**FORM 10-Q**

 

**SECURITIESAND 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  March 31, 2004**                                                                                                                                   |
|                                                                                                                                                                                      |
| **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 ofregistrant as 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’s telephone number, including areacode:   **(209) 725-2200**

 

Former name, former address and former fiscal year, ifchanged since last report:  **Not applicable**

 

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

Yes  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

 

The number of shares outstanding of the registrant’scommon stock, no par value, as of March 31, 2004 was 5,690,602.  No shares of preferred stock, no par value,were outstanding at March 31, 2004.

 

 

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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  Shareholders 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, Use of Proceeds and  Issuer Purchase of Equity Securities                  |                                                                    |
| 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 ofthe West

Consolidated BalanceSheets

(Unaudited)

 
|                                                                                                                                                           |   | **March 31,  2004**    |      | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-----------|-----------------------------|--------|
|                                                                                                                                                           |   | **(Dollars  in thousands)** |      |
| **Assets**                                                                                                                                                     |   |                        |      |                        |   |
| Cash and noninterest-bearing deposits in  other banks                                                                                                          |   | $                           | 40,951    |                        | $      | 44,292 |   |
| Federal funds sold                                                                                                                                             |   | 2,025                       |      | 1,190                       |   |
| Time deposits at other financial  institutions                                                                                                                 |   | 350                         |      | 350                         |   |
| Investment securities available for sale,  at fair value                                                                                                       |   | 281,716                     |      | 275,403                     |   |
| Investment securities held to maturity at  cost, fair value of $103,921 and $97,295 at March 31, 2004 and  December 31, 2003                         |   | 102,191                     |      | 96,612                      |   |
| Loans, net of allowance for loan losses of  $13,575 and $13,263 at March 31, 2004 and December 31, 2003                                              |   | 774,806                     |      | 750,989                     |   |
| Interest receivable                                                                                                                                            |   | 5,921                       |      | 6,045                       |   |
| Premises and equipment, net                                                                                                                                    |   | 17,331                      |      | 16,557                      |   |
| Goodwill and other intangible assets                                                                                                                           |   | 2,482                       |      | 2,649                       |   |
| Cash value of life insurance                                                                                                                                   |   | 24,355                      |      | 24,138                      |   |
| Investment in housing tax credit limited  partnerships                                                                                                         |   | 8,621                       |      | 8,717                       |   |
| Other assets                                                                                                                                                   |   | 6,808                       |      | 7,600                       |   |
|                                                                                                                                                           |   |                        |      |                        |   |
| Total assets                                                                                                                                                   |   | $                           | 1,267,557 |                        | $      | 1,234,542 |   |
|                                                                                                                                                           |   |                        |      |                        |   |
| **Liabilities and Shareholders’ Equity**                                                                                                                  |   |                        |      |                        |   |
| Deposits                                                                                                                                                       |   |                        |      |                        |   |
| Noninterest-bearing demand                                                                                                                                     |   | $                           | 197,705   |                        | $      | 206,709 |   |
| Negotiable orders of withdrawal                                                                                                                                |   | 137,505                     |      | 136,975                     |   |
| Savings                                                                                                                                                        |   | 343,297                     |      | 330,023                     |   |
| Time, under $100,000                                                                                                                                           |   | 184,669                     |      | 182,363                     |   |
| Time, $100,000 and over                                                                                                                                        |   | 175,580                     |      | 172,738                     |   |
| Total deposits                                                                                                                                                 |   | 1,038,756                   |      | 1,028,808                   |   |
|                                                                                                                                                           |   |                        |      |                        |   |
| Borrowed funds                                                                                                                                                 |   | 113,348                     |      | 92,817                      |   |
| Junior Subordinated Debentures                                                                                                                                 |   | 16,496                      |      | 16,496                      |   |
| Accrued interest, taxes and other  liabilities                                                                                                                 |   | 4,563                       |      | 6,936                       |   |
| Total liabilities                                                                                                                                              |   | 1,173,163                   |      | 1,145,057                   |   |
|                                                                                                                                                           |   |                        |      |                        |   |
| Preferred stock, no par value; 10,000,000  shares authorized; None outstanding                                                                                 |   | —                      |      | —                      |   |
| Common stock, no par value; 20,000,000  shares authorized; 5,690,602 and 5,660,739 issued & outstanding at  March 31, 2004 and December 31, 2003 |   | 54,734                      |      | 54,228                      |   |
| Retained earnings                                                                                                                                              |   | 38,174                      |      | 34,816                      |   |
| Accumulated other comprehensive income                                                                                                                         |   | 1,486                       |      | 441                         |   |
|                                                                                                                                                           |   |                        |      |                        |   |
| Total shareholders’ equity                                                                                                                                |   | 94,394                      |      | 89,485                      |   |
|                                                                                                                                                           |   |                        |      |                        |   |
| Total liabilities and shareholders’ equity                                                                                                                |   | $                           | 1,267,557 |                        | $      | 1,234,542 |   |

 

See accompanyingnotes

 

3

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Capital Corp ofthe West

Consolidated Statementsof Income and Comprehensive Income

(Unaudited)

 
|                                                            |   | **For the  three months  ended March 31,** |   |
|-----------------------------------------------------------------|--------|-------------------------------------------------|--------|
| **(Dollars in thousands, except per  share data)**              |   | **2004**                                        |   | **2003** |   |
| **Interest income:**                                            |   |                                            |   |   |   |
| Interest and fees on loans                                      |   | $                                               | 13,148 |   | $ | 11,333 |   |
| Interest on deposits with other financial  institutions         |   | 2                                               |   | 2 |   |
| Interest on investments held to maturity:                       |   |                                            |   |   |   |
| Taxable                                                         |   | 601                                             |   | 766 |   |
| Non-taxable                                                     |   | 480                                             |   | 55 |   |
| Interest on investments available for sale:                     |   |                                            |   |   |   |
| Taxable                                                         |   | 2,653                                           |   | 2,176 |   |
| Non-taxable                                                     |   | 11                                              |   | 272 |   |
| Interest on federal funds sold                                  |   | 11                                              |   | 39 |   |
| Total interest income                                           |   | 16,906                                          |   | 14,643 |   |
|                                                            |   |                                            |   |   |   |
| **Interest expense:**                                           |   |                                            |   |   |   |
| Interest on negotiable orders of withdrawal                     |   | 15                                              |   | 14 |   |
| Interest on savings deposits                                    |   | 765                                             |   | 580 |   |
| Interest on time deposits, under $100                           |   | 1,083                                           |   | 1,120 |   |
| Interest on time deposits, $100 and over                        |   | 927                                             |   | 989 |   |
| Interest on Subordinated Debentures                             |   | 264                                             |   | 157 |   |
| Interest on other borrowings                                    |   | 1,065                                           |   | 1,151 |   |
| Total interest expense                                          |   | 4,119                                           |   | 4,011 |   |
|                                                            |   |                                            |   |   |   |
| Net interest income                                             |   | 12,787                                          |   | 10,632 |   |
| Provision for loan losses                                       |   | 620                                             |   | 671 |   |
| Net interest income after provision for  loan losses            |   | 12,167                                          |   | 9,961 |   |
|                                                            |   |                                            |   |   |   |
| **Noninterest income:**                                         |   |                                            |   |   |   |
| Service charges on deposit accounts                             |   | 1,434                                           |   | 1,277 |   |
| Increase in cash surrender value of life  insurance policies    |   | 234                                             |   | 246 |   |
| Other                                                           |   | 772                                             |   | 807 |   |
| Total noninterest income                                        |   | 2,440                                           |   | 2,330 |   |
|                                                            |   |                                            |   |   |   |
| **Noninterest expenses:**                                       |   |                                            |   |   |   |
| Salaries and related benefits                                   |   | 5,056                                           |   | 4,503 |   |
| Premises and occupancy                                          |   | 779                                             |   | 670 |   |
| Equipment                                                       |   | 826                                             |   | 759 |   |
| Professional fees                                               |   | 370                                             |   | 274 |   |
| Supplies                                                        |   | 222                                             |   | 235 |   |
| Marketing                                                       |   | 348                                             |   | 260 |   |
| Intangible amortization                                         |   | 167                                             |   | 170 |   |
| Other                                                           |   | 1,558                                           |   | 1,489 |   |
| Total noninterest expenses                                      |   | 9,326                                           |   | 8,360 |   |
|                                                            |   |                                            |   |   |   |
| Income before provision for income taxes                        |   | 5,281                                           |   | 3,931 |   |
| Provision for income taxes                                      |   | 1,637                                           |   | 904 |   |
| Net income                                                      |   | $                                               | 3,644  |   | $ | 3,027 |   |
| Comprehensive income:                                           |   |                                            |   |   |   |
| Unrealized gain (loss) on securities  arising during the period |   | 1,045                                           |   | (355 | ) |
| Comprehensive income                                            |   | $                                               | 4,689  |   | $ | 2,672 |   |
| Basic earnings per share                                        |   | $                                               | 0.64   |   | $ | 0.54 |   |
| Diluted earnings per share                                      |   | $                                               | 0.62   |   | $ | 0.52 |   |

 

See accompanyingnotes

 

4

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Capital Corp ofthe West

Consolidated Statement ofChanges in Shareholders’ Equity

(Unaudited)

 
| **(Amounts in thousands)**                                                                             |   | **Common Stock** |   | **Retained  earnings** |   | **Accumulated  other  comprehensive  income** |   | **Total** |   |
|--------------------------------------------------------------------------------------------------------|--------|------------------|--------|------------------------|--------|-----------------------------------------------|--------|-----------|--------|
| **Number of  shares**                                                                                  |   | **Amounts**      |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Balance, December 31, 2003                                                                        |   | 5,661            |   | $                      | 54,228 |                                          | $      | 34,816    |   | $ | 441 |   | $ | 89,485 |   |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Exercise of stock options                                                                              |   | 26               |   | 346                    |   | —                                        |   | —    |   | 346 |   |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Issuance of shares pursuant to 401K and  ESOP plans                                                    |   | 4                |   | 160                    |   | —                                        |   | —    |   | 160 |   |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Net change in fair market value of  investment securities and swaps, net of   tax benefit of $726 |   | —           |   | —                 |   | —                                        |   | 1,045     |   | 1,045 |   |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Cash dividend                                                                                          |   | —           |   | —                 |   | (286                                          | )      |      |   | (286 | ) |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Net income                                                                                             |   | —           |   | —                 |   | 3,644                                         |   | —    |   | 3,644 |   |
|                                                                                                   |   |             |   |                   |   |                                          |   |      |   |   |   |
| Balance, March 31, 2004                                                                           |   | 5,691            |   | $                      | 54,734 |                                          | $      | 38,174    |   | $ | 1,486 |   | $ | 94,394 |   |

 

See accompanyingnotes

 

5

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Capital Corp ofthe West

Consolidated Statementsof Cash Flows

(Unaudited)

 
| **(Dollars in thousands)**                                                         |   | **3 months  ended  March 31,  2004** |   | **3 months  ended  March 31,  2003** |   |
|------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
| **Operating activities:**                                                          |   |                                      |   |                                      |   |
| Net income                                                                         |   | $                                         | 3,644  |                                      | $      | 3,027 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                                      |   |                                      |   |
| Provision for loan losses                                                          |   | 620                                       |   | 671                                       |   |
| Depreciation, amortization and accretion,  net                                     |   | 1,445                                     |   | 1,276                                     |   |
| Net increase in interest receivable &  other assets                            |   | (89                                       | )      | (4,187                                    | )      |
| Net increase in deferred loan fees                                                 |   | 214                                       |   | 129                                       |   |
| Net decrease in accrued interest payable  & other liabilities                  |   | (2,373                                    | )      | (441                                      | )      |
| Net cash provided by operating activities                                          |   | 3,461                                     |   | 475                                       |   |
|                                                                               |   |                                      |   |                                      |   |
| **Investing activities:**                                                          |   |                                      |   |                                      |   |
| Investment securities purchases - available  for sale securities                   |   | (19,270                                   | )      | (41,505                                   | )      |
| Investment securities purchases - held to  maturity securities                     |   | (8,325                                    | )      | (10,111                                   | )      |
| Proceeds from maturities of available for  sale investment securities              |   | 8,839                                     |   | 15,952                                    |   |
| Proceeds from maturities of held to  maturity investment securities                |   | 2,746                                     |   | 5,964                                     |   |
| Net increase in time deposits in other  financial institutions                     |   | —                                    |   | (100                                      | )      |
| Proceeds from sales of securities,  available for sale                             |   | 5,577                                     |   | —                                    |   |
| Proceeds from sales of loans                                                       |   | 1,205                                     |   | 1,991                                     |   |
| Net increase in loans                                                              |   | (26,265                                   | )      | (24,150                                   | )      |
| Purchases of premises and equipment                                                |   | (1,173                                    | )      | (1,739                                    | )      |
| Net cash used in investing activities                                              |   | (36,666                                   | )      | (53,698                                   | )      |
|                                                                               |   |                                      |   |                                      |   |
| **Financing activities:**                                                          |   |                                      |   |                                      |   |
| Net increase (decrease) in demand, NOW and  savings deposits                       |   | 4,800                                     |   | (13,673                                   | )      |
| Net increase (decrease) in certificates of  deposit                                |   | 5,148                                     |   | (13,935                                   | )      |
| Net proceeds from other borrowings                                                 |   | 20,531                                    |   | 40,805                                    |   |
| Payment of cash dividends                                                          |   | (286                                      | )      | —                                    |   |
| Issuance of shares pursuant to 401K and  ESOP plans                                |   | 160                                       |   | —                                    |   |
| Exercise of stock options                                                          |   | 346                                       |   | 40                                        |   |
| Net cash provided by financing activities                                          |   | 30,699                                    |   | 13,237                                    |   |
|                                                                               |   |                                      |   |                                      |   |
| Net decrease in cash and cash equivalents                                          |   | (2,506                                    | )      | (39,986                                   | )      |
|                                                                               |   |                                      |   |                                      |   |
| Cash and cash equivalents at beginning of  period                                  |   | 45,482                                    |   | 73,183                                    |   |
| Cash and cash equivalents at end of period                                         |   | $                                         | 42,976 |                                      | $      | 33,197 |   |
|                                                                               |   |                                      |   |                                      |   |
| **Cash paid during the quarter:**                                                  |   |                                      |   |                                      |   |
| Interest paid                                                                      |   | $                                         | 3,703  |                                      | $      | 3,488 |   |
| Income tax payments                                                                |   | 5,761                                     |   | —                                    |   |
| **Supplemental disclosure of noncash  investing****and financing activities:**     |   |                                      |   |                                      |   |
| Investment securities unrealized gains  (losses) and swaps, net of tax             |   | 1,045                                     |   | (355                                      | )      |

 

See accompanyingnotes

 

6

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Capital Corp ofthe West

Notes toConsolidated Financial Statements

March 31,2003 and December 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 onApril 26, 1995.  OnNovember 1, 1995, the Company became registered as a bank holding company,and is a holder of all of the capital stock of County Bank (the “Bank”).  During 1998, the Company formed Capital WestGroup, a subsidiary that engages in the financial institution advisory businessbut is currently inactive.  TheCompany’s primary asset is the Bank****and the Bank is the Company’s primarysource of income.  The Company’ssecurities consist of 20,000,000 shares of Common Stock, no par value,10,000,000 shares of Authorized Preferred Stock.  As of March 31, 2004 there were 5,690,602 common sharesoutstanding, held of record by approximately 1,700 shareholders.  There were no preferred shares outstandingat March 31, 2004.  The Bank hasthree wholly owned subsidiaries, Merced Area Investment & Development, Inc.(“MAID”), County Asset Advisors (“CAA”), and County Investment Trust(“REIT”).  CAA is currentlyinactive.  The Company also has twounconsolidated trusts, County Statutory Trust and County Statutory Trust II(the “Trusts”).  In the second quarterof 2002, the Company purchased Regency Investment Advisors, Inc (“RIA”).  The Company has one wholly owned subsidiary,Capital West Group, Inc. (“CWG”).  CWGis 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 County Bank ofMerced, a California state banking corporation.  The Bank commenced operations on December 22, 1977.  In November 1992, the Bank changed itslegal name to County Bank.  The Bank’ssecurities consist of one class of Common Stock, no par value and is whollyowned by the Company.  The Bank’sdeposits are insured under the Federal Deposit Insurance Act by the FederalDeposit Insurance Corporation (“FDIC”) up to applicable limits statedtherein.  Like most state-charteredbanks of its size in California, it is not a member of the Federal ReserveSystem.

 

INDUSTRY AND MARKET AREA

 

The Bank engages in general commercial banking business primarily inFresno, Madera, Mariposa, Merced, San Francisco, San Joaquin, Stanislaus andTuolomne counties.  The Bank hasnineteen full service branch offices; two of which are located in Merced withthe branch located in downtown Merced currently serving as both a branch and asadministrative headquarters. There are offices in Atwater, Dos Palos, Hilmar,Livingston, Los Banos, Madera, Mariposa, San Francisco, Sonora, Stockton, twooffices in Modesto, three in Fresno and two offices in Turlock.  The Bank’s administrative headquarters alsoprovides accommodations for the activities of Merced Area Investment &Development (“MAID”), the Bank’s wholly owned real estate subsidiary.

 

OTHER FINANCIAL NOTES

 

All adjustments which in the opinion of Management are necessary for afair presentation of the Company’s financial position at March 31, 2004and December 2003 and the results of operations for the three monthperiods ended March 31, 2004 and 2003, and the statements of cash flowsfor the three months ended March 31, 2004 and 2003 have been included.  The interim results for the three months

 

7

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ended March 31, 2004 and 2003 are not necessarily indicative ofresults for the full year.  Thesefinancial statements should be read in conjunction with the financialstatements and the notes included in the Company’s Annual Report for the yearended December 31, 2003.

 

The accompanying unaudited financial statements have been prepared on abasis consistent with generally accepted accounting principles and with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.

 

Basic earnings per share (EPS) is computed by dividing net incomeavailable to shareholders by the weighted average number of common sharesoutstanding during the period.  Dilutedearnings per share is computed by dividing net income available to commonshareholders by the weighted average number of common shares outstanding duringthe period plus potential common shares outstanding.  Diluted earnings per share reflects the potential dilution thatcould occur if securities or other contracts to issue common stock wereexercised or converted into common stock or resulted in the issuance of commonstock that then shared in the earnings of the Company.

 

The following table provides a reconciliation of the numerator anddenominator of the basic and diluted earnings per share computation of thethree month periods ended March 31, 2004 and 2003:

 

|                                               |   | **For The  Three Months  Ended March 31,** |   |
|----------------------------------------------------|--------|-------------------------------------------------|--------|
| **(Dollars in thousands, except per  share data)** |   | **2004**                                        |   | **2003** |   |
|                                               |   |                                            |   |   |   |
| Basic EPS computation:                             |   |                                            |   |   |   |
| Net income                                         |   | $                                               | 3,644  |   | $ | 3,027 |   |
| Average common shares outstanding                  |   | 5,673                                           |   | 5,592 |   |
| Basic EPS                                          |   | $                                               | 0.64   |   | $ | 0.54 |   |
|                                               |   |                                            |   |   |   |
| Diluted EPS Computations:                          |   |                                            |   |   |   |
| Net income                                         |   | $                                               | 3,644  |   | $ | 3,027 |   |
| Average common shares outstanding                  |   | 5,673                                           |   | 5,592 |   |
| Effect of stock options                            |   | 235                                             |   | 184 |   |
|                                               |   | 5,908                                           |   | 5,776 |   |
| Diluted EPS                                        |   | $                                               | 0.62   |   | $ | 0.52 |   |

 

The Company has intangible assets consisting of core deposit premiumsand goodwill.  Core deposit premiums areamortized using an accelerated method over a period of ten years.  Intangible assets related to goodwill havenot been amortized after December 31, 2001 but are reviewed periodicallyfor potential impairment.  During 2004,management has determined there was no impairment of goodwill.  As of March 31, 2004 andDecember 31, 2003, the Company had unamortized core deposit premiums of$557,000 and $724,000, respectively. Amortization of core deposit premiums and other intangibles was $167,000and $170,000 during the first quarter of 2004 and 2003, respectively.  Core deposit premiums and other intangiblesare scheduled to amortize at a rate of approximately $167,000 per quarterthrough the quarter ended December 31, 2004 and at a rate of $56,000during the first quarter of 2005.  Coredeposit premiums of $460,000 and $4,340,000 were initially recorded as a resultof purchasing deposits from Town and Country Finance and Thrift in July, 1996and from the purchase of three branches from Bank of America in December, 1997,respectively.

 

8

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The Company provides stock-based compensation to certain officers anddirectors.  The Company uses theintrinsic value method to account for its stock option plans (in accordancewith the provisions of Accounting Principles Board Opinion No. 25).  Under this method, compensation expense isrecognized for awards of options to purchase shares of common stock toemployees under compensatory plans only if the fair market value of the stockat the option grant date (or other measurement date, if later) is greater thanthe 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.

 

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:

 
|                                                                                         |   | **Three  months ended March 31,** |   |
|----------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
| **(dollars in thousands except per  share amounts)**                                         |   | **2004**                               |   | **2003** |   |
|                                                                                         |   |                                   |   |   |   |
| Net income:                                                                             |   |                                   |   |   |   |
| As reported                                                                                  |   | $                                      | 3,644  |   | $ | 3,027 |   |
| Pro forma                                                                                    |   | $                                      | 3,285  |   | $ | 2,851 |   |
|                                                                                         |   |                                   |   |   |   |
| Basic earnings per share:                                                                    |   |                                   |   |   |   |
| As reported                                                                                  |   | $                                      | 0.64   |   | $ | 0.54 |   |
| Pro forma                                                                                    |   | $                                      | 0.58   |   | $ | 0.51 |   |
|                                                                                         |   |                                   |   |   |   |
| Diluted earnings per share:                                                                  |   |                                   |   |   |   |
| As reported                                                                                  |   | $                                      | 0.62   |   | $ | 0.52 |   |
| Pro forma                                                                                    |   | $                                      | 0.56   |   | $ | 0.49 |   |
|                                                                                         |   |                                   |   |   |   |
| Stock-based employee compensation cost, net  of related tax effects, included in net income: |   |                                   |   |   |   |
| As reported                                                                                  |   | $                                      | — |   | $ | — |   |
| Pro forma                                                                                    |   | $                                      | 415    |   | $ | 176 |   |

 

**Recent AccountingPronouncements**

 

In December 2003, FASB issued Statement No. 132 (revised 2003), *Employers’Disclosures about Pensions and Other Postretirement Benefits. *This Statement prescribesemployers’ disclosures about pension plans and other postretirement benefitplans; it does not change the measurement or recognition of those plans.  The Statement  retains and revises the disclosure requirements contained in theoriginal Statement 132.  It alsorequires additional disclosures about the assets, obligations, cash flows, andnet periodic benefit cost of defined benefit plans and other postretimentbenefit plans.  The Statement generallyis effective for fiscal years ending after December 15, 2003.  The Company currently does not have anypostretirement benefit plans that are within the scope of this Statement.

 

In December 2003, the FASB issued FASB Interpretation No. 46 (revisedDecember 2003), *Consolidation of VariableInterest Entities,* which addresses how a business enterprise shouldevaluate whether it has a controlling financial interest in a “VariableInterest Equity” (“VIE”) through means other than voting rights and accordinglyshould consolidate the entity.  FIN 46Rreplaces FASB Interpretation No. 46, *Consolidationof Variable Interest Entities,* which was issued in January2003.  The Company will be required toapply FIN 46R to variable interests in VIEs created after December 31,2003.  For variable interests in VIEs createdbefore January 1, 2004, the Interpretation will be applied beginning on January1, 2005.  For any VIEs that must beconsolidated under FIN 46R that were created before January 1, 2004, theassets, liabilities and noncontrolling interests of the VIE initially would bemeasured at their carrying amounts with any difference between the net amountadded to the balance sheet and any previously recognized interest beingrecognized as the cumulative effect of an accounting change.  If determining the carrying amounts is notpracticable, fair value at the date FIN 46R first applies may be used tomeasure the assets, liabilities and noncontrolling interest of the VIE.

 

The Company has adopted FIN 46R and applied it to existing VIEs inwhich the Company has variable interests. As a result of adopting FIN 46R, the balance sheet line items related toCapital Securities and the related income statement effect of dividends onCapital Securities in the March 31, 2003 consolidated financial statements havebeen reclassified to conform with the 2004 presentation.  The junior subordinated debentures issued tothe Trusts as VIEs were reflected as long-term debt in the consolidated balancesheets at March 31, 2004 and December 31, 2003.  Prior to December 31, 2003, the Trusts were consolidatedsubsidiaries and were included in liabilities in the consolidated balancesheet, as “Capital Securities”.  Thecommon securities and debentures, along with the related income effects wereeliminated in the consolidated financial statements.

 

In March, 2004 the Emerging Issues Task Force (“EITF”) Issue No. 03-1“The Meaning of Other-Than-Temporary Impairment and its Application to CertainInvestments,” consensus was published. Issue No. 03-1 contained new guidance effectively codifying theprovisions of SEC Staff Accounting Bulletin No. 59 and creates a new model thatcalls for new judgements and additional evidence gathering.  This EITF issue has not had an impact on theCompany’s Consolidated Financial Statements.

 

9

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**Item2.****           Management’s DiscussionAnd Analysis Of Financial Condition And Results Of Operations**

 

The following Management’s Discussion and Analysis of FinancialCondition and Results of Operations contains forward-looking statements thatare subject to risks and uncertainties and include information about possibleor assumed future results of operations. Many possible events or factors could affect the future financialresults and performance of the company. This could cause results or performance to differ materially from thoseexpressed in our forward-looking statements. Words such as “experts”, “anticipates”, “believes”, “estimates”,variations of such words and other similar expressions are intended to identifysuch forward-looking statements.  Thesestatements are not guarantees of future performance and involve certain risks,uncertainties and assumptions which are difficult to predict.  Therefore, actual outcomes and results maydiffer materially from what is expressed or forecasted in, or implied by, suchforward-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 2003 Annual Report on Form 10-K filed March 15, 2004.  These statements are representative only onthe date hereof, and the Company undertakes no obligation to update anyforward-looking statements made.  Somepossible events or factors that could occur that may cause differences fromexpected results include the following: the Company’s loan growth is dependenton economic conditions, as well as various discretionary factors, such asdecisions to sell, or purchase certain loans or loan portfolios; participationsof loans and the management of borrower, industry, product and geographicconcentrations and the mix of the loan portfolio.  The rate of charge-offs and provision expense can be affected bylocal, regional and international economic and market conditions,concentrations of borrowers, industries, products and geographical conditions,the mix of the loan portfolio and management’s judgements regarding thecollectibility of loans.  Liquidityrequirements may change as a result of fluctuations in assets and liabilitiesand off-balance sheet exposures, which will impact the capital and debtfinancing needs of the Company and the mix of funding sources.  Decisions to purchase, hold, or sellsecurities are also dependent on liquidity requirements and market volatility,as well as on and off-balance sheet positions. Factors that may impact interest rate risk include local, regional andinternational economic conditions, levels, mix, maturities, yields or rates ofassets and liabilities and the wholesale and retail funding sources of theCompany.

 

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, theFederal Deposit Insurance Corporation and state regulators, whose policies andregulations could affect the Company’s results.

 

Other factors that may cause actual results to differ from theforward-looking statements include the following: competition with other localand regional banks, savings and loan associations, credit unions and othernonbank financial institutions, such as investment banking firms, investmentadvisory firms, brokerage firms, mutual funds and insurance companies, as wellas other entities which offer financial services; interest rate, market andmonetary fluctuations; inflation; market volatility; general economicconditions; introduction and acceptance of new banking-related products,services and enhancements; fee pricing strategies, mergers and acquisitions andtheir integration into the Company, civil disturbances or terrorist threats oracts, or apprehension about the possible future occurrences or acts of thistype, outbreak or escalation of hostilities in which the United States isinvolved, any declaration of war by the

 

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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.

 

**Critical accountingpolicies 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, valuationof deferred income taxes and contingencies. The Company bases its estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources.  Actual results may differ fromthese estimates under different assumptions or conditions. (See caption“Allowance for Loan Losses” for a more detailed discussion).

 

During 2003, California enacted tax legislation thatadded new penalties for institutions that engaged in strategies andtransactions that the Franchise Tax Board (“FTB”) defined as abusive taxshelters.  The FTB gave taxpayers untilApril 15, 2004 to take advantage of a voluntary compliance initiative(“VCI”) that would allow taxpayers to amend prior year filings without beingsubject to the new tax shelter penalties. On April 15, 2004, the Company took advantage of the VCI, amendedtax returns for the tax years ended December 31, 2001 and 2002, and paidthe Franchise Tax Board $2,411,000.  Aspart of this process, the Company maintained the legal rights to pursue a claimof refund from the Franchise Tax Board for the amounts paid, and has everyintention of doing so.  Companymanagement believes the strategy used is lawful and defensible, and intends todefend the tax position taken.  If thecompany is ultimately unsuccessful in its claims against California, it wouldadversely affect the Company’s financial condition and results of operationsand the Company could be held liable for additional accuracy related penalties.  As of March 31, 2004, the Company had acumulative recorded net tax benefit of $1,563,000 related to the REIT.

 

11

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The followingdiscussion and analysis is designed to provide a better understanding of thesignificant changes and trends related to the Company and its subsidiaries’financial condition, operating results, asset and liability management,liquidity and capital resources and should be read in conjunction with theConsolidated Financial Statements of the Company and the Notes thereto.

 

**Results Of Operations**

 

**Three Months Ended March 31, 2004Compared With Three Months Ended March 31, 2003**

 

*Overview.*  For the three months ended March 31,2004 the Company reported record net income of $3,644,000.  This compares to $3,027,000 for the sameperiod in 2003 and represents an increase of $617,000 or 20%.  Basic and fully diluted earnings per sharewere $0.64 and $0.62 for the three months ended March 31, 2004. Thiscompares to basic and fully diluted earnings per share of $0.54 and $0.52 forthe three months ended March 31, 2003 and represents an increase of $0.10per share for both basic and fully diluted earnings per share. The basic andfully diluted earnings per share are reflective of the 5% stock dividend paidin April, 2003.  The annualized returnon average assets was 1.17% and 1.20% for the first three months of 2004 and2003.  The Company’s annualized returnon average equity was 15.83% and 15.37% for the three months endedMarch 31, 2004 and 2003.

 

*Net Interest 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 months ended March 31, 2004 totaled $12,787,000 and representedan increase of $2,155,000 or 20% when compared to the $10,632,000 achievedduring the three months ended March 31, 2003.

 

Total interest andfees on earning assets were $16,906,000 for the three months endedMarch 31, 2004, an increase of $2,263,000 or 15% from the $14,643,000 forthe same period in 2003.  The level ofinterest income is affected by changes in volume of and rates earned oninterest-earning assets.  Interest-earningassets consist primarily of loans, investment securities and federal fundssold.  The increase in total interestincome for the three months ended March 31, 2004 was primarily the resultof an increase in volume of interest-earning assets.  Average interest-earning assets for the three months endedMarch 31, 2004 were $1,150,109,000 compared with $934,810,000 for thethree months ended March 31, 2003, an increase of $215,299,000 or23%.  Average interest rates earned oninterest-earning assets were 5.96% for the three months ended March 31,2004 compared with 6.41% for the same three months of 2003, a decrease of 45basis points or 7%.  The modest declinein the interest rates earned between 2003 and 2004 was primarily the result ofdecreased market interest rates and the corresponding repricing of maturing andadjustable, higher yielding assets during the period.

 

Interest expenseis 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 $4,119,000 forthe three months ended March 31, 2004, compared with $4,011,000 for thethree months ended March 31, 2003, an increase of $108,000 or 3%. Thisincrease was primarily the result of a increase in the volume ofinterest-bearing liabilities. Average interest-bearing liabilities were$952,111,000 for the three months ended March 31, 2004 compared with$775,508,000 for the same three months in 2003, an increase of $176,603,000 or23%.  Average interest rates paid oninterest-bearing liabilities were 1.74% for the three months endingMarch 31, 2004 compared with 2.10% for the same three months of 2003, adecrease in interest rates paid of 36 basis points or 17%.  The decline in the interest rates paidbetween 2003 and 2004 was primarily the result of decreased market interestrates and the corresponding repricing of maturing, higher yielding liabilitiesduring the period.

 

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The increase ininterest-earning assets and interest-bearing liabilities is primarily theresult of increased market penetration within our target markets which has beenaccomplished by increasing the utilization of existing facilities and theaddition of branches in Fresno, California.

 

The Company’staxable equivalent net interest margin, the ratio of net interest income toaverage interest-earning assets, was 4.53% for the three months endedMarch 31, 2004 compared with 4.67% for the same period in 2003.  Net interest margin provides a measurementof the Company’s ability to employ funds profitably during the period beingmeasured.  The Company’s decrease in netinterest margin was primarily attributable to a larger decline in the interestrate earned on interest-earning assets than the decline in the interest ratepaid on interest-bearing liabilities. Loans as a percentage of average interest-earning assets decreasedslightly to 67% for the three months ended March 31, 2004 compared with68% for the three months ended March 31, 2003.  

 

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*Average Balances AndRates Earned And Paid.*  The following table presents condensed average balance sheetinformation for the Company, together with interest rates earned and paid onthe various sources and uses of its funds for each of the periodsindicated.  Nonaccruing loans areincluded in the calculation of the average balances of loans, but thenonaccrued interest on such loans is excluded.

 

AVERAGE BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS

 
|                                            |   | **Three  months ended  March 31, 2004** |      | **Three  months ended  March 31, 2003** |   |
|-------------------------------------------------|--------|----------------------------------------------|-----------|----------------------------------------------|--------|
|                                            |   | **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                              |   | $                                            | 4,216     |                                         | $      | 11 |   | 1.05 | % | $ | 13,349 |   | $ | 39 |   | 1.18 | % |
| Time deposits at other financial  institutions  |   | 350                                          |      | 2                                            |   | 2.29 |   | 559 |   | 2 |   | 1.45 |   |
| Taxable investment securities  (1)         |   | 325,790                                      |      | 3,285                                        |   | 4.04 |   | 256,905 |   | 2,977 |   | 4.70 |   |
| Nontaxable investment securities (1)            |   | 48,755                                       |      | 651                                          |   | 5.36 |   | 28,908 |   | 434 |   | 6.09 |   |
| Loans, gross: (2)                               |   | 770,998                                      |      | 13,148                                       |   | 6.84 |   | 635,089 |   | 11,333 |   | 7.24 |   |
| Total interest-earning assets                   |   | 1,150,109                                    |      | 17,097                                       |   | 5.96 |   | 934,810 |   | 14,785 |   | 6.41 |   |
| Allowance for loan losses                       |   | (13,472                                      | )         |                                         |   |   |   | (12,390 | ) |   |   |   |   |
| Cash and due from banks                         |   | 39,317                                       |      |                                         |   |   |   | 32,575 |   |   |   |   |   |
| Premises and equipment, net                     |   | 16,866                                       |      |                                         |   |   |   | 14,343 |   |   |   |   |   |
| Interest receivable and other assets            |   | 48,088                                       |      |                                         |   |   |   | 39,062 |   |   |   |   |   |
| Total assets                                    |   | $                                            | 1,240,908 |                                         |   |   |   |   | $ | 1,008,400 |   |   |   |   |   |
|                                            |   |                                         |      |                                         |   |   |   |   |   |   |   |   |   |
| **Liabilities And Shareholders’ Equity**   |   |                                         |      |                                         |   |   |   |   |   |   |   |   |   |
| Negotiable order of withdrawal                  |   | $                                            | 134,678   |                                         | $      | 15 |   | 0.04 |   | $ | 117,514 |   | $ | 14 |   | 0.05 |   |
| Savings deposits                                |   | 340,444                                      |      | 765                                          |   | 0.90 |   | 224,096 |   | 580 |   | 1.05 |   |
| Time deposits                                   |   | 361,653                                      |      | 2,010                                        |   | 2.23 |   | 315,352 |   | 2,109 |   | 2.71 |   |
| Other borrowings                                |   | 98,840                                       |      | 1,065                                        |   | 4.32 |   | 112,360 |   | 1,151 |   | 4.15 |   |
| Subordinated Debentures                         |   | 16,496                                       |      | 264                                          |   | 6.42 |   | 6,186 |   | 157 |   | 10.29 |   |
| Total interest-bearing liabilities              |   | 952,111                                      |      | 4,119                                        |   | 1.74 |   | 775,508 |   | 4,011 |   | 2.10 |   |
|                                            |   |                                         |      |                                         |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing deposits                    |   | 190,585                                      |      |                                         |   |   |   | 148,426 |   |   |   |   |   |
| Accrued interest, taxes and other  liabilities  |   | 6,110                                        |      |                                         |   |   |   | 5,666 |   |   |   |   |   |
| Total liabilities                               |   | 1,148,806                                    |      |                                         |   |   |   | 929,600 |   |   |   |   |   |
|                                            |   |                                         |      |                                         |   |   |   |   |   |   |   |   |   |
| Total shareholders’ equity                 |   | 92,102                                       |      |                                         |   |   |   | 78,800 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $                                            | 1,240,908 |                                         |   |   |   |   | $ | 1,008,400 |   |   |   |   |   |
|                                            |   |                                         |      |                                         |   |   |   |   |   |   |   |   |   |
| Net interest income and margin (3)              |   |                                         |      | $                                            | 12,978 |   | 4.53 | % |   |   | $ | 10,774 |   | 4.67 | % |

 

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(1)                                  Tax-equivalent adjustments included inthe nontaxable investment securities portfolio are $160,000 and $107,000 forthe three months ended March 31, 2004 and 2003.  Tax equivalent adjustments included in the taxable investmentsecurities created by a dividends received deduction were $31,000 and $35,000for the three months ended March 31, 2004 and 2003.

(2)                                  Amounts of interestearned included loan fees of $511,000 and $1,098,000 and loan costs of $102,000and $737,000 for the three months ended March 31, 2004 and 2003,respectively.

(3)                                  Net interest marginis computed by dividing net interest income by total average interest-earningassets.

 

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*Net Interest Income Changes Due To Volume And Rate.*  The following table sets forth, for theperiods indicated, a summary of the changes in average asset and liabilitybalances and interest earned and interest paid resulting from changes inaverage asset and liability balances (volume) and changes in average interestrates and the total net change in interest income and expenses.  The changes in interest due to both rate andvolume have been allocated to volume and rate changes in proportion to therelationship of the absolute dollar amount of the change in each.

 

Net Interest Income Variance Analysis:

 

|                                       |   | **Three  months ended  March 31, 2004 compared to March 31, 2003** |   |
|--------------------------------------------|--------|------------------------------------------------------------------------------|--------|
| **(Dollar in thousands)**                  |   | **Volume**                                                                   |   | **Rate** |   | **Total** |   |
|                                       |   |                                                                         |   |   |   |   |   |
| Increase (decrease) in interest income:    |   |                                                                         |   |   |   |   |   |
| Federal funds sold                         |   | $                                                                            | (24    | ) | $ | (4 | ) | $ | (28 | ) |
| Taxable investment securities              |   | 756                                                                          |   | (448 | ) | 308 |   |
| Tax-exempt investment securities           |   | 275                                                                          |   | (58 | ) | 217 |   |
| Loans                                      |   | 2,448                                                                        |   | (633 | ) | 1,815 |   |
| Total:                                     |   | $                                                                            | 3,455  |   | $ | (1,143 | ) | $ | 2,312 |   |
|                                       |   |                                                                         |   |   |   |   |   |
| Increase (decrease) in interest expense:   |   |                                                                         |   |   |   |   |   |
| Interest bearing demand                    |   | $                                                                            | 2      |   | $ | (1 | ) | $ | 1 |   |
| Savings deposits                           |   | 276                                                                          |   | (91 | ) | 185 |   |
| Time deposits                              |   | 299                                                                          |   | (398 | ) | (99 | ) |
| Other borrowings                           |   | (135                                                                         | )      | 49 |   | (86 | ) |
| Subordinated Debentures                    |   | 185                                                                          |   | (78 | ) | 107 |   |
| Total:                                     |   | $                                                                            | 627    |   | $ | (519 | ) | $ | 108 |   |
|                                       |   |                                                                         |   |   |   |   |   |
| Increase (decrease) in net interest income |   | $                                                                            | 2,828  |   | $ | (624 | ) | $ | 2,204 |   |

 

*Provision For Loan Losses.*** **The provision for loan losses forthe three months ended March 31, 2004 was $620,000 compared with $671,000for the three months ended March 31, 2003, a decrease of $51,000 or 8%.See “Allowance for Loan Losses” contained herein.  As of March 31, 2004 the allowance for loan losses was$13,575,000 or 1.72% of total loans compared to the allowance for loan lossesof $13,263,000 or 1.74% of total loans as of December 31, 2003.  At March 31, 2004, nonperforming assetstotaled $3,302,000 or 0.26% of total assets, nonperforming loans totaled$3,242,000 or 0.41% of total loans and the allowance for loan losses totaled419% of nonperforming loans.  At December 31,2003, nonperforming assets totaled $4,047,000 or 0.33% of total assets,nonperforming loans totaled $3,987,000 or 0.52% of total loans and theallowance for loan losses totaled 333% of nonperforming loans.  No assurance can be given that nonperformingloans will not increase or that the allowance for loan losses will be adequateto cover losses inherent in the loan portfolio.

 

*Noninterest Income.*** **Noninterest income increased by$110,000 or 5% to $2,440,000 for the three months ended March 31, 2004compared with $2,330,000 in the same period during 2003.  Service charges on deposit accountsincreased by $157,000 or 12% to $1,434,000 for the three months endedMarch 31, 2004 compared with $1,277,000 for the same period in 2003.  The increase in fees is the result of growthobtained in total deposits and number of deposit customers.  Other noninterest income decreased by$35,000 or 4% for the three month period ended March 31, 2004 whencompared to the same period in 2003. The primary source of this decreased other income is a

 

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one-time gain was recorded in the first quarter of 2003 of $82,000 fromthe sale of the consumer credit card portfolio.

 

*Noninterest Expense.*** **Noninterest expenses increased by $966,000 or 12% to$9,326,000 for the three months ended March 31, 2004 compared with$8,360,000 for the same period in 2003. The primary components of noninterest expenses were salaries andemployee benefits, premises and occupancy expenses, equipment expenses,professional fees, supplies expenses, marketing expenses, intangibleamortization and other operating expenses.

 

For the threemonths ended March 31, 2004, salaries and related benefits increased by$553,000 or 12% to $5,056,000 from the $4,503,000 recorded for the same periodin 2003. The salary expense increase was primarily the result of normal salaryprogression and increased support staff used in operations and regulatorysupport functions.  Premises andoccupancy expenses increased by $109,000 or 16% to $779,000 for the threemonths ending March 31, 2004 from $670,000 during the same period in2003.  The primary reason for theincrease in occupancy costs in 2004 is related to remodeling charges for branchfacilities in Dos Palos, Fresno, Mariposa and Modesto.  Equipment expenses increased by $67,000 or9% to $826,000 during the three months ended March 31, 2004 from the$759,000 experienced during the same period in 2003.  The additional equipment expenses were primarily the result ofbranch and department equipment upgrades. When comparing the results of the three months ended March 31, 2004to the three months ended March 31, 2003, professional fees increased by$96,000 or 35%, marketing expenses increased by $88,000 or 34%, supplies expensesdecreased by $13,000 or 5%, intangible amortization expenses decreased by$3,000, and other expenses increased $69,000 or 5% from 2003 levels. Increasedprofessional fees in 2004 were the result of an increased use of consultants inthe officer recruitment process, technology implementation projects, andinternal control processes reviews.  Theincrease marketing expenses were primarily the result of increased publicrelations expenses.  The decrease insupplies expenses was related to decreased printing costs.  The decrease in intangible amortizationexpense is related to the complete amortization of the start-up costs of theholding company during 2003.   Theincreased other expenses were primarily the result of increased correspondentbank charges caused be increased transaction volumes.

 

*Provision For Income Taxes.*** **The Company recorded an increaseof $733,000 or 81% in the income tax provision to $1,637,000 for the threemonths ended March 31, 2004 compared to the $904,000 recorded for the sameperiod in 2003.  During the firstquarter of 2004 and 2003, the Company achieved an effective tax rate of 31% and23%, respectively.  The effective taxrate for the first quarter of 2003 includes a REIT benefit that was reversed inthe fourth quarter of 2003 when the Franchise Tax Board listed certain REITtransactions as abusive tax shelters. For the full year 2003, the Company’s effective tax rate was 26%.  The increase in the effective tax rate in2004 was primarily the result of the elimination of a recorded tax benefitrelated to the Bank’s REIT as well as increased levels of taxable earnings.

 

**Financial Condition**

 

 Total assets at March 31, 2004 were$1,267,557,000, an increase of $33,015,000 or 3% compared with total assets of$1,234,542,000 at December 31, 2003. Net loans were $774,806,000 at March 31, 2004, an increase of$23,817,000 or 3% compared with net loans of $750,989,000 at December 31,2003.  Deposits were $1,038,756,000 atMarch 31, 2004, an increase of $9,948,000 or 1% compared with deposits of$1,028,808,000 at December 31, 2003. The increase in total assets of the Company between December 31,2003 and March 31, 2004 was primarily the result of an increase inborrowings that were obtained to fund additional purchases of investmentsecurities.

 

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Totalshareholders’ equity was $94,394,000 at March 31, 2004, an increase of$4,909,000 or 5% from the $89,485,000 at December 31, 2003. The growth inshareholders’ equity between December 31, 2003 and March 31, 2004 wasachieved through the retention of accumulated earnings plus an increase inother comprehensive income.  Othercomprehensive income consists of changes in the fair market value compared to bookvalue of available for sale investment securities and valuation changes in theBank’s interest rate swap, net of estimated federal and state income taxes.

 

* Off-Balance Sheet Commitments. *The following table shows the distribution of theCompany’s undisbursed loan commitments at the dates indicated.

 

| **(Dollars in thousands)**   |   | **March 31,  2004** |    | **December 31,  2003** |   |
|------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                         |   |                     |    |                        |   |
| Letters of credit            |   | $                        | 13,768  |                        | $      | 7,380 |   |
| Commitments to extend credit |   | 342,667                  |    | 348,282                     |   |
| Total                        |   | $                        | 356,435 |                        | $      | 355,662 |   |

 

*Other Interest-Earning Assets. *The following table relatesto other interest-earning assets not disclosed previously for the datesindicated.  This item consists of bankowned life insurance, some of which are universal life insurance policies thatare informally linked to a salary continuation plan for the Company’s executivemanagement and deferred retirement benefits for participating boardmembers.  The remainder of the bankowned life insurance is owned as a way to help offset the costs of employeebenefit plans.  Income from all thesepolicies is reflected in noninterest income.

 
| **(Dollars in thousands)**             |   | **At  March 31,  2004** |   | **At  December 31,  2003** |   |
|----------------------------------------|--------|------------------------------|--------|---------------------------------|--------|
|                                   |   |                         |   |                            |   |
| Cash surrender value of life insurance |   | $                            | 24,355 |                            | $      | 24,138 |   |
|                                        |        |                              |        |                                 |        |  |  |

 

*NonperformingAssets. *Nonperformingassets include nonaccrual loans, loans 90 days or more past due, restructuredloans 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

 

17

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reported on a cash basis until the borrower’s ability to service therestructured loan in accordance with its terms is established.  The Company had no restructured loans as ofthe dates indicated in the table below.

 

18

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The followingtable summarizes nonperforming assets of the Company at March 31, 2004 andDecember 31, 2003:

 

 

| **(Dollars in thousands)**              |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-----------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                    |   |                     |   |                        |   |
| Nonaccrual loans                        |   | $                        | 2,779  |                        | $      | 3,987 |   |
| Accruing loans past due 90 days or more |   | 463                      |   | —                      |   |
| Total nonperforming loans               |   | 3,242                    |   | 3,987                       |   |
| Other real estate owned                 |   | 60                       |   | 60                          |   |
| Total nonperforming assets              |   | $                        | 3,302  |                        | $      | 4,047 |   |
|                                    |   |                     |   |                        |   |
| Nonperforming loans to total loans      |   | 0.41                     | %      | 0.52                        | %      |
| Nonperforming assets to total assets    |   | 0.26                     | %      | 0.33                        | %      |

 

Contractualaccrued interest income on loans on nonaccrual status as of March 31, 2004and 2003, that would have been recognized if the loans had been current inaccordance with their original terms was approximately $61,000 and $41,000,respectively.

 

At March 31,2004, nonperforming assets represented 0.26% of total assets, a decrease of 7basis point when compared to the 0.33% at December 31, 2003.  Nonperforming loans represented 0.41% of totalloans at March 31, 2004, a decrease of 11 basis points compared to the0.52% at December 31, 2003. Nonperforming loans that were secured by first deeds of trust on realproperty were $0 at March 31, 2004 and December 31, 2003.  The decrease in nonperforming loans andnonperforming assets was primarily the result of the continuation of a strongreal estate market that has allowed for successful workouts on a few strugglingcommercial real estate and agricultural properties.  Other forms of collateral such as inventory and equipment secureda portion of the nonperforming loans as of each date.  No assurance can be given that the collateral securingnonperforming loans will be sufficient to prevent losses on such loans.

 

At March 31,2004 and December 31, 2003, the Company had $60,000 invested in oneproperty that had been acquired through foreclosure.  The property was carried at the lower of its estimated marketvalue, as evidenced by an independent appraisal, or the recorded investment inthe related loan, less estimated selling expenses.  At foreclosure, if the fair value of the real estate is less thanthe Company’s recorded investment in the related loan, a charge is made to theallowance for loan losses.  The Companydoes not expect to sell its one remaining property within the next twelve monthperiod due to the fact that the property is subject to a lifetime tenancy forthe current occupant of the residence. During the first quarter of 2004, no new foreclosure properties wereacquired or sold.  No assurance can begiven that the Company will sell the remaining property during 2004 or at anytime or the amount for which the property might be sold.

 

Management definesimpaired loans, regardless of past due status on loans, as those on whichprincipal and interest are not expected to be collected under the originalcontractual loan repayment terms.  Animpaired loan is charged off at the time management believes the collectionprocess has been exhausted.  AtMarch 31, 2004 and December 31, 2003, impaired loans were measuredbased on the present value of future cash flows discounted at the loan’seffective rate, the loan’s observable market price or the fair value ofcollateral if the loan is collateral-dependent.  Impaired loans at March 31, 2004

 

19

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were $3,242,000 for which the Company made provisions to the allowancefor loan losses of approximately $486,000.

 

Except for loansthat are disclosed above, there were no assets as of March 31, 2004, whereknown information about possible credit problems of borrower causes managementto have serious doubts as to the ability of the borrower to comply with thepresent loan repayment terms and which may become nonperforming assets.  Given the magnitude of the Company’s loanportfolio, however, it is always possible that current credit problems mayexist that may not have been discovered by management.

 

**Allowance for Loan Losses**

 

The following table summarizes the loan loss experience of the Companyfor the three months ended March 31, 2004 and 2003, and for the year endedDecember 31, 2003.

 

|                                        |   | **March 31**           |    | **December 31  2003** |   |
|---------------------------------------------|--------|-----------------------------|---------|----------------------------|--------|
| **2004**                                    |   | **2003**                    |
|                                        |   | **(Dollars  in thousands)** |    |
| **Allowance for Loan  Losses:**             |   |                        |    |                       |   |   |   |
| Balance at beginning of period              |   | $                           | 13,263  |                       | $      | 12,134 |   | $ | 12,134 |   |
| Provision for loan losses                   |   | 620                         |    | 671                        |   | 2,455 |   |
| Charge-offs:                                |   |                        |    |                       |   |   |   |
| Commercial and  agricultural           |   | 249                         |    | 6                          |   | 1,010 |   |
| Real estate - mortgage                      |   | —                      |    | —                     |   | 29 |   |
| Consumer                                    |   | 201                         |    | 306                        |   | 956 |   |
| Total charge-offs                           |   | 450                         |    | 312                        |   | 1,995 |   |
| Recoveries                                  |   |                        |    |                       |   |   |   |
| Commercial and agricultural                 |   | 21                          |    | 69                         |   | 302 |   |
| Consumer                                    |   | 121                         |    | 128                        |   | 367 |   |
| Total recoveries                            |   | 142                         |    | 197                        |   | 669 |   |
| Net charge-offs                             |   | 308                         |    | 115                        |   | 1,326 |   |
| Balance at end of period                    |   | $                           | 13,575  |                       | $      | 12,690 |   | $ | 13,263 |   |
|                                        |   |                        |    |                       |   |   |   |
| Loans outstanding at period-end             |   | $                           | 788,380 |                       | $      | 655,328 |   | $ | 764,252 |   |
| Average loans outstanding                   |   | $                           | 770,998 |                       | $      | 635,089 |   | $ | 687,419 |   |
|                                        |   |                        |    |                       |   |   |   |
| Annualized net charge-offs to average loans |   | 0.16                        | %       | 0.07                       | %      | 0.19 | % |
| Allowance for loan losses                   |   |                        |    |                       |   |   |   |
| To total loans                              |   | 1.72                        | %       | 1.94                       | %      | 1.74 | % |
| To nonperforming loans                      |   | 418.73                      | %       | 579.98                     | %      | 332.70 | % |
| To nonperforming assets                     |   | 411.07                      | %       | 564.50                     | %      | 327.74 | % |

 

The Companymaintains an allowance for loan losses at a level considered by management tobe adequate to cover the inherent risks of loss associated with its loanportfolio under prevailing and anticipated economic conditions.  In determining the adequacy of the allowancefor loan losses, management takes into consideration growth trends in theportfolio, examination of financial institution supervisory authorities, priorloan loss experience for the Company, concentrations of credit risk,delinquency trends, general economic conditions, the interest rate environmentand internal and external credit reviews. In addition, the risks management considers vary depending on the natureof the loan.  The normal risksconsidered by management with respect to agricultural loans include thefluctuating value of the collateral, changes in weather conditions and theavailability of adequate water resources in the Company’s local marketarea.  The normal risks considered bymanagement with respect to real estate

 

20

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construction loans include fluctuation in real estate values, thedemand for improved commercial and industrial properties and housing, theavailability of permanent financing in the Company’s market area and borrowers’ability to obtain permanent financing. The normal risks considered by management with respect to real estatemortgage loans include fluctuations in the value of real estate.  Additionally, the Company relies on dataobtained through independent appraisals for significant properties to determineloss exposure on nonperforming loans.

 

The balance in theallowance is affected by the amounts provided from operations, amounts chargedoff and recoveries of loans previously charged off.  The Company recorded provisions for loan losses in the firstthree months of 2004 of $620,000 compared with $671,000 in the same period of2003. The decrease in loan loss provisions in 2004 was related to the overallimprovement in graded loans in the first quarter of 2004 when compared to thesame period in 2003.  The Company’scharge-offs, net of recoveries, were $308,000 for the three months endedMarch 31, 2004 compared with $115,000 for the same three months in2003.  The increase in net charge-offsfor the first quarter of 2004 was primarily due to increased charge-offs thatoccurred within the commercial and agricultural segment of the loanportfolio.  The increased charge-offs inthis segment were primarily attributable to problems specific to individualborrowers rather than market or industry concerns that apply to a broadercustomer base.

 

As ofMarch 31, 2004, the allowance for loan losses was $13,575,000 or 1.72% oftotal loans outstanding, compared with $13,263,000 or 1.74% of total loansoutstanding as of December 31, 2003 and $12,690,000 or 1.94% of totalloans outstanding as of March 31, 2003.

 

The Company uses amethod developed by management for determining the appropriate level of itsallowance for loan losses.  This methodapplies relevant risk factors to the entire loan portfolio, includingnonperforming loans.  The methodology isbased, in part, on the Company’s loan grading and classification system.  The Company grades its loans throughinternal reviews and periodically subjects loans to external reviews which thenare 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.

 

The allowance isbased on estimates and ultimate future losses may vary from currentestimates.  It is always possible thatfuture economic or other factors may adversely affect the Company’s borrowers,and thereby cause loan losses to exceed the current allowance.  In addition, there can be no assurance thatfuture economic or other factors will not adversely affect the Company’sborrowers, or that the Company’s asset quality may not deteriorate through rapidgrowth, failure to enforce underwriting standards, failure to maintainappropriate underwriting standards, failure to maintain an adequate number ofqualified loan personnel, failure to identify and monitor potential problemloans or for other reasons, and thereby cause loan losses to exceed the currentallowance.

 

21

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The allocation ofthe allowance to loan categories is an estimate by management of the relativerisk characteristics of loans in those categories.  No assurance can be given that losses in one or more loancategories will not exceed the portion of the allowance allocated to thatcategory or even exceed the entire allowance.

 

*External Factors Affecting AssetQuality. *As a resultof the Company’s loan portfolio mix, the future quality of its assets could beaffected by adverse economic trends in its region or in the agriculturalcommunity.  These trends are beyond thecontrol of the Company.

 

California is anearthquake-prone region.  Accordingly, amajor earthquake could result in material loss to the Company.  At times the Company’s service area hasexperienced 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 the Company.

 

Parts ofCalifornia have experienced significant floods in the late 1990s. No assurancecan be given that future flooding will not have an adverse impact on theCompany and its borrowers and depositors.

 

*Liquidity.*Inorder to maintain 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 andpotential loan sales as sources of asset liquidity.  Deposit growth and access to credit lines established withcorrespondent banks and market sources of funds are considered by the Companyas sources of liability liquidity.  Theholding company’s primary source of liquidity is from dividends received fromthe Bank.  Dividends from the Bank aresubject to certain regulatory restrictions.

 

The Companyreviews its liquidity position on a regular basis based upon its currentposition and expected trends of loans and deposits. These assets include cashand deposits in other banks, available-for-sale securities and federal fundssold.  The Company’s liquid assetstotaled $325,042,000 and $321,235,000 on March 31, 2004 andDecember 31, 2003, respectively, and constituted 26% of total assets onboth those dates.  Liquidity is alsoaffected by the collateral requirements of its public deposits and certainborrowings.  Total pledged securitieswere $323,425,000 at March 31, 2004 compared with $295,024,000 atDecember 31, 2003.

 

Although theCompany’s primary sources of liquidity include liquid assets and a stabledeposit base, the Company maintains lines of credit with the Federal ReserveBank of San Francisco, Federal Home Loan Bank of San Francisco, Pacific CoastBankers’ Bank, Union Bank of California, Wells Fargo

 

22

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Bank and First Tennessee Bank aggregating $190,089,000 of which$107,815,000 was outstanding as of March 31, 2004 and $83,346,000 wasoutstanding as of December 31, 2003. The increase in borrowingsoutstanding during the first quarter of 2004 produced an inflow of funds thatwere used to purchase additional investment securities.  Management believes that the Companymaintains adequate amounts of liquid assets to meet its liquidity needs.  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.

 

*Capital Resources. *Capital serves as a sourceof funds and helps protect depositors against potential losses.  The primary source of capital for theCompany has been internally generated capital through retained earnings.  The Company’s shareholders’ equity increasedby $4,909,000 or 5% from December 31, 2003 to March 31, 2004.  This increase was caused by the retention ofaccumulated earnings and the increase in the unrealized gain on investmentsecurities during the 1st quarter of 2004.

 

The Company issubject to various regulatory capital requirements administered by the federalbanking agencies.  Failure to meetminimum capital requirements can initiate mandatory and possibly additionaldiscretionary actions by the regulators that, if undertaken, could have amaterial adverse effect on the Company’s financial statements.  Management believes, as of March 31,2004, that the Company and the Bank met all applicable capitalrequirements.  The Company’s leveragecapital ratio at March 31, 2004 was 8.50% as compared with 8.55% as ofDecember 31, 2003.  The Company’stotal risk based capital ratio at March 31, 2004 was 11.77% as compared to11.57% as of December 31, 2003.

 

The Company’s andBank’s actual capital amounts and ratios met all regulatory requirements as ofMarch 31, 2004 and were summarized as follows:

 
| **Dollars in thousands**                 |   | **Actual** |    | **For Capital  Adequacy Purposes** |   | **To Be Well  Capitalized  Under Prompt  Corrective  Action Provisions:** |   |
|------------------------------------------|--------|------------|---------|------------------------------------|--------|---------------------------------------------------------------------------|--------|
| **Consolidated**                         |   | **Amount** |    | **Ratio**                          |   | **Amount**                                                                |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| As of March 31, 2004                |   |       |    |                               |   |                                                                      |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 117,851 |                               | 11.77  | %                                                                         | $      | 80,082 |   | 8.0 | % | $ | 100,103 |   | 10.0 | % |
| Tier 1 capital (to risk weighted assets) |   | 105,325    |    | 10.52                              |   | 40,041                                                                    |   | 4.0 |   | 60,062 |   | 6.0 |   |
| Leverage ratio*                          |   | 105,325    |    | 8.50                               |   | 49,537                                                                    |   | 4.0 |   | 61,921 |   | 5.0 |   |
|                                     |   |       |    |                               |   |                                                                      |   |   |   |   |   |   |   |
| The Bank:                                |   |       |    |                               |   |                                                                      |   |   |   |   |   |   |   |
| As of March 31, 2004                |   |       |    |                               |   |                                                                      |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 107,031 |                               | 10.72  | %                                                                         | $      | 79,859 |   | 8.0 | % | $ | 99,823 |   | 10.0 | % |
| Tier 1 capital (to risk weighted assets) |   | 94,541     |    | 9.47                               |   | 39,929                                                                    |   | 4.0 |   | 59,894 |   | 6.0 |   |
| Leverage ratio*                          |   | 94,541     |    | 7.65                               |   | 49,446                                                                    |   | 4.0 |   | 61,808 |   | 5.0 |   |

 

----

* Theleverage ratio consists of Tier 1 capital divided by adjusted quarterly averageassets.  The minimum leverage ratio is 3percent for banking organizations that do not anticipate significant growth andthat have well-diversified risk, excellent asset quality and in general, areconsidered top-rated banks.

 

The Company hasadopted a formal dividend policy, however dividends are issued solely at thediscretion of the Company’s Board of Directors, subject to compliance withregulatory requirements.  The Companybegan paying a $0.05 per share quarterly cash dividend in the first quarter of2004.  In order to pay any cashdividends, the Company must receive payments of dividends or management feesfrom the Bank.  There are certain regulatorylimitations on the payment of cash dividends by banks.

 

Notwithstandingregulatory restrictions, in order for the Company to maintain a 10% riskweighted capital ratio, the Company had the ability to pay cash dividends atMarch 31, 2004 of $17,748,000.  Anyfuture dividends will depend upon the Board’s determination as to whether adividend is appropriate in light of the financial condition of the Company andapplicable restrictions.

 

23

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*Deposits.*  Deposits are the Company’s primary source offunds.  At March 31, 2004, theCompany had a deposit mix of 33% in savings deposits, 35% in time deposits, 13%in interest-bearing checking accounts and 19% in noninterest-bearing demandaccounts.  Noninterest-bearing demanddeposits enhance the Company’s net interest income by lowering its costs offunds.

 

The Companyobtains 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 innature.  The Company accepts deposits inexcess of $100,000 from customers. These deposits are priced to remain competitive.  At March 31, 2004, the Company hadbrokered deposits of $15,299,000.

 

Maturities of timecertificates of deposits of $100,000 or more outstanding at March 31, 2004and December 31, 2003 are summarized as follows:

 
|                      |   | **March 31,  2004**    |    | **December 31,  2003** |   |
|---------------------------|--------|-----------------------------|---------|-----------------------------|--------|
|                      |   | **(Dollars  in thousands)** |    |
|                      |   |                        |    |                        |   |
| Three months or less      |   | $                           | 65,407  |                        | $      | 68,249 |   |
| Over three to six months  |   | 39,523                      |    | 37,829                      |   |
| Over six to twelve months |   | 41,578                      |    | 31,060                      |   |
| Over twelve months        |   | 29,072                      |    | 35,600                      |   |
| Total                     |   | $                           | 175,580 |                        | $      | 172,738 |   |

 

**Borrowed Funds**

 

Borrowed fundsincreased by $20,531,000 or 22% to $113,348,000 at March 31, 2004 comparedto the $92,817,000 outstanding at December 31, 2003.  The increase in borrowed funds during thefirst quarter of 2004 was primarily due to the use of a leveraged investmentstrategy that uses additional FHLB borrowings to fund purchases of investmentsecurities within the Bank’s investment portfolio.

 

**Return on Equity and Assets**

 
|                                |   | **Three  months ended  March 31  2004** |   | **Three  months ended  March 31  2003** |   | **Year ended  December 31  2003** |   |
|-------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------|--------|
|                                |   |                                         |   |                                         |   |                                   |   |
| Annualized return on average assets |   | 1.17                                         | %      | 1.20                                         | %      | 1.23                                   | %      |
| Annualized return on average equity |   | 15.83                                        | %      | 15.37                                        | %      | 16.43                                  | %      |
| Dividend payout ratio               |   | 8.06                                         | %      | —                                       | %      | —                                 | %      |
| Average equity to average assets    |   | 7.42                                         | %      | 7.82                                         | %      | 7.46                                   | %      |

 

**Impact of Inflation**

 

The primary impactof inflation on the Company is its effect on interest rates.  The Company’s primary source of income isnet interest income which is affected by changes in interest rates.  The Company attempts to limit inflation’simpact on its net interest margin through management of rate sensitive assetsand liabilities and the analysis of interest rate sensitivity.  The effect of inflation on premises andequipment, as well as on interest expenses, has not been significant for theperiods covered in this report.

 

24

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**Item 3.****                                   Quantitativeand Qualitative Disclosures about Market Risk**

 

In the normal course ofbusiness, the Company is exposed to market risk which includes both price andliquidity risk.  Price risk is createdfrom fluctuations in interest rates and the mismatch in repricingcharacteristics of assets, liabilities, and off balance sheet instruments at aspecified point in time.  Mismatches ininterest rate repricing among assets and liabilities arise primarily throughthe interaction of the various types of loans versus the types of deposits thatare maintained as well as from management’s discretionary investment and fundsgathering activities.  Liquidity riskarises from the possibility that the Company may not be able to satisfy currentand future financial commitments or that the Company may not be able toliquidate financial instruments at market prices.  Risk management policies and procedures have been established andare utilized to manage the Company’s exposure to market risk.  Quarterly testing of the Company’s assetsand liabilities under both increasing and decreasing interest rate environmentsare performed to insure the Company does not assume a magnitude of risk that isoutside approved policy limits.

 

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 interestrate risk management is the responsibility of the Asset/Liability ManagementCommittee (ALCO), which reports to the Board of Directors.  ALCO establishes policies that monitors andcoordinates the Company’s sources, uses and pricing of funds.  ALCO is also involved in formulating theeconomic projections for the Company’s budget and strategic plan.  ALCO sets specific rate sensitivity limitsfor the Company.  ALCO monitors andadjusts the Company’s exposure to changes in interest rates to achievepredetermined risk targets that it believes are consistent with current andexpected market conditions.  Balance sheetmanagement personnel monitor the asset and liability changes on an ongoingbasis and provide report information and recommendations to the ALCO committeein regards to those changes.

 

It is the opinion ofmanagement there has been no material change in the Company’s market riskduring the first quarter of 2004 when compared to the level of market risk atDecember 31, 2003.  If interestrates were to suddenly and materially fall from levels experienced during thefirst quarter of 2004, the Company could become susceptible to an increasedlevel of market risk.

 

25

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

 

Evaluation Of Disclosure Controls And Procedures

 

Under the supervision and with the participation of the Company’smanagement, including its chief executive office and chief financial officer,the Company conducted an evaluation of the effectiveness of the design andoperation of its disclosure controls and procedures as defined by Rules 13a -15(e) under the Securities Exchange Act of 1934.

 

Based on the evaluation, the chief executive officer and chieffinancial officer concluded that as of the Evaluation Date the disclosurecontrols and procedures were adequate and effective, and that the materialinformation required to be included in this report, including information fromthe Company’s consolidated subsidiaries, was properly recorded, processed,summarized and reported, and was made known to the chief executive officer andchief financial officer by others within the Company in a timely manner,particularly during the period when this quarterly report on Form 10-Q wasbeing prepared.

 

Changes In Internal Controls

 

There were no changes in our internal control over financial reportingthat occurred during our last fiscal quarter that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

26

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**PARTII - Other Information**

 

**Item 1.****                                                          ****LegalProceedings**

 

The Company is a party to routine litigation in theordinary course of its business.  In theopinion of management, pending and threatened litigation is not likely to havea material adverse effect on the financial condition or results of operationsof the Company.

 

**Item 2.****                                                          ****Changes inSecurities****, Use of Proceeds andIssuer Purchase of Equity Securities.**

 

None.

 

**Item 3.****                                                          ****DefaultsUpon Senior Securities.**

 

None.

 

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

 

None.

 

**Item 5.****                                                          ****OtherInformation.**

 

In the opinion of management, there is no additionalinformation relating to these periods being reported which warrants inclusionin the report.

 

27

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**Item6.  Exhibits and Reports on Form 8-K.**

 

See Exhibit Index

 

**Reports on Form 8-K**

 

None

 

28

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                    | CAPITAL CORP OF THE WEST |
|-------------------------|--------------------------|
|                    | (Registrant)             |
|                    |                     |   |   |
| Date:  May 9, 2004 | By                       |  /s/ Thomas T. Hawker |   |
|                    |                     | Thomas T. Hawker |   |
|                    |                     | President and |   |
|                    |                     | Chief Executive Officer |   |
|                    |                     |   |   |
|                    |                     |   |   |
| Date: May 9, 2004       | By                       |  /s/ R. Dale McKinney |   |
|                    |                     | R. Dale McKinney |   |
|                    |                     | Chief Financial Officer |   |

 

29

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**Exhibit Index**

 

The following is a list of all exhibits required by Item 601 ofRegulation S-K to be filed as part of this 10-K.  Exhibits not attached to this 10-K are incorporated by referenceas stated in the Index:

 
| **Exhibit   Number** |   | **Exhibit**                                                                  |   |   |
|----------------------|--------|------------------------------------------------------------------------------|--------|--------|
| 10                   |   | Employment Agreement between Thomas T. Hawker and Capital Corp. of  the West |   | *      |

 

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| 31.1   |   | Certification  of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                |   |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   |                                                                                                                                                 |   |   |
| 31.2   |   | Certification  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                |   |   |
|   |   |                                                                                                                                                 |   |   |
| 32.1   |   | Certification  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |   |   |
|   |   |                                                                                                                                                 |   |   |
| 32.2   |   | Certification  of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |   |   |
| *      |   | Denotes management contract or compensatory plan arrangement.                                                                                        |   |   |

 

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