258 OR 18.1%. SERVICE CHARGE INCOME
INCREASED FROM $328,633 DURING THE FIRST SIX MONTHS OF 1998 TO $354,591 FOR
THE SIX MONTHS ENDED JUNE 30, 1999. THIS MODEST INCREASE IN SERVICE CHARGES
IS A RESULT OF THE BANK'S GROWTH IN DEPOSIT ACCOUNTS. ATM TRANSACTION FEES AND
INTERCHANGE INCOME WERE $1,580,843 DURING THE SIX MONTHS ENDED JUNE 30, 1999
COMPARED TO $2,166,921 DURING THE SAME PERIOD FOR 1998. THE BANK RECEIVES
INCOME FOR EACH TRANSACTION. APPROXIMATELY 18% OF THE ATMS ARE LOCATED AT
GAMING SITES ON NATIVE AMERICAN LANDS. THE COMPETITION RELATED TO THE
INSTALLATION OF ATM MACHINES HAS BEEN INCREASING AND HAS REDUCED CURRENT
INCOME FROM THESE MACHINES. IN ORDER FOR NON-FINANCIAL INSTITUTIONS TO
UTILIZE THE VARIOUS REGIONAL, NATIONAL AND INTERNATIONAL NETWORKS, THEY NEED
A FINANCIAL INSTITUTION TO SPONSOR THEM ON THESE NETWORKS. THE BANK HAS
ENTERED AN AGREEMENT WITH A FEW NON-FINANCIAL INSTITUTIONS TO SPONSOR THEM ON
THESE NETWORKS. THE BANK RECEIVES A NOMINAL SPONSORSHIP FEE FOR EACH
TRANSACTION RUN THROUGH THE NETWORKS. THE SPONSORSHIP REVENUE FOR THE SIX
MONTHS ENDED JUNE 30, 1999 WAS $44,117 COMPARED TO $67,243 FOR THE SAME
PERIOD DURING 1998. INCOME FROM BANKCARD MERCHANT FEES DECREASED TO $370,812
FOR THE SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO $410,386 FOR THE SAME
PERIOD DURING 1998. TO DEFRAY LIABILITY, THE BANK HAS TAKEN A MORE
CONSERVATIVE STANCE ON THIS PRODUCT LINE AND HAS ELIMINATED HIGHER RISK
MERCHANTS THAT GENERATED SIGNIFICANT REVENUES IN THE PAST. THE BANK IS
CURRENTLY FINALIZING AN OFFER TO ELIMINATE LIABILITY AND CHANGE THE REVENUE
FLOW TO REFLECT "NET" EARNINGS ON A MONTHLY BASIS. THE PROPOSED TRANSACTION
WILL PROVIDE A PROFITABLE PRODUCT WITH CONTINUED REVENUE BASED ON THE NET
VOLUME OF SALES. IT IS THE BANK'S INTENTION TO ACTIVELY MARKET THIS PRODUCT
TO PROVIDE GREATER ONGOING REVENUE, WITHOUT THE RISK.
14
<PAGE>
NON-INTEREST INCOME FOR THE THREE MONTHS ENDED JUNE 30, 1999 WAS $1,440,019
COMPARED TO $1,643,798 FOR THE SAME PERIOD IN 1998. THAT REPRESENTS A DECREASE
OF $203,779 OR 12.4%. SERVICE CHARGE INCOME REMAINED STATIC AT $181,143 DURING
THE FIRST THREE MONTHS OF 1998 AND $181,729 FOR THE SAME PERIOD IN 1998. ATM
TRANSACTION FEES AND INTERCHANGE INCOME WERE $885,300 DURING THE THREE MONTHS
ENDED JUNE 30, 1999 COMPARED TO $1,018,752 DURING THE SAME PERIOD FOR 1998. THE
SPONSORSHIP REVENUE FOR THE THREE MONTHS ENDED JUNE 30, 1999 WAS $29,275
COMPARED TO $33,469 FOR THE SAME PERIOD DURING 1998. INCOME FROM BANKCARD
MERCHANT FEES DECREASED TO $192,724 FOR THE THREE MONTHS ENDED JUNE 30, 1999
COMPARED TO $216,260 FOR THE SAME PERIOD DURING 1998.
OTHER EXPENSE
THE BANK OPENED DE NOVO BRANCHES IN SANTA MARIA AND ATASCADERO ON FEBRUARY 1
AND MARCH 15, 1999, RESPECTIVELY. OTHER EXPENSES HAVE GROWN AS A RESULT OF
THE ADDITIONAL BRANCHES AND OVERALL GROWTH OF THE BANK. NON-INTEREST EXPENSE
WAS $5,140,043 AND $4,621,938 FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND THE
SAME PERIOD IN 1998, RESPECTIVELY. SALARIES AND EMPLOYEE BENEFITS EXPENSE
WERE $1,754,977 AND $1,402,702 FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND
1998, RESPECTIVELY. FULL TIME EQUIVALENT EMPLOYEES WERE 86 AT JUNE 30, 1999
COMPARED TO 66 AT JUNE 30, 1998. OCCUPANCY AND EQUIPMENT COSTS GREW TO
$747,255 FOR THE SIX MONTHS ENDED JUNE 30, 1999 FROM $530,027 FOR THE SAME
PERIOD OF 1998. THE BANK HAS FINALIZED PURCHASES IN CONJUNCTION WITH Y2K
COMPLIANCE. (REFER TO THE YEAR 2000 SECTION OF THIS DOCUMENT) EXPENSE
ASSOCIATED WITH THE ATM NETWORK WAS $1,122,862 AND $1,238,721 FOR THE SIX
MONTHS ENDED JUNE 30, 1999 AND 1998, RESPECTIVELY. EXPENSE ASSOCIATED WITH
THE MERCHANT BANCARD PROGRAM WAS $278,379 AND $431,708 FOR THE SIX MONTHS
ENDED JUNE 30, 1999 AND 1998, RESPECTIVELY. EXPENSE ASSOCIATED WITH ALL OTHER
NON-INTEREST EXPENSE CATEGORIES WAS $1,136,570 AND $1,018,780 FOR THE SIX
MONTHS ENDED JUNE 30, 1999 AND 1998, RESPECTIVELY. THE INCREASE IN OTHER
EXPENSE REFLECTS INCREASES ASSOCIATED WITH THE GROWTH AS A RESULT OF THE TWO
NEW BRANCHES AND THE OVERALL GROWTH OF THE BANK.
NON-INTEREST EXPENSE WAS $2,697,343 AND $2,360,755 FOR THE THREE MONTHS ENDED
JUNE 30, 1999 AND THE SAME PERIOD IN 1998, RESPECTIVELY. SALARIES AND EMPLOYEE
BENEFITS EXPENSE WERE $884,259 AND $719,019 FOR THE THREE MONTHS ENDED JUNE 30,
1999 AND 1998, RESPECTIVELY. OCCUPANCY AND EQUIPMENT COSTS GREW TO $404,845 FOR
THE THREE MONTHS ENDED JUNE 30, 1999 FROM $259,959
15
<PAGE>
FOR THE SAME PERIOD OF 1998. EXPENSE ASSOCIATED WITH THE ATM NETWORK WAS
$605,897 AND $743,075 FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998,
RESPECTIVELY. EXPENSE ASSOCIATED WITH THE MERCHANT BANCARD PROGRAM WAS
$199,095 AND $209,795 FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998,
RESPECTIVELY. EXPENSE ASSOCIATED WITH ALL OTHER NON-INTEREST EXPENSE
CATEGORIES WAS $603,247 AND $428,907 FOR THE THREE MONTHS ENDED JUNE 30, 1999
AND 1998, RESPECTIVELY. THE INCREASE IN OTHER EXPENSE REFLECTS INCREASES
ASSOCIATED WITH THE GROWTH AS A RESULT OF THE TWO NEW BRANCHES AND THE
OVERALL GROWTH OF THE BANK.
LOCAL ECONOMY
ACCORDING TO THE 1999 SAN LUIS OBISPO COUNTY ECONOMIC OUTLOOK, PREPARED BY THE
UCSB ECONOMIC FORECAST PROJECT, THE APPARENT SLOWDOWN OF THE U.S. ECONOMY HAS
NOT OBVIOUSLY INFLUENCED THE LOCAL SAN LUIS OBISPO COUNTY ECONOMY, YET. THE
HEALTHY RATE OF U.S. ECONOMIC GROWTH DURING 1998 HAS BEEN INTERRUPTED,
PREDOMINANTLY BY EVENTS AND FINANCIAL PROBLEMS ABROAD. CONSUMER CONFIDENCE AND
SPENDING, INDUSTRIAL PRODUCTION, AND EMPLOYMENT GROWTH HAVE BEEN SLIDING
RECENTLY.
THE PUBLICATION GOES ON TO SAY THAT TO DATE, HOWEVER, THE LOCAL ECONOMY HAS NOT
EXPERIENCED ANY PRONOUNCED WEAKNESS IN ANY PARTICULAR SECTOR. GROWTH IN
EMPLOYMENT, RESIDENT SPENDING, TOURISM SPENDING, AND INCOME HAVE REMAINED SOLID.
RESIDENTIAL BUILDING ACTIVITY IS CURRENTLY HIGHER THAN ANY YEAR OF THE 1990S.
THE HOME SALES MARKET IS ESPECIALLY STRONG. AT THIS POINT, THE SAN LUIS OBISPO
COUNTY ECONOMY DOES NOT APPEAR AFFECTED BY THE SPREADING INTERNATIONAL WEAKNESS.
A FIVE YEAR EXPANSION OF THE CALIFORNIA ECONOMY, THE SEVEN YEAR EXPANSION OF THE
U.S. ECONOMY, THE UNPRECEDENTED RETURNS FROM FINANCIAL AND EQUITY MARKETS, AND
THE STEADY GROWTH OF VISITOR TRAVEL ALONG THE CENTRAL COAST OF CALIFORNIA, ARE
THE PRINCIPAL REASONS FOR THE CURRENT PROSPERITY OF SAN LUIS OBISPO COUNTY. MORE
JOB OPPORTUNITIES, AND AN INCREASE IN MIGRATION TO SAN LUIS OBISPO COUNTY,
RESULTING IN HIGHER DEMAND FOR HOUSING ARE ALSO RESPONSIBLE FOR INCREASED
ECONOMIC GROWTH THIS YEAR.
THE CONTINUING HEALTH OF THE SAN LUIS OBISPO COUNTY ECONOMY IS CONFIRMED BY A
VARIETY OF INDICATORS. THE RECENT EVIDENCE IS BOTH CLEAR AND CONSISTENT.
EMPLOYMENT GROWTH IS QUITE HEALTHY, VISITOR SPENDING CONTINUES TO RISE, AND
RETAIL MARKETS ARE RECORDING SOLID GAINS. BECAUSE THERE IS LITTLE NEW
COMMERCIAL BUILDING,
16
<PAGE>
AVAILABLE OFFICE AND INDUSTRIAL SPACE IS EVAPORATING. THE FARM SECTOR SET
ANOTHER RECORD FOR BOTH CROP SALES IN 1997 AND EMPLOYMENT IN 1998, AND PER
CAPITA INCOME CONTINUED TO RISE TO HISTORICAL HIGHS. JUST SINCE 1995, THE
NUMBER OF JOBS IN AGRICULTURE HAS DOUBLED; TO OVER 6,300 IN THE COUNTY AND
AVERAGE WAGES FOR FARM WORKERS JUMPED 11% IN 1998.
THE BANK'S BRANCH LOCATIONS HAVE BEEN LOCATED TO TAKE ADVANTAGE OF THIS
GROWING ECONOMY, AS EVIDENCED BY THE TWO DE NOVO BRANCHES OPENED DURING THE
FIRST QUARTER OF 1999. THE BANK IS CURRENTLY NEGOTIATING A LEASE TO ESTABLISH
A FULL SERVICE BRANCH OFFICE IN ARROYO GRANDE WITH AN ANTICIPATED OPENING
DATE SOMETIME DURING THE FOURTH QUARTER OF 1999.
CAPITAL
THE COMPANY'S TOTAL STOCKHOLDERS EQUITY WAS $9,847,894 AT JUNE 30, 1999
COMPARED TO $9,436,670 AS OF DECEMBER 31, 1998. THE INCREASE IN CAPITAL WAS
FROM NET INCOME OF $520,926, $36,524 FROM STOCK OPTIONS EXERCISED, ($2,882)
FOR FRACTIONAL SHARES FROM A 4% STOCK DIVIDEND DURING THE FIRST QUARTER AND
($146,226) NET CHANGE IN OTHER COMPREHENSIVE INCOME RELATED TO UNREALIZED
SECURITY HOLDING LOSS, NET OF TAX.
CAPITAL RATIOS FOR COMMERCIAL BANKS IN THE UNITED STATES ARE GENERALLY
CALCULATED USING NINE DIFFERENT FORMULAS. THESE CALCULATIONS ARE REFERRED TO
AS THE "LEVERAGE RATIO" AND TWO "RISK BASED" CALCULATIONS KNOWN AS: "TIER ONE
RISK BASED CAPITAL RATIO" AND THE "TOTAL RISK BASED CAPITAL RATIO." THESE
STANDARDS WERE DEVELOPED THROUGH JOINT EFFORTS OF BANKING AUTHORITIES FROM 12
DIFFERENT COUNTRIES AROUND THE WORLD. THE STANDARDS ESSENTIALLY TAKE INTO
ACCOUNT THE FACT THAT DIFFERENT TYPES OF ASSETS HAVE DIFFERENT LEVELS OF RISK
ASSOCIATED WITH THEM. FURTHER, THEY TAKE INTO ACCOUNT THE OFF-BALANCE SHEET
EXPOSURES OF BANKS WHEN ASSESSING CAPITAL ADEQUACY.
THE LEVERAGE RATIO CALCULATION SIMPLY DIVIDES COMMON STOCKHOLDERS' EQUITY
(REDUCED BY ANY GOODWILL A BANK MAY HAVE) BY THE TOTAL AVERAGE ASSETS OF THE
BANK. IN THE TIER ONE RISK BASED CAPITAL RATIO, THE NUMERATOR IS THE SAME AS
THE LEVERAGE RATIO, BUT THE DENOMINATOR IS THE TOTAL "RISK-WEIGHTED ASSETS"
OF THE BANK. RISK WEIGHTED ASSETS ARE DETERMINED BY SEGREGATING ALL THE
ASSETS AND OFF BALANCE SHEET EXPOSURES INTO DIFFERENT RISK CATEGORIES AND
WEIGHING THEM BY A PERCENTAGE RANGING FROM 0% (LOWEST RISK) TO 100% (HIGHEST
RISK). THE TOTAL RISK BASED
17
<PAGE>
CAPITAL RATIO AGAIN USES "RISK-WEIGHTED ASSETS" IN THE DENOMINATOR, BUT
EXPANDS THE NUMERATOR TO INCLUDE OTHER CAPITAL ITEMS BESIDES EQUITY SUCH AS A
LIMITED AMOUNT OF THE LOAN LOSS RESERVE, LONG-TERM CAPITAL DEBT, PREFERRED
STOCK AND OTHER INSTRUMENTS.
SUMMARIZED BELOW ARE THE BANK'S CAPITAL RATIOS AT JUNE 30, 1999:
<TABLE>
<CAPTION>
ADEQUATELY-CAPITALIZED HERITAGE
REGULATORY STANDARD OAKS BANK
<S> <C>> <C>
LEVERAGE RATIO 4.00% 7.25%
TIER ONE RISK BASED CAPITAL RATIO 4.00% 9.88%
TOTAL RISK BASED CAPITAL RATIO 8.00% 11.09%
</TABLE>
IT IS THE INTENT OF MANAGEMENT TO CONTINUE TO MAINTAIN STRONG CAPITAL RATIOS.
LIQUIDITY
THE OBJECTIVE OF LIQUIDITY MANAGEMENT IS TO ENSURE THE CONTINUOUS AVAILABILITY
OF FUNDS TO MEET THE DEMANDS OF DEPOSITORS, INVESTORS AND BORROWERS. ASSET
LIQUIDITY IS PRIMARILY DERIVED FROM LOAN PAYMENTS AND THE MATURITY OF OTHER
EARNING ASSETS. LIQUIDITY FROM LIABILITIES IS OBTAINED PRIMARILY FROM THE
RECEIPT OF NEW DEPOSITS. THE BANK'S ASSET LIABILITY COMMITTEE (ALCO) IS
RESPONSIBLE FOR MANAGING THE ON-AND OFF-BALANCE SHEET COMMITMENTS TO MEET THE
NEEDS OF CUSTOMERS WHILE ACHIEVING THE BANK'S FINANCIAL OBJECTIVES. ALCO MEETS
REGULARLY TO ASSESS THE PROJECTED FUNDING REQUIREMENTS BY REVIEWING HISTORICAL
FUNDING PATTERNS, CURRENT AND FORECASTED ECONOMIC CONDITIONS, AND INDIVIDUAL
CUSTOMER FUNDING NEEDS. DEPOSITS GENERATED FROM BANK CUSTOMERS SERVE AS THE
PRIMARY SOURCE OF LIQUIDITY. THE BANK HAS CREDIT ARRANGEMENTS WITH CORRESPONDENT
BANKS THAT SERVE AS A SECONDARY LIQUIDITY SOURCE IN THE AMOUNT OF $5,500,000 AND
ADDITIONALLY CAN BORROW MONEY THROUGH REPURCHASE AGREEMENTS WITH TWO BROKERAGE
FIRMS. THE BANK IS ALSO NEGOTIATING A BORROWING LINE WITH FEDERAL HOME LOAN BANK
OF SAN FRANCISCO. DURING THE SECOND QUARTER OF 1999, THE BANK DID NOT BORROW ON
ARRANGED FED FUND LINES; HOWEVER, A REVERSE REPURCHASE AGREEMENT FOR
APPROXIMATELY $2.3 MILLION WAS IN PLACE FOR 60 DAYS, ENDING ON
18
<PAGE>
JUNE 25, 1999.
THE BANK MANAGES ITS LIQUIDITY BY MAINTAINING A MAJORITY OF ITS INVESTMENT
PORTFOLIO IN FEDERAL FUNDS SOLD AND OTHER LIQUID INVESTMENTS. AT JUNE 30, 1999,
THE RATIO OF LIQUID ASSETS TO DEPOSITS AND OTHER LIABILITIES WAS 27.39%. THE
RATIO OF GROSS LOANS TO DEPOSITS, ANOTHER KEY LIQUIDITY RATIO, WAS 71.1% AT JUNE
30, 1999.
INFLATION
THE ASSETS AND LIABILITIES OF A FINANCIAL INSTITUTION ARE PRIMARILY MONETARY IN
NATURE. AS SUCH, THEY REPRESENT OBLIGATIONS TO PAY OR RECEIVE FIXED AND
DETERMINABLE AMOUNTS OF MONEY, WHICH ARE NOT AFFECTED BY FUTURE CHANGES IN
PRICES. GENERALLY, THE IMPACT OF INFLATION ON A FINANCIAL INSTITUTION IS
REFLECTED BY FLUCTUATIONS IN INTEREST RATES, THE ABILITY OF CUSTOMERS TO REPAY
DEBT AND UPWARD PRESSURE ON OPERATING EXPENSES. IN ADDITION, INFLATION AFFECTS
THE GROWTH OF TOTAL ASSETS BY INCREASING THE LEVEL OF LOAN DEMAND, AND MAY
POTENTIALLY ADVERSELY AFFECT THE BANK'S CAPITAL ADEQUACY BECAUSE LOAN GROWTH IN
INFLATIONARY PERIODS MAY INCREASE MORE RAPIDLY THAN CAPITAL. THE EFFECT ON
INFLATION DURING THE PERIOD ENDED JUNE 30, 1999 HAS NOT BEEN SIGNIFICANT TO THE
BANK'S FINANCIAL POSITION OR RESULT OF OPERATIONS.
YEAR 2000 RISKS AND PREPAREDNESS
MANY EXISTING COMPUTER PROGRAMS USE ONLY TWO DIGITS TO IDENTIFY A YEAR IN A DATA
FIELD. THESE PROGRAMS WERE DESIGNED AND DEVELOPED WITHOUT CONSIDERING THE IMPACT
OF THE UPCOMING CHANGE IN THE CENTURY. IF NOT CORRECTED, MANY COMPUTER
APPLICATIONS COULD FAIL OR CREATE ERRONEOUS RESULTS BY OR AT THE YEAR 2000 OR
POSSIBLY EARLIER. THE YEAR 2000 ISSUE AFFECTS THE COMPANY IN THAT THE FINANCIAL
SERVICES BUSINESS IS HIGHLY DEPENDENT ON COMPUTER APPLICATIONS IN A VARIETY OF
WAYS, INCLUDING THE FOLLOWING (i) THE COMPANY RELIES ON COMPUTER SYSTEMS IN
ALMOST ALL ASPECTS OF ITS BUSINESS, INCLUDING THE PROCESSING OF DEPOSITS, LOANS
AND OTHER SERVICES AND PRODUCTS OFFERED TO CUSTOMERS, THE FAILURE OF WHICH IN
CONNECTION WITH THE YEAR 2000 COULD CAUSE SYSTEMIC DISRUPTIONS AND FAILURES IN
THE PRODUCTS AND SERVICES OFFERED BY THE COMPANY, (ii) OTHER BANKS, CLEARING
HOUSES AND VENDORS WHOSE PRODUCTS AND SERVICES THE COMPANY USES ARE AT RISK OF
SYSTEMIC DISRUPTIONS AND POTENTIAL FAILURES IN THE EVENT THAT SUCH
19
<PAGE>
ENTITIES HAVE NOT ADEQUATELY ADDRESSED THEIR YEAR 2000 ISSUE PRIOR TO THE
YEAR 2000, (iii) THE CREDITWORTHINESS OF BORROWERS OF THE COMPANY MIGHT BE
DIMINISHED BY SIGNIFICANT DISRUPTIONS OF THEIR BUSINESS AS A RESULT OF THEIR
OWN OR OTHERS FAILURE TO ADDRESS ADEQUATELY THE YEAR 2000 ISSUES PRIOR TO THE
YEAR 2000, AND (iv) FEDERAL BALANCING AGENCIES HAVE ISSUED INTERAGENCY
GUIDANCE ON THE BUSINESS-WIDE RISK POSED TO FINANCIAL INSTITUTIONS BY THE
YEAR 2000 PROBLEM PURSUANT TO WHICH THE FEDERAL BANKING AGENCIES MAY TAKE
SUPERVISORY ACTION AGAINST FINANCIAL INSTITUTIONS THAT FAIL TO ADDRESS
APPROPRIATELY YEAR 2000 ISSUES PRIOR TO THE YEAR 2000, INCLUDING FORMAL AND
INFORMAL ENFORCEMENT ACTIONS, DENIAL OF APPLICATIONS TO THE FEDERAL BANKING
AGENCIES, CIVIL MONEY PENALTIES AND A REDUCTION IN THE MANAGEMENT COMPONENT
RATING OF THE INSTITUTIONS COMPOSITE RATING.
IN ORDER TO ADDRESS THE YEAR 2000 ISSUES FACING THE COMPANY, THE COMPANY'S
MANAGEMENT HAS INITIATED A PROGRAM TO PREPARE THE COMPANY'S COMPUTER SYSTEMS
AND APPLICATIONS FOR THE YEAR 2000 (THE "YEAR 2000 PLAN). THE PRIMARY FOCUS
OF THE YEAR 2000 PLAN IS TO CONVERT TO THE TARGET SYSTEMS IDENTIFIED AND
BELIEVED TO BE YEAR 2000 COMPLIANT. THE COMPANY EXPECTS TO INCUR INTERNAL
STAFF COSTS AS WELL AS CONSULTING AND OTHER EXPENSES RELATED TO
INFRASTRUCTURE AND FACILITIES ENHANCEMENTS NECESSARY TO PREPARE FOR
CONVERSION AND YEAR 2000 SYSTEM PREPARATIONS, TESTING AND CONVERSION OF
PRIMARY SYSTEM APPLICATIONS AND HARDWARE IS EXPECTED TO COST APPROXIMATELY
$191,000 TO BE EXPENDED DURING FISCAL YEARS 1998 AND 1999.
AS A PART OF THE YEAR 2000 PLAN, THE COMPANY IS NOT ONLY UNDERTAKING THE
INFRASTRUCTURE AND FACILITIES ENHANCEMENT AND TESTING NECESSARY TO ENSURE THAT
THE COMPANY IS ADEQUATELY PREPARED FOR THE YEAR 2000, BUT THE COMPANY IS ALSO
COMMUNICATING WITH ITS VENDORS UPON WHOSE SERVICES THE COMPANY RELIES TO ENSURE
YEAR 2000 COMPLIANCE. PURSUANT TO THE YEAR 2000 PLAN, THE COMPANY HAS COMPLETED
TESTING OF ITS MISSION-CRITICAL SYSTEMS AND THE COMPUTER-RELATED INTERACTIVE
VENDOR SYSTEMS AS OF MARCH 31, 1999. IN ADDITION, AS PART OF THE CREDIT REVIEW
PROCESS, THE COMPANY IS COMMUNICATING WITH ITS MAJOR BORROWERS IN AN EFFORT TO
ENSURE THAT SUCH BORROWERS HAVE TAKEN APPROPRIATE STEPS TO ADDRESS THEIR YEAR
2000 ISSUES AND WILL NOT BE MATERIALLY AFFECTED BY ANY YEAR 2000 PROBLEMS. THE
COMPANY IS COMMUNICATING WITH ITS DEPOSIT CUSTOMERS AS WELL. THE COMPANY HAS
CONTINGENCY PLANS TO PROTECT THE COMPANY IN THE EVENT THAT THE COMPANY IS UNABLE
TO ATTAIN YEAR 2000 COMPLIANCE IN CERTAIN APPLICATIONS ACCORDING TO THE YEAR
2000 PLAN.
THE COMPANY HAS ESTABLISHED A WORKING COMMITTEE COMPRISED OF
20
<PAGE>
SENIOR AND MIDDLE MANAGEMENT TO PLAN FOR AND MONITOR THE COMPANY'S COMPLIANCE
WITH YEAR 2000 ISSUES. THIS COMMITTEE HAS DEVELOPED A COMPREHENSIVE POLICY
SETTING FORTH PRIORITIES AND A TIMETABLE FOR THE BANK TO FOLLOW IN THIS
PROCESS.
THE COMPANY HAS DEVELOPED A CONTINGENCY PLAN THAT IDENTIFIES THE MISSION
CRITICAL PROCESSES AND SERVICE PROVIDERS. AN ALTERNATIVE PROVIDER OR PROCESS HAS
BEEN IDENTIFIED FOR EACH MISSION CRITICAL VENDOR. IN ADDITION, ON THE ASSUMPTION
THAT THE ORIGINAL OR ALTERNATIVE PROCESS FAILS AT THE POINT OF PROCESSING IN THE
YEAR 2000, CONTINGENCY PLANS ARE BEING DESIGNED THAT WILL PROVIDE MINIMUM LEVELS
OF SERVICE OR OUTPUTS UNTIL THE FAILED SYSTEM CAN BE REPAIRED OR REPLACED. MOST
OF THESE CONTINGENCY PLANS ARE MANUAL EFFORT SYSTEMS. TEST RESULTS TO-DATE
INDICATES THAT THE ORIGINAL SYSTEM FOR EACH MISSION CRITICAL SYSTEM SHOULD MEET
THE DEMANDS OF PROCESSING IN THE YEAR 2000. AS A REASONABLE WORST CASE, THE
MANUAL SYSTEMS DESIGNED SHOULD PROVIDE THE MINIMUM LEVELS OF SERVICE FOR THE
TIME REQUIRED TO REPAIR OR REPLACE FAILED SYSTEMS. HOWEVER, IN THE CASE OF
FAILURE, THE ULTIMATE IMPACT ON FINANCIAL OPERATIONS IS NOT KNOWN, NOR IS IT
KNOWN WHAT IMPACT A REGIONAL OR NATIONWIDE POWER FAILURE OR COMMUNICATIONS
BREAKDOWN WOULD HAVE ON THE FINANCIAL PERFORMANCE OF THE COMPANY.
THE COMPANY HAS CREATED A BUDGET SPECIFIC TO YEAR 2000 READINESS. THE BUDGET IS
COMPRISED OF THE FOLLOWING COMPONENTS: (1) CONSULTING ASSISTANCE FOR TESTING,
(2) AUDITING, AND (3) OPERATING SYSTEM AND NETWORK UPGRADES. THIS COMPONENT IS
BUDGETED AT $191,000. AT JUNE 30, 1999, A TOTAL OF $164,768 OR 86% HAS BEEN
SPENT, $93,664 IN 1999 AND $71,104 IN 1998. SENIOR MANAGEMENT REVIEWS THE BUDGET
FROM TIME TO TIME AS THE YEAR 2000 PLAN IS IMPLEMENTED. THERE IS NO ASSURANCE
THAT ADDITIONAL AMOUNTS WILL NOT BE ADDED TO THE AMOUNTS ALREADY BUDGETED FOR
YEAR 2000 EXPENDITURES. WITH RESPECT COMPONENTS NUMBER (1) AND (2), IT SHOULD BE
NOTED THAT HERITAGE OAKS BANK HAS THE RESOURCES IN-HOUSE TO AUDIT REVIEW THE
EFFECTIVENESS OF THE YEAR 2000 PLAN AND THE TECHNOLOGICAL ASSISTANCE NECESSARY
IN PREPARING FOR AND CONDUCTING THE COMPANY'S TESTING PLAN.
IN ADDITION, THE COMPANY HAS DEDICATED SIGNIFICANT HUMAN RESOURCES TO THE YEAR
2000 PLAN. THIS INCLUDES THE SALARIES AND BENEFITS OF PERSONNEL DEVOTING
SIGNIFICANT TIME TO THE PLAN. AS OF JUNE 30, 1999, THE COMPANY HAD EXPENDED OVER
$27,500 IN "MAN-HOURS" TO THE PROJECT. IN ADDITION, EXPENDITURES HAVE BEEN MADE
IN THE AREAS OF ADVERTISING AND PUBLIC RELATIONS, CUSTOMER AND EMPLOYEE
AWARENESS PROGRAMS AND MORE.
21
<PAGE>
IN APRIL OF 1998, THE COMPANY INITIATED A CREDIT RISK ASSESSMENT PROGRAM, WITH
LOAN OFFICERS COMPLETING A YEAR 2000 QUESTIONNAIRE FOR ALL NEW AND RENEWED
CREDITS IN AMOUNTS OVER $150,000.00. THESE QUESTIONNAIRES WERE DESIGNED TO
PROVIDE THE COMPANY'S MANAGEMENT WITH INFORMATION BY WHICH IT COULD EVALUATE THE
BORROWER'S AWARENESS OF AND SENSITIVITY TO YEAR 2000 RISK. QUESTIONNAIRES ARE
REVIEWED AND DISCUSSED AT WEEKLY OFFICER LOAN COMMITTEE MEETINGS AND ARE FURTHER
REVIEWED BY CREDIT ADMINISTRATION AND SENIOR LENDER TO ASCERTAIN YEAR 2000 RISK
ASSOCIATED WITH THE CREDIT. AS A RESULT OF THIS REVIEW, $105,057 HAS BEEN
ALLOCATED TO THE COMPANY'S LOAN LOSS PROVISION. IN ADDITION, LEGAL YEAR 2000
ISSUES ARE INCLUDED IN SIGNIFICANT COMMITMENT LETTERS AND LOAN DOCUMENTATION FOR
CERTAIN BORROWERS. FINALLY, ON LOAN PARTICIPATION'S PURCHASED, THE COMPANY
REQUIRES ASSURANCES FROM THE LEAD LENDER THAT IT HAS OBTAINED A YEAR 2000
QUESTIONNAIRE FROM THE BORROWER AND ALSO THAT THE LEAD LENDER IS SATISFACTORILY
PROGRESSING TOWARD YEAR 2000 COMPLIANCE.
ALTHOUGH THE COMPANY BELIEVES THAT ITS YEAR 2000 PLAN AND OTHER STEPS BEING
TAKEN ARE ADEQUATE TO ENSURE THAT IT WILL NOT BE MATERIALLY AFFECTED BY THE YEAR
2000 PROBLEM, THERE CAN BE NO ASSURANCE THAT THE YEAR 2000 PLAN AND THE
COMPANY'S OTHER YEAR 2000 REMEDIAL AND CONTINGENCY PLANS WILL FULLY PROTECT THE
COMPANY FROM THE RISKS ASSOCIATED WITH THE YEAR 2000. THE ANALYSIS OF, AND
PREPARATION FOR, THE YEAR 2000 AND RELATED PROBLEMS NECESSARILY RELY ON A
VARIETY OF ASSUMPTIONS ABOUT FUTURE EVENTS AND THERE CAN BE NO ASSURANCE THAT
THE COMPANY'S MANAGEMENT HAS ACCURATELY PREDICTED SUCH FUTURE EVENTS OR THAT THE
REMEDIAL AND CONTINGENCY PLANS OF THE COMPANY WILL ADEQUATELY ADDRESS SUCH
FUTURE EVENTS. IN THE EVENT THAT THE BUSINESS OF THE COMPANY, OF VENDORS OF THE
COMPANY OR OF CUSTOMERS OF THE COMPANY IS DISRUPTED AS A RESULT OF THE YEAR 2000
PROBLEM, SUCH DISRUPTION COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY.
PART 2. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
THE BANK IS NOT AWARE OF ANY LEGAL PROCEEDING AGAINST IT THAT WILL HAVE A
MATERIAL EFFECT ON THE COMPANY'S FINANCIAL STATEMENTS.
22
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
HERITAGE OAKS BANCORP
DATE: JULY 20, 1998
S/ LAWRENCE P. WARD
-------------------
LAWRENCE P. WARD
PRESIDENT
CHIEF EXECUTIVE OFFICER
S/ MARGARET A. TORRES
---------------------
MARGARET A. TORRES
CHIEF FINANCIAL OFFICER
EXECUTIVE VICE PRESIDENT
23
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<PAGE>
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 16,997,472
<INT-BEARING-DEPOSITS> 670,124
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<TRADING-ASSETS> 0
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<ALLOWANCE> 1,155,032
<TOTAL-ASSETS> 132,261,502
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0
0
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