**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

 

**ý****  Quarterly Report Under Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

** **

**for the Quarterly Period Ended June30, 2002**

**or**

 

**o****  Transition Report pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

 

**for the Transition Period from                to                **

 

**Commission File Number:  0-27384**

 

| **CAPITAL  CORP OF THE WEST**                                    |
|------------------------------------------------------------------|
| (Exact name of  registrant 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 area code:  **(209)725-2200**

 

Former name, former address and former fiscal year, if changed sincelast report:  **Not applicable**

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes ý No o

 

The number of shares outstanding of the registrant’s common stock, nopar value, as of June 30, 2002 was 5,296,423. No shares of preferred stock, no par value, were outstanding at June 30,2002.

 

 

----

 

**Capital Corp of the West**

Table of Contents

 
| PART I. — FINANCIAL  INFORMATION |
|---------------------------------------|
|                                  |   |
| Item 1.                               | Financial Statements |
|                                  | Consolidated Balance Sheets  (unaudited) |
|                                  | Consolidated  Statements of Income and Comprehensive Income (unaudited) |
|                                  | Consolidated  Statement of Changes in Stockholders Equity (unaudited) |
|                                  | Consolidated  Statements of Cash Flows (unaudited) |
|                                  | Notes to the  Consolidated Financial Statements (unaudited) |
|                                  |   |
| Item  2.                              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                  |   |
| Item  3.                              | Quantitative  and Qualitative Disclosures about Market Risk |
|                                  |   |
|                                  |   |
|                                  |   |
| PART II. — OTHER INFORMATION     |
|                                  |   |
| Item 1.                               | Legal Proceedings |
| Item  2.                              | Changes  in 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                            |
|                                       |  |  |

 

2

----

 

Capital Corp of the West

Consolidated Balance Sheets

(Unaudited)

 
|                                                                                                                                               |   | **June 30,  2002**          |    | **December  31,  2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|-------------------------|--------|
|                                                                                                                                               |   | **(Dollars  in thousands)** |    |
| **Assets**                                                                                                                                         |   |                        |    |                    |   |
| Cash and  noninterest-bearing deposits in other banks                                                                                              |   | $                           | 40,340  |                    | $      | 38,003 |   |
| Federal funds  sold                                                                                                                                |   | 15,340                      |    | 11,285                  |   |
| Time deposits at  other financial institutions                                                                                                     |   | 500                         |    | 500                     |   |
| Investment  securities available for sale, at fair value                                                                                           |   | 230,831                     |    | 229,852                 |   |
| Investment  securities held to maturity at cost, fair value of $65,410,000, and  $42,185,000 at June 30, 2002 and December 31, 2001                |   | 64,399                      |    | 41,559                  |   |
| Loans, net of  allowance for loan losses of   $11,261,000 and $9,743,000 at June 30, 2002 and December 31, 2001                               |   | 572,393                     |    | 522,677                 |   |
| Interest  receivable                                                                                                                               |   | 5,771                       |    | 5,757                   |   |
| Premises and  equipment, net                                                                                                                       |   | 13,956                      |    | 13,143                  |   |
| Intangible  assets                                                                                                                                 |   | 3,665                       |    | 3,493                   |   |
| Other assets                                                                                                                                       |   | 28,637                      |    | 28,058                  |   |
|                                                                                                                                               |   |                        |    |                    |   |
| Total assets                                                                                                                                       |   | $                           | 975,832 |                    | $      | 894,327 |   |
|                                                                                                                                               |   |                        |    |                    |   |
| **Liabilities  and Shareholders’ Equity**                                                                                                     |   |                        |    |                    |   |
| Deposits                                                                                                                                           |   |                        |    |                    |   |
| Noninterest-bearing  demand                                                                                                                        |   | $                           | 138,851 |                    | $      | 132,496 |   |
| Negotiable  orders of withdrawal                                                                                                                   |   | 100,019                     |    | 102,055                 |   |
| Savings                                                                                                                                            |   | 221,840                     |    | 203,721                 |   |
| Time, under  $100,000                                                                                                                              |   | 158,793                     |    | 163,195                 |   |
| Time, $100,000  and over                                                                                                                           |   | 154,380                     |    | 131,174                 |   |
| Total deposits                                                                                                                                     |   | 773,883                     |    | 732,641                 |   |
|                                                                                                                                               |   |                        |    |                    |   |
| Borrowed funds                                                                                                                                     |   | 120,607                     |    | 80,685                  |   |
| Accrued  interest, taxes and other liabilities                                                                                                     |   | 5,519                       |    | 10,881                  |   |
| Total  liabilities                                                                                                                                 |   | 900,009                     |    | 824,207                 |   |
|                                                                                                                                               |   |                        |    |                    |   |
| Capital  Securities and minority interests                                                                                                         |   | 6,031                       |    | 6,000                   |   |
|                                                                                                                                               |   |                        |    |                    |   |
| Preferred Stock,  no par value; 10,000,000 shares authorized;   None outstanding                                                              |   | —                      |    | —                  |   |
| Common stock, no  par value; 20,000,000 shares authorized;5,296,423 and 5,173,838 issued &  outstanding at June 30, 2002 and December 31, 2001 |   | 45,898                      |    | 40,089                  |   |
| Retained  earnings                                                                                                                                 |   | 22,004                      |    | 22,372                  |   |
| Accumulated  other comprehensive income                                                                                                            |   | 1,890                       |    | 1,659                   |   |
|                                                                                                                                               |   |                        |    |                    |   |
| Total  shareholders’ equity                                                                                                                   |   | 69,792                      |    | 64,120                  |   |
|                                                                                                                                               |   |                        |    |                    |   |
| Total liabilities,  Capital Securities and minority interests and shareholders’ equity                                                        |   | $                           | 975,832 |                    | $      | 894,327 |   |

 

See accompanying notes

 

3

----

 

Capital Corp of the West

Consolidated Statementsof Income and Comprehensive Income

(Unaudited)

 
|                                                                 |   | **For the  Three Months  Ended June 30,**  |   | **For the  Six Months  Ended June 30,** |   |
|----------------------------------------------------------------------|--------|--------------------------------------------|--------|-----------------------------------------|--------|
|                                                                 |   | **2002**                                   |   | **2001**                                |   | **2002** |   | **2001** |   |
|                                                                 |   | **(In  thousands, except per share data)** |   |
| Interest income:                                                     |   |                                       |   |                                    |   |   |   |   |   |
| Interest and  fees on loans                                          |   | $                                          | 10,678 |                                    | $      | 10,497 |   | $ | 20,815 |   | $ | 21,277 |   |
| Interest on  deposits with other financial institutions              |   | 3                                          |   | 5                                       |   | 5 |   | 7 |   |
| Interest on  investments held to maturity:                           |   |                                       |   |                                    |   |   |   |   |   |
| Taxable                                                              |   | 968                                        |   | 551                                     |   | 1,895 |   | 1,127 |   |
| Non-taxable                                                          |   | 55                                         |   | 55                                      |   | 110 |   | 111 |   |
| Interest on  investments available for sale:                         |   |                                       |   |                                    |   |   |   |   |   |
| Taxable                                                              |   | 2,526                                      |   | 2,539                                   |   | 4,998 |   | 4,795 |   |
| Non-taxable                                                          |   | 273                                        |   | 272                                     |   | 545 |   | 544 |   |
| Interest on  federal funds sold                                      |   | 87                                         |   | 227                                     |   | 99 |   | 571 |   |
| Total interest  income                                               |   | 14,590                                     |   | 14,146                                  |   | 28,467 |   | 28,432 |   |
|                                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Interest  expense:                                                   |   |                                       |   |                                    |   |   |   |   |   |
| Interest on  negotiable orders of withdrawal                         |   | 58                                         |   | 61                                      |   | 112 |   | 152 |   |
| Interest on  savings deposits                                        |   | 859                                        |   | 1,614                                   |   | 1,690 |   | 3,421 |   |
| Interest on time  deposits, under $100,000                           |   | 1,345                                      |   | 2,099                                   |   | 2,884 |   | 4,191 |   |
| Interest on  time, $100,000 and over                                 |   | 1,169                                      |   | 1,431                                   |   | 2,348 |   | 2,922 |   |
| Interest on  other borrowings                                        |   | 1,226                                      |   | 463                                     |   | 2,174 |   | 853 |   |
| Total interest  expense                                              |   | 4,657                                      |   | 5,668                                   |   | 9,208 |   | 11,539 |   |
|                                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Net interest  income                                                 |   | 9,933                                      |   | 8,478                                   |   | 19,259 |   | 16,893 |   |
| Provision for  loan losses                                           |   | 1,451                                      |   | 789                                     |   | 2,231 |   | 1,539 |   |
| Net interest  income after provision for loan losses                 |   | 8,482                                      |   | 7,689                                   |   | 17,028 |   | 15,354 |   |
|                                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Noninterest  income:                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Service charges  on deposit accounts                                 |   | 1,279                                      |   | 1,004                                   |   | 2,406 |   | 1,906 |   |
| Income from real  estate held for sale                               |   | 33                                         |   | —                                  |   | 33 |   | — |   |
| Other                                                                |   | 818                                        |   | 570                                     |   | 1,470 |   | 1,021 |   |
| Total  noninterest income                                            |   | 2,130                                      |   | 1,574                                   |   | 3,909 |   | 2,927 |   |
|                                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Noninterest  Expenses:                                               |   |                                       |   |                                    |   |   |   |   |   |
| Salaries and  related benefits                                       |   | 3,839                                      |   | 3,328                                   |   | 7,783 |   | 6,641 |   |
| Equipment                                                            |   | 704                                        |   | 680                                     |   | 1,420 |   | 1,304 |   |
| Premises and  occupancy                                              |   | 571                                        |   | 519                                     |   | 1,140 |   | 984 |   |
| Professional  fees                                                   |   | 317                                        |   | 99                                      |   | 570 |   | 216 |   |
| Marketing                                                            |   | 219                                        |   | 230                                     |   | 407 |   | 441 |   |
| Intangible  amortization                                             |   | 170                                        |   | 198                                     |   | 340 |   | 396 |   |
| Supplies                                                             |   | 171                                        |   | 252                                     |   | 357 |   | 454 |   |
| Dividend Expense  on Capital Securities                              |   | 152                                        |   | 155                                     |   | 306 |   | 218 |   |
| Other                                                                |   | 1,370                                      |   | 1,015                                   |   | 2,615 |   | 2,161 |   |
| Total  noninterest expenses                                          |   | 7,513                                      |   | 6,476                                   |   | 14,938 |   | 12,815 |   |
|                                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Income before  income taxes                                          |   | 3,099                                      |   | 2,787                                   |   | 5,999 |   | 5,466 |   |
| Provision for  income taxes                                          |   | 715                                        |   | 806                                     |   | 1,391 |   | 1,573 |   |
| Net income                                                           |   | $                                          | 2,384  |                                    | $      | 1,981 |   | $ | 4,608 |   | $ | 3,893 |   |
| Comprehensive  Income:                                               |   |                                       |   |                                    |   |   |   |   |   |
| Unrealized gain  (loss) on securities arising during the period, net |   | 1,617                                      |   | (97                                     | )      | 231 |   | 1,118 |   |
| Comprehensive  income                                                |   | $                                          | 4,001  |                                    | $      | 1,884 |   | $ | 4,839 |   | $ | 5,011 |   |
|                                                                 |   |                                       |   |                                    |   |   |   |   |   |
| Basic earnings  per share                                            |   | $                                          | 0.45   |                                    | $      | 0.39 |   | $ | 0.88 |   | $ | 0.77 |   |
| Diluted earnings  per share                                          |   | $                                          | 0.44   |                                    | $      | 0.38 |   | $ | 0.85 |   | $ | 0.75 |   |

 

See accompanying notes

 

4

----

 

Capital Corp of the West

Consolidated Statement ofChanges in Shareholders’ Equity

(Unaudited)

 
|                                                                                                |   | **Common  Stock**     |   |        |   | **Accumulated  other  comprehensive  income** |   |   |      |
|-----------------------------------------------------------------------------------------------------|--------|-----------------------|--------|-------------|--------|-----------------------------------------------|--------|--------|-----------|
| **(Amounts  in thousands)**                                                                         |   | **Number of  shares** |   | **Amounts** |   | **Retained  earnings**                        |   |   | **Total** |   |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| Balance,  December 31, 2001                                                                         |   | 5,174                 |   | $           | 40,089 |                                          | $      | 22,372 |      | $ | 1,659 |   | $ | 64,120 |   |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| Exercise of  stock options                                                                          |   | 98                    |   | 458         |   | —                                        |   | — |      | 458 |   |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| Issuance of  shares pursuant to 401K and ESOP plans                                                 |   | 24                    |   | 387         |   | —                                        |   | — |      | 387 |   |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| Net Change in  fair market value of  investment  securities, net of tax benefit of   $924 |   | —                |   | —      |   | —                                        |   | 231    |      | 231 |   |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| 5% stock  dividend, including cash payment for fractional shares                                    |   | —                |   | 4,964       |   | (4,976                                        | )      | — |      | (12 | ) |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| Net income                                                                                          |   | —                |   | —      |   | 4,608                                         |   | — |      | 4,608 |   |
|                                                                                                |   |                  |   |        |   |                                          |   |   |      |   |   |
| Balance, June  30, 2002                                                                             |   | 5,296                 |   | $           | 45,898 |                                          | $      | 22,004 |      | $ | 1,890 |   | $ | 69,792 |   |

 

See accompanying notes

 

5

----

 

Capital Corp of the West

Consolidated Statements of Cash Flows

(Unaudited)

 
| **(Dollars  in thousands)**                                                        |   | **6 months  ended  June 30,  2002** |   | **6 months  ended  June 30,  2001** |   |
|------------------------------------------------------------------------------------|--------|-------------------------------------|--------|-------------------------------------|--------|
| **Operating activities:**                                                          |   |                                |   |                                |   |
| Net income                                                                         |   | $                                   | 4,608  |                                | $      | 3,893 |   |
| Adjustments to  reconcile net income to net cash provided by Operating activities: |   |                                |   |                                |   |
| Provision for  loan losses                                                         |   | 2,231                               |   | 1,539                               |   |
| Depreciation,  amortization and accretion, net                                     |   | 1,829                               |   | 1,447                               |   |
| Gain on sale of  real estate owned                                                 |   | 33                                  |   | —                              |   |
| Net increase in  interest receivable & other assets                            |   | (1,133                              | )      | (7,657                              | )      |
| Net increase in  deferred loan fees                                                |   | 347                                 |   | 52                                  |   |
| Net (decrease)  increase in accrued interest payable & other liabilities       |   | (5,362                              | )      | 2,328                               |   |
| Net cash  provided by operating activities                                         |   | 2,553                               |   | 1,602                               |   |
|                                                                               |   |                                |   |                                |   |
| **Investing activities:**                                                          |   |                                |   |                                |   |
| Investment  securities purchases                                                   |   | (56,227                             | )      | (64,595                             | )      |
| Proceeds from  maturities of investment securities                                 |   | 25,727                              |   | 14,778                              |   |
| Proceeds from  sales of AFS investment securities                                  |   | 6,969                               |   | —                              |   |
| Net increase in  time deposits in other financial institutions                     |   | —                              |   | (400                                | )      |
| Proceeds from  sales of commercial and real estate loans                           |   | 1,633                               |   | 1,605                               |   |
| Net increase in  loans                                                             |   | (54,002                             | )      | (38,540                             | )      |
| Purchases of  premises and equipment                                               |   | (1,769                              | )      | (1,497                              | )      |
| Purchase of  subsidiary                                                            |   | (520                                | )      | —                              |   |
| Net cash used in  investing activities                                             |   | (78,189                             | )      | (88,649                             | )      |
|                                                                               |   |                                |   |                                |   |
| **Financing activities:**                                                          |   |                                |   |                                |   |
| Net increase in  demand, NOW and savings deposits                                  |   | 22,438                              |   | 13,198                              |   |
| Net increase in  certificates of deposit                                           |   | 18,804                              |   | 41,440                              |   |
| Net proceeds  from other borrowings                                                |   | 39,922                              |   | 19,350                              |   |
| Issuance of  Capital Securities and increase in minority interests                 |   | 31                                  |   | 6,000                               |   |
| Issuance of  shares pursuant to 401K and ESOP plans                                |   | 387                                 |   | 350                                 |   |
| Exercise of  stock options                                                         |   | 458                                 |   | 334                                 |   |
| Cash in lieu  fractional shares from stock dividend                                |   | (12                                 | )      | (7                                  | )      |
| Net cash  provided by financing activities                                         |   | 82,028                              |   | 80,665                              |   |
|                                                                               |   |                                |   |                                |   |
| Net increase  (decrease) in cash and cash equivalents                              |   | 6,392                               |   | (6,382                              | )      |
|                                                                               |   |                                |   |                                |   |
| Cash and cash  equivalents at beginning of period                                  |   | 49,288                              |   | 47,768                              |   |
| Cash and cash  equivalents at end of period                                        |   | $                                   | 55,680 |                                | $      | 41,386 |   |
|                                                                               |   |                                |   |                                |   |
| **Cash paid during the quarter:**                                                  |   |                                |   |                                |   |
| Interest paid                                                                      |   | $                                   | 7,107  |                                | $      | 11,705 |   |
| Income tax  payments                                                               |   | 1,775                               |   | 2,325                               |   |
| **Supplemental disclosure of noncash  investing****and financing activities:**     |   |                                |   |                                |   |
| Investment  securities unrealized gains, net of tax                                |   | 231                                 |   | 1,118                               |   |
| Loans  transferred to other real estate owned                                      |   | —                              |   | 335                                 |   |

 

See accompanying notes

 

6

----

 

Capital Corp of the West

Notes to ConsolidatedFinancial Statements

March 31, 2002 andDecember 31, 2001

(Unaudited)

 

GENERAL - COMPANY

 

Capital Corp ofthe West (the “Company” or “Capital Corp”) is a bank holding companyincorporated under the laws of the State of California on April 26, 1995.  On November 1, 1995, the Company becameregistered as a bank holding company, and is a holder of all of the capital stockof County Bank (the “Bank”).  During1998, the Company formed Capital West Group, a subsidiary that engages in thefinancial institution advisory business but is currently inactive.  The Company’s primary asset is the Bank****andthe Bank is the Company’s primary source of income.  The Company’s securities consist of 20,000,000 shares of CommonStock, no par value, 10,000,000 shares of Authorized Preferred Stock, and6,000,000 of Trust Preferred 10.20% Capital Securities which have a liquidationamount of $1,000 per capital security. As of June 30, 2002 there were 5,296,423 common shares outstanding, heldof record by approximately 2,000 shareholders. There were no preferred shares outstanding at June 30, 2002.  On June 28, 2002, the Company acquired RegencyInvestment Advisors, Incorporated (“RIA”) as a wholly owned subsidiary fromCalifornia Bank & Trust, a subsidiary of Zions Bancorporation.  RIA provides financial advisory services forindividuals, small business and retirement programs.  The Bank has three wholly owned subsidiaries, Merced AreaInvestment & Development, Inc. (“MAID”), County Asset Advisors (“CAA”) andCounty Investment Trust (“REIT”). During January 2002, the board approved the dissolution of CountyInvestment II (“REIT 2”) which was completed in the second quarter of2002.  CAA is currently inactive.  All references herein to the “Company”include the Bank and the Bank’s subsidiaries, unless the context otherwiserequires.

 

GENERAL - BANK

 

The Bank was organized on August 1, 1977, as CountyBank of Merced, a California state banking corporation.  The Bank commenced operations on December22, 1977.  In November 1992, the Bankchanged its legal name to County Bank. The Bank’s securities consist of one class of Common Stock, no par valueand is wholly owned by the Company.  TheBank’s deposits are insured under the Federal Deposit Insurance Act by theFederal Deposit Insurance Corporation (“FDIC”) up to applicable limits statedtherein.  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 bankingbusiness primarily in Fresno, Madera, Mariposa, Merced, San Francisco, SanJoaquin, Stanislaus and Tuolomne counties. The Bank has eighteen full service branch offices; two of which arelocated in Merced with the branch located in downtown Merced currently servingas both a branch and as administrative headquarters. There are offices inAtwater, Dos Palos, Hilmar, Livingston, Los Banos, Madera, Mariposa, SanFrancisco, Sonora, Stockton and two offices in Modesto, two in Fresno and twooffices in Turlock.  The Bank’sadministrative headquarters also provides accommodations for the activities ofMerced Area Investment & Development (“MAID”), the Bank’s wholly owned realestate subsidiary.

 

7

----

 

OTHER FINANCIAL NOTES

 

All adjustments which in the opinion of Management arenecessary for a fair presentation of the Company’s financial position at June30, 2002 and December 2001 and the results of operations for the three and sixmonth periods ended June 30, 2002 and 2001, and the statements of cash flowsfor the six months ended June 30, 2002 and 2001 have been included.  Earnings per share have been adjusted toreflect the affect of the 5% stock dividend that was paid April 26, 2002 toshareholders of record on April 5, 2002. The interim results for the three and six months ended June 30, 2002 and2001 are not necessarily indicative of results for the full year.  These financial statements should be read inconjunction with the financial statements and the notes included in theCompany’s Annual Report for the year ended December 31, 2001.

 

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

 

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

 

The following table provides a reconciliation of thenumerator and denominator of the basic and diluted earnings per sharecomputation of the three and six month periods ended June 30, 2002 and 2001:

 
|                                              |   | **For The  Three Months  Ended June 30,** |       | **For The  Six Months  Ended June 30,** |       |
|---------------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------|------------|
| **(Dollars in thousands, except per share data)** |   | **2002**                                  | ** ** | **2001**                                | ** ** | **2002** | ** ** | **2001** |   |
|                                              |   |                                      |       |                                    |       |   |   |   |   |
| Basic EPS  computation:                           |   |                                      |       |                                    |       |   |   |   |   |
| Net income                                        |   | $                                         | 2,384      |                                    | $          | 1,981 |   | $ | 4,608 |   | $ | 3,893 |   |
| Average common  shares outstanding                |   | 5,279                                     |       | 5,087                                   |       | 5,238 |   | 5,066 |   |
| Basic EPS                                         |   | $                                         | 0.45       |                                    | $          | 0.39 |   | $ | 0.88 |   | $ | 0.77 |   |
|                                              |   |                                      |       |                                    |       |   |   |   |   |
| Diluted EPS  Computations:                        |   |                                      |       |                                    |       |   |   |   |   |
| Net income                                        |   | $                                         | 2,384      |                                    | $          | 1,981 |   | $ | 4,608 |   | $ | 3,893 |   |
| Average common  shares outstanding                |   | 5,279                                     |       | 5,087                                   |       | 5,238 |   | 5,066 |   |
| Effect of stock  options                          |   | 157                                       |       | 156                                     |       | 162 |   | 146 |   |
|                                              |   | 5,436                                     |       | 5,243                                   |       | 5,400 |   | 5,212 |   |
| Diluted EPS                                       |   | $                                         | 0.44       |                                    | $          | 0.38 |   | $ | 0.85 |   | $ | 0.75 |   |

 

On February 22, 2001, the Company issued $6,000,000 inCapital Securities through its 100% ownership position in the County StatutoryTrust I.  The Capital Securities payquarterly cumulative cash distributions at an annual rate of 10.2% of theliquidation value of $1,000 per share. The Capital Securities represent undivided beneficial interests in theTrust.  The Company owns all of theissued and outstanding common securities of the Trust.  Proceeds from the offering and from theissuance of common securities were invested in the Trust in the Company’s 10.2%Junior Subordinated Deferrable

 

8

----

 

Interest Debentures due February 22, 2031 with an aggregate principalamount of $6,000,000.  The primary assetof the Trust is the Junior Debentures. The obligations of the Trust with respect to the Capital Securities arefully and unconditionally guaranteed by the Company to the extent provided inthe Guarantee Agreement with respect to the Capital Securities.  The proceeds are to be used for generalcorporate purposes.  The all-in costs ofthe Capital Securities was 10.39%.  TheCapital Securities have the added benefit of qualifying as Tier 1 capital forregulatory purposes.

 

During January, 2002, the County Investment Trust realestate investment trust (“REIT”) issued $31,000 in Preferred Stock to 123individual investors that was accounted for on the balance sheet as otherminority interests.  County Bank owns100% of the common stock of the REIT. The REIT may issue, at management’s discretion, Preferred Stock or othercapital instruments in the future in the normal course of operations.  Management has no such plans to issueadditional common or preferred stock in the REIT at this time.  The REIT’s primary business purpose is toinvest in mortgage related assets of the Bank and to provide management with anadditional channel through which equity capital may be raised in the future.

 

On April 26, 2002, the Companyentered into an agreement to purchase Regency Investment Advisors, Incorporated(“RIA”) from California Bank and Trust, a subsidiary of ZionsBancorporation.  The all cash purchasewas completed on June 28, 2002 at a price of $520,000.  RIA’s purchase price included no physicalassets but provided the Company with expected future financial advisory feeincome.  The entire purchase price wasrecorded as a purchase of goodwill.  Infuture periods, the estimates and assumptions utilized in recording thisadditional goodwill will be reviewed. If it is determined that valuations have permanently declined andgoodwill is deemed impaired, the amount of the impairment will be written-offto expense in that period.

 

Effective January 1, 2002, theCompany was required to adopt the provisions of SFAS 142. Accordingly, anygoodwill and any intangible asset determined to have an indefinite useful lifethat are acquired in a purchase business combination will not be amortized, butwill continue to be evaluated for impairment in accordance with the appropriateaccounting literature. The Company was also required to reassess the usefullives and residual values of all such intangible assets and make any necessaryamortization period adjustments by March 31, 2002. As a result of thisassessment, management determined that no accounting adjustments werenecessary. As of June 30, 2002 and December 31, 2001, the Company had recordedgoodwill of $1,925,000 and $1,405,000. The recording of goodwill occurred with the acquisition of Town andCountry Finance and Thrift (“T&C”) in June, 1996 and RIA in June, 2002.  The original amount of recorded goodwill atthe time of the T&C and RIA acquisitions was $2,023,000 and $520,000,respectively.  From July 1, 1996 throughDecember 31, 2001, goodwill attributable to the T&C acquisition wasamortized at a rate of $98,000 per quarter. During the first six months of2001, the goodwill amortization lowered earnings by $196,000 or $0.05 per shareon an after tax basis when compared with the same period in 2002.  There has been no recorded amortization ofthe RIA acquisition and there has been no impairment losses recognized on the T&Cand RIA recorded goodwill as of June 30, 2002.

 

As of the date of adoption, theCompany had identifiable intangible assets consisting of core deposit premiumsand goodwill.  Core deposit premiums areamortized using an accelerated method over a period of ten years. Intangibleassets related to goodwill will no longer be amortized after December 31, 2001but will be reviewed for potential impairment. Management has determined there was no impairment of goodwill as ofJanuary 1, 2002.  As of June 30, 2002and December 31, 2001, the Company had unamortized core deposit premiums of$1,723,000 and $2,088,000, respectively. Amortization of core deposit premiums was $340,000 for the six monthsended June 30, 2002 and 2001.  Coredeposit premiums are scheduled to amortize at a rate of approximately $170,000per quarter through the quarter ended September 30, 2004 and at a rate of  $47,000 during the fourth quarter of2004.  Core deposit premiums of $460,000and $4,340,000 were initially recorded as the result of purchasing depositsfrom T&C in July, 1996 and from the purchase of three branches from Bank ofAmerica in December, 1997, respectively.

 

9

----

 

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

 

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

 

Readers of the Company’s Form 10-Q should not relysolely on forward looking statements and should consider all uncertainties andrisks discussed throughout this report, as well as those discussed in theCompany’s 2001 Annual Report on Form 10-K filed March 29, 2002.  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 banking industryin general is subject to various monetary and fiscal policies and regulations,which include those determined by the Federal Reserve Board, the FederalDeposit Insurance Corporation and state regulators, whose policies andregulations could affect the Company’s results.

 

Other factors that may cause actual results to differfrom the forward-looking statements include the following: competition withother local and regional banks, savings and loan associations, credit unionsand other nonbank financial institutions, such as investment banking firms,investment advisory firms, brokerage firms, mutual funds and insurancecompanies, as well as other entities which offer financial services; interestrate, market and monetary fluctuations; inflation; market volatility; generaleconomic conditions; introduction and acceptance of new banking-relatedproducts, services and enhancements; fee pricing strategies, mergers andacquisitions and their integration into the Company and management’s ability tomanage these and other risks.

 

10

----

 

**Criticalaccounting policies and estimates**

 

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

 

11

----

 

The following discussion and analysis is designed toprovide a better understanding of the significant changes and trends related tothe Company and its subsidiaries’ financial condition, operating results, assetand liability management, liquidity and capital resources and should be read inconjunction with the Consolidated Financial Statements of the Company and theNotes thereto.

 

**Results Of Operations**

 

**Three and Six Months Ended June 30, 2002 Compared With Threeand Six Months Ended June 30, 2001**

 

*Overview.*  For the three and six months ended June 30,2002 the Company reported record net income of $2,384,000 and $4,608,000.  This compares to $1,981,000 and $3,893,000for the same periods in 2001 and represents an increase of $403,000 and$715,000 or 20% and 18%.  Basic earningsper share were $.45 and $.88 for the three and six months ended June 30, 2002.Fully diluted earnings per share were $.44 and $.85 for the three and sixmonths ended June 30, 2002.  Thiscompares to basic and fully diluted earnings per share of $.39 and $.38 for thethree months and $.77 and $.75 for the six months ended June 30, 2001 andrepresents an increase of $0.06 per share for both basic and fully dilutedearnings per share for the three months ended June 30, 2002 and an increase of$.11 and $.10 for the six months ended June 30, 2002.  The basic and fully diluted earnings per share are reflective ofthe 5% stock dividend paid in April, 2002. The annualized return on average assets was 1.01% for both the three andsix months ended June 30, 2002 which compares with 1.08% and 1.09% of the threeand six months ended June 30, 2001 a decrease of 7 and 8 basis points,respectively.  The Company’s annualizedreturn on average equity was 14.10% and 13.87% for the three and six monthsended June 30, 2002 which compares with 13.80% and 13.87% for the three and sixmonths ended June 30, 2001 an increase of 30 and 0 basis points.  The increased return on equity was theresult of growth in net interest income that exceeded the growth in noninterestexpenses.  The decreased return onassets were primarily due to the lower rates of interest earned during thefirst six months of 2002 as compared to the same period in 2001 which caused adecrease in net interest margin. Between June 30, 2001 and June 30, 2002, general market interest rateshave declined significantly.

 

*NetInterest Income.*  TheCompany’s primary source of income is net interest income and is determined bythe difference between interest income and fees derived from earning assets andinterest paid on interest bearing liabilities. Net interest income for the three and six months ended June 30, 2002totaled $9,933,000 and $19,259,000 which represents an increase of $1,455,000and $2,366,000 or 17% and 14% when compared to the $8,478,000 and $16,893,000achieved during the three and six months ended June 30, 2001.

 

Total interest on earning assets were $14,590,000 and$28,467,000 for the three and six months ended June 30, 2002, an increase of$444,000 and $35,000 or 3% and less than 1% from the $14,146,000 and$28,432,000 achieved during the same periods in 2001.  The level of interest income is affected by changes in volume ofand rates earned on interest-earning assets. Interest-earning assets consist primarily of loans, investmentsecurities and federal funds sold.  Thesmall increase in total interest income for the three and six months ended June30, 2002 was primarily the result of a decrease in the rates earned oninterest-earning assets and an increase in volumes of interest-earnings assetsgenerated.  Average interest-earningassets for the three and six months ended June 30, 2002 were $876,327,000 and$843,946,000 which compares with $668,802,000 and $650,423,000 for the three andsix months ended June 30, 2001, an increase of $207,525,000 and $193,523,000 or31% and 30%, respectively.

 

12

----

 

Interest expense is a function of the volume of andthe rates paid on interest-bearing liabilities.  Interest-bearing liabilities consist primarily of certaindeposits and borrowed funds.  Totalinterest expense was $4,657,000 and $9,208,000 for the three and six monthsended June 30, 2002, compared with $5,668,000 and $11,539,000 for the three andsix months ended June 30, 2001, a decrease of $1,011,000 and $2,331,000 or 18%and 20%.  This decrease was primarilythe result of a decrease in the interest rate paid on interest-bearingliabilities.  Average interest-bearingliabilities were $741,766,000 and $714,701,000 for the three and six monthsended June 30, 2002 compared with $563,895,000 and $546,964,000 for the samethree and six months in 2001, an increase of $177,871,000 and $167,737,000 or32% and 31%.  Average interest ratespaid on interest-bearing liabilities were 2.51% and 2.58% for the three and sixmonths ending June 30, 2002 compared with 4.02% and 4.22% for the same threeand six months of 2001, a decrease in interest rates paid of 151 and 164 basispoints or 38% and 39%.

 

The increase in interest-earning assets is primarilythe result of increased market penetration within our target markets byincreasing the utilization of existing facilities.  Deposit and loan growth has been achieved primarily throughexisting product lines.  The increase inaverage interest-bearing liabilities was primarily achieved through theincreased use of borrowed funds in the form of Federal Home Loan Bank advancesand increased savings and certificate of deposit balances.

 

The Company’s taxable equivalent net interest margin,the ratio of net interest income to average interest-earning assets, was 4.59%and 4.62% for the three and six months ended June 30, 2002 compared with 5.12%and 5.24% for the same period in 2001. The decrease in net interest margin in 2002 compared with 2001 wasprimarily the result of a decrease in prevailing market interest rates.  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 decrease in prevailing marketinterest rates.  Loans as a percentageof average interest-earning assets were 64% and 65% for the three and sixmonths ended June 30, 2002 equaling the 64% for the three months ended June 30,2001 and 100 basis points better than the 64% for the six months ended June 30,2001.

 

13

----

 

*AverageBalances And Rates 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  June 30, 2002** |    | **Three months ended  June 30, 2001** |   |
|-------------------------------------------------|--------|---------------------------------------|---------|---------------------------------------|--------|
|                                            |   | **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                              |   | $                                     | 20,576  |                                  | $      | 87 |   | 1.69 | % | $ | 20,759 |   | $ | 227 |   | 4.37 | % |
| Time deposits at other financial institutions   |   | 500                                   |    | 3                                     |   | 2.40 |   | 427 |   | 5 |   | 4.68 |   |
| Taxable investment securities  (1)         |   | 264,050                               |    | 3,524                                 |   | 5.34 |   | 193,888 |   | 3,131 |   | 6.46 |   |
| Nontaxable investment securities (1)            |   | 28,946                                |    | 423                                   |   | 5.85 |   | 28,991 |   | 376 |   | 5.19 |   |
| Loans, gross: (2)                               |   | 562,255                               |    | 10,678                                |   | 7.60 |   | 424,737 |   | 10,497 |   | 9.89 |   |
| Total interest-earning assets:                  |   | 876,327                               |    | 14,715                                |   | 6.72 |   | 668,802 |   | 14,236 |   | 8.51 |   |
| Allowance for loan losses                       |   | (10,655                               | )       |                                  |   |   |   | (8,608 | ) |   |   |   |   |
| Cash and due from banks                         |   | 28,337                                |    |                                  |   |   |   | 26,453 |   |   |   |   |   |
| Premises and equipment, net                     |   | 13,044                                |    |                                  |   |   |   | 13,323 |   |   |   |   |   |
| Interest receivable and other assets            |   | 38,721                                |    |                                  |   |   |   | 33,108 |   |   |   |   |   |
| Total assets                                    |   | $                                     | 945,774 |                                  |   |   |   |   | $ | 733,078 |   |   |   |   |   |
|                                            |   |                                  |    |                                  |   |   |   |   |   |   |   |   |   |
| **Liabilities And Shareholders’ Equity**   |   |                                  |    |                                  |   |   |   |   |   |   |   |   |   |
| Negotiable order of withdrawal                  |   | $                                     | 101,901 |                                  | $      | 58 |   | 0.23 |   | $ | 81,995 |   | $ | 61 |   | 0.30 |   |
| Savings deposits                                |   | 217,504                               |    | 859                                   |   | 1.58 |   | 193,457 |   | 1,614 |   | 3.34 |   |
| Time deposits                                   |   | 304,922                               |    | 2,514                                 |   | 3.30 |   | 255,454 |   | 3,530 |   | 5.53 |   |
| Other borrowings                                |   | 117,439                               |    | 1,226                                 |   | 4.18 |   | 32,989 |   | 463 |   | 5.61 |   |
| Total interest-bearing liabilities              |   | 741,766                               |    | 4,657                                 |   | 2.51 |   | 563,895 |   | 5,668 |   | 4.02 |   |
|                                            |   |                                  |    |                                  |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing deposits                    |   | 124,917                               |    |                                  |   |   |   | 100,391 |   |   |   |   |   |
| Accrued interest, taxes and other liabilities   |   | 5,430                                 |    |                                  |   |   |   | 5,387 |   |   |   |   |   |
| Total liabilities                               |   | 872,113                               |    |                                  |   |   |   | 669,673 |   |   |   |   |   |
|                                            |   |                                  |    |                                  |   |   |   |   |   |   |   |   |   |
| Capital Securities and other minority interests |   | 6,031                                 |    |                                  |   |   |   | 6,000 |   |   |   |   |   |
|                                            |   |                                  |    |                                  |   |   |   |   |   |   |   |   |   |
| Total shareholders’ equity                 |   | 67,630                                |    |                                  |   |   |   | 57,405 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $                                     | 945,774 |                                  |   |   |   |   | $ | 733,078 |   |   |   |   |   |
|                                            |   |                                  |    |                                  |   |   |   |   |   |   |   |   |   |
| Net interest income and margin (3)              |   |                                  |    | $                                     | 10,058 |   | 4.59 | % |   |   | $ | 8,568 |   | 5.12 | % |

 

----

(1)                                  Tax-equivalent adjustments included in nontaxableinvestment securities income totaled $95,000 and $49,000 for the three monthsended June 30, 2002 and 2001, respectively. Tax equivalent income adjustments included in the nontaxable investmentsecurities income were derived from nontaxable municipal interest income.  Tax equivalent income adjustments includedin taxable investment securities income were created by a dividends receiveddeduction of $30,000 and $41,000 for the three months ended June 30, 2002 and2001.

(2)                                  Amounts of interest earned includes loan fees of$477,000 and $533,000 for June 30, 2002 and 2001 respectively.

(3)                                  Net interest margin is computed by dividing netinterest income by total average interest-earning assets.

 

14

----

 

*AverageBalances And Rates 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

 
|                                            |   | **Six months ended  June 30, 2002** |    | **Six months ended  June 30, 2001** |   |
|-------------------------------------------------|--------|-------------------------------------|---------|-------------------------------------|--------|
|                                            |   | **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                              |   | $                                   | 11,755  |                                | $      | 99 |   | 1.68 | % | $ | 22,761 |   | $ | 571 |   | 5.02 | % |
| Time deposits at other financial institutions   |   | 500                                 |    | 5                                   |   | 2.00 |   | 269 |   | 7 |   | 5.20 |   |
| Taxable investment securities  (1)         |   | 256,416                             |    | 6,967                               |   | 5.43 |   | 180,711 |   | 5,972 |   | 6.61 |   |
| Nontaxable investment securities (1)            |   | 28,951                              |    | 820                                 |   | 5.66 |   | 28,997 |   | 750 |   | 5.17 |   |
| Loans, gross: (2)                               |   | 546,324                             |    | 20,815                              |   | 7.62 |   | 417,685 |   | 21,277 |   | 10.19 |   |
| Total interest-earning assets:                  |   | 843,946                             |    | 28,706                              |   | 6.80 |   | 650,423 |   | 28,577 |   | 8.79 |   |
| Allowance for loan losses                       |   | (10,351                             | )       |                                |   |   |   | (8,506 | ) |   |   |   |   |
| Cash and due from banks                         |   | 28,214                              |    |                                |   |   |   | 26,716 |   |   |   |   |   |
| Premises and equipment, net                     |   | 13,086                              |    |                                |   |   |   | 13,190 |   |   |   |   |   |
| Interest receivable and other assets            |   | 38,698                              |    |                                |   |   |   | 29,769 |   |   |   |   |   |
| Total assets                                    |   | $                                   | 913,593 |                                |   |   |   |   | $ | 711,592 |   |   |   |   |   |
|                                            |   |                                |    |                                |   |   |   |   |   |   |   |   |   |
| **Liabilities And Shareholders’ Equity**   |   |                                |    |                                |   |   |   |   |   |   |   |   |   |
| Negotiable order of withdrawal                  |   | $                                   | 99,771  |                                | $      | 112 |   | 0.22 |   | $ | 81,224 |   | $ | 152 |   | 0.37 |   |
| Savings deposits                                |   | 213,989                             |    | 1,690                               |   | 1.58 |   | 190,159 |   | 3,421 |   | 3.60 |   |
| Time deposits                                   |   | 294,715                             |    | 5,232                               |   | 3.55 |   | 246,254 |   | 7,113 |   | 5.78 |   |
| Other borrowings                                |   | 106,226                             |    | 2,174                               |   | 4.09 |   | 29,327 |   | 853 |   | 5.82 |   |
| Total interest-bearing liabilities              |   | 714,701                             |    | 9,208                               |   | 2.58 |   | 546,964 |   | 11,539 |   | 4.22 |   |
|                                            |   |                                |    |                                |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing deposits                    |   | 120,760                             |    |                                |   |   |   | 98,548 |   |   |   |   |   |
| Accrued interest, taxes and other liabilities   |   | 5,675                               |    |                                |   |   |   | 5,652 |   |   |   |   |   |
| Total liabilities                               |   | 841,136                             |    |                                |   |   |   | 651,164 |   |   |   |   |   |
|                                            |   |                                |    |                                |   |   |   |   |   |   |   |   |   |
| Capital Securities and other minority interests |   | 6,026                               |    |                                |   |   |   | 4,276 |   |   |   |   |   |
|                                            |   |                                |    |                                |   |   |   |   |   |   |   |   |   |
| Total shareholders’ equity                 |   | 66,431                              |    |                                |   |   |   | 56,152 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $                                   | 913,593 |                                |   |   |   |   | $ | 711,592 |   |   |   |   |   |
|                                            |   |                                |    |                                |   |   |   |   |   |   |   |   |   |
| Net interest income and margin (3)              |   |                                |    | $                                   | 19,498 |   | 4.62 | % |   |   | $ | 17,038 |   | 5.24 | % |
|                                                 |        |                                     |         |                                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  Tax-equivalent adjustments included in nontaxableinvestment securities income totaled $165,000 and $95,000 for the three months ended June 30, 2002 and 2001,respectively.  Tax equivalent incomeadjustments included in the nontaxable investment securities income werederived from nontaxable municipal interest income.  Tax equivalent income adjustments included in taxable investmentsecurities income were created by a dividends received deduction of $74,000 and$50,000 for the six months ended June 30, 2002 and 2001.

(2)                                  Amounts of interest earned includes loan fees of$695,000 and $533,000 for June 30, 2002 and 2001 respectively.

(3)                                  Net interest margin is computed by dividing netinterest income by total average interest-earning assets.

 

15

----

 

*NetInterest 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  June 30, 2002 compared to June 30, 2001** |       |
|-----------------------------------------------|--------|-----------------------------------------------------------------|------------|
| **(Dollar in  thousands)**                    |   | **Volume**                                                      | ** ** | **Rate** | ** ** | **Total** |   |
|                                          |   |                                                            |       |   |   |   |   |
| Increase (decrease) in interest  income: |   |                                                            |       |   |   |   |   |
| Federal funds sold                            |   | $                                                               | (—    | ) | $ | (140 | ) | $ | (140 | ) |
| Time deposits at other financial institutions |   | 1                                                               |       | (3 | ) | (2 | ) |
| Taxable investment securities                 |   | 1,624                                                           |       | (1,231 | ) | 393 |   |
| Tax-exempt investment securities              |   | (1                                                              | )          | 48 |   | 47 |   |
| Loans                                         |   | 2,940                                                           |       | (2,759 | ) | 181 |   |
| Total:                                        |   | $                                                               | 4,564      |   | $ | (4,085 | ) | $ | 479 |   |
|                                          |   |                                                            |       |   |   |   |   |
| Increase (decrease) in interest expense:      |   |                                                            |       |   |   |   |   |
| Interest bearing demand                       |   | $                                                               | 13         |   | $ | (16 | ) | $ | (3 | ) |
| Savings deposits                              |   | 180                                                             |       | (935 | ) | (755 | ) |
| Time deposits                                 |   | 594                                                             |       | (1,610 | ) | (1,016 | ) |
| Other borrowings                              |   | 909                                                             |       | (146 | ) | 763 |   |
| Total:                                        |   | $                                                               | 1,696      |   | $ | (2,707 | ) | $ | (1,011 | ) |
|                                          |   |                                                            |       |   |   |   |   |
| Increase (decrease) in net interest income    |   | $                                                               | 2,868      |   | $ | (1,378 | ) | $ | (1,490 | ) |

 

|                                          |   | **Six months ended  June 30, 2002 compared to June 30, 2001** |       |
|-----------------------------------------------|--------|---------------------------------------------------------------|------------|
| **(Dollar in  thousands)**                    |   | **Volume**                                                    | ** ** | **Rate** | ** ** | **Total** | ** ** |
|                                          |   |                                                          |       |   |   |   |   |
| Increase (decrease) in interest  income: |   |                                                          |       |   |   |   |   |
| Federal funds sold                            |   | $                                                             | (199       | ) | $ | (273 | ) | $ | (472 | ) |
| Time deposits at other financial institutions |   | 9                                                             |       | (11 | ) | (2 | ) |
| Taxable investment securities                 |   | 3,681                                                         |       | (2,686 | ) | 995 |   |
| Tax-exempt investment securities              |   | (4                                                            | )          | 74 |   | 70 |   |
| Loans                                         |   | 11,543                                                        |       | (12,005 | ) | (462 | ) |
| Total:                                        |   | $                                                             | 15,030     |   | $ | (14,901 | ) | $ | 129 |   |
|                                          |   |                                                          |       |   |   |   |   |
| Increase (decrease) in interest expense:      |   |                                                          |       |   |   |   |   |
| Interest bearing demand                       |   | $                                                             | 74         |   | $ | (114 | ) | $ | (40 | ) |
| Savings deposits                              |   | 1,086                                                         |       | (2,817 | ) | (1,731 | ) |
| Time deposits                                 |   | 3,071                                                         |       | (4,952 | ) | (1,881 | ) |
| Other borrowings                              |   | 2,095                                                         |       | (774 | ) | 1,321 |   |
| Total:                                        |   | $                                                             | 6,326      |   | $ | (8,657 | ) | $ | (2,331 | ) |
|                                          |   |                                                          |       |   |   |   |   |
| Increase (decrease) in net interest income    |   | $                                                             | 8,704      |   | $ | (6,244 | ) | $ | 2,460 |   |

 

16

----

 

*Provision For Loan Losses.*** **The provision for loan losses for the three andsix months ended June 30, 2002 was $1,451,000 and $2,231,000 compared with$789,000 and $1,539,000 for the three and six months ended June 30, 2001, anincrease of $662,000 and $692,000 or 84% and 45% . See “Allowance for LoanLosses” contained herein.  As ofJune 30, 2002 the allowance for loan losses was $11,261,000 or 1.93% of totalloans which compares to the allowance for loan losses of $9,743,000 or 1.83% asof December 31, 2001.  At June 30, 2002,nonperforming assets totaled $6,785,000 or 0.69% of total assets, nonperformingloans totaled $6,725,000 or 1.15% of total loans and the allowance for loanlosses totaled 167% of nonperforming loans. At December 31, 2001, nonperforming assets totaled $5,328,000 or 0.60%of total assets, nonperforming loans totaled $4,856,000 or 0.91% of total loansand the allowance for loan losses totaled 201% 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.

* *

*NoninterestIncome.*** **Noninterestincome increased by $556,000 and $982,000 or 35% and 34% to $2,130,000 and$3,909,000 for the three and six months ended June 30, 2002 compared with$1,574,000 and $2,927,000 during the same period in 2001.  Service charges on deposit accountsincreased by $275,000 and $500,000 or 27% and 26% to $1,279,000 and $2,406,000for the three and six months ended June 30, 2002 compared with $1,004,000 and$1,906,000 for the same period in 2001. The increase in fees is the result of increased customer use of feebased products.  Income from the sale ofreal estate increase totaled $33,000 for the three and six months ended June30, 2002.  During the 2ndquarter of 2002 the Company sold two other real estate owned properties for anet gain of $33,000.  There were no realestate sales during the comparable period in 2001.  Other income increased by $248,000 and $449,000 or 44% and 44%for the three and six month periods ended June 30, 2002 when compared to thesame periods in 2001.  The primarysource of this increased other income is an increase in interest income accruedand included in the cash surrender value of bank owned life insurance.

 

*NoninterestExpense.*** **Noninterestexpenses increased by $1,037,000 and $2,123,000 or 16% and 17% to $7,513,000and $14,938,000 for the three and six months ended June 30, 2002 compared with$6,476,000 and $12,815,000 for the same periods in 2001.  The primary components of noninterestexpenses were salaries and employee benefits, furniture and equipment expenses,occupancy expenses, professional fees, marketing expenses, goodwill andintangible amortization, supplies expense and other expense.

 

For the three and six months ended June 30, 2002,salaries and related benefits increased by $511,000 and $1,142,000 or 15% and17% to $3,839,000 and $7,783,000 from the $3,328,000 and $6,641,000 recordedfor the same periods in 2001. The salary expense increase was primarily theresult of increased staffing levels needed for expanded business volumes andnormal salary progression.  Equipmentexpenses decreased by $109,000 and $164,000 or 16% and 13% to $571,000 and$680,000 during the three and six months ended June 30, 2002 from the$1,140,000 and $1,304,000 experienced during the same periods in 2001.  The reduction in equipment expense isprimarily the result of decreased spending on technology during 2002 ascompared to 2001.  Premises andoccupancy expenses increased by $185,000 and $436,000 or 36% and 44% to$704,000 and $1,420,000 for the three and six months ended June 30, 2002 from$519,000 and $984,000 recorded during the same period in 2001.  The primary reason for the increase inoccupancy costs in 2002 is related to retrofit charges for branch facilities inAtwater, Fresno, and Merced and the costs of branch expansion into Stockton andSan Francisco.  When comparing theresults of the three and six months ending June 30, 2002 to the three and sixmonths ended June 30, 2001, professional fees increased by $218,000 and$354,000 or 220% or 164%, marketing expenses decreased by $11,000 and $34,000or 5% and 8%, goodwill and intangible amortization expense decreased by $28,000and $56,000 or 14% in both periods, supplies expense decreased by $81,000 and$97,000 or 32% and 21%, dividend expense on Capital Securities decreased by$3,000 and

 

17

----

 

increased by 88,000 or 2% and 40% and other expenses increased $355,000and $454,000 or 35% and 21% from 2001 levels. Increased professional fees in2002 were the result of an increased use of consultants used to identify newbusiness profitability and tax saving strategies and consulting fees related tothe RIA acquisition.  The decreaseddividend expense on Capital Securities during the three months ended June 30,2002 as compared with the same period in 2001 was primarily the result or anadjustment in amortized cost related to the issuance of the securities.  The increased dividend expense on CapitalSecurities during the six months ended June 30, 2002 as compared to the sameperiod in 2001 was due to the fact that the securities were issued during thelatter part of the first quarter of 2001 and therefore were only outstandingduring a small portion of that quarter.

* *

*ProvisionFor Income Taxes.*** **TheCompany recorded a decrease of $91,000 and $182,000 or 11% and 12% in theincome tax provision to $715,000 and $1,391,000 for the three and six monthsended June 30, 2002 compared to the $806,000 and $1,573,000 recorded for thesame period in 2001.  During the threeand six months ended June 30, 2002, the Company achieved an effective tax rateof 23% compared to 29% recorded for the same periods in 2001. During 2002, thereduced effective tax rate was made possible by the continued utilization of areal estate investment trust established during the fourth quarter of 2001 thatprovides the Company with a means to potentially generate future additionalcapital for the Bank as well as to currently reduce state income tax expense.

 

**InterestRate Risk**

 

A measure of interest rate sensitivity that theCompany monitors through a detailed model is its expected change in netinterest income.  This model’s estimateof interest rate sensitivity takes into account the differing time intervalsand differing rate change increments of each type of interest-sensitive assetand liability.  It then measures theprojected impact of changes in market interest rates on the Company’s netinterest income.  Based upon the June30, 2002 mix of interest-sensitive assets and liabilities, given an immediateand sustained decrease in the market interest rates of 1%, this model estimatesthe Company’s net interest income over the next year would decrease by $512,000or 1% of net interest income.  Noassurance can be given that the actual net interest income would not decreaseby more than $512,000 or 1% in response to a 1% decrease in market interestrates or that actual net interest income would not decrease substantially ifmarket interest rates decreased by more than 1%.

 

**FinancialCondition**

 

Total assets at June 30, 2002 were $975,832,000, anincrease of $81,505,000 or 9% compared with total assets of $894,327,000 atDecember 31, 2001.  Net loans were$572,393,000 at June 30, 2002, an increase of $49,716,000 or 10% compared withnet loans of $522,677,000 on December 31, 2001.  Deposits totaled $773,883,000 at June 30, 2002, an increase of$41,242,000 or 6% compared with deposits of $732,641,000 at December 31,2001.  The increase in total assets ofthe Company between December 31, 2001 and June 30, 2002 was primarily theresult of an increase in leverage that was maintained in the Company’sinvestment portfolio that were funded with increased borrowed funds andincreased cash utilization and an increase in the overall size of the loanportfolio.

 

On February 22, 2001, the Company issued $6,000,000 inCapital Securities through its 100% ownership position in the County StatutoryTrust I.  The Capital Securities payquarterly cumulative cash distributions at an annual rate of 10.2% of theliquidation value of $1,000 per share. The Capital Securities represent undivided beneficial interests in theTrust.  The Company owns all of theissued and outstanding common securities of the Trust.  Proceeds from the offering and from theissuance of common securities were invested in the Trust in the Company’s 10.2%Junior Subordinated Deferrable Interest Debentures due February 22, 2031 withan aggregate principal amount of $6,000,000. The

 

18

----

 

primary asset of the Trust is the Junior Debentures.  The obligations of the Trust with respect tothe Capital Securities are fully and unconditionally guaranteed by us to theextent provided in the Guarantee Agreement with respect to the CapitalSecurities.  The proceeds were used forgeneral corporate purposes.  The all-incosts of the Capital Securities was 10.39%. The Capital Securities have the added benefit of qualifying as Tier 1capital for regulatory purposes.

 

Total shareholders’ equity was $69,792,000 at June 30,2002, an increase of $5,672,000 or 9% from $64,120,000 at December 31, 2001.The growth in shareholders’ equity between December 31, 2001 and June 30, 2002was achieved through the retention of accumulated earnings.  Other comprehensive increased by $231,000 to$1,890,000 at June 30, 2002 compared with $1,659,000 at December 31, 2001.  Other comprehensive income consists ofchanges in the fair market value compared to book value of available for saleinvestment securities and valuation changes in the Bank’s interest rate swap,net of estimated federal and state income taxes.

 

*InvestmentPortfolio.*  At June30, 2002 and December 31, 2001 the carrying amount (fair value) of availablefor sale investment securities totaled $230,831,000 and $229,852,000 respectively.  At June 30, 2002 and December 31, 2001 theamortized cost of available for sale investment securities totaled $228,099,000and $227,866,000.  The amortized cost ofheld to maturity securities at June 30, 2002 and December 31, 2001 was$64,399,000 and $41,559,000.  The fairvalue of held to maturity securities at June 30, 2002 and December 31, 2001 was$65,410,000 and $42,185,000.

 

*Off-BalanceSheet Commitments. *Thefollowing table shows the distribution of the Company’s undisbursed loancommitments at the dates indicated.

 

| **(Dollars in thousands)**   |   | **June 30,  2002** |    | **December 31,  2001** | ** ** |
|------------------------------|--------|--------------------|---------|------------------------|------------|
|                         |   |               |    |                   |       |
| Letters of credit            |   | $                  | 3,411   |                   | $          | 3,852 |   |
| Commitments to extend credit |   | 212,870            |    | 188,802                |       |
| Total                        |   | $                  | 216,281 |                   | $          | 192,654 |   |

 

*OtherInterest-Earning Assets. *Thefollowing table relates to other interest–earning assets not disclosedpreviously for the dates indicated. This item consists of a salary continuation plan for the Company’sexecutive management and deferred retirement benefits for participating boardmembers.  The plan is informally linkedwith universal life insurance policies for the salary continuation plan.  Income from these policies is reflected innoninterest income.

 
| **(Dollars in  thousands)**            |   | **At June 30,  2002** |   | **At  December 31,  2001** | ** ** |
|----------------------------------------|--------|-----------------------|--------|---------------------------------|------------|
|                                   |   |                  |   |                            |       |
| Cash surrender value of life insurance |   | $                     | 16,607 |                            | $          | 16,160 |   |
|                                        |        |                       |        |                                 |            |  |  |

 

*Nonperforming Assets. *Nonperforming assetsinclude nonaccrual loans, loans 90 days or more past due, restructured loansand other real estate owned.

 

19

----

 

Nonperforming loans are those which the borrower failsto perform in accordance with the original terms of the obligation and includeloans on nonaccrual status, loans past due 90 days or more and restructuredloans.  The Company generally places loanson nonaccrual status and accrued but unpaid interest is reversed against thecurrent year’s income when interest or principal payments become 90 days ormore past due unless the outstanding principal and interest is adequatelysecured and, in the opinion of management, is deemed in the process ofcollection.  Interest income onnonaccrual loans is recorded on a cash basis. Payments may be treated as interest income or return of principaldepending upon management’s opinion of the ultimate risk of loss on theindividual loan.  Cash payments aretreated as interest income where management believes the remaining principalbalance is fully collectible. Additional loans not 90 days past due may also be placed on nonaccrualstatus if management reasonably believes the borrower will not be able tocomply with the contractual loan repayment terms and collection of principal orinterest is in question.

 

A “restructured loan” is a loan on which interestaccrues at a below market rate or upon which certain principal has beenforgiven so as to aid the borrower in the final repayment of the loan, with anyinterest previously accrued, but not yet collected, being reversed againstcurrent income.  Interest is reported ona cash basis until the borrower’s ability to service the restructured loan inaccordance with its terms is established. The Company had no restructured loans as of the dates indicated in thetable below.

 

The following table summarizes nonperforming assets ofthe Company at June 30, 2002 and December 31, 2001:

 

|                                    |   | **June 30,  2002** |       | **December 31,  2001** |       |
|-----------------------------------------|--------|--------------------|------------|------------------------|------------|
| **(Dollars in  thousands)**             |   |               | ** ** |                   | ** ** |
|                                    |   |               |       |                   |       |
| Nonaccrual loans                        |   | $                  | 6,060      |                   | $          | 4,247 |   |
| Accruing loans past due 90 days or more |   | 665                |       | 609                    |       |
| Total nonperforming loans               |   | 6,725              |       | 4,856                  |       |
| Other real estate owned                 |   | 60                 |       | 472                    |       |
| Total nonperforming assets              |   | $                  | 6,785      |                   | $          | 5,328 |   |
|                                    |   |               |       |                   |       |
| Nonperforming loans to total loans      |   | 1.15               | %          | 0.91                   | %          |
| Nonperforming assets to total assets    |   | 0.69               | %          | 0.60                   | %          |
|                                    |   |               |       |                   |       |

 

Contractual accrued interest income on loans onnonaccrual status as of June 30, 2002 and 2001, that would have been recognizedif the loans had been current in accordance with their original terms wasapproximately $129,000 and $81,000 for the six months ended June 30, 2002 and2001.

 

At June 30, 2002, nonperforming assets represented..70% of total assets, an increase of 10 basis point when compared to the .60%at December 31, 2001.  Nonperformingloans represented 1.15% of total loans at June 30, 2002, an increase of 24basis points compared to the .91% at December 31, 2001.  Nonperforming loans that were secured byfirst deeds of trust on real property were $0 at June 30, 2002 and December 31,2001.   Other forms of collateral suchas inventory and equipment secured the remaining nonperforming loans as of eachdate.  No assurance can be given thatthe collateral securing nonperforming loans will be sufficient to preventlosses on such loans.

 

The increase in nonperforming loans and nonperformingassets as of June 30, 2002 compared with their levels as of December 31, 2001,was due to a growth in nonperforming loans in the agricultural segment of theloan portfolio.

 

20

----

 

At June 30, 2002, the Company had $60,000 invested inone property acquired through foreclosure. This property is carried at the lower of its estimated market value, asevidenced by an independent appraisal, or the recorded investment in therelated loan, less estimated selling expenses. At foreclosure, if the fair value of the real estate is less than theCompany’s recorded investment in the related loan, a charge is made to theallowance for loan losses.  The Companyexpects to sell this property within a twelve month period.  No assurance can be given that the Companywill sell this property during 2002 or at any time or the amount for which suchproperty might be sold.

 

Management defines impaired loans, regardless of pastdue status on loans, as those on which principal and interest are not expectedto be collected under the original contractual loan repayment terms.  An impaired loan is charged off at the timemanagement believes the collection process has been exhausted.  At June 30, 2002 and December 31, 2001,impaired loans were measured based on the present value of future cash flowsdiscounted at the loan’s effective rate, the loan’s observable market price orthe fair value of collateral if the loan is collateral-dependent.  Impaired loans at June 30, 2002 were$6,725,000 on account of which the Company had made provisions to the allowancefor loan losses of approximately $702,000.

 

Except for loans that are disclosed above, there wereno assets as of June 30, 2002, where known information about possible creditproblems of borrower causes management to have serious doubts as to the abilityof the borrower to comply with the present loan repayment terms and which maybecome nonperforming assets.  Given themagnitude of the Company’s loan portfolio, however, it is always possible thatcurrent credit problems may exist that may not have been discovered bymanagement.

 

21

----

 

**Allowance for Loan Losses**

 

The following table summarizes the loan loss experience of the Companyfor the three months ended June 30, 2002 and 2001, and for the year endedDecember 31, 2001.

 
|                                        |   | **June 30**                |    | **December 31** |   |
|---------------------------------------------|--------|----------------------------|---------|-----------------|--------|
|                                        |   | **2002**                   |    | **2001**        |   | **2001** |   |
|                                        |   | **(Dollars in thousands)** |    |
| **Allowance  for Loan Losses:**             |   |                       |    |            |   |   |   |
| Balance at beginning of period              |   | $                          | 9,743   |            | $      | 8,207 |   | $ | 8,207 |   |
| Provision for loan losses                   |   | 2,231                      |    | 1,539           |   | 4,115 |   |
| Charge-offs:                                |   |                       |    |            |   |   |   |
| Commercial and  agricultural           |   | 572                        |    | 188             |   | 864 |   |
| Consumer                                    |   | 560                        |    | 1,088           |   | 2,288 |   |
| Total charge-offs                           |   | 1,132                      |    | 1, 276          |   | 3,152 |   |
| Recoveries                                  |   |                       |    |            |   |   |   |
| Commercial and agricultural                 |   | 133                        |    | 125             |   | 159 |   |
| Consumer                                    |   | 186                        |    | 207             |   | 414 |   |
| Total recoveries                            |   | 419                        |    | 332             |   | 573 |   |
| Net charge-offs                             |   | 713                        |    | 944             |   | 2,579 |   |
| Balance at end of period                    |   | $                          | 11,261  |            | $      | 8,802 |   | $ | 9,743 |   |
|                                        |   |                       |    |            |   |   |   |
| Loans outstanding at period-end             |   | $                          | 583,625 |            | $      | 448,612 |   | $ | 532,420 |   |
| Average loans outstanding                   |   | $                          | 546,324 |            | $      | 417,685 |   | $ | 453,503 |   |
|                                        |   |                       |    |            |   |   |   |
| Annualized net charge-offs to average loans |   | 0.26                       | %       | 0.45            | %      | 0.57 | % |
| Allowance for loan losses                   |   |                       |    |            |   |   |   |
| To total loans                              |   | 1.93                       | %       | 1.96            | %      | 1.83 | % |
| To nonperforming assets                     |   | 165.97                     | %       | 289.99          | %      | 182.85 | % |

 

The Company maintains an allowance for loan losses ata level considered by management to be adequate to cover the inherent risks ofloss associated with its loan portfolio under prevailing and anticipatedeconomic conditions.  In determining theadequacy of the allowance for loan losses, management takes into consideration growthtrends in the portfolio, examination of financial institution supervisoryauthorities, prior loan loss experience for the Company, concentrations ofcredit risk, delinquency trends, general economic conditions, the interest rateenvironment and internal and external credit reviews.  In addition, the risks management considers vary depending on thenature of 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 construction loans include fluctuationin real estate values, the demand for improved commercial and industrialproperties and housing, the availability of permanent financing in theCompany’s market area and borrowers’ ability to obtain permanentfinancing.  The normal risks consideredby management with respect to real estate mortgage loans include fluctuationsin the value of real estate. Additionally, the Company relies on data obtained through independentappraisals for significant properties to determine loss exposure onnonperforming loans.

 

The balance in the allowance is affected by theamounts provided from operations, amounts charged off and recoveries of loanspreviously charged off.  The Companyrecorded provisions for loan losses for the three and six months ended June 30,2002 of $1,451,000 and $2,231,000 compared with

 

22

----

 

$789,000 and $1,539,000 during the same periods in 2001. The increasein loan loss provisions in 2002 was recorded to adequately provide for thegeneral loan growth of the Company that has occurred during the period.

 

The Company’s charge-offs, net of recoveries, were$713,000 for the six months ended June 30, 2002 compared with $944,000 for thesame six months in 2001.  The decreasein net charge-offs for the six months ended June 30, 2002 when compared to thesame period in 2001 was primarily due to decreased charge-offs that occurredwithin the consumer installment segment of the loan portfolio.  The decreased charge-offs in this segment ofthe portfolio are primarily attributable to a tightening of the creditstandards in the indirect automobile contract segment of the loan portfoliothat occurred during the second half of 2001.

 

As of June 30, 2002, the allowance for loan losses was$11,261,000 or 1.93% of total loans outstanding, compared with $9,743,000 or1.83% of total loans outstanding as of December 31, 2001 and $8,802,000 or1.96% of total loans outstanding as of June 30, 2001.  Between June 30, 2001 and 2002, the allowance for loan lossincreased $2,459,000 or 28%.

 

The Company uses a method developed by management fordetermining the appropriate level of its allowance for loan losses.  This method applies relevant risk factors tothe entire loan portfolio, including nonperforming loans.  The methodology is based, in part, on theCompany’s loan grading and classification system.  The Company grades its loans through internal reviews andperiodically subjects loans to external reviews which then are assessed by theCompany’s audit committee and management. Credit reviews are performed on a monthly basis and the quality gradingprocess occurs on a quarterly basis. Risk factors applied to the performingloan portfolio are based on the Company’s past loss history considering thecurrent portfolio’s characteristics, current economic conditions and otherrelevant factors.  General reserves areapplied to various categories of loans at percentages ranging up to 1.8% basedon the Company’s assessment of credit risks for each category.  Risk factors are applied to the carryingvalue of each classified loan: (i) loans internally graded “Watch” or“Special Mention” carry a risk factor from 1.0% to 2.0%;(ii) ”Substandard” loans carry a risk factor from 15% to 40% depending oncollateral securing the loan, if any; (iii) “Doubtful” loans carry a 50% riskfactor; and (iv) “Loss” loans are charged off 100%.  In addition, a portion of the allowance is specially allocated toidentified problem credits.  Theanalysis also includes reference to factors such as the delinquency status ofthe loan portfolio, inherent risk by type of loans, industry statistical data,recommendations made by the Company’s regulatory authorities and outside loanreviewers, and current economic environment. Important components of the overall credit rating process are the assetquality rating process and the internal loan review process.

 

The allowance is based on estimates and ultimatefuture losses may vary from current estimates. It is always possible that future economic or other factors mayadversely affect the Company’s borrowers, and thereby cause loan losses toexceed the current allowance.  Inaddition, there can be no assurance that future economic or other factors willnot adversely affect the Company’s borrowers, or that the Company’s assetquality may not deteriorate through rapid growth, failure to enforceunderwriting standards, failure to maintain appropriate underwriting standards,failure to maintain an adequate number of qualified loan personnel, failure toidentify and monitor potential problem loans or for other reasons, and therebycause loan losses to exceed the current allowance.

 

The allocation of the allowance to loan categories isan estimate by management of the relative risk characteristics of loans inthose categories.  No assurance can begiven that losses in one or more loan categories will not exceed the portion ofthe allowance allocated to that category or even exceed the entire allowance.

 

23

----

 

*ExternalFactors Affecting Asset Quality. *Asa result of the Company’s loan portfolio mix, the future quality of its assetscould be affected by adverse economic trends in its region or in theagricultural community.  These trendsare beyond the control of the Company.

 

California is an earthquake-prone region.  Accordingly, a major earthquake could resultin material loss to the Company.  Attimes the Company’s service area has experienced other natural disasters suchas floods and droughts.  The Company’sproperties and substantially all of the real and personal property securingloans in the Company’s portfolio are located in California.  The Company faces the risk that many of itsborrowers face uninsured property damage, interruption of their businesses orloss of their jobs from earthquakes, floods or droughts.  As a result these borrowers may be unable torepay their loans in accordance with their terms and the collateral for suchloans may decline significantly in value. The Company’s service area is a largely agricultural region andtherefore is highly dependent on a reliable supply of water for irrigationpurposes.  The area obtains nearly allof its water from the run-off of melting snow in the mountains of the SierraNevada to the east.  Although suchsources have usually been available in the past, water supply can be adverselyaffected by light snowfall over one or more winters or by any diversion ofwater from its present natural courses. Any such natural disaster could impair the ability of many of theCompany’s borrowers to meet their obligations to the Company.

 

Parts of California have experienced significantfloods in the late 1990s. No assurance can be given that future flooding willnot have an adverse impact on the Company and its borrowers and depositors.

* *

*Liquidity.*In order to maintain adequate liquidity, the Company musthave sufficient resources available at all times to meet its cash flowrequirements.  The need for liquidity ina banking institution arises principally to provide for deposit withdrawals,the credit needs of its customers and to take advantage of investmentopportunities as they arise.  TheCompany may achieve desired liquidity from both assets and liabilities.  The Company considers cash and deposits heldin other banks, federal funds sold, other short term investments, maturing loansand investments, payments of principal and interest on loans and investmentsand potential loan sales as sources of asset liquidity.  Deposit growth and access to credit linesestablished with correspondent banks and market sources of funds are consideredby the Company as sources of liability liquidity.  The holding company’s primary source of liquidity is fromdividends received from the Bank. Dividends from the Bank are subject to certain regulatory restrictions.

 

The Company reviews its liquidity position on aregular basis based upon its current position and expected trends of loans anddeposits. These assets include cash and deposits in other banks,available-for-sale securities and federal funds sold.  The Company’s liquid assets totaled $287,011,000 and $279,640,000on June 30, 2002 and December 31, 2001, respectively, and constituted 29% and31% of total assets on those dates. Liquidity is also affected by the collateral requirements of its publicdeposits and certain borrowings.  Totalpledged securities were $230,961,000 at June 30, 2002 compared with$141,386,000 at December 31, 2001.

 

Although the Company’s primary sources of liquidityinclude liquid assets and a stable deposit base, the Company maintains lines ofcredit with the Federal Reserve Bank of San Francisco, Federal Home Loan Bankof San Francisco and Pacific Coast Bankers’ Bank aggregating $148,164,000 ofwhich $111,307,000 was outstanding as of June 30, 2002 and $73,759,000 wasoutstanding as of December 31, 2001. The increase in borrowings outstandingduring the first six months of 2002 produced an inflow of funds that were usedto purchase additional investment securities and fund loan production.  Management believes that the Company maintainsadequate amounts of liquid assets to meet its liquidity needs.  The Company’s liquidity might beinsufficient if deposit withdrawals were to exceed anticipated levels.

 

24

----

 

Deposit withdrawals can increase if a company experiences financial difficultiesor receives adverse publicity for other reasons, or if its pricing, products orservices are not competitive with those offered by other institutions.

* *

*CapitalResources. *Capitalserves as a source of funds and helps protect depositors against potentiallosses.  The primary source of capitalfor the Company has been internally generated capital through retainedearnings.  The Company’s shareholders’equity increased by $5,672,000 or 9% from December 31, 2001 to June 30, 2002.

 

The Company is subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate mandatory and possibly additional discretionary actions by theregulators that, if undertaken, could have a material adverse effect on theCompany’s financial statements. Management believes, as of June 30, 2002, that the Company and the Bankmet all applicable capital requirements. The Company’s leverage capital ratio at June 30, 2002 was 7.46% ascompared with 7.72% as of December 31, 2001. The Company’s total risk based capital ratio at June 30, 2002 was 10.76%as compared to 10.74% as of December 31, 2001.

 

The Company’s and Bank’s actual capital amounts andratios met all regulatory requirements as of June 30, 2002 and were summarizedas follows:

 
|                                     |   | **Actual** |   | **For Capital  Adequacy Purposes** |   | **To Be Well Capitalized  Under Prompt  Corrective  Action Provisions:** |   |
|------------------------------------------|--------|------------|--------|------------------------------------|--------|--------------------------------------------------------------------------|--------|
| **Dollars in thousands**                 |   | **Amount** |   | **Ratio**                          |   | **Amount**                                                               |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| Consolidated                             |   |       |   |                               |   |                                                                     |   |   |   |   |   |   |   |
| As of June 30, 2002                      |   |       |   |                               |   |                                                                     |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 79,572 |                               | 10.76  | %                                                                        | $      | 59,141 |   | 8.0 | % | $ | 73,926 |   | 10.0 | % |
| Tier 1 capital (to risk weighted assets) |   | 70,306     |   | 9.51                               |   | 29,571                                                                   |   | 4.0 |   | 44,356 |   | 6.0 |   |
| Leverage ratio*                          |   | 70,306     |   | 7.46                               |   | 37,706                                                                   |   | 4.0 |   | 47,132 |   | 5.0 |   |
|                                     |   |       |   |                               |   |                                                                     |   |   |   |   |   |   |   |
| The Bank:                                |   |       |   |                               |   |                                                                     |   |   |   |   |   |   |   |
| As of June 30, 2002                      |   |       |   |                               |   |                                                                     |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 76,955 |                               | 10.43  | %                                                                        | $      | 59,002 |   | 8.0 | % | $ | 73,753 |   | 10.0 | % |
| Tier 1 capital (to risk weighted assets) |   | 67,711     |   | 9.18                               |   | 29,501                                                                   |   | 4.0 |   | 44,252 |   | 6.0 |   |
| Leverage ratio*                          |   | 67,711     |   | 7.19                               |   | 37,658                                                                   |   | 4.0 |   | 47,073 |   | 5.0 |   |

 

----

* The leverage ratio consists ofTier 1 capital divided by adjusted quarterly average assets.  The minimum leverage ratio is 3 percent for bankingorganizations that do not anticipate significant growth and that havewell-diversified risk, excellent asset quality and in general, are consideredtop-rated banks.

 

The Company has no formal dividend policy, anddividends are issued solely at the discretion of the Company’s Board ofDirectors, subject to compliance with regulatory requirements.  In order to pay any cash dividends, theCompany must receive payments of dividends or management fees from the Bank.  There are certain regulatory limitations onthe payment of cash dividends by banks.

 

*Deposits.*  Deposits are the Company’s primary source offunds.  At June 30, 2002, the Companyhad a deposit mix of 29% in savings deposits, 40% in time deposits, 13% ininterest-bearing checking accounts and 18% in noninterest-bearing demandaccounts.  Noninterest-bearing demanddeposits enhance the Company’s net interest income by lowering its costs offunds.

 

The Company obtains deposits primarily from thecommunities it serves.  No materialportion of its deposits has been obtained from or is dependent on any oneperson or industry.  The Company’s

 

25

----

 

business is not seasonal in nature. The Company accepts deposits in excess of $100,000 from customers.  These deposits are priced to remaincompetitive.  At June 30, 2002, theCompany had brokered deposits of $15,495,000.

 

Maturities of time certificates of deposits of$100,000 or more outstanding at June 30, 2002 and December 31, 2001 aresummarized as follows:

 
|                      |   | **June 30, 2002**          |    | **December 31, 2001** | ** ** |
|---------------------------|--------|----------------------------|---------|-----------------------|------------|
|                      |   | **(Dollars in thousands)** |    |
|                      |   |                       |    |                  |       |
| Three months or less      |   | $                          | 38,596  |                  | $          | 53,879 |   |
| Over three to six months  |   | 46,774                     |    | 37,358                |       |
| Over six to twelve months |   | 38,765                     |    | 30,776                |       |
| Over twelve months        |   | 30,245                     |    | 9,161                 |       |
| Total                     |   | $                          | 154,380 |                  | $          | 131,174 |   |
|                           |        |                            |         |                       |            |  |  |  |

 

**Borrowed Funds**

 

The increase in other borrowings during the first sixmonths of 2002 was primarily due to the use of a leveraged investment strategythat uses additional FHLB borrowings to fund purchases of investment securitieswithin the Bank’s investment portfolio.

 

**Returnon Equity and Assets**

 
|                                |   | **Six months ended  June 30  2002** |   | **Six months ended  June 30  2001** | ** ** | **Year ended  December 31  2001** |   |
|-------------------------------------|--------|-------------------------------------|--------|-------------------------------------|------------|-----------------------------------|--------|
|                                |   |                                |   |                                |       |                              |   |
| Annualized return on average assets |   | 1.01                                | %      | 1.09                                | %          | 1.03                              | %      |
| Annualized return on average equity |   | 13.87                               | %      | 13.87                               | %          | 13.40                             | %      |
| Average equity to average assets    |   | 7.27                                | %      | 7.89                                | %          | 7.69                              | %      |

 

**Impactof Inflation**

 

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

 

26

----

 

**Item3.    Quantitative and QualitativeDisclosures about Market Risk**

 

In the normal course of business,the Company is exposed to market risk which includes both price and liquidityrisk.  Price risk is created fromfluctuations in interest rates and the mismatch in repricing characteristics ofassets, liabilities, and off balance sheet instruments at a specified point intime.  Mismatches in interest raterepricing among assets and liabilities arise primarily through the interactionof the various types of loans versus the types of deposits that are maintainedas well as from management’s discretionary investment and funds gatheringactivities.  Liquidity risk arises fromthe possibility that the Company may not be able to satisfy current and futurefinancial commitments or that the Company may not be able to liquidate financialinstruments at market prices.  Riskmanagement policies and procedures have been established and are utilized tomanage the Company’s exposure to market risk. Quarterly testing of the Company’s assets and liabilities under bothincreasing and decreasing interest rate environments are performed to insurethe Company does not assume a magnitude of risk that is outside approved policylimits.

 

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

 

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

 

It is the opinion of managementthere has been no material change in the Company’s market risk during the firstsix months of 2002 when compared to the level of market risk at December 31,2001.  If interest rates were tosuddenly and materially fall from levels experienced during the first sixmonths of 2002, the Company could become susceptible to an increased level ofmarket risk.

 

27

----

 

**PART II - Other Information**

 

**Item1.              Legal Proceedings**

 

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

 

**Item2.              Changes in Securities andUse of Proceeds.**

 

None.

 

**Item3.              Defaults Upon SeniorSecurities.**

 

None.

 

**Item4.              Submission of Matters to aVote of Securities Holders.**

 
| (a.)   | Annual Meeting was held April 23, 2002.  The number of shares represented in person  or by proxy and constituting a quorum was 4,236,509 which equals  approximately 86% of the shares outstanding. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                     |   |   |   |   |   |
| (b.)   | **Election  of directors**                                                                                                                                                                               |   | **Votes For** |   |   |
|   | G. Michael Graves                                                                                                                                                                                        |   | 3,913.010 |   |   |
|   | Bertyl W.  Johnson                                                                                                                                                                                       |   | 3,910,835 |   |   |
|   | James W.  Tolladay                                                                                                                                                                                       |   | 3,912,723 |   |   |
|   | Tom A. L. Van  Groningen                                                                                                                                                                                 |   | 3,913,901 |   |   |
|   | Gerald L.  Tahajian                                                                                                                                                                                      |   | 3,909,128 |   |   |
|   |                                                                                                                                                                                                     |   |   |   |   |
| (c.)   | Proposal to approve the Capital Corp of the West  2002 Stokc Option Plan.  The proposal  was approved with 2,509,892 voting in favor and 896,848 were opposed.                                      |

 

**Item5.              Other Information.**

 

In the opinion of management, there is no additional informationrelating to these periods being reported which warrants inclusion in thereport.

 

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

 

(a)                                Exhibits.

 

28

----

 
| **Exhibit  Number** |   | **Exhibit**                                                                                                                                                                                                                                                                                                        |   |   |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| 3.1                 |   | Articles of Incorporation (filed as Exhibit 3.1 of  the Company’s September 30, 1996 Form 10-Q filed with the SEC on or about  November 14, 1996).                                                                                                                                                            |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 3.2                 |   | Bylaws (filed as Exhibit 3.2 of the Company’s  September 30, 1996 Form 10-Q filed with the SEC on or about November 14,  1996)                                                                                                                                                                                |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 3.3                 |   | Rights Agreement between Capital Corp of the West  and Harris Trust Company of California dated as of September 26, 1997,  including Form of Right Certificate attached thereto as Exhibit B (filed as  Exhibit 4 to the Company’s Registration Statement on Form 8-A filed with the  SEC on October 1, 1997. |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.1                |   | Administration Construction Agreement (filed as  Exhibit 10.4 of the Company’s 1995 Form 10-K filed with the SEC on or about  March 31, 1996).                                                                                                                                                                |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.2                |   | Stock Option Plan (filed as Exhibit 10.6 of the  Company’s 1995 Form 10-K filed with the SEC on or about March 31, 1996).                                                                                                                                                                                     |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.3                |   | 401(k) Plan (filed as Exhibit 10.7 of the Company’s  1995 Form 10-K filed with the SEC on or about March 31, 1996).                                                                                                                                                                                           |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.4                |   | Employee Stock Ownership Plan (filed as Exhibit 10.8  of the Company’s 1995 Form 10-K filed with the SEC on or about March 31,  1996).                                                                                                                                                                        |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.5                |   | Purchase Agreement for three branches from Bank of  America is incorporated herein by reference from Exhibit 2.1 Registration  Statement on Form S-2 filed July 14, 1997, File No. 333-31193.                                                                                                                      |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.6                |   | Change-in-Control Agreement between R. Dale McKinney  and Capital Corp of the West (filed as Exhibit 10.6 of the Company’s 1999  Form  10-K with the SEC on or about  March 17, 2000).                                                                                                                   |   | *      |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.7                |   | Deferred Compensation Agreement between members of  the board of directors and Capital Corp of the West (filed as exhibit 10.7 of  the Company’s 1999 Form 10-K with the SEC on or about March 17, 2000).                                                                                                     |   | *      |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.8                |   | Executive Salary Continuation Agreement between  certain members of executive management and Capital Corp of the West (filed  as Exhibit 10.8 of the Company’s 1999 Form 10-K with the SEC in or about  March 17, 2000).                                                                                      |   | *      |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.9                |   | Executive Salary Continuation Agreement between  senior executive management and Capital Corp of the West (filed as Exhibit  10.9 of the Company’s 2001 Form 10-K with the SEC on or about March 29,  2002).                                                                                                  |   | *      |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 10.10               |   | Employment Agreement between Thomas T. Hawker and  Capital Corp. of the West                                                                                                                                                                                                                                       |   | *      |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 11                  |   | Statement Regarding the Computation of Earnings Per  Share is incorporated herein by reference from Note 1 of the Company’s  Consolidated Financial Statements.                                                                                                                                          |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 13                  |   | Annual Report to Security Holders  (filed as Exhibit 13 of the Company’s 2001  Form 10-K with the SEC on March 29, 2002).                                                                                                                                                                                |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 99.1                |   | Chief Executive Officer Certification pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                  |   |   |
|                |   |                                                                                                                                                                                                                                                                                                               |   |   |
| 99.2                |   | Chief Financial Officer Certification pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                  |   |   |

 

----

*                         Denotesmanagement contract or compensatory plan arrangement.

 

29

----

 

**Reports on Form 8-K**

 

None

 

30

----

 

**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)             |
|            |                     |
| August 13, 2002 | By                       | /s/ | Thomas T. Hawker |
|            |                     | Thomas T. Hawker |
|            |                     | President and |
|            |                     | Chief Executive Officer |
|            |                     |
|            | By                       | /s/ | R. Dale McKinney |
|            |                     | R. Dale McKinney |
|            |                     | Chief Financial Officer |

 

31

----