**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

| **ý****  Quarterly Report Under Section  13 or 15(d) of the Securities Exchange Act of 1934**                                                                                   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                      |
| **for the Quarterly Period Ended  September 30, 2003**                                                                                                                                    |
| **or**                                                                                                                                                                                    |
|                                                                                                                                                                                      |
| **o****  Transition Report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                 |
|                                                                                                                                                                                      |
| **for the Transition Period from                 to            ** |

 

**Commission File Number: 0-27384**

 

**CAPITAL CORP OF THE WEST**

(Exact name of registrantas specified in its charter)

 

| **California**                                                   |   | **77-0405791**         |
|------------------------------------------------------------------|--------|------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | IRS Employer ID Number |
|                                                             |   |                   |
| **550  West Main, Merced, CA  95340**                       |
| (Address of principal  executive offices)                        |

 

Registrant’stelephone number, including area code:     **(209) 725-2200**

 

Formername, former address and former fiscal year, if changed since last report:  **Notapplicable**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes   ý No   o

 

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

 

Thenumber of shares outstanding of the registrant’s common stock, no par value, asof November 6, 2003 was 5,631,887.

 

 

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**Capital Corp of the West**

Table of Contents

 

 
| PART I. —  FINANCIAL INFORMATION                                                                      |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| Item 1.   Financial Statements                                                                        |
| Consolidated Balance Sheets  (unaudited)                                                                   |
| Consolidated  Statements of Income and Comprehensive Income (unaudited)                                    |
| Consolidated  Statement of Changes in Stockholders’ Equity (unaudited)                                |
| Consolidated  Statements of Cash Flows (unaudited)                                                         |
| Notes to the  Consolidated Financial Statements (unaudited)                                                |
|                                                                                                       |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations |
|                                                                                                       |
| Item  3.  Quantitative and Qualitative  Disclosures about Market Risk                                 |
| Item  4.  Controls and Procedures                                                                     |
|                                                                                                       |
| PART II.  — OTHER INFORMATION                                                                    |
|                                                                                                       |
| Item  1.  Legal Proceedings                                                                           |
| Item 2.   Changes in Securities and Use of Proceeds                                                   |
| Item 3.   Defaults Upon Senior Securities                                                             |
| Item 4.   Submission of Matters to a Vote of Security Holders                                         |
| Item 5.   Other Information                                                                           |
| Item  6.  Exhibits and Reports on Form 8-K                                                            |
|                                                                                                       |
| SIGNATURES                                                                                                 |
|                                                                                                       |
| Exhibit Index                                                                                              |

 

2

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Capital Corp of the West

Consolidated Balance Sheets

(Unaudited)

 
|                                                                                                                                                     |   | **September  30,  2003**    |      | **December  31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-----------|-------------------------|--------|
|                                                                                                                                                     |   | **(Dollars  in thousands)** |      |
| **Assets**                                                                                                                                               |   |                        |      |                    |   |
| Cash and  noninterest-bearing deposits in other banks                                                                                                    |   | $                           | 40,540    |                    | $      | 46,628 |   |
| Federal funds  sold                                                                                                                                      |   | 28,290                      |      | 26,555                  |   |
| Time deposits at  other financial institutions                                                                                                           |   | 350                         |      | 500                     |   |
| Investment  securities available for sale, at fair value                                                                                                 |   | 237,114                     |      | 231,392                 |   |
| Investment  securities held to maturity at cost, fair value of $89,380 and $57,905 at  September 30, 2003 and December 31, 2002                          |   | 89,480                      |      | 55,628                  |   |
| Loans, net of  allowance for loan losses of  $13,177  and $12,134 at September 30, 2003 and December 31, 2002                                       |   | 708,745                     |      | 621,639                 |   |
| Interest  receivable                                                                                                                                     |   | 5,378                       |      | 5,532                   |   |
| Premises and  equipment, net                                                                                                                             |   | 14,429                      |      | 13,942                  |   |
| Intangible assets                                                                                                                                        |   | 2,815                       |      | 3,325                   |   |
| Other assets                                                                                                                                             |   | 35,250                      |      | 29,069                  |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| Total assets                                                                                                                                             |   | $                           | 1,162,391 |                    | $      | 1,034,210 |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| **Liabilities  and Shareholders’ Equity**                                                                                                           |   |                        |      |                    |   |
| Deposits                                                                                                                                                 |   |                        |      |                    |   |
| Noninterest-bearing  demand                                                                                                                              |   | $                           | 172,945   |                    | $      | 164,852 |   |
| Negotiable  orders of withdrawal                                                                                                                         |   | 125,076                     |      | 120,449                 |   |
| Savings                                                                                                                                                  |   | 308,254                     |      | 223,404                 |   |
| Time, under  $100,000                                                                                                                                    |   | 175,060                     |      | 164,959                 |   |
| Time, $100,000  and over                                                                                                                                 |   | 193,497                     |      | 160,715                 |   |
| Total deposits                                                                                                                                           |   | 974,832                     |      | 834,379                 |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| Borrowed funds                                                                                                                                           |   | 90,235                      |      | 110,204                 |   |
| Accrued  interest, taxes and other liabilities                                                                                                           |   | 5,711                       |      | 6,458                   |   |
| Total  liabilities                                                                                                                                  |   | 1,070,778                   |      | 951,041                 |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| Capital  Securities                                                                                                                                      |   | 6,000                       |      | 6,000                   |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| Preferred Stock,  no par value; 10,000,000 shares authorized;   None outstanding                                                                    |   | —                      |      | —                  |   |
| Common stock, no  par value; 20,000,000 shares authorized; 5,619,770 and 5,591,336 issued &  outstanding at September 30, 2003 and December 31, 2002 |   | 53,436                      |      | 46,436                  |   |
| Retained  earnings                                                                                                                                       |   | 31,228                      |      | 27,824                  |   |
| Accumulated  other comprehensive income                                                                                                                  |   | 949                         |      | 2,909                   |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| Total  shareholders’ equity                                                                                                                         |   | 85,613                      |      | 77,169                  |   |
|                                                                                                                                                     |   |                        |      |                    |   |
| Total  liabilities, Capital Securities and shareholders’ equity                                                                                     |   | $                           | 1,162,391 |                    | $      | 1,034,210 |   |

 

See accompanying notes toconsolidated financial statements

 

3

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Capital Corp of the West

Consolidated Statements of Income and ComprehensiveIncome

(Unaudited)

 
|                                                                           |   | **For the  Three Months  Ended September 30,** |   | **For the  Nine Months  Ended September 30,** |   |
|--------------------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                           |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                                                           |   | **(In  thousands, except per share data)**     |   |
| Interest income:                                                               |   |                                           |   |                                          |   |   |   |   |   |
| Interest and  fees on loans                                                    |   | $                                              | 12,735 |                                          | $      | 11,292 |   | $ | 36,154 |   | $ | 32,107 |   |
| Interest on  deposits with other financial institutions                        |   | 2                                              |   | 3                                             |   | 7 |   | 8 |   |
| Interest on  investments held to maturity:                                     |   |                                           |   |                                          |   |   |   |   |   |
| Taxable                                                                        |   | 621                                            |   | 846                                           |   | 2,101 |   | 2,741 |   |
| Non-taxable                                                                    |   | 328                                            |   | 55                                            |   | 438 |   | 165 |   |
| Interest on  investments available for sale:                                   |   |                                           |   |                                          |   |   |   |   |   |
| Taxable                                                                        |   | 2,271                                          |   | 2,697                                         |   | 6,766 |   | 7,695 |   |
| Non-taxable                                                                    |   | —                                         |   | 272                                           |   | 545 |   | 817 |   |
| Interest on  federal funds sold                                                |   | 95                                             |   | 127                                           |   | 185 |   | 226 |   |
| Total interest  income                                                         |   | 16,052                                         |   | 15,292                                        |   | 46,196 |   | 43,759 |   |
|                                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Interest  expense:                                                             |   |                                           |   |                                          |   |   |   |   |   |
| Interest on  negotiable orders of withdrawal                                   |   | 14                                             |   | 47                                            |   | 42 |   | 159 |   |
| Interest on  savings deposits                                                  |   | 728                                            |   | 787                                           |   | 1,951 |   | 2,477 |   |
| Interest on time  deposits, under $100,000                                     |   | 1,127                                          |   | 1,416                                         |   | 3,351 |   | 4,300 |   |
| Interest on  time, $100,000 and over                                           |   | 1,103                                          |   | 1,229                                         |   | 3,153 |   | 3,577 |   |
| Interest on  other borrowings                                                  |   | 1,012                                          |   | 1,237                                         |   | 3,356 |   | 3,411 |   |
| Total interest  expense                                                        |   | 3,984                                          |   | 4,716                                         |   | 11,853 |   | 13,924 |   |
|                                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Net interest  income                                                           |   | 12,068                                         |   | 10,576                                        |   | 34,343 |   | 29,835 |   |
| Provision for  loan losses                                                     |   | 751                                            |   | 1,190                                         |   | 1,904 |   | 3,421 |   |
| Net interest  income after provision for loan losses                           |   | 11,317                                         |   | 9,386                                         |   | 32,439 |   | 26,414 |   |
|                                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Noninterest  income:                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Service charges  on deposit accounts                                           |   | 1,430                                          |   | 1,326                                         |   | 4,064 |   | 3,732 |   |
| Other                                                                          |   | 1,114                                          |   | 960                                           |   | 3,202 |   | 2,463 |   |
| Total  noninterest income                                                      |   | 2,544                                          |   | 2,286                                         |   | 7,266 |   | 6,195 |   |
|                                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Noninterest  Expense:                                                          |   |                                           |   |                                          |   |   |   |   |   |
| Salaries and  related benefits                                                 |   | 4,742                                          |   | 4,232                                         |   | 14,179 |   | 12,015 |   |
| Equipment                                                                      |   | 875                                            |   | 745                                           |   | 2,336 |   | 2,165 |   |
| Premises and  occupancy                                                        |   | 727                                            |   | 676                                           |   | 2,109 |   | 1,816 |   |
| Professional  fees                                                             |   | 310                                            |   | 322                                           |   | 1,068 |   | 892 |   |
| Marketing                                                                      |   | 208                                            |   | 270                                           |   | 716 |   | 677 |   |
| Intangible  amortization                                                       |   | 170                                            |   | 170                                           |   | 510 |   | 510 |   |
| Supplies                                                                       |   | 183                                            |   | 201                                           |   | 615 |   | 558 |   |
| Other                                                                          |   | 1,934                                          |   | 1,714                                         |   | 5,120 |   | 4,635 |   |
| Total  noninterest expense                                                     |   | 9,149                                          |   | 8,330                                         |   | 26,653 |   | 23,268 |   |
|                                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Income before  income taxes                                                    |   | 4,712                                          |   | 3,342                                         |   | 13,052 |   | 9,341 |   |
| Provision for  income taxes                                                    |   | 1,084                                          |   | 356                                           |   | 3,002 |   | 1,747 |   |
| Net income                                                                     |   | $                                              | 3,628  |                                          | $      | 2,986 |   | $ | 10,050 |   | $ | 7,594 |   |
| Comprehensive  Income:                                                         |   |                                           |   |                                          |   |   |   |   |   |
| Unrealized  (loss) gain on securities and swaps arising during the period, net |   | (1,368                                         | )      | 1,199                                         |   | (1,960 | ) | 1,430 |   |
| Comprehensive  income                                                          |   | $                                              | 2,260  |                                          | $      | 4,185 |   | $ | 8,090 |   | $ | 9,024 |   |
|                                                                           |   |                                           |   |                                          |   |   |   |   |   |
| Basic earnings  per share                                                      |   | $                                              | 0.65   |                                          | $      | 0.54 |   | $ | 1.79 |   | $ | 1.38 |   |
| Diluted earnings  per share                                                    |   | $                                              | 0.62   |                                          | $      | 0.52 |   | $ | 1.73 |   | $ | 1.34 |   |

 

See accompanying notes toconsolidated financial statements

 

4

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Capital Corp of the West

Consolidated Statement ofChanges in Shareholders’ Equity

(Unaudited)

 
| **(Amounts in thousands)**                                                                                      |   | **Common Stock** |   | **Retained  earnings** |   | **Accumulated  Other  comprehensive  income (loss)** |   | **Total** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|------------------|--------|------------------------|--------|------------------------------------------------------|--------|-----------|--------|
| **Number of  shares**                                                                                           |   | **Amounts**      |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| Balance,  December 31, 2002                                                                                     |   | 5,325            |   | $                      | 46,436 |                                                 | $      | 27,824    |   | $ | 2,909 |   | $ | 77,169 |   |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| Exercise of  stock options                                                                                      |   | 28               |   | 325                    |   | —                                               |   | —    |   | 325 |   |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| Issuance of  shares pursuant to 401K plan                                                                       |   | 1                |   | 43                     |   |                                                 |   |      |   | 43 |   |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| Net Change in  fair market value of  investment  securities and swaps, net of  tax  benefit of $1,307 |   | —           |   | —                 |   | —                                               |   | (1,960    | )      | (1,960 | ) |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| 5% stock  dividend, including cash payment for fractional shares                                                |   | 266              |   | 6,632                  |   | (6,646                                               | )      |      |   | (14 | ) |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| Net income                                                                                                      |   | —           |   | —                 |   | 10,050                                               |   | —    |   | 10,050 |   |
|                                                                                                            |   |             |   |                   |   |                                                 |   |      |   |   |   |
| Balance,  September 30, 2003                                                                                    |   | 5,620            |   | $                      | 53,436 |                                                 | $      | 31,228    |   | $ | 949 |   | $ | 85,613 |   |

 

See accompanying notes toconsolidated financial statements

 

5

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Capital Corp of the West

Consolidated Statements of Cash Flows

(Unaudited)

 
| **(Dollars in thousands)**                                                         |   | **9 months  ended  September 30,  2003** |   | **9 months  ended  September 30,  2002** |   |
|------------------------------------------------------------------------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
| **Operating activities:**                                                          |   |                                     |   |                                     |   |
| Net income                                                                         |   | $                                        | 10,050 |                                     | $      | 7,594 |   |
| Adjustments to  reconcile net income to net cash provided by Operating activities: |   |                                     |   |                                     |   |
| Provision for  loan losses                                                         |   | 1,904                                    |   | 3,421                                    |   |
| Depreciation,  amortization and accretion, net                                     |   | 4,069                                    |   | 2,827                                    |   |
| (Gain) loss on  sale of real estate owned                                          |   | (81                                      | )      | 33                                       |   |
| Net increase in  interest receivable & other assets                            |   | (4,970                                   | )      | (1,016                                   | )      |
| Net increase in  deferred loan fees                                                |   | 560                                      |   | 579                                      |   |
| Net decrease in  accrued interest payable & other liabilities                  |   | (747                                     | )      | (5,691                                   | )      |
| Net cash  provided by operating activities                                         |   | 10,785                                   |   | 7,747                                    |   |
|                                                                               |   |                                     |   |                                     |   |
| **Investing activities:**                                                          |   |                                     |   |                                     |   |
| Investment  securities purchases                                                   |   | (167,156                                 | )      | (66,311                                  | )      |
| Proceeds from  maturities of investment securities                                 |   | 119,196                                  |   | 37,724                                   |   |
| Proceeds from  sales of available for sale securities                              |   | 4,034                                    |   | 11,057                                   |   |
| Net decrease in  time deposits in other financial institutions                     |   | 150                                      |   | —                                   |   |
| Proceeds from  sales of  loans                                                |   | 3,210                                    |   | 1,901                                    |   |
| Net increase in  loans                                                             |   | (93,775                                  | )      | (84,312                                  | )      |
| Purchase of  premises and equipment                                                |   | (1,716                                   | )      | (2,301                                   | )      |
| Proceeds from  sales of real estate owned                                          |   | 81                                       |   | —                                   |   |
| Purchase of  subsidiary                                                            |   | —                                   |   | (520                                     | )      |
| Net cash used in  investing activities                                             |   | (135,976                                 | )      | (102,762                                 | )      |
|                                                                               |   |                                     |   |                                     |   |
| **Financing activities:**                                                          |   |                                     |   |                                     |   |
| Net increase in  demand, NOW and savings deposits                                  |   | 97,570                                   |   | 29,066                                   |   |
| Net increase in  certificates of deposit                                           |   | 42,883                                   |   | 38,203                                   |   |
| Net (repayments)  proceeds from other borrowings                                   |   | (19,969                                  | )      | 50,462                                   |   |
| Issuance of  shares pursuant to 401K and ESOP plans                                |   | 43                                       |   | 471                                      |   |
| Exercise of  stock options                                                         |   | 325                                      |   | 551                                      |   |
| Cash in lieu  fractional shares from stock dividend                                |   | (14                                      | )      | (12                                      | )      |
| Net cash  provided by financing activities                                         |   | 120,838                                  |   | 118,741                                  |   |
|                                                                               |   |                                     |   |                                     |   |
| Net (decrease)  increase in cash and cash equivalents                              |   | (4,353                                   | )      | 23,726                                   |   |
|                                                                               |   |                                     |   |                                     |   |
| Cash and cash  equivalents at beginning of period                                  |   | 73,183                                   |   | 49,288                                   |   |
| Cash and cash  equivalents at end of period                                        |   | $                                        | 68,830 |                                     | $      | 73,014 |   |
|                                                                               |   |                                     |   |                                     |   |
| **Cash paid during the quarter:**                                                  |   |                                     |   |                                     |   |
| Interest paid                                                                      |   | $                                        | 11,757 |                                     | $      | 13,972 |   |
| Income tax  payments                                                               |   | 3,775                                    |   | 3,075                                    |   |
| **Supplemental disclosure of noncash  investing****and financing activities:**     |   |                                     |   |                                     |   |
| Investment  securities unrealized (losses) gains and swaps, net of tax             |   | (1,960                                   | )      | 1,430                                    |   |
| Transfer of  securities from available for sale to held to maturity                |   | 24,557                                   |   | —                                   |   |

 

See accompanying notes toconsolidated financial statements

 

6

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Capital Corp of the West

Notes to ConsolidatedFinancial Statements

September 30, 2003 andDecember 31, 2002

(Unaudited)

 

GENERAL - COMPANY

 

Capital Corp of the West (the “Company” or “Capital Corp”) is a bankholding company incorporated under the laws of the State of California on April26, 1995.  On November 1, 1995, theCompany became registered as a bank holding company, and is a holder of all ofthe capital stock of County Bank (the “Bank”). During 1998, the Company formed Capital West Group, a subsidiary thatengages in the financial institution advisory business but is currentlyinactive.  The Company’s primary assetis the Bank****and the Bank is the Company’s primary source of income.  The Company’s securities consist of20,000,000 shares of Common Stock, no par value, 10,000,000 shares ofAuthorized Preferred Stock, and $6,000,000 of Trust Preferred 10.20% CapitalSecurities which have a liquidation amount of $1,000 per capital security.  As of September 30, 2003 there were 5,619,770common shares outstanding, held of record by approximately 1,700shareholders.  There were no preferredshares outstanding at September 30, 2003. The Bank has three wholly owned subsidiaries, Merced Area Investment& Development, Inc. (“MAID”), County Asset Advisors (“CAA”), and County InvestmentTrust (“REIT”).  CAA is currentlyinactive.  The Company purchased RegencyInvestment Advisors, Incorporated (“RIA”) on June 28, 2002.  RIA performs asset management and advisoryservices for businesses and individuals. The Company has two other wholly owned subsidiaries, County StatutoryTrust (“Trust”), and Capital West Group, Inc. The Trust is used in connection with the Capital Securities issued bythe Company.  Capital West Group, Inc.is currently inactive.  All referencesherein to the “Company” include the Company, the Company’s subsidiaries, theBank and the Bank’s subsidiaries, unless the context otherwise requires.

 

GENERAL - BANK

 

The Bank was organized on August 1, 1977, as CountyBank of Merced, a California state banking corporation.  The Bank commenced operations on December22, 1977.  In November 1992, the Bankchanged its legal name to County Bank. The Bank’s securities consist of one class of Common Stock, no par valueand is wholly owned by the Company.  TheBank’s deposits are insured under the Federal Deposit Insurance Act by theFederal Deposit Insurance Corporation (“FDIC”) up to applicable limits statedtherein.  The Bank is a member of theFederal Reserve System.

 

INDUSTRY AND MARKET AREA

 

The Bank engages in general commercial bankingbusiness primarily in Fresno, Madera, Mariposa, Merced, San Francisco, SanJoaquin, Stanislaus and Tuolomne counties. The Bank has nineteen full service branch offices; two of which arelocated in Merced with the branch located in downtown Merced currently servingas both a branch and as administrative headquarters. There are offices inAtwater, Dos Palos, Hilmar, Livingston, Los Banos, Madera, Mariposa, SanFrancisco, Sonora, Stockton, two offices in Modesto, three in Fresno and twooffices in Turlock.  The Bank’sadministrative headquarters also provides accommodations for the activities ofMerced Area Investment & Development (“MAID”), the Bank’s wholly owned realestate subsidiary.

 

OTHER FINANCIAL NOTES

 

All adjustments which in the opinion of Management arenecessary for a fair presentation of the Company’s financial position atSeptember 30, 2003 and December 2002 and the results of operations for

 

7

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the three and nine month periods ended September 30, 2003 and 2002, andthe statements of cash flows for the nine months ended September 30, 2003 and2002 have been included.  Earnings pershare have been adjusted to reflect the affect of the 5% stock dividend thatwas paid April 25, 2003 to shareholders of record on April 1, 2003.  The interim results for the three and ninemonths ended September 30, 2003 are not necessarily indicative of results to beexpected for the full year.  Thesefinancial statements should be read in conjunction with the financialstatements and the notes included in the Company’s Annual Report on From 10-Kfor the year ended December 31, 2002.

 

The accompanying unaudited financial statements havebeen prepared on a basis consistent with generally accepted accounting principlesand with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.

 

EARNINGS PER SHARE

 

Basic earnings per share (EPS) is computed by dividingnet income available to shareholders by the weighted average number of commonshares outstanding during the period. Diluted earnings per share is computed by dividing net income availableto common shareholders by the weighted average number of common sharesoutstanding during the period plus potential common shares outstanding.  Diluted earnings per share reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the Company.

 

The following tables provide a reconciliation of thenumerator and denominator of the basic and diluted earnings per sharecomputation for the three and nine month periods ended September 30, 2003 and2002:

 
|                                              |   | **For The  Three Months  Ended September 30,** |   | **For The Nine  Months  Ended September 30,** |   |
|---------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
| **(Dollars in thousands, except per share data)** |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                              |   |                                           |   |                                          |   |   |   |   |   |
| Basic EPS  computation:                           |   |                                           |   |                                          |   |   |   |   |   |
| Net income                                        |   | $                                              | 3,628  |                                          | $      | 2,986 |   | $ | 10,050 |   | $ | 7,594 |   |
| Average common  shares outstanding                |   | 5,610                                          |   | 5,568                                         |   | 5,602 |   | 5,522 |   |
| Basic EPS                                         |   | $                                              | 0.65   |                                          | $      | 0.54 |   | $ | 1.79 |   | $ | 1.38 |   |
|                                              |   |                                           |   |                                          |   |   |   |   |   |
| Diluted EPS  Computations:                        |   |                                           |   |                                          |   |   |   |   |   |
| Net income                                        |   | $                                              | 3,628  |                                          | $      | 2,986 |   | $ | 10,050 |   | $ | 7,594 |   |
| Average common  shares outstanding                |   | 5,610                                          |   | 5,568                                         |   | 5,602 |   | 5,522 |   |
| Effect of stock  options                          |   | 238                                            |   | 133                                           |   | 211 |   | 155 |   |
|                                              |   | 5,848                                          |   | 5,701                                         |   | 5,813 |   | 5,677 |   |
| Diluted EPS                                       |   | $                                              | 0.62   |                                          | $      | 0.52 |   | $ | 1.73 |   | $ | 1.34 |   |

 

8

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INTANGIBLE ASSETS

 

The Company has intangible assets consisting of coredeposit premiums and goodwill.  Coredeposit premiums are amortized using an accelerated method over a period of tenyears.  Intangible assets related togoodwill are no longer amortized after December 31, 2001 but will be reviewedfor potential impairment.  Managementhas determined there was no impairment of goodwill as of December 31,2002.  Additionally, there have been noevents that have occurred during the first nine months of 2003 that wouldrequire another assessment.  As ofSeptember 30, 2003 and December 31, 2002, the Company had unamortized coredeposit premiums of $890,000 and $1,390,000, respectively.  Amortization of core deposit premiums andother intangibles was $170,000 during the third quarter of 2003 and 2002 and$510,000 for the nine months ended September 30, 2003 and 2002.  Core deposit premiums and other intangiblesare scheduled to amortize at a rate of approximately $167,000 per quarterthrough the quarter ended September 30, 2004, $153,000 during the fourthquarter of 2004, $11,499 for all of 2005 and the first quarter of 2006 and$11,505 during the second quarter of 2006. Core deposit premiums of $460,000 and $4,340,000 were initially recordedas a result of purchasing deposits from Town and Country Finance and Thrift inJuly, 1996 and from the purchase of three branches from Bank of America inDecember, 1997, respectively.

 

STOCK COMPENSATION

 

The Company provides stock-based compensation tocertain officers and directors.  TheCompany uses the intrinsic value method to account for its stock option plans(in accordance with the provisions of Accounting Principles Board Opinion No.25).  Under this method, compensationexpense is recognized for awards of options to purchase shares of common stockto employees under compensatory plans only if the fair market value of thestock at the option grant date (or other measurement date, if later) is greaterthan the amount the employee must pay to acquire the stock.  Statement of Financial Accounting StandardsNo. 123, Accounting for Stock-Based Compensation (SFAS 123) permits companiesto continue using the intrinsic value method or to adopt a fair value basedmodel  to account for stock optionplans.  The fair value based methodresults in recognizing as expense over the vesting period the fair value of allstock-based awards on the date of grant. The Company has elected to continue to use the intrinsic value method.

 

9

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Had compensation cost for the Company’s option plans been determined inaccordance with SFAS 123, the Company’s net income and earnings per share wouldhave been reduced to the pro forma amounts indicated as follows:

 
|                                                                                         |   | **For the  three months  ended September 30,** |   | **For the  nine months  ended September 30,** |   |
|----------------------------------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
| **(dollars in thousands except per share amounts)**                                          |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
| Net income:                                                                                  |   |                                           |   |                                          |   |   |   |   |   |
| As reported                                                                                  |   | $                                              | 3,628  |                                          | $      | 2,986 |   | $ | 10,050 |   | $ | 7,594 |   |
| Pro forma                                                                                    |   | $                                              | 3,446  |                                          | $      | 2,891 |   | $ | 9,580 |   | $ | 7,256 |   |
|                                                                                         |   |                                           |   |                                          |   |   |   |   |   |
| Basic earnings  per share:                                                                   |   |                                           |   |                                          |   |   |   |   |   |
| As reported                                                                                  |   | $                                              | 0.65   |                                          | $      | 0.54 |   | $ | 1.79 |   | $ | 1.38 |   |
| Pro forma                                                                                    |   | $                                              | 0.61   |                                          | $      | 0.52 |   | $ | 1.71 |   | $ | 1.31 |   |
|                                                                                         |   |                                           |   |                                          |   |   |   |   |   |
| Diluted earnings  per share:                                                                 |   |                                           |   |                                          |   |   |   |   |   |
| As reported                                                                                  |   | $                                              | 0.62   |                                          | $      | 0.52 |   | $ | 1.73 |   | $ | 1.34 |   |
| Pro forma                                                                                    |   | $                                              | 0.59   |                                          | $      | 0.51 |   | $ | 1.65 |   | $ | 1.28 |   |
|                                                                                         |   |                                           |   |                                          |   |   |   |   |   |
| Stock-based  employee compensation cost included in salaries and related benefits:           |   |                                           |   |                                          |   |   |   |   |   |
| As reported                                                                                  |   | $                                              | — |                                          | $      | — |   | $ | — |   | $ | — |   |
| Pro forma                                                                                    |   | $                                              | 189    |                                          | $      | 101 |   | $ | 486 |   | $ | 357 |   |
|                                                                                         |   |                                           |   |                                          |   |   |   |   |   |
| Stock-based  employee compensation cost, net of related tax effects, included in net income: |   |                                           |   |                                          |   |   |   |   |   |
| As reported                                                                                  |   | $                                              | — |                                          | $      | — |   | $ | — |   | $ | — |   |
| Pro forma                                                                                    |   | $                                              | 182    |                                          | $      | 95 |   | $ | 470 |   | $ | 338 |   |

 

10

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RECENT ACCOUNTING PRONOUNCEMETS

 

InJanuary 2003, the FASB issued FIN 46, which clarifies the application ofAccounting Research Bulletin (“ARB”) 51, consolidated financial statements, tocertain entities (called variable interest entities) in which equity investorsdo not have the characteristics of a controlling financial interest or do nothave sufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties. The disclosurerequirements of this Interpretation are effective for all financial statementsissued after January 31, 2003. The consolidation requirements apply to allvariable interest entities created after January 31, 2003 and are effective forall financial statements issued after January 31, 2003.  In addition, public companies must apply theconsolidation requirements to variable interest entities that existed prior toFebruary 1, 2003 and remain in existence. This interpretation’s effective date was postponed to December 31, 2003as the FASB is expected to propose additional modifications by that date.

 

In April, 2003, the FASB issued FASB No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities*, which established accounting and reportingstandards for derivative instruments including certain derivative instrumentsembedded in other contracts (collectively referred to as derivatives) and forhedging activities.  Statement No. 149amends Statement 133 for decisions made (1), as part of the DerivativesImplementation Group process that effectively required amendments to Statement133, (2) in connection with other FASB projects dealing with financialinstruments, and (3) in connection with implementation issues raised inrelation to the application of the definition of a derivative.  This Statement was effective on July 1,2003.  This statement requires that anissuer classify a financial instrument that is within its scope as a liability(or asset in some circumstances).  TheCompany does have a derivative instrument in the form of a $20,000,000 notionalamount interest rate swap that was entered into in the fourth quarter of 2001and that matures on August 23, 2004. This interest rate swap has served as an effective cash flow hedge, andthis Statement did not have a material effect in the financial condition oroperating results of the Company.

 

In May 2003, the FASB issued FASB No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity,*which providesaccounting guidance for the classification and recording of financialinstruments that have characteristics of both liabilities and equity.  The Statement requires reporting thecumulative effect of a change in accounting principle for financial instrumentscreated before May 15, 2003 and still existing at the beginning of the interimperiod of adoption.  Restatement is notpermitted.  Certain provisions of thisStatement have been deferred to periods ending December 15, 2003.  The Company does not expect the applicationof this Statement to have a material effect on the financial statements.

 

11

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**Item2.      Management’s Discussion AndAnalysis Of Financial Condition And Results Of Operations**

 

The following Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements that are subject to risks and uncertainties and include informationabout possible or assumed future results of operations.  Many possible events or factors could affectthe future financial results and performance of the company.  This could cause results or performance todiffer materially from those expressed in our forward-looking statements.  Words such as “expects”, “anticipates”,“believes”, “estimates”, variations of such words and other similar expressionsare intended to identify such forward-looking statements.  These statements are not guarantees offuture performance and involve certain risks, uncertainties and assumptionswhich are difficult to predict. Therefore, actual outcomes and results may differ materially from whatis expressed or forecasted in, or implied by, such forward-looking statements.

 

Readers of the Company’s Form 10-Q should not relysolely on forward looking statements and should consider all uncertainties andrisks discussed throughout this report, as well as those discussed in theCompany’s 2002 Annual Report on Form 10-K filed March 27, 2003.  These statements are representative only onthe date hereof, and the Company undertakes no obligation to update any forward-lookingstatements made.  Some possible eventsor factors that could occur that may cause differences from expected resultsinclude the following: the Company’s loan growth is dependent on economicconditions, as well as various discretionary factors, such as decisions tosell, or purchase certain loans or loan portfolios; participations of loans andthe management of borrower, industry, product and geographic concentrations andthe mix of the loan portfolio.  The rateof charge-offs and provision expense can be affected by local, regional and internationaleconomic and market conditions, concentrations of borrowers, industries,products and geographical conditions, the mix of the loan portfolio andmanagement’s judgements regarding the collectibility of loans.  Liquidity requirements may change as aresult of fluctuations in assets and liabilities and off-balance sheetexposures, which will impact the capital and debt financing needs of theCompany and the mix of funding sources. Decisions to purchase, hold, or sell securities are also dependent onliquidity requirements and market volatility, as well as on and off-balancesheet positions.  Factors that mayimpact interest rate risk include local, regional and international economicconditions, levels, mix, maturities, yields or rates of assets and liabilitiesand the wholesale and retail funding sources of the Company.

 

The Company is also exposed to the potential of lossesarising from adverse changes in market rates and prices which can adverselyimpact the value of financial products, including securities, loans, anddeposits.  In addition, the bankingindustry in general is subject to various monetary and fiscal policies andregulations, which include those determined by the Federal Reserve Board, the FederalDeposit Insurance Corporation and state regulators, whose policies andregulations could affect the Company’s results.

 

Other factors that may cause actual results to differfrom the forward-looking statements include the following: competition withother local and regional banks, savings and loan associations, credit unionsand other nonbank financial institutions, such as investment banking firms,investment advisory firms, brokerage firms, mutual funds and insurancecompanies, as well as other entities which offer financial services; interestrate, market and monetary fluctuations; inflation; market volatility; generaleconomic conditions; introduction and acceptance of new banking-relatedproducts, services and enhancements; fee pricing strategies, mergers andacquisitions and their integration into the Company, civil disturbances orterrorist threats or acts, or apprehension about the possible futureoccurrences or acts of this type, outbreak or escalation of hostilities inwhich the United States is involved, any declaration of war by the

 

12

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U.S. Congress or any other national or international calamity, crisisor emergency, and management’s ability to manage these and other risks.

 

**Criticalaccounting policies and estimates**

 

The company’s discussion and analysis of its financialcondition and results of operations are based upon the Company’s consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States.  The preparation of these financial statements requires theCompany to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  Onan on-going basis, the Company evaluates its estimates, including those relatedto the adequacy of the allowance for loan losses, intangible assets, andcontingencies.  The Company bases itsestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions. (See caption “Allowancefor Loan Losses” for a more detailed discussion).

 

13

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Thefollowing discussion and analysis is designed to provide a better understandingof the significant changes and trends related to the Company and itssubsidiaries’ financial condition, operating results, asset and liabilitymanagement, liquidity and capital resources and should be read in conjunctionwith the Consolidated Financial Statements of the Company and the Notesthereto.

 

**Results Of Operations**

 

**Threeand Nine Months Ended September 30, 2003 Compared With Three and Nine MonthsEnded September 30, 2002**

 

*Overview.* For the three and nine months ended September 30, 2003 the Company reportedrecord net income of $3,628,000 and $10,050,000.  This compares to $2,986,000 and $7,594,000 for the same periodsin 2002 and represents an increase of $642,000 and $2,456,000 or 22% and 32%.  Basic earnings per share were $.65 and $1.79for the three and nine months ended September 30, 2003 and fully dilutedearnings per share were $.62 and $1.73. This compares to basic and fully diluted earnings per share of $.54 and$.52 for the three months and $1.38 and $1.34 for the nine months endedSeptember 30, 2002 and represents an increase of $0.11 and $0.10 per share forbasic and fully diluted earnings per share for the three months and $.41 and$.39 per share for the nine months ended September 30, 2003.  The basic and fully diluted earnings pershare reflect the 5% stock dividend paid in April, 2003.  The annualized return on average assets was1.26% and 1.23% for the three and nine months ended September 30, 2003 whichcompares with 1.20% and 1.08% for the three and nine months ended September 30,2002.  The Company’s annualized returnon average equity was 17.27% and 16.43% for the three and nine months endedSeptember 30, 2003 which compares with 16.72% and 14.87% for the same periodsin 2002.  The increased return on assetsand increased return on equity were primarily achieved through an increase ininterest earning assets and a reduction in the provision for loan losses.

* *

*NetInterest Income.*  The Company’s primary source of income isnet interest income and is determined by the difference between interest incomeand fees derived from earning assets and interest paid on interest bearingliabilities.  Net interest income forthe three and nine months ended September 30, 2003 rose 14% and 15% to a totalof $12,068,000 and $34,343,000, an increase of $1,492,000 and $4,508,000 whencompared to the $10,576,000 and $29,835,000 achieved during the three and ninemonths ended September 30, 2002.

 

Totalinterest and fees on earning assets were $16,052,000 and $46,196,000 for thethree and nine months ended September 30, 2003, rising 5% and 6% or $760,000and $2,437,000 when compared to the $15,292,000 and $43,759,000 achieved duringthe three and nine months ended September 30, 2002.  Total interest income is affected by changes in volume of andrates earned on interest-earning assets. Interest-earning assets consist primarily of loans, investmentsecurities and federal funds sold.  Theincrease in total interest income for the three and nine months ended September30, 2003 was primarily the result of an increase in volume of interest earningassets.  Average interest-earning assetsfor the three and nine months ended September 30, 2003 were $1,074,219,000 and$1,009,309,000 compared with $921,822,000 and $870,188,000 for the three andnine months ended September 30, 2002, an increase of $152,397,000 and$139,121,000 or 17% and 16%, respectively.

 

Interestexpense is a function of the volume of and the rates paid on interest-bearingliabilities.  Interest-bearingliabilities consist primarily of certain deposits and borrowed funds.  Total interest expense was $3,984,000 and$11,853,000 for the three and nine months ended September 30, 2003, comparedwith $4,716,000 and $13,924,000 for the three and nine months ended September30, 2002, a decrease of $732,000 and $2,071,000 or 16% and 15% for theseperiods. This decrease was primarily the result of a

 

14

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decrease in the average interest rate paid on interest-bearingliabilities which was due to a decrease in prevailing market interest rates.Average interest-bearing liabilities were $889,912,000 and $837,045,000 for thethree and nine months ended September 30, 2003 compared with $773,105,000 and$734,383,000 for the same three and nine months in 2002, an increase of$116,807,000 and $102,662,000 or 15% and 14%. Average interest rates paid on interest-bearing liabilities were 1.80%and 1.89% for the three and nine months ended September 30, 2003 compared with2.45% and 2.53% for the same three and nine months of 2002, a decrease ininterest rates paid of 65 and 64 basis points or 27% and 25%.

 

Theincrease in interest-earning assets and interest-bearing liabilities isprimarily the result of increased market penetration within our target markets,accomplished by increasing the loan and deposit production of existingfacilities and the addition of one new retail banking facility in Fresno,California.

 

TheCompany’s taxable equivalent net interest margin, the ratio of net interestincome to average interest-earning assets, was 4.50% and 4.54% for the threeand nine months ended September 30, 2003 compared with 4.66% and 4.65% for thesame periods in 2002.  Net interestmargin provides a measurement of the Company’s ability to employ fundsprofitably during the period being measured. The Company’s decrease in net interest margin was primarily attributableto a drop in overall yields that was partially offset by an increase in volumein earning assets.  Loans as apercentage of average interest-earning assets increased to 66% and 67% for thethree and nine months ended September 30, 2003 compared with 65% and 65% forthe three and nine months ended September 30, 2002.

 

15

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*AverageBalances And Rates Earned And Paid.*  The followingtable presents condensed average balance sheet information for the Company,together with interest rates earned and paid on the various sources and uses ofits funds for each of the periods indicated. Nonaccruing loans are included in the calculation of the averagebalances of loans, but the nonaccrued interest on such loans is excluded.

 

AVERAGE BALANCE SHEET & ANALYSIS OF NET INTERESTEARNINGS

 
|                                             |   | **Three  months ended  September 30, 2003** |      | **Three  months ended  September 30, 2002** |   |
|--------------------------------------------------|--------|---------------------------------------------|-----------|---------------------------------------------|--------|
|                                             |   | **Average  Balance**                        |      | **Taxable  Equivalent  Interest**           |   | **Taxable  Equivalent  Yield/rate** |   | **Average  Balance** |   | **Taxable  Equivalent  Interest** |   | **Taxable  Equivalent  Yield/rate** |   |
|                                             |   | **(Dollars  in thousands)**                 |      |
| **Assets**                                       |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| Federal  funds sold                              |   | $                                           | 39,055    |                                        | $      | 95 |   | 0.98 | % | $ | 29,802 |   | $ | 127 |   | 1.71 | % |
| Time  deposits at other financial institutions   |   | 510                                         |      | 2                                           |   | 1.57 |   | 500 |   | 3 |   | 2.41 |   |
| Taxable  investment securities  (1)         |   | 298,688                                     |      | 2,926                                       |   | 3.93 |   | 265,241 |   | 3,581 |   | 5.42 |   |
| Nontaxable  investment securities (1)            |   | 30,763                                      |      | 438                                         |   | 5.71 |   | 28,923 |   | 430 |   | 5.96 |   |
| Loans,  gross: (2)                               |   | 705,203                                     |      | 12,735                                      |   | 7.24 |   | 597,346 |   | 11,292 |   | 7.58 |   |
| Total  interest-earning assets:                  |   | 1,074,219                                   |      | 16,196                                      |   | 6.05 |   | 921,812 |   | 15,433 |   | 6.72 |   |
| Allowance  for loan losses                       |   | (12,962                                     | )         |                                        |   |   |   | (11,750 | ) |   |   |   |   |
| Cash  and due from banks                         |   | 35,422                                      |      |                                        |   |   |   | 32,127 |   |   |   |   |   |
| Premises  and equipment, net                     |   | 15,238                                      |      |                                        |   |   |   | 14,085 |   |   |   |   |   |
| Interest  receivable and other assets            |   | 42,870                                      |      |                                        |   |   |   | 38,649 |   |   |   |   |   |
| Total  assets                                    |   | $                                           | 1,154,787 |                                        |   |   |   |   | $ | 994,923 |   |   |   |   |   |
|                                             |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| **Liabilities  And Shareholders’ Equity**   |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| Negotiable  order of withdrawal                  |   | $                                           | 123,275   |                                        | $      | 14 |   | 0.05 |   | $ | 102,565 |   | $ | 47 |   | 0.18 |   |
| Savings  deposits                                |   | 305,228                                     |      | 728                                         |   | .96 |   | 221,130 |   | 787 |   | 1.43 |   |
| Time  deposits                                   |   | 373,908                                     |      | 2,230                                       |   | 2.39 |   | 331,509 |   | 2,645 |   | 3.20 |   |
| Other  borrowings                                |   | 87,501                                      |      | 1,012                                       |   | 4.64 |   | 117,901 |   | 1,237 |   | 4.21 |   |
| Total  interest-bearing liabilities              |   | 889,912                                     |      | 3,984                                       |   | 1.80 |   | 773,105 |   | 4,716 |   | 2.45 |   |
|                                             |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |   | 168,849                                     |      |                                        |   |   |   | 138,441 |   |   |   |   |   |
| Accrued  interest, taxes and other liabilities   |   | 5,999                                       |      |                                        |   |   |   | 5,965 |   |   |   |   |   |
| Total  liabilities                               |   | 1,064,760                                   |      |                                        |   |   |   | 917,511 |   |   |   |   |   |
|                                             |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| Capital  Securities                              |   | 6,000                                       |      |                                        |   |   |   | 6,000 |   |   |   |   |   |
|                                             |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| Total  shareholders’ equity                 |   | 84,027                                      |      |                                        |   |   |   | 71,412 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |   | $                                           | 1,154,787 |                                        |   |   |   |   | $ | 994,923 |   |   |   |   |   |
|                                             |   |                                        |      |                                        |   |   |   |   |   |   |   |   |   |
| Net  interest income and margin (3)              |   |                                        |      | $                                           | 12,212 |   | 4.56 | % |   |   | $ | 10,717 |   | 4.66 | % |

 

----

(1)                                  Tax-equivalentadjustments included in the nontaxable investment securities portfolio createdby nontaxable investment securities interest are $110,000 and $103,000 for thethree months ended September 30, 2003 and 2002, respectively.  Tax equivalent adjustments included in thetaxable investment securities created by a dividends received deduction were$34,000 and $38,000 for the three months ended September 30, 2003 and 2002,respectively.

(2)                                  Amountsof interest earned includes loan fees of $308,000 and $155,000 for the threemonths ended September 30, 2003 and 2002, respectively.

(3)                                  Netinterest margin is computed by dividing net interest income by total averageinterest-earning assets.

 

16

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AVERAGE BALANCE SHEET & ANALYSIS OF NET INTERESTEARNINGS

 
|                                             |   | **Nine  months ended  September 30, 2003** |      | **Nine  months ended  September 30, 2002** |   |
|--------------------------------------------------|--------|--------------------------------------------|-----------|--------------------------------------------|--------|
|                                             |   | **Average  Balance**                       |      | **Taxable  Equivalent  Interest**          |   | **Taxable  Equivalent  Yield/rate** |   | **Average  Balance** |   | **Taxable  Equivalent  Interest** |   | **Taxable  Equivalent  Yield/rate** |   |
|                                             |   | **(Dollars  in thousands)**                |      |
| **Assets**                                       |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| Federal funds  sold                              |   | $                                          | 23,215    |                                       | $      | 185 |   | 1.07 | % | $ | 17,837 |   | $ | 226 |   | 1.69 | % |
| Time deposits at  other financial institutions   |   | 556                                        |      | 7                                          |   | 1.68 |   | 500 |   | 8 |   | 2.14 |   |
| Taxable  investment securities  (1)         |   | 283,558                                    |      | 8,968                                      |   | 4.23 |   | 259,389 |   | 10,550 |   | 5.44 |   |
| Nontaxable  investment securities (1)            |   | 29,610                                     |      | 1,305                                      |   | 5.89 |   | 28,943 |   | 1,287 |   | 5.95 |   |
| Loans, gross:  (2)                               |   | 672,370                                    |      | 36,154                                     |   | 7.19 |   | 563,519 |   | 32,107 |   | 7.62 |   |
| Total  interest-earning assets:                  |   | 1,009,309                                  |      | 46,619                                     |   | 6.18 |   | 870,188 |   | 44,178 |   | 6.69 |   |
| Allowance for  loan losses                       |   | (12,735                                    | )         |                                       |   |   |   | (10,823 | ) |   |   |   |   |
| Cash and due  from banks                         |   | 34,198                                     |      |                                       |   |   |   | 29,533 |   |   |   |   |   |
| Premises and  equipment, net                     |   | 14,951                                     |      |                                       |   |   |   | 13,422 |   |   |   |   |   |
| Interest  receivable and other assets            |   | 41,341                                     |      |                                       |   |   |   | 38,680 |   |   |   |   |   |
| Total assets                                     |   | $                                          | 1,087,064 |                                       |   |   |   |   | $ | 941,001 |   |   |   |   |   |
|                                             |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| **Liabilities  And Shareholders’ Equity**   |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| Negotiable order  of withdrawal                  |   | $                                          | 119,517   |                                       | $      | 42 |   | 0.05 |   | $ | 100,713 |   | $ | 159 |   | 0.21 |   |
| Savings deposits                                 |   | 259,356                                    |      | 1,951                                      |   | 1.01 |   | 216,396 |   | 2,477 |   | 1.53 |   |
| Time deposits                                    |   | 346,955                                    |      | 6,504                                      |   | 2.51 |   | 307,114 |   | 7,877 |   | 3.43 |   |
| Other borrowings                                 |   | 111,217                                    |      | 3,356                                      |   | 4.03 |   | 110,160 |   | 3,411 |   | 4.14 |   |
| Total  interest-bearing liabilities              |   | 837,045                                    |      | 11,853                                     |   | 1.89 |   | 734,383 |   | 13,924 |   | 2.53 |   |
|                                             |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |   | 156,638                                    |      |                                       |   |   |   | 126,718 |   |   |   |   |   |
| Accrued  interest, taxes and other liabilities   |   | 5,843                                      |      |                                       |   |   |   | 5,794 |   |   |   |   |   |
| Total  liabilities                               |   | 999,526                                    |      |                                       |   |   |   | 866,895 |   |   |   |   |   |
|                                             |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| Capital  Securities                              |   | 6,000                                      |      |                                       |   |   |   | 6,000 |   |   |   |   |   |
|                                             |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| Total  shareholders’ equity                 |   | 81,538                                     |      |                                       |   |   |   | 68,106 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |   | $                                          | 1,087,064 |                                       |   |   |   |   | $ | 941,001 |   |   |   |   |   |
|                                             |   |                                       |      |                                       |   |   |   |   |   |   |   |   |   |
| Net interest  income and margin (3)              |   |                                       |      | $                                          | 34,766 |   | 4.61 | % |   |   | $ | 30,254 |   | 4.65 | % |

 

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(1)                                  Tax-equivalentadjustments included in the nontaxable investment securities portfolio createdby nontaxable investment securities interest are $322,000 and $305,000 for  the nine months ended September 30, 2003 and2002, respectively.  Tax equivalentadjustments included in the taxable investment securities created by adividends received deduction were $101,000 and $114,000 for the nine monthsended September 30, 2003 and 2002, respectively.

(2)                                  Amountsof interest earned includes loan fees of $1,408,000 and $850,000 for the ninemonths ended September 30, 2003 and 2002, respectively.

(3)                                  Netinterest margin is computed by dividing net interest income by total averageinterest-earning assets.

 

17

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*NetInterest Income Changes Due To Volume And Rate.*  The followingtable sets forth, for the periods indicated, a summary of the changes inaverage asset and liability balances and interest earned and interest paidresulting from changes in average asset and liability balances (volume) andchanges in average interest rates and the total net change in interest incomeand expenses.  The changes in interestdue to both rate and volume have been allocated to volume and rate changes inproportion to the relationship of the absolute dollar amount of the change ineach.

 

Net Interest IncomeVariance Analysis:

 

|                                           |   | **Three  months ended  September 30, 2003 compared to September 30, 2002** |   |
|------------------------------------------------|--------|----------------------------------------------------------------------------|--------|
| **(Dollar in thousands)**                      |   | **Volume**                                                                 |   | **Rate** |   | **Total** |   |
|                                           |   |                                                                       |   |   |   |   |   |
| Increase  (decrease) in interest  income: |   |                                                                       |   |   |   |   |   |
| Federal funds  sold                            |   | $                                                                          | 63     |   | $ | (95 | ) | $ | (32 | ) |
| Time deposits at  other financial institutions |   | —                                                                     |   | (1 | ) | (1 | ) |
| Taxable  investment securities                 |   | 745                                                                        |   | (1,400 | ) | (655 | ) |
| Tax-exempt  investment securities              |   | 42                                                                         |   | (34 | ) | 8 |   |
| Loans                                          |   | 1,968                                                                      |   | (525 | ) | 1,443 |   |
| Total:                                         |   | $                                                                          | 2,818  |   | $ | (2,055 | ) | $ | 763 |   |
|                                           |   |                                                                       |   |   |   |   |   |
| Increase  (decrease) in interest expense:      |   |                                                                       |   |   |   |   |   |
| Interest bearing  demand                       |   | $                                                                          | 8      |   | $ | (41 | ) | $ | (33 | ) |
| Savings deposits                               |   | 247                                                                        |   | (306 | ) | (59 | ) |
| Time deposits                                  |   | 311                                                                        |   | (726 | ) | (415 | ) |
| Other borrowings                               |   | (343                                                                       | )      | 118 |   | (225 | ) |
| Total:                                         |   | $                                                                          | 223    |   | $ | (955 | ) | $ | (732 | ) |
|                                           |   |                                                                       |   |   |   |   |   |
| Increase  (decrease) in net interest income    |   | $                                                                          | 2,595  |   | $ | (1,100 | ) | $ | 1,495 |   |

* *

|                                           |   | **Nine  months ended  September 30, 2003 compared to September 30, 2002** |   |
|------------------------------------------------|--------|---------------------------------------------------------------------------|--------|
| **(Dollar in thousands)**                      |   | **Volume**                                                                |   | **Rate** |   | **Total** |   |
|                                           |   |                                                                      |   |   |   |   |   |
| Increase  (decrease) in interest  income: |   |                                                                      |   |   |   |   |   |
| Federal  funds sold                            |   | $                                                                         | 82     |   | $ | (123 | ) | $ | (41 | ) |
| Time  deposits at other financial institutions |   | 1                                                                         |   | (2 | ) | (1 | ) |
| Taxable  investment securities                 |   | 1,385                                                                     |   | (2,967 | ) | (1,582 | ) |
| Tax-exempt  investment securities              |   | 35                                                                        |   | (17 | ) | 18 |   |
| Loans                                          |   | 6,874                                                                     |   | (2,827 | ) | 4,047 |   |
| Total:                                         |   | $                                                                         | 8,377  |   | $ | (5,936 | ) | $ | 2,441 |   |
|                                           |   |                                                                      |   |   |   |   |   |
| Increase  (decrease) in interest expense:      |   |                                                                      |   |   |   |   |   |
| Interest  bearing demand                       |   | $                                                                         | 41     |   | $ | (158 | ) | $ | (117 | ) |
| Savings  deposits                              |   | 640                                                                       |   | (1,166 | ) | (526 | ) |
| Time  deposits                                 |   | 1,397                                                                     |   | (2,770 | ) | (1,373 | ) |
| Other  borrowings                              |   | 49                                                                        |   | (104 | ) | (55 | ) |
| Total:                                         |   | $                                                                         | 2,127  |   | $ | (4,198 | ) | $ | (2,071 | ) |
|                                           |   |                                                                      |   |   |   |   |   |
| Increase  (decrease) in net interest income    |   | $                                                                         | 6,250  |   | $ | (1,738 | ) | $ | 4,512 |   |

 

18

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*ProvisionFor Loan Losses.*** **The provision for loan losses for the three and ninemonths ended September 30, 2003 was $751,000 and $1,904,000 compared with$1,190,000 and $3,421,000 for the three and nine months ended September 30,2002, a decrease of $439,000 and $1,517,000 or 37% and 44%.  See “Allowance for Loan Losses” containedherein.  As of September 30, 2003 theallowance for loan losses was $13,177,000 or 1.83% of total loans which comparesto the allowance for loan losses of $12,134,000 or 1.91% of total loans as ofDecember 31, 2002.  At September 30,2003, nonperforming assets totaled $1,793,000 or 0.15% of total assets,nonperforming loans totaled $1,733,000 or 0.24% of total loans and theallowance for loan losses totaled 760% of nonperforming loans.  At December 31, 2002, nonperforming assetstotaled $2,443,000 or 0.24% of total assets, nonperforming loans totaled$2,383,000 or 0.38% of total loans and the allowance for loan losses totaled509% of nonperforming loans.  Noassurance can be given that nonperforming loans will not increase or that theallowance for loan losses will be adequate to cover losses inherent in the loanportfolio.

 

*NoninterestIncome.*** **Noninterestincome increased by $258,000 and $1,071,000 or 11% and 17% to $2,544,000 and$7,266,000 for the three and nine months ended September 30, 2003 compared with$2,286,000 and $6,195,000 for the same periods during 2002.  Service charges on deposit accountsincreased by $104,000 and $332,000 or 8% and 9% to $1,430,000 and $4,064,000for the three and nine months ended September 30, 2003 compared with $1,326,000and $3,732,000 achieved during for the same periods in 2002.  The increase in fees is the result ofincreased customer use of existing fee based products.  Other income increased by $154,000 and$739,000 or 16% and 30% for the three and nine month periods ended September30, 2003 when compared to the same periods in 2002.  The primary source of this increased other income is the sale ofthe consumer credit card portfolio in March, 2003 for a gain of $82,000, thegain on sale of foreclosure property with a book basis of $0 for an $81,000gain, an increase in mortgage packaging fees of $167,000 and $265,000, and the$13,000 and $266,000 in fees generated by Regency Investment Advisors, Incorporatedfor the three and nine months ended September 30, 2003.  Regency Investment Advisors, Incorporatedwas acquired in June, 2002.

 

*NoninterestExpense.*** **Noninterestexpenses increased by $819,000 and $3,385,000 or 10% and 15% to $9,149,000 and$26,653,000 for the three and nine months ended September 30, 2003 comparedwith the $8,330,000 and $23,268,000 recorded during for the same periods in2002.  The primary components ofnoninterest expenses were salaries and employee benefits, premises andoccupancy expense, equipment expense, professional fees, marketing expense,supplies expense and other operating expenses.

 

For the three and nine months ended September 30,2003, salaries and related benefits increased by $510,000 and $2,164,000 or 12%and 18% to $4,742,000 and $14,179,000 from the $4,232,000 and $12,015,000recorded for the same period in 2002. The salary expense increase was primarilythe result of normal salary progression and incentive bonus payments.  Equipment expense increased by $130,000 and$171,000 or 17% and 8% to $875,000 and $2,336,000 for the three and nine monthsended September 30, 2003 from the $745,000 and $2,165,000 recorded during thesame periods in 2002.  The increasedequipment costs were related to branch equipment upgrades and increasedtechnology spending.  Premises andoccupancy expenses increased by $51,000 and $293,00 to $727,000 and $2,109,000for the three and nine months ended September 30, 2003 from $676,000 and$1,816,000 during the same periods in 2002. The primary reason for the increase in occupancy costs in 2003 isrelated to retrofit charges for branch facilities in Atwater, Fresno, andMerced, and the addition of a new retail banking facility in Fresno.  When comparing the results of the three andnine months ended September 30, 2003 to three and nine months ended September30, 2002, professional fees decreased by $12,000 and increased by $176,000 or4% and 20%, marketing expenses decreased by $62,000 and

 

19

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increased by $39,000 or 23% and 6%, goodwill and intangibleamortization expense were constant at $170,000 and $510,000, supplies expensedecreased by $18,000 and increased by $57,000 or 9% and 10%, and other expensesincreased $220,000 and $485,000 or 13% and 10% from 2002 levels. Increasedprofessional fees for the first nine months of 2003 were the result of anincreased use of consultants to identify new business profitability strategiesand potential business combinations while decreases for the three monthsresulted primarily from the timing of receipt of consulting services.  The increased other expenses were primarilythe result of valuation write-downs of $102,000 related to the bankruptcy of amortgage brokerage company that dishonored its funding commitments onapproximately $7,000,000 in loan originations during the third quarter of 2003.

* *

*ProvisionFor Income Taxes.*** **The Company recorded an increase in the income taxprovision of $728,000 and $1,255,000 or 204% and 72% to $1,084,000 and$3,002,000 for the three and nine months ended September 30, 2003 compared to$356,000 and $1,747,000 recorded for the same period in 2002.  During the three and nine months endedSeptember 30, 2003, the Company achieved an effective tax rate of 23%, comparedwith 11% and 19% achieved during the same periods in 2002. During the thirdquarter of 2002, the Company received a one-time tax benefit of $290,000related to a change in state tax law. This benefit was the primary reason forthe lower 2002 effective tax rate. Increases in pretax income levels achievedduring 2003 over 2002 levels have also contributed to the increase in the 2003provision for income tax. Effective tax rates below statutory tax rate levelshave been achieved primarily through the continued utilization of a real estateinvestment trust established during the fourth quarter of 2001 that providesthe Company with a means to potentially generate future additional capital forthe Bank as well as to currently reduce state income tax expense.

 

**Financial Condition**

 

Totalassets at September 30, 2003 were $1,162,391,000, an increase of $128,181,000or 12% compared with total assets of $1,034,210,000 at December 31, 2002.  Net loans were $708,745,000 at September 30,2003, an increase of $87,106,000 or 14% compared with net loans of $621,639,000at December 31, 2002.  Deposits were$974,832,000 at September 30, 2003, an increase of $140,453,000 or 17% comparedwith deposits of $834,379,000 at December 31, 2002.  The increase in total assets of the Company between December 31,2002 and September 30, 2003 was primarily the result of an increase in savingsand certificate deposits that were obtained to fund additional purchases ofinterest earning assets.

 

Totalshareholders’ equity was $85,613,000 at September 30, 2003, an increase of$8,444,000 or 11% from the $77,169,000 at December 31, 2002. The growth inshareholders’ equity between December 31, 2002 and September 30, 2003 wasachieved through the retention of accumulated earnings, which was partiallyoffset by a decline in other comprehensive income.  Other comprehensive income consists of changes in the fair marketvalue compared to book value of available for sale investment securities andvaluation changes in the Bank’s interest rate swap, net of estimated federaland state income taxes.

* *

*Off-BalanceSheet Commitments. *The following table shows thedistribution of the Company’s undisbursed loan commitments at the datesindicated.

 

| **(Dollars in thousands)**    |   | **September  30,  2003** |    | **December  31,  2002** |   |
|-------------------------------|--------|--------------------------|---------|-------------------------|--------|
|                          |   |                     |    |                    |   |
| Letters  of credit            |   | $                        | 14,090  |                    | $      | 6,522 |   |
| Commitments  to extend credit |   | 314,470                  |    | 235,140                 |   |
| Total                         |   | $                        | 328,560 |                    | $      | 241,662 |   |

 

20

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*OtherInterest-Earning Assets. *The following table relates to the cashsurrender value of life insurance policies that are carried in other assets atthe dates indicated.  The insurancepolices are associated with employee benefit plans of the Company, including asalary continuation plan for the Company’s executive management and deferredretirement benefits for participating board members.  The salary continuation plan and deferred retirement benefits forparticipating board members are informally linked with approximately $7,732,000in universal Life insurance policies purchased by the Company.  Income from these policies is reflected innoninterest income.

 
| **(Dollars in thousands)**              |   | **At  September 30,  2003** |   | **At  December 31,  2002** |   |
|-----------------------------------------|--------|-----------------------------|--------|---------------------------------|--------|
|                                    |   |                        |   |                            |   |
| Cash  surrender value of life insurance |   | $                           | 20,936 |                            | $      | 17,240 |   |
|                                         |        |                             |        |                                 |        |  |  |

 

*Nonperforming Assets. *Nonperforming assets include nonaccrual loans, loans90 days or more past due, restructured loans and other real estate owned.

 

Nonperformingloans are those which the borrower fails to perform in accordance with theoriginal terms of the obligation and include loans on nonaccrual status, loanspast due 90 days or more and restructured loans.  The Company generally places loans on nonaccrual status andaccrued but unpaid interest is reversed against the current year’s income wheninterest or principal payments become 90 days or more past due unless theoutstanding principal and interest is adequately secured and, in the opinion ofmanagement, is deemed in the process of collection.  Interest income on nonaccrual loans is recorded on a cashbasis.  Payments may be treated asinterest income or return of principal depending upon management’s opinion ofthe ultimate risk of loss on the individual loan.  Cash payments are treated as interest income where managementbelieves the remaining principal balance is fully collectible.  Additional loans not 90 days past due mayalso be placed on nonaccrual status if management reasonably believes theborrower will not be able to comply with the contractual loan repayment termsand collection of principal or interest is in question.

 

A “restructuredloan” is a loan on which interest accrues at a below market rate or upon whichcertain principal has been forgiven so as to aid the borrower in the finalrepayment of the loan, with any interest previously accrued, but not yetcollected, being reversed against current income.  Interest is reported on a cash basis until the borrower’s abilityto service the restructured loan in accordance with its terms isestablished.  The Company had norestructured loans as of the dates indicated in the table below.

 

21

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Thefollowing table summarizes nonperforming assets of the Company at September 30,2003 and December 31, 2002:

 

| **(Dollars in thousands)**               |   | **September  30,  2003** |   | **December  31,  2002** |   |
|------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                     |   |                     |   |                    |   |
| Nonaccrual loans                         |   | $                        | 1,725  |                    | $      | 2,381 |   |
| Accruing loans  past due 90 days or more |   | 8                        |   | 2                       |   |
| Total  nonperforming loans               |   | 1,733                    |   | 2,383                   |   |
| Other real  estate owned                 |   | 60                       |   | 60                      |   |
| Total  nonperforming assets              |   | $                        | 1,793  |                    | $      | 2,443 |   |
|                                     |   |                     |   |                    |   |
| Nonperforming  loans to total loans      |   | 0.24                     | %      | 0.38                    | %      |
| Nonperforming  assets to total assets    |   | 0.15                     | %      | 0.24                    | %      |

 

Contractualaccrued interest income on loans on nonaccrual status as of September 30, 2003and 2002, that would have been recognized if the loans had been current inaccordance with their original terms was approximately $45,000 and $169,000,respectively.

 

AtSeptember 30, 2003, nonperforming assets represented .15% of total assets, adecrease of 9 basis points when compared to the .24% at December 31, 2002.  Nonperforming loans represented .24% oftotal loans at September 30, 2003, a decrease of 14 basis points compared tothe .38% at December 31, 2002. Nonperforming loans that were secured by first deeds of trust on realproperty were $0 at September 30, 2003 and December 31, 2002.   Other forms of collateral such as inventoryand equipment secured the nonperforming loans as of each date.  No assurance can be given that thecollateral securing nonperforming loans will be sufficient to prevent losses onsuch loans.

 

Thedecrease in nonperforming loans and nonperforming assets as of September 30,2003 compared with their levels as of December 31, 2002, was due primarily to adecrease in the nonperforming agricultural segment of the loan portfolio.

 

AtSeptember 30, 2003 and December 31, 2002, the Company had $60,000 invested inone property, respectively, that had been acquired through foreclosure.  The property was carried at the lower of itsestimated market value, as evidenced by an independent appraisal, or therecorded investment in the related loan, less estimated selling expenses.  At foreclosure, if the fair value of thereal estate is less than the Company’s recorded investment in the related loan,a charge is made to the allowance for loan losses.  The Company expects to sell most of these properties within atwelve month period.  During the firstquarter of 2003, one foreclosure property was acquired and sold for $81,000that had no assigned book value for a gain on sale of $81,000.  No assurance can be given that the Companywill sell the remaining property during 2003 or at any time or the amount forwhich the property might be sold.

 

Managementdefines impaired loans, regardless of past due status on loans, as those onwhich principal and interest are not expected to be collected under theoriginal contractual loan repayment terms. An impaired loan is charged off at the time management believes thecollection process has been exhausted. At September 30, 2003 and December 31, 2002, impaired loans weremeasured based on the present value of future cash flows discounted at theloan’s effective rate, the loan’s observable market price or the fair value ofcollateral if the loan is collateral-dependent.  Impaired loans at September 30,

 

22

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2003 were $1,733,000 for which the Company made provisions to theallowance for loan losses of approximately $273,000.

 

Exceptfor loans that are disclosed above, there were no assets as of September 30,2003, where known information about possible credit problems of the borrowercauses management to have serious doubts as to the ability of the borrower tocomply with the present loan repayment terms and which may become nonperformingassets.  Given the magnitude of theCompany’s loan portfolio, however, it is always possible that current creditproblems may exist that may not have been discovered by management.

 

**Allowancefor Loan Losses**

 

The following tablesummarizes the loan loss experience of the Company for the nine months endedSeptember 30, 2003 and 2002, and for the year ended December 31, 2002.

 

|                                         |   | **September  30**           |    | **December  31** |   |
|----------------------------------------------|--------|-----------------------------|---------|------------------|--------|
|                                         |   | **2003**                    |    | **2002**         |   | **2002** |   |
|                                         |   | **(Dollars  in thousands)** |    |
| **Allowance  for Loan Losses:**              |   |                        |    |             |   |   |   |
| Balance at  beginning of period              |   | $                           | 12,134  |             | $      | 9,743 |   | $ | 9,743 |   |
| Provision for  loan losses                   |   | 1,904                       |    | 3,421            |   | 4,151 |   |
| Charge-offs:                                 |   |                        |    |             |   |   |   |
| Commercial  and  agricultural           |   | 750                         |    | 980              |   | 1,504 |   |
| Consumer                                     |   | 646                         |    | 867              |   | 1,085 |   |
| Total  charge-offs                           |   | 1,396                       |    | 1,847            |   | 2,589 |   |
| Recoveries                                   |   |                        |    |             |   |   |   |
| Commercial and  agricultural                 |   | 229                         |    | 157              |   | 233 |   |
| Consumer                                     |   | 306                         |    | 460              |   | 596 |   |
| Total recoveries                             |   | 535                         |    | 617              |   | 829 |   |
| Net charge-offs                              |   | 861                         |    | 1,230            |   | 1,760 |   |
| Balance at end  of period                    |   | $                           | 13,177  |             | $      | 11,934 |   | $ | 12,134 |   |
|                                         |   |                        |    |             |   |   |   |
| Loans  outstanding at period-end             |   | $                           | 721,922 |             | $      | 612,755 |   | $ | 633,733 |   |
| Average loans  outstanding                   |   | $                           | 672,370 |             | $      | 563,518 |   | $ | 576,156 |   |
|                                         |   |                        |    |             |   |   |   |
| Annualized net  charge-offs to average loans |   | 0.17                        | %       | 0.29             | %      | 0.31 | % |
| Allowance for  loan losses                   |   |                        |    |             |   |   |   |
| To total loans                               |   | 1.83                        | %       | 1.95             | %      | 1.91 | % |
| To nonperforming  assets                     |   | 734.86                      | %       | 159.56           | %      | 496.56 | % |

 

The Company maintains an allowance for loan losses ata level considered by management to be adequate to cover the inherent risks ofloss associated with its loan portfolio under prevailing and anticipatedeconomic conditions.  In determining theadequacy of the allowance for loan losses, management takes into considerationgrowth trends in the portfolio, examination of financial institutionsupervisory authorities, prior loan loss experience for the Company,concentrations of credit risk, delinquency trends, general economic conditions,the interest rate environment and internal and external credit reviews.  In addition, the risks management considersvary depending on the nature of the loan. The normal risks considered by management with respect to agriculturalloans include the fluctuating value of the collateral, changes in weatherconditions and the availability of adequate water resources in the Company’slocal market area.  The normal risksconsidered by management with respect to real estate construction loans includefluctuation in real estate values, the demand for improved commercial and

 

23

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industrial properties and housing, the availability of permanentfinancing in the Company’s market area and borrowers’ ability to obtainpermanent financing.  The normal risksconsidered by management with respect to real estate mortgage loans includefluctuations in the value of real estate. Additionally, the Company relies on data obtained through independent appraisalsfor significant properties to determine loss exposure on nonperforming loans.

 

Thebalance in the allowance is affected by the amounts provided from operations,amounts charged off and recoveries of loans previously charged off.  The Company recorded a provision for loanlosses of $751,000 and $1,904,000 for the three and nine months ended September30, 2003 compared with 1,190,000 and $3,421,000 during the same periods of2002. The decrease in loan loss provision during the first nine months of 2003was recorded to coincide with the lower level of charge-offs experienced andreduced nonperforming loan levels during 2003 when compared to the same periodin 2002.  The Company’s charge-offs, netof recoveries, were $861,000 for the nine months ended September 30, 2003compared with $1,230,000 for the same nine months in 2002.  The decrease in net charge-offs for thefirst nine months of 2003 was primarily due to decreased charge-offs thatoccurred within the commercial and agricultural portfolio segments andincreased recoveries within the consumer loan segment of the loan portfolio.

 

Asof September 30, 2003, the allowance for loan losses was $13,177,000 or 1.83%of total loans outstanding, compared with $12,134,000 or 1.91% of total loansoutstanding as of December 31, 2002 and $11,934,000 or 1.95% of total loansoutstanding as of September 30, 2002.

 

TheCompany uses a method developed by management for determining the appropriatelevel of its allowance for loan losses. This method applies relevant risk factors to the entire loan portfolio,including nonperforming loans.  Themethodology is based, in part, on the Company’s loan grading and classificationsystem.  The Company grades its loansthrough internal reviews and periodically subjects loans to external reviewswhich then are assessed by the Company’s audit committee and management.  Credit reviews are performed on a monthlybasis and the quality grading process occurs on a quarterly basis. Risk factorsapplied to the performing loan portfolio are based on the Company’s past losshistory considering the current portfolio’s characteristics, current economicconditions and other relevant factors. General reserves are applied to various categories of loans atpercentages ranging up to 1.8% based on the Company’s assessment of creditrisks for each category.  Risk factorsare applied to the carrying value of each classified loan: (i) loansinternally graded “Watch” or “Special Mention” carry a risk factor from 1.0% to2.0%; (ii) ”Substandard” loans carry a risk factor from 15% to 40%depending on collateral securing the loan, if any; (iii) “Doubtful” loans carrya 50% risk factor; and (iv) “Loss” loans are charged off 100%.  In addition, a portion of the allowance isspecially allocated to identified problem credits.  The analysis also includes reference to factors such as thedelinquency status of the loan portfolio, inherent risk by type of loans,industry statistical data, recommendations made by the Company’s regulatoryauthorities and outside loan reviewers, and current economic environment.  Important components of the overall creditrating process are the asset quality rating process and the internal loanreview process.

 

Theallowance is based on estimates and ultimate future losses may vary fromcurrent estimates.  It is alwayspossible that future economic or other factors may adversely affect theCompany’s borrowers, and thereby cause loan losses to exceed the currentallowance.  In addition, there can be noassurance that future economic or other factors will not adversely affect theCompany’s borrowers, or that the Company’s asset quality may not deterioratethrough rapid growth, failure to enforce underwriting standards, failure tomaintain appropriate underwriting standards, failure to maintain an adequatenumber of qualified loan personnel, failure to identify and monitor potentialproblem loans or for other reasons, and thereby cause loan losses to exceed thecurrent allowance.

 

24

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Theallocation of the allowance to loan categories is an estimate by management ofthe relative risk characteristics of loans in those categories.  No assurance can be given that losses in oneor more loan categories will not exceed the portion of the allowance allocatedto that category or even exceed the entire allowance.

* *

*ExternalFactors Affecting Asset Quality. *As a result of the Company’s loanportfolio mix, the future quality of its assets could be affected by adverseeconomic trends in its region or in the agricultural community.  These trends are beyond the control of theCompany.

 

Californiais an earthquake-prone region. Accordingly, a major earthquake could result in material loss to theCompany.  At times the Company’s servicearea has experienced other natural disasters such as floods and droughts.  The Company’s properties and substantiallyall of the real and personal property securing loans in the Company’s portfolioare located in California.  The Companyfaces the risk that many of its borrowers face uninsured property damage,interruption of their businesses or loss of their jobs from earthquakes, floodsor droughts.  As a result theseborrowers may be unable to repay their loans in accordance with their terms andthe collateral for such loans may decline significantly in value.  The Company’s service area is a largelyagricultural region and therefore is highly dependent on a reliable supply ofwater for irrigation purposes.  The areaobtains nearly all of its water from the run-off of melting snow in themountains of the Sierra Nevada to the east. Although such sources have usually been available in the past, watersupply can be adversely affected by light snowfall over one or more winters orby any diversion of water from its present natural courses.  Any such natural disaster could impair theability of many of the Company’s borrowers to meet their obligations to theCompany.

 

Partsof California have experienced significant floods in the late 1990s. Noassurance can be given that future flooding will not have an adverse impact onthe Company and its borrowers and depositors.

* *

*Liquidity.*In order tomaintain adequate liquidity, the Company must have sufficient resourcesavailable at all times to meet its cash flow requirements.  The need for liquidity in a bankinginstitution arises principally to provide for deposit withdrawals, the creditneeds of its customers and to take advantage of investment opportunities asthey arise.  The Company may achievedesired liquidity from both assets and liabilities.  The Company considers cash and deposits held in other banks,federal funds sold, other short term investments, maturing loans andinvestments, payments of principal and interest on loans and investments and potentialloan sales as sources of asset liquidity. Deposit growth and access to credit lines established with correspondentbanks and market sources of funds are considered by the Company as sources ofliability liquidity.  The holdingcompany’s primary source of liquidity is from dividends received from theBank.  Dividends from the Bank aresubject to certain regulatory restrictions.

 

TheCompany reviews its liquidity position on a regular basis based upon itscurrent position and expected trends of loans and deposits. These assetsinclude cash and deposits in other banks, available-for-sale securities andfederal funds sold.  The Company’sliquid assets totaled $306,294,000 and $305,075,000 on September 30, 2003 andDecember 31, 2002, respectively, and constituted 26% and 29% of total assets onthose dates.  Liquidity is also affectedby the collateral requirements of its public deposits and certainborrowings.  Total pledged securitieswere $262,965,000 at September 30, 2003 compared with $193,962,000 at December31, 2002.

 

Although the Company’s primary sources of liquidityinclude liquid assets and a stable deposit base, the Company maintains lines ofcredit with the Federal Reserve Bank of San Francisco, Federal Home Loan Bankof San Francisco, Pacific Coast Bankers’ Bank, Union Bank of California, WellsFargo

 

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Bank and First Tennessee Bank aggregating $153,725,000 of which$81,419,000 was outstanding as of September 30, 2003 and $100,841,000 wasoutstanding as of December 31, 2002. The decrease in borrowings betweenDecember 31, 2003 and September 30, 2003 were funded primarily with cash flowsderived from principal repayments occurring within the investmentportfolio.  Management believes that theCompany maintains adequate amounts of liquid assets to meet its liquidityneeds.  The Company’s liquidity might beinsufficient if deposit withdrawals were to exceed anticipated levels.  Deposit withdrawals can increase if acompany experiences financial difficulties or receives adverse publicity forother reasons, or if its pricing, products or services are not competitive withthose offered by other institutions.

* *

*CapitalResources. *Capital serves as a source of funds andhelps protect depositors against potential losses.  The primary source of capital for the Company has been internallygenerated capital through retained earnings. The Company’s shareholders’ equity increased by $8,444,000 or 10.9% fromDecember 31, 2002 to September 30, 2003.

 

TheCompany is subject to various regulatory capital requirements administered bythe federal banking agencies.  Failureto meet minimum capital requirements can initiate mandatory and possiblyadditional discretionary actions by the regulators that, if undertaken, couldhave a material adverse effect on the Company’s financial statements.  Management believes, as of September 30,2003, that the Company and the Bank met all applicable capitalrequirements.  The Company’s leveragecapital ratio at September 30, 2003 was 7.66% as compared with 7.68% as of December31, 2002.  The Company’s total riskbased capital ratio at September 30, 2003 was 10.85% as compared to 10.74% asof December 31, 2002.

 

TheCompany’s and Bank’s actual capital amounts and ratios met all regulatoryrequirements as of September 30, 2003 and were summarized as follows:

 
|                                      |   | **Actual** |   | **For  Capital  Adequacy Purposes** |   | **To Be Well  Capitalized  Under Prompt  Corrective  Action Provisions:** |   |
|-------------------------------------------|--------|------------|--------|-------------------------------------|--------|---------------------------------------------------------------------------|--------|
| **Dollars in thousands**                  |   | **Amount** |   | **Ratio**                           |   | **Amount**                                                                |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| Consolidated                              |   |       |   |                                |   |                                                                      |   |   |   |   |   |   |   |
| As  of September 30, 2003                 |   |       |   |                                |   |                                                                      |   |   |   |   |   |   |   |
| Total  capital (to risk weighted assets)  |   | $          | 99,770 |                                | 10.85  | %                                                                         | $      | 73,586 |   | 8.0 | % | $ | 91,982 |   | 10.0 | % |
| Tier  1 capital (to risk weighted assets) |   | 88,250     |   | 9.59                                |   | 36,793                                                                    |   | 4.0 |   | 55,189 |   | 6.0 |   |
| Leverage  ratio*                          |   | 88,250     |   | 7.66                                |   | 46,079                                                                    |   | 4.0 |   | 57,599 |   | 5.0 |   |
|                                      |   |       |   |                                |   |                                                                      |   |   |   |   |   |   |   |
| The  Bank:                                |   |       |   |                                |   |                                                                      |   |   |   |   |   |   |   |
| As  of September 30, 2003                 |   |       |   |                                |   |                                                                      |   |   |   |   |   |   |   |
| Total  capital (to risk weighted assets)  |   | $          | 96,983 |                                | 10.59  | %                                                                         | $      | 73,292 |   | 8.0 | % | $ | 91,615 |   | 10.0 | % |
| Tier  1 capital (to risk weighted assets) |   | 85,512     |   | 9.33                                |   | 36,646                                                                    |   | 4.0 |   | 54,969 |   | 6.0 |   |
| Leverage  ratio*                          |   | 85,512     |   | 7.43                                |   | 46,015                                                                    |   | 4.0 |   | 57,519 |   | 5.0 |   |

 

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* The leverage ratio consists of Tier 1 capitaldivided by adjusted quarterly average assets. The minimum leverage ratio is 3 percent for banking organizations thatdo not anticipate significant growth and that have well-diversified risk,excellent asset quality and in general, are considered top-rated banks.

 

TheCompany has no formal dividend policy, and dividends are issued solely at thediscretion of the Company’s Board of Directors, subject to compliance withregulatory requirements.  In order topay any cash dividends, the Company must receive payments of dividends ormanagement fees from the Bank.  Thereare certain regulatory limitations on the payment of cash dividends by banks.

 

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*Deposits.* Deposits are the Company’s primary source of funds.  At September 30, 2003, the Company had adeposit mix of 32% in savings deposits, 37% in time deposits, 13% ininterest-bearing checking accounts and 18% in noninterest-bearing demandaccounts.  Noninterest-bearing demanddeposits enhance the Company’s net interest income by lowering its costs offunds.

 

TheCompany obtains deposits primarily from the communities it serves.  No material portion of its deposits has beenobtained from or is dependent on any one person or industry.  The Company’s business is not seasonal in nature.  The Company accepts deposits in excess of$100,000 from customers.  These depositsare priced to remain competitive.  AtSeptember 30, 2003, the Company had brokered deposits of $44,299,000.

 

Maturitiesof time certificates of deposits of $100,000 or more outstanding at September30, 2003 and December 31, 2002 are summarized as follows:

 
|                       |   | **September  30, 2003**     |    | **December  31, 2002** |   |
|----------------------------|--------|-----------------------------|---------|------------------------|--------|
|                       |   | **(Dollars  in thousands)** |    |
|                       |   |                        |    |                   |   |
| Three months or  less      |   | $                           | 93,878  |                   | $      | 69,661 |   |
| Over three to  six months  |   | 43,008                      |    | 38,863                 |   |
| Over six to  twelve months |   | 39,981                      |    | 23,319                 |   |
| Over twelve  months        |   | 16,630                      |    | 28,872                 |   |
| Total                      |   | $                           | 193,497 |                   | $      | 160,715 |   |

 

**Borrowed Funds**

 

Thedecrease in other borrowings during the third quarter of 2003 was primarily dueto the payment at maturity of short-term FHLB borrowings funded by new savingsand certificate of deposit inflows from public agencies and water districts.

 

**Returnon Equity and Assets**

 
|                                 |   | **Three  months ended  September 30  2003** |   | **Three  months ended  September 30  2002** |   | **Year ended  December 31  2002** |   |
|--------------------------------------|--------|---------------------------------------------|--------|---------------------------------------------|--------|-----------------------------------|--------|
|                                 |   |                                        |   |                                        |   |                              |   |
| Annualized  return on average assets |   | 1.26                                        | %      | 1.20                                        | %      | 1.09                              | %      |
| Annualized  return on average equity |   | 17.27                                       | %      | 16.72                                       | %      | 14.94                             | %      |
| Average  equity to average assets    |   | 7.28                                        | %      | 7.18                                        | %      | 7.29                              | %      |

 

**Impactof Inflation**

 

Theprimary impact of inflation on the Company is its effect on interestrates.  The Company’s primary source ofincome is net interest income which is affected by changes in interestrates.  The Company attempts to limitinflation’s impact on its net interest margin through management of ratesensitive assets and liabilities and the analysis of interest ratesensitivity.  The effect of inflation onpremises and equipment, as well as on interest expenses, has not beensignificant for the periods covered in this report.

 

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**Item3.****                                                        Quantitativeand Qualitative Disclosures about Market Risk**

 

In the normal course of business, the Company isexposed to market risk which includes both price and liquidity risk.  Price risk is created from fluctuations ininterest rates and the mismatch in repricing characteristics of assets, liabilities,and off balance sheet instruments at a specified point in time.  Mismatches in interest rate repricing amongassets and liabilities arise primarily through the interaction of the varioustypes of loans versus the types of deposits that are maintained as well as frommanagement’s discretionary investment and funds gathering activities.  Liquidity risk arises from the possibilitythat the Company may not be able to satisfy current and future financialcommitments or that the Company may not be able to liquidate financialinstruments at market prices.  Riskmanagement policies and procedures have been established and are utilized tomanage the Company’s exposure to market risk. Quarterly testing of the Company’s assets and liabilities under bothincreasing and decreasing interest rate environments are performed to insurethe Company does not assume a magnitude of risk that is outside approved policylimits.

 

The Company’s success is largely dependent upon itsability to manage interest rate risk. Interest rate risk can be defined as the exposure of the Company’s netinterest income to adverse movements in interest rates.  Although the Company manages other risks,such as credit and liquidity risk in the normal course of its business,management considers interest rate risk to be its most significant market riskand could potentially have the largest material effect on the Company’sfinancial condition and results of operations. Correspondingly, the overall strategy of the Company is to manageinterest rate risk, through balance sheet structure, to be interest rateneutral.

 

The Company’s interest rate risk management is theresponsibility of the Asset/Liability Management Committee (ALCO), whichreports to the Board of Directors.  ALCOestablishes policies that monitors and coordinates the Company’s sources, usesand pricing of funds.  ALCO is alsoinvolved in formulating the economic projections for the Company’s budget andstrategic plan.  ALCO sets specific ratesensitivity limits for the Company. ALCO monitors and adjusts the Company’s exposure to changes in interestrates to achieve predetermined risk targets that it believes are consistentwith current and expected market conditions. Balance sheet management personnel monitor the asset and liabilitychanges on an ongoing basis and provide report information and recommendationsto the ALCO committee in regards to those changes.

 

It is the opinion of management there has been nomaterial change in the Company’s market risk during the nine months ended September30, 2003 when compared to the level of market risk at December 31, 2002.  If interest rates were to suddenly andmaterially fall from levels experienced during the third quarter of 2003, theCompany could become susceptible to an increased level of market risk.

 

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**Item 4.****                                                        Controlsand Procedures**

 

Evaluation Of Disclosure Controls And Procedures

 

We carried out an evaluation, under the supervisionand with the participation of our management, including our principal executiveofficer and our principal financial officer, of the effectiveness of the designand operation of our disclosure controls and procedures as of the end of theperiod covered by this report, pursuant to Rule 15a – 15(e) under theSecurities Exchange Act of 1934.

 

Based on their review of our disclosure controls andprocedures, the principal executive officer and principal financial officerhave concluded our disclosure controls and procedures are effective in timelyalerting them to material information relating to us that is required to beincluded in our periodic SEC filings.

 

Changes In Internal Controls

 

There were no changes in our internal controls overfinancial reporting that occurred during our last fiscal quarter that hasmaterially affected, or is reasonably likely to materially effect, our internalcontrols over financial reporting.

 

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**PARTII - Other Information**

 

**Item 1.****                                                        Legal Proceedings**

 

The Company is a party to routine litigation in the ordinary course ofits business.  In the opinion ofmanagement, pending and threatened litigation is not likely to have a materialadverse effect on the financial condition or results of operations of theCompany.

 

**Item 2.****                                                           Changes in Securities and Use of Proceeds.**

 

None.

 

**Item 3.****                                                           Defaults Upon Senior Securities.**

 

None.

 

**Item 4.****                                                           Submission of Matters to a Vote of Securities Holders.**

 

None

 

**Item 5.****                                                          ****Other Infor****mation.**

 

None

 

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**Item 6.  Exhibits and Reports on Form 8-K.**

 

(a)                                  Exhibits.

 
| **Exhibit  Number** |   | **Exhibit**                                                                                                                                                                                      |   |   |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| 4.1                 |   | Indenture, dated as of February 22, 2001 between  Capital Corp of the West, as Issuer, and State Street Bank and Trust Company  of Connecticut, National Association, as Trustee.                |   |   |
|                |   |                                                                                                                                                                                             |   |   |
| 4.2                 |   | Amended and Restated Declaration of Trust  by and between State Street Bank and Trust  Company of Connecticut, National Association, as Trustee, and Capital Corp of  the West, as Sponsor. |   |   |
|                |   |                                                                                                                                                                                             |   |   |
| 10.10               |   | Form of Capital Corp of the West Amended Salary  Continuation Agreement Entered Into with Executive Officers in October 2003.                                                                    |   | *      |
|                |   |                                                                                                                                                                                             |   |   |
| 31.1                |   | Certification of Registrant’s Chief Executive  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003                                                                            |   |   |
|                |   |                                                                                                                                                                                             |   |   |
| 31.2                |   | Certification of Registrant’s Chief Financial  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003                                                                            |   |   |
|                |   |                                                                                                                                                                                             |   |   |
| 32.1                |   | Certification of Registrant’s Chief Executive  Officer Pursuant to 18 U.S.C. Section 1350                                                                                                   |   |   |
|                |   |                                                                                                                                                                                             |   |   |
| 32.2                |   | Certification of Registrant’s Chief Financial Officer  Pursuant to 18 U.S.C. Section 1350                                                                                                   |   |   |
|                |   |                                                                                                                                                                                             |
|                     |   |                                                                                                                                                                                             |
| *                   |   | Denotes management contract or compensatory plan  arrangement.                                                                                                                                   |   |   |

 

The exhibit list is incorporated by reference to the exhibit index inthis report.

 

**Reportson Form 8-K**

 

None

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                           | CAPITAL CORP OF THE WEST |
|--------------------------------|--------------------------|
|                           | (Registrant)             |
|                           |                     |   |
|                           |                     |   |
| Date:   November 12, 2003 | By                       |   | /s/ | Thomas T. Hawker |
|                           |                     |   | Thomas T. Hawker |
|                           |                     |   | President and  Chief Executive Officer |
|                           |                     |   |
|                           |                     |   |
| Date: November 12, 2003        | By                       | /s/ | R. Dale McKinney |
|                           |                     |   | R. Dale McKinney |
|                           |                     |   | Chief Financial Officer |
|                                |                          |  |  |  |

 

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Exhibit Index

 
| **Exhibit** |   | **Description**                                                                                                                                                                            |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                       |
| 4.1         |   | Indenture, dated as of February 22, 2001 between  Capital Corp of the West, as Issuer, and State Street Bank and Trust Company  of Connecticut, National Association, as Trustee.          |
|        |   |                                                                                                                                                                                       |
| 4.2         |   | Amended and Restated Declaration of Trust by and  between State Street Bank and Trust Company of Connecticut, National  Association, as Trustee, and Capital Corp of the West, as Sponsor. |
|        |   |                                                                                                                                                                                       |
| 10.10       |   | Form of Capital Corp of the West Amended Salary  Continuation Agreement Entered Into with Executive Officers in October 2003.                                                              |
|        |   |                                                                                                                                                                                       |
| 31.1        |   | Certification of Registrant’s Chief Executive  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003                                                                      |
|        |   |                                                                                                                                                                                       |
| 31.2        |   | Certification of Registrant’s Chief Financial  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003                                                                      |
|        |   |                                                                                                                                                                                       |
| 32.1        |   | Certification of Registrant’s Chief Executive  Officer Pursuant to 18 U.S.C. Section 1350                                                                                             |
|        |   |                                                                                                                                                                                       |
| 32.2        |   | Certification of Registrant’s Chief Financial  Officer Pursuant to 18 U.S.C. Section 1350                                                                                             |

 

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