**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For the quarterly period endedMarch 31, 2003**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For the Transition Period from            to           **

 

**Commission File No. 0-25020**

 

| **HERITAGE  OAKS BANCORP**                                     |
|----------------------------------------------------------------|
| (Exact name of registrant as specified in  charter)            |
|                                                           |
| **STATE OF  CALIFORNIA**                                       |
| (State or other jurisdiction of incorporation or organization) |
|                                                           |
| **77-0388249**                                                 |
| (I.R.S. Employer Identification Code)                          |
|                                                           |
| **545 12th  STREET, PASO ROBLES, CA  93446**              |
| (Address of principal office)                                  |
|                                                           |
| **(805)  239-5200**                                            |
| (Registrant’s telephone number, including  area code)     |

 

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

YES  ý    NO  o

 

Indicate by check mark whether the registrant is an accelerated filer (asdefined in Exchange Act Rule 12b-2).

Yes  o    No  ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

No par value Common Stock – 2,935,081 sharesoutstanding at April 14, 2003.

 

 

----

 

**TABLE OFCONTENTS**

 
| Part 1. Financial  Information                                                                       |
|------------------------------------------------------------------------------------------------------|
|                                                                                                 |
| Item 1. Financial  Statements                                                                        |
|                                                                                                 |
| Consolidated Balance Sheets                                                                          |
| Consolidated Statements of Operations (Un-audited)                                                   |
| Consolidated Statements  of Cash Flows (Un-audited)                                                  |
| Consolidated  Statement of Changes in Stockholders’ Equity (Un-audited)                         |
| Notes to  Consolidated Financial Statements (Un-audited)                                             |
|                                                                                                 |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations |
|                                                                                                 |
| Item 3.  Controls and Procedures                                                                |
|                                                                                                 |
| Part 2.  Other Information                                                                      |
|                                                                                                 |
| Item 6. Exhibits  and Reports on Form 8-K                                                            |
|                                                                                                 |
| Signatures                                                                                           |
|                                                                                                 |
| Certifications                                                                                       |
|                                                                                                 |
| Exhibits                                                                                             |

 

2

----

 

**PART 1. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

** **

**HERITAGE OAKS BANCORP**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                                               |   | **31-Dec-02** |        | **31-Mar-03**   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|-------------|-----------------|--------|
|                                                                                                                                                               |   |          |        | **(Unaudited)** |   |
| ASSETS                                                                                                                                                             |   |          |        |            |   |
| Cash and due from banks                                                                                                                                            |   | $             | 23,513,631  |            | $      | 21,108,712 |   |
| Federal funds sold                                                                                                                                                 |   | 37,040,000    |        | 27,340,000      |   |
|                                                                                                                                                               |   |          |        |            |   |
| Total cash and cash equivalents                                                                                                                                    |   | 60,553,631    |        | 48,448,712      |   |
|                                                                                                                                                               |   |          |        |            |   |
| Interest bearing deposits other banks                                                                                                                              |   | 497,000       |        | 497,000         |   |
|                                                                                                                                                               |   |          |        |            |   |
| Securities Available for sale                                                                                                                                      |   | 65,396,494    |        | 59,153,321      |   |
| Federal Home Loan Bank Stock, at cost                                                                                                                              |   | 1,950,900     |        | 1,950,900       |   |
| Loans Held For Sale                                                                                                                                                |   | 8,166,011     |        | 4,978,634       |   |
| Loans, net                                                                                                                                                         |   | 187,311,368   |        | 205,156,584     |   |
|                                                                                                                                                               |   |          |        |            |   |
| Property, premises and equipment, net                                                                                                                              |   | 4,542,591     |        | 4,577,256       |   |
| Cash surrender value life insurance                                                                                                                                |   | 5,415,500     |        | 5,477,143       |   |
| Deferred Tax Assets                                                                                                                                                |   | 1,170,783     |        | 1,253,587       |   |
| Core Deposit Intangible                                                                                                                                            |   | 358,557       |        | 348,410         |   |
| Other assets                                                                                                                                                       |   | 1,900,477     |        | 1,848,271       |   |
|                                                                                                                                                               |   |          |        |            |   |
| TOTAL ASSETS                                                                                                                                                       |   | $             | 337,263,312 |            | $      | 333,689,818 |   |
|                                                                                                                                                               |   |          |        |            |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                          |   |          |        |            |   |
| LIABILITIES                                                                                                                                                        |   |          |        |            |   |
| Deposits:                                                                                                                                                          |   |          |        |            |   |
| Demand, non-interest bearing                                                                                                                                       |   | $             | 106,556,079 |            | $      | 113,085,329 |   |
| Savings, NOW, and money market deposits                                                                                                                            |   | 112,567,856   |        | 109,766,187     |   |
| Time deposits of $100,000 or more                                                                                                                                  |   | 8,154,256     |        | 8,581,411       |   |
| Time deposits under $100,000                                                                                                                                       |   | 36,900,414    |        | 37,693,132      |   |
| Total deposits                                                                                                                                                     |   | 264,178,605   |        | 269,126,059     |   |
|                                                                                                                                                               |   |          |        |            |   |
| Other borrowed money                                                                                                                                               |   | 38,000,000    |        | 28,500,000      |   |
| Securities Sold under Agreement to Repurchase                                                                                                                      |   | 257,737       |        | 118,147         |   |
| Company Obligated Preferred Securities of Subsidiary Trust Holding  Floating Rate Junior Subordinated Deferred Interest Debentures                                 |   | 8,000,000     |        | 8,000,000       |   |
| Other liabilities                                                                                                                                                  |   | 7,013,500     |        | 7,384,791       |   |
| Total liabilities                                                                                                                                                  |   | 317,449,842   |        | 313,128,997     |   |
|                                                                                                                                                               |   |          |        |            |   |
| Stockholders’ equity                                                                                                                                          |   |          |        |            |   |
| Common stock, no par value; 20,000,000 shares authorized; issued and  outstanding 2,924,810 and 2,935,081 for December 31, 2002 and March 31, 2003,  respectively. |   | 9,703,022     |        | 11,358,064      |   |
| Accumulated other comprehensive income                                                                                                                             |   | 562,359       |        | 438,153         |   |
| Retained earnings                                                                                                                                                  |   | 9,548,089     |        | 8,764,604       |   |
| Total stockholders’ equity                                                                                                                                    |   | 19,813,470    |        | 20,560,821      |   |
|                                                                                                                                                               |   |          |        |            |   |
| TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY                                                                                                                  |   | $             | 337,263,312 |            | $      | 333,689,818 |   |

 

----

(1)  These numbers have beenderived from the audited financial statements.

 

See notes to condensed financial statements

 

3

----

 

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF INCOME**

**For the three months ended March 31,**

 
|                                                      |          | **2002**        |      | **2003**        |   |
|-----------------------------------------------------------|---------------|-----------------|-----------|-----------------|--------|
|                                                      |          | **(Unaudited)** |      | **(Unaudited)** |   |
| Interest Income:                                          |          |            |      |            |   |
|                                                      |          |            |      |            |   |
| Interest and fees on loans                                |          | $               | 3,108,349 |            | $      | 3,674,863 |   |
| Investment securities                                     |          | 270,624         |      | 536,514         |   |
| Federal funds sold and commercial paper                   |          | 38,360          |      | 66,934          |   |
| Time certificates of deposit                              |          | 790             |      | 3,100           |   |
| Total interest income                                     |          | 3,418,123       |      | 4,281,411       |   |
|                                                      |          |            |      |            |   |
| Interest Expense:                                         |          |            |      |            |   |
|                                                      |          |            |      |            |   |
| Now accounts                                              |          | 59,666          |      | 36,718          |   |
| MMDA accounts                                             |          | 29,392          |      | 144,821         |   |
| Savings accounts                                          |          | 11,237          |      | 11,299          |   |
| Time deposits of $100,000 or more                         |          | 40,256          |      | 41,949          |   |
| Other time deposits                                       |          | 314,233         |      | 237,818         |   |
| Other borrowed funds                                      |          | 53,417          |      | 464,327         |   |
| Total interest expense                                    |          | 508,201         |      | 936,932         |   |
|                                                      |          |            |      |            |   |
| Net Interest Income Before Prov. for Possible Loan Losses |          | 2,909,922       |      | 3,344,479       |   |
| Provision for loan losses                                 |          | 135,000         |      | 125,000         |   |
| Net interest income after provision for loan losses       |          | 2,774,922       |      | 3,219,479       |   |
|                                                      |          |            |      |            |   |
| Non-interest Income:                                      |          |            |      |            |   |
| Service charges on deposit accounts                       |          | 316,213         |      | 390,473         |   |
| Investment securities gains (losses), net                 |          | 0               |      | 51,773          |   |
| Other income                                              |          | 465,903         |      | 459,034         |   |
| Total Non-interest Income                                 |          | 782,116         |      | 901,280         |   |
|                                                      |          |            |      |            |   |
| Non-interest  Expense:                               |          |            |      |            |   |
| Salaries and employee benefits                            |          | 1,257,061       |      | 1,503,300       |   |
| Occupancy and equipment                                   |          | 439,650         |      | 389,503         |   |
| Other expenses                                            |          | 981,685         |      | 975,920         |   |
| Total Noninterest Expenses                                |          | 2,678,396       |      | 2,868,723       |   |
| Income before provision for income taxes                  |          | 878,642         |      | 1,252,036       |   |
| Provision for applicable income taxes                     |          | 310,422         |      | 427,467         |   |
| Net Income                                                |          | $               | 568,220   |            | $      | 824,569 |   |
|                                                      |          |            |      |            |   |
| Earnings per share:                                       | (See note #4) |            |      |            |   |   |
| Basic                                                     |          | $               | 0.20      |            | $      | 0.28 |   |
| Fully Diluted                                             |          | $               | 0.18      |            | $      | 0.26 |   |
|                                                           |               |                 |           |                 |        |  |  |  |

 

See notes to consolidated financial statements

 

4

----

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Periods ended March 31,**

 
|                                                                                                |   | **2002**        |       | **2003**        |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------------|------------|-----------------|--------|
|                                                                                                |   | **(Unaudited)** |       | **(Unaudited)** |   |
| **Cash Flows from Operating Activities**                                                            |   |            |       |            |   |
| Net income                                                                                          |   | $               | 568,220    |            | $      | 824,569 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities                   |   |            |       |            |   |
| Net cash provided by operating activities                                                           |   |            |       |            |   |
| Depreciation and amortization                                                                       |   | 168,461         |       | 157,889         |   |
| Provision for possible loan losses                                                                  |   | 135,000         |       | 125,000         |   |
| Provision for possible unfunded loan losses                                                         |   | 0               |       | 25,000          |   |
| Realized (gain) loss on sales of available-for-sale securities, net                                 |   | 0               |       | (51,773         | )      |
| (Gain) on sales of property, premise and equipment                                                  |   | (17,120         | )          | 0               |   |
| Amortization of premiums/discounts on investment securities, net                                    |   | (41,324         | )          | 150,317         |   |
| (Increase)/decrease in loans held for sale                                                          |   | 2,039,700       |       | 3,187,377       |   |
| (Increase)/decrease in deferred tax asset                                                           |   | (46,539         | )          | 0               |   |
| Net increase in cash surrender value of life insurance                                              |   | 0               |       | (61,643         | )      |
| (Increase)/decrease in other assets                                                                 |   | (172,742        | )          | 62,353          |   |
| Increase/(decrease) in other liabilities                                                            |   | 239,991         |       | 346,291         |   |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                                                       |   | 2,873,647       |       | 4,765,380       |   |
| **Cash Flows From Investing Activities**                                                            |   |            |       |            |   |
| Purchase of securities available-for-sale                                                           |   | 0               |       | (5,248,438      | )      |
| Purchase of mortgage-backed securities available-for-sale                                           |   | 0               |       | (4,995,313      | )      |
| Proceeds from sales of securities available-for-sale                                                |   | 0               |       | 0               |   |
| Proceeds from principal reductions and maturities of securities  available-for-sale                 |   | 1,372,887       |       | 162,670         |   |
| Proceeds from sales of mortgage-backed securities available-for-sale                                |   | 0               |       | 7,400,144       |   |
| Proceeds from principal reductions and maturities of mortgage-backed  securities available-for-sale |   | 0               |       | 8,618,555       |   |
| Purchase of life insurance policies                                                                 |   | 0               |       | 0               |   |
| Recoveries on loans previously written off                                                          |   | 0               |       | 572             |   |
| Increase in loans, net                                                                              |   | (3,113,942      | )          | (17,970,788     | )      |
| Purchase of property, premises and equipment, net                                                   |   | (107,775        | )          | (192,553        | )      |
| **NET CASH USED IN INVESTING ACTIVITIES**                                                           |   | (1,848,830      | )          | (12,225,151     | )      |
| **Cash Flows From Financing Activities**                                                            |   |            |       |            |   |
| Increase in deposits, net                                                                           |   | $               | 13,492,365 |            | $      | 4,947,454 |   |
| Net increase/(decrease) in other borrowings                                                         |   | 6,897,909       |       | (9,639,590      | )      |
| Net (decrease)/increase in notes payable                                                            |   | 0               |       | 0               |   |
| Proceeds from exercise of stock options                                                             |   | 0               |       | 50,240          |   |
| Cash paid in lieu of fractional shares                                                              |   | (6,405          | )          | (3,252          | )      |
| Cash dividends paid or declared                                                                     |   |            |       |            |   |
| **NET CASH PROVIDED BY FINANCING ACTIVITIES**                                                       |   | 20,383,869      |       | (4,645,148      | )      |
| **Net (Decrease)/Increase In Cash and Cash Equivalents**                                            |   | 21,408,686      |       | (12,104,919     | )      |
| **Cash and Cash Equivalents**, Beginning of year                                                    |   | 20,398,048      |       | 60,553,631      |   |
| **Cash and Cash Equivalents**, End of year                                                          |   | $               | 41,806,734 |            | $      | 48,448,712 |   |

 

See notes to condensed financial statements

 

5

----

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**March 31, 2002 and March 31, 2003**

**(Unaudited)**

 
|                                                              |   | **Shares  Outstanding** |       | **Common  Stock** |          | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Income** |       | **Total  Stockholders’  Equity** |         |
|-------------------------------------------------------------------|--------|-------------------------|------------|-------------------|---------------|------------------------|--------|-----------------------------------------------|------------|---------------------------------------|--------------|
|                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |         |
| **Balance January 1, 2002**                                       |   | 1,297,880               |       | $                 | 7,535,495     |                   | $      | 8,496,122                                     |       | $                                     | (154,836     | ) | $ | 15,876,781 |   |
|                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |         |
| Exercise of Stock Options                                         |   | 0                       |       | 0                 |          | 0                      |   |                                          |       | 0                                     |         |
|                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |         |
| 5% Stock Dividend to be distributed March 29, 2002                |   | 64,648                  |       | 1,680,848         |          | (1,680,848             | )      |                                          |       | 0                                     |         |
| Cash Paid in lieu of Fractional Shares                            |   |                    |       |              |          | (6,405                 | )      |                                          |       | (6,405                                | )            |
|                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |         |
| Comprehensive Income                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |         |
| Net Income                                                        |   |                    |       |              |          | 568,220                |   |                                          |       | 568,220                               |         |
| Unrealized Security Holding Loss (Net of $46,938 tax)             |   |                    |       |              |          |                   |   | (68,386                                       | )          | (68,386                               | )            |
| Less reclasification   adjustment for loss (net of $766 tax) |   |                    |       |              |          |                   |   | (1,422                                        | )          | (1,422                                | )            |
| Total Other Comprehensive Income                                  |   |                    |       |              |          |                   |   |                                          |       | (69,808                               | )            |
| Total comprehensive Income                                        |   |                    |       |              |          |                   |   |                                          |       | 498,412                               |         |
|                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |         |
| **Balance March 31, 2002**                                        |   | **1,362,528**           | ** ** | **$**             | **9,216,343** | ** **             | **$**  | **7,377,089**                                 | ** ** | **$**                                 | **(224,644** | **)** | **$** | **16,368,788** | ** ** |

 
|                                                                               |   | **Shares  Outstanding** |       | **Common  Stock** |           | **Retained  Earnings** |       | **Accumulated  Other  Comprehensive  Income** |       | **Total  Stockholders’  Equity** |        |
|------------------------------------------------------------------------------------|--------|-------------------------|------------|-------------------|----------------|------------------------|------------|-----------------------------------------------|------------|---------------------------------------|-------------|
|                                                                               |   |                    | ** ** |              | ** **     |                   | ** ** |                                          | ** ** |                                  | ** **  |
| **Balance January 1, 2003**                                                        |   | 2,785,533               |       | $                 | 9,703,022      |                   | $          | 9,548,089                                     |       | $                                     | 562,359     |   | $ | 19,813,470 |   |
|                                                                               |   |                    |       |              |           |                   |       |                                          |       |                                  |        |
| Exercise of Stock Options                                                          |   | 10,000                  |       | 50,240            |           | 0                      |       |                                          |       | 50,240                                |        |
|                                                                               |   |                    |       |              |           |                   |       |                                          |       |                                  |        |
| Stock dividend - 5%                                                                |   | 139,548                 |       | 1,604,802         |           | (1,604,802             | )          |                                          |       | 0                                     |        |
| Cash paid to Shareholders’ in Lieu of fractional shares on 5% Stock  Dividend |   |                    |       |              |           | (3,252                 | )          |                                          |       | (3,252                                | )           |
|                                                                               |   |                    |       |              |           |                   |       |                                          |       |                                  |        |
| Comprehensive Income                                                               |   |                    |       |              |           |                   |       |                                          |       |                                  |        |
| Net Income                                                                         |   |                    |       |              |           | 824,569                |       |                                          |       | 824,569                               |        |
| Unrealized Security Holding Gains/(Losses) ‘(net of $103,513 tax)             |   |                    |       |              |           |                   |       | (155,270                                      | )          | (155,270                              | )           |
| Less reclasification   adjustment for gain (net of $20,709 tax)               |   |                    |       |              |           |                   |       | 31,064                                        |       | 31,064                                |        |
|                                                                               |   |                    |       |              |           |                   |       |                                          |       |                                  |        |
| Total other comprehensive Income                                                   |   |                    |       |              |           |                   |       |                                          |       | 669,299                               |        |
|                                                                               |   |                    |       |              |           |                   |       |                                          |       |                                  |        |
| **Balance March 31, 2003**                                                         |   | **2,935,081**           | ** ** | **$**             | **11,358,064** | ** **             | **$**      | **8,764,604**                                 | ** ** | **$**                                 | **438,153** | ** ** | **$** | **20,560,821** | ** ** |

 

6

----

 

 

**Note 1.****         ****CONSOLIDATEDFINANCIAL STATEMENTS**

 

In the opinion ofManagement, the un-audited consolidated condensed financial statements containall (consisting of only normal recurring adjustments) adjustments necessary topresent fairly Heritage Oaks Bancorp’s (the “Company”) consolidated financialposition at March 31, 2003 and results of cash flows for the three months endedMarch 31, 2002 and 2003 and the results of operation for the three months endedMarch 31, 2002 and 2003.

 

Certaininformation and footnote disclosures normally presented in financial statementsprepared in accordance with generally accepted accounting principles have beenomitted. These interim consolidated condensed financial statements should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s 2002 Annual Report to shareholders. Theresults for the three months ended March 31, 2002 and 2003 may not necessarilybe indicative of the operating results for the full year.

 

**Note 2.****          INVESTMENT SECURITIES**

 

In accordance withSFAS No. 115 “Accounting for Certain Investments in Debt and EquitySecurities”, which addresses the accounting for investments in equitysecurities that have a readily determinable fair values and for investments inall debt securities, securities are classified in three categories andaccounted for as follows: debit and equity securities that the Company has thepositive intent and ability to hold to maturity are classified asheld-to-maturity and are measured at amortized cost; debt and equity securitiesbought and held principally for the purpose of selling in the near term areclassified as trading securities and are measured at fair value, with theunrealized gains and losses included in earnings; debt and equity securitiesnot classified as either held-to-maturity or trading securities are deemed asavailable-for-sale and are measured at fair value, with the unrealized gainsand losses, net of applicable taxes, reported in a separate component ofstockholders’ equity. Any gains and losses on sales of investments are computedon a specific identification basis.

 

The amortized cost and fair values of investment securities availablefor sale at March 31, 2003 and December 31, 2002:

 
| **March 31, 2003**                                       |   | **Amortized  Cost** |           | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** |        |
|----------------------------------------------------------|--------|---------------------|----------------|------------------------------|--------|-------------------------------|------------|-----------------|-------------|
|                                                     |   |                |           |                         |   |                          |       |            |        |
| Obligations of U.S. government agencies and corporations |   | $                   | 598,137        |                         | $      | 0                             |       | $               | (17,293     | ) | $ | 580,844 |   |
| Mortgage-backed securities                               |   | 48,632,207          |           | 556,666                      |   | (7,674                        | )          | 49,181,199      |        |
| Obligations of State and Political Subdivisions          |   | 9,184,084           |           | 256,666                      |   | (58,110                       | )          | 9,382,640       |        |
| Other Securities                                         |   | 8,638               |           | 0                            |   | 0                             |       | 8,638           |        |
| **TOTAL**                                                |   | **$**               | **58,423,066** | ** **                   | **$**  | **813,332**                   | ** ** | **$**           | **(83,077** | **)** | **$** | **59,153,321** | ** ** |

 
| **December 31, 2002**                                    |   | **Amortized  Cost** |           | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** | ** **  |
|----------------------------------------------------------|--------|---------------------|----------------|------------------------------|--------|-------------------------------|------------|-----------------|-------------|
|                                                     |   |                |           |                         |   |                          |       |            |        |
| Obligations of U.S. government agencies and corporations |   | $                   | 816,521        |                         | $      | 562                           |       | $               | (18,469     | ) | $ | 798,614 |   |
| Mortgage-backed securities                               |   | 54,480,395          |           | 777,972                      |   | (4,342                        | )          | 55,254,025      |        |
| Obligations of State and Political Subdivisions          |   | 9,153,674           |           | 247,715                      |   | (66,172                       | )          | 9,335,217       |        |
| Other Securities                                         |   | 8,638               |           | 0                            |   | 0                             |       | 8,638           |        |
| **TOTAL**                                                |   | **$**               | **64,459,228** | ** **                   | **$**  | **1,026,249**                 | ** ** | **$**           | **(88,983** | **)** | **$** | **65,396,494** | ** ** |

 

7

----

 

**Note 3.****          LOANS AND ALLOWANCE FORLOAN LOSSES**

 

Major classifications of loans were:
|                                    |   | **December 31,  2002** |        | **March 31  2003** |   |
|-----------------------------------------|--------|------------------------|-------------|--------------------|--------|
|                                    |   |                   |        |               |   |
| Commercial, financial, and agricultural |   | $                      | 40,373,350  |               | $      | 39,838,291 |   |
| Real estate-construction                |   | 40,722,838             |        | 49,141,253         |   |
| Real estate-mortgage                    |   | 106,809,586            |        | 116,969,060        |   |
| Installment loans to individuals        |   | 2,290,874              |        | 2,172,296          |   |
| All other loans (including overdrafts)  |   | 272,607                |        | 281,265            |   |
|                                    |   | 190,469,255            |        | 208,402,165        |   |
|                                    |   |                   |        |               |   |
| Less - deferred loan fees               |   | (821,668               | )           | (783,790           | )      |
| Less - allowance for loan losses        |   | (2,336,219             | )           | (2,461,791         | )      |
|                                    |   |                   |        |               |   |
| Total loans                             |   | $                      | 187,311,368 |               | $      | 205,156,584 |   |
|                                    |   |                   |        |               |   |
| Loans Held For Sale                     |   | $                      | 8,166,011   |               | $      | 4,978,634 |   |

 

Concentration of Credit Risk

 

At March 31, 2003,approximately $166.1 million of the Bank’s loan portfolio was collateralized byvarious forms of real estate. Such loans are generally made to borrowerslocated in San Luis Obispo and Santa Barbara Counties. The Bank attempts toreduce its concentration of credit risk by making loans which are diversifiedby project type. While Management believes that the collateral presentlysecuring this portfolio is adequate, there can be no assurances thatsignificant deterioration in the California real estate market would not exposethe Bank to significantly greater credit risk.

 

At March 31, 2003, the Bank was contingently liable for letters ofcredit accommodations made to its customer totaling approximately $1.4 millionand un-disbursed loan commitments in the approximate amount of $70.0 million.The Bank makes commitments to extend credit in the normal course of business tomeet the financing needs of its customers. Commitments to extend credit areagreement to lend to a customer as long as there is no violation of anycondition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses and may require payment of a fee.Since many of the commitments are expected to expire without being drawn upon,the total outstanding commitment amount does not necessarily represent futurecash requirements. Standby letters of credit written are conditionalcommitments issued by the Bank to guarantee the performance of a customer to athird party. The credit risk involved in issuing letters of credit isessentially the same as that involve in extending loan facilities to customers.The Bank anticipates no losses as a result of such transactions.

 

Allowance for Loan Losses

 

An allowance forloan losses has been established by management to provide for those loans thatmay not be repaid in their entirety for a variety of reasons. The allowance ismaintained at a level considered by management to be adequate to provide forprobable incurred losses. The allowance is increased by provisions charged toearnings and is reduced by charge-offs, net of recoveries. The provision forloan losses is based upon past loan loss experience and management’s evaluationof the loan portfolio under current economic conditions. Loans are charged tothe allowance for loan losses when, and to the extent, they are deemed bymanagement to be un-collectible. The allowance for loan losses is composed ofallocations for specific loans and a historical portion for all other loans.

 

8

----

 

Ananalysis of the changes in the allowance for loan losses is as follows:

 
|                                       |   | **December 31,  2002** |      | **March 31  2003** |   |
|--------------------------------------------|--------|------------------------|-----------|--------------------|--------|
|                                       |   |                   |      |               |   |
| Balance at beginning of year               |   | $                      | 1,744,070 |               | $      | 2,336,219 |   |
| Additions charged to operating expense     |   | 545,000                |      | 125,000            |   |
| Loans charged off                          |   | (81,405                | )         | 0                  |   |
| Recoveries of loans previously charged off |   | 128,554                |      | 572                |   |
| Balance at end of period                   |   | $                      | 2,336,219 |               | $      | 2,461,791 |   |

 

The Bank recognizes that credit losses will be experienced and the riskof loss will vary with, among other things, general economic conditions; thetype of loan being made; the creditworthiness of the borrower over the term ofthe loan and in the case of a collateralized loan, the quality of thecollateral for such loan. The allowance for loan loss represents the Bank’sestimate of the allowance necessary to provide for probable incurred losses inthe portfolio. In making this determination, the Bank analyzes the ultimatecollectibility of the loans in its portfolio by incorporating feedback providedby internal loan staff, an independent loan review function, and informationprovided by examinations performed by regulatory agencies. The Bank makesmonthly evaluations as to the adequacy of the allowance for loan losses.

 

The analysis of the allowance for loan losses is comprised of threecomponents; specific credit allocation; general portfolio allocation; andsubjectively by determined allocation. Effective January 1, 1995, the Bankadopted Statement of Financial Accounting Standards No.114, Accounting byCreditors for Impairment of a Loan (SFAS 114), as amended by SFAS No. 118,Accounting by Creditors for Impairment of a Loan - Income Recognition andDisclosures. These pronouncements provide that when it is probable that acreditor will be unable to collect all amounts due in accordance with the termsof the loan that such loan is deemed impaired. Impaired loans are accounted fordifferently in that the amount of the impairment is measured and reflected inthe records of the creditor. Theallowance for credit losses related to loans that are identified for evaluationin accordance with Statement 114 is based on discounted cash flows using theloan’s initial effect interest rate or the fair value of the collateral forcertain collateral dependent loans. The general portfolio allocation consistsof an assigned reserve percentage based on the credit rating of the loan. The subjectiveportion is determined based on loan history and the Bank’s evaluation ofvarious factors including current economic conditions and trends in theportfolio including delinquencies and impairment, as well as changes in thecomposition of the portfolio.

 

The allowance forloan losses is based on estimate, and ultimate losses will vary from currentestimates. These estimates are reviewed monthly, and as adjustments, eitherpositive or negative, become necessary, a corresponding increase or decrease ismade in the provision for loan losses. The methodology used to determine theadequacy of the allowance for possible loan losses for the first quarter of2003 is consistent with prior periods.

 

The Bank’sprovision for loan losses was $125,000 for the first quarter of 2003, comparedto $135,000 for the same period in 2002. However, the Bank also has reserved$25,000 in 2003 as a provision for possible loan loss in conjunction with offbalance sheet loan commitments.

 

The allowance forloan losses as a percentage of total net loans was 1.20% as of March 31, 2003and 1.23% as of December 31, 2002. Management believes that the allowance forcredit losses at March 31, 2003 is prudent and warranted, based on informationcurrently available.

 

Non-Accrual and Non-Performing Loans

 

Loan onnon-accrual status totaled $1,345,755 and $1,024,101 at December 31, 2002 andMarch 31,

 

9

----

 

2003, respectively. Typically, these loans have adequate collateralprotection and/or personal guaranties to provide a source of repayment to theBank. Most of the loans on non-accrual are related to several commercial loansthat are being addressed by specific workout plans at this time. Interestincome that would have been recognized on non-accrual loans if they hadperformed in accordance with the terms of the loans was approximately $134,508and $31,708 for the period ended December 31, 2002 and March 31, 2003,respectively.

 

Non-performingloans include non-accrual loans and accruing loans that are 90 days or moredelinquent. The Bank had no loans that were 90 days or more delinquent andstill accruing interest at December 31, 2002, however, there was $4,341 atMarch 31, 2003.

 

Non-performingloans were .40% and .50% of total assets as of December 31, 2001 and March 31,2003, respectively. The allowance for loan loss to non-performing loans was1.74x and 2.39x at December 31, 2002 and March 31, 2003, respectively.

 

**Note 4.****          EARNINGS PER SHARE**

 

Basic earnings pershare are based on the weighted average number of shares outstanding before anydilution from common stock equivalents. 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 shares in the earnings of the entity.

 

On July 19, 2002,the Company announced that the Board of Directors of the Company approved atwo-for-one stock split. The record date for the stock split was August 2, 2002and the pay date was August 15, 2002. Holders of shares of common stock ofHeritage Oaks Bancorp were issued one additional share of common stock for eachshare of common stock owned on the record date of August 2, 2002.

 

On March 4, 2003,the Company announced that the Board of Directors of the Company approved a 5%stock dividend. The record date for the stock dividend was March 14, 2003 andthe pay date was March 28, 2003.

 

Share informationhas been retroactively adjusted for the two-for-one stock split in August 2002and the 5% stock dividend in March 2003.

 

Earnings per shareand total number of shares used for calculating basic earnings per share forthe three months ended March 31, 2002 and 2003, were $.20 and $.28 and2,861,309 and 2,925,948, respectively. Earnings per share and total number ofshares used for calculating diluted earnings per share for the three monthsended March 31, 2002 and 2003, were $.18 and $.26 and 3,147,286 and 3,115,788,respectively.

 

The following table illustrates the effecton net income and earnings per share if the Company had applied the fair valuerecognition provision of SFAS 123, Accounting for Stock Based Compensation, tostock based employee compensation:

 
|                                                       |   | **3/31/2003** |    | **3/31/2002** |   |
|------------------------------------------------------------|--------|---------------|---------|---------------|--------|
| Net income:                                                |   |          |    |          |   |
| As reported                                                |   | $             | 824,569 |          | $      | 568,220 |   |
| Stock-based  compensation using the intrinsic value method |   | —        |    | —        |   |
| Stock-based  compensation that would have been reported    |   | —        |    | —        |   |
| using the fair  value method of SFAS 123                   |   | (34,841       | )       | (35,481       | )      |
| Pro forma net  income                                      |   | $             | 789,728 |          | $      | 532,739 |   |
|                                                       |   |          |    |          |   |
| Basic Earnings per share                                   |   |          |    |          |   |
| As reported                                                |   | $             | 0.28    |          | $      | 0.20 |   |
| Pro forma                                                  |   | $             | 0.27    |          | $      | 0.19 |   |
|                                                       |   |          |    |          |   |
| Earnings per share - assuming dilution                     |   |          |    |          |   |
| As reported                                                |   | $             | 0.26    |          | $      | 0.18 |   |
| Pro forma                                                  |   | $             | 0.25    |          | $      | 0.17 |   |

 

10

----

 

**Note 5.****          PREMISE**

 

On July 26, 2002,the Bank purchased a parcel of land (approximately 2 acres) on the corner ofNiblick and South River Roads in Paso Robles, Ca. The purchase price was$900,000. It is the intent of the Bank to build a full service branch on thisparcel and to relocate the existing “Woodland” office, that is currentlylocated at 171 Niblick Road, Paso Robles, Ca. At this time, the Bankanticipates that the building will be approximately 5,000 square feet in sizeand will open sometime in the fourth quarter of 2003 or first quarter of 2004.

 

**Note 6.****          ISSUANCE OF TRUSTPREFERRED SECURITIES**

 

On April 10, 2002, the Company completed its offering of trustpreferred securities in the amount of $8.0 million. The securities were issuedby a special purpose business trust formed by the Company and were sold to apooled investment vehicle sponsored by Sandler O’Neill & Partners, L.P. andSalomon Smith Barney Inc. in a private transaction. The securities were soldpursuant to an applicable exemption from registration under the Securities Actof 1933, as amended (the “Act”), and have not been registered under theAct.  Sandler O’Neill assisted theCompany in the placement of the trust preferred securities. The securities maynot be offered or sold in the United States absent registration or anapplicable exemption from registration requirements.

 

The $8.0 million in trust preferred securities have a floating rate ofinterest, which is reset semi-annually, equal to 6-month LIBOR plus 3.70%.  The floating rate, however, may not exceed11.0% for the first five years. The $8.0 million accounts for approximately 4%of the increase in total assets.

 

As the result of the issuance of $8.0 million in trust preferred securities,on April 11, 2002, the Company down-streamed $5.2 million to the Bank in theform of Tier I Capital. This enabled the Bank to implement an investmentstrategy whereby the Bank borrowed $38 million from the Federal Home Loan Bank(FHLB) and purchased approximately $40 million in investment securities. Thepurchased investment securities serve as collateral for the borrowing. OnFebruary 22, 2003, the Bank repaid $9.5 million of the borrowing.

 

**Note7.****          RECENTLEGISLATIVE ACTIVITY SARBANES-OXLEY ACT OF 2002**

 

On July 30, 2002, President Bush signed intolaw the Sarbanes-Oxley Act of 2002 (the “Act”).

 

On August 28, 2002, in accordance with Section 302 of the Act, theSecurities and Exchange Commission (the “SEC”) adopted final rules that requirean issuer’s principal executive and principal financial officer to certify thecontents, including the financial and other information, of the issuer’squarterly and annual reports. The rules became effective on August 29, 2002. Inaddition, the SEC adopted previously proposed rules requiring issuers tomaintain, and regularly evaluate the effectiveness of control and proceduresdesigned to ensure that the information required in reports 

 

11

----

 

filed under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported on a timely basis.

 

A separate provision of the Act (section906) creates an independent CEO and CFO certification obligation that tookeffect immediately upon signing the Act into law and impacted periodicreporting beginning with the June 30, 2002 10-QSB. The certification in section906 provides for a statement that any periodic report containing financialstatements fully complies with Section 13(a) or 15 (d) of the Exchange Act and thatthe information contained in the periodic report fairly presents, in allmaterial respects, the financial condition and results of operation of thepublic company.

 

The SEC has also adopted new Exchange ActRules 13a-14 and 15d-14 that require an issuer to establish and maintain anoverall system of disclosure controls and procedures that are adequate to meetits Exchange Act reporting obligations.

 

**Note 8.****         ****Recent Accounting Pronouncements**

 

At its August 7,2002 Board meeting, the FASB approved, in principle, Statement 147 which willreplace certain paragraphs in Statement 72, “Accounting for CertainAcquisitions of Banking or Thrift Institutions”. The new guidance was effectiveon September 30, 2002. The requirement in Statement 72 to recognize (and amortize)an “unidentifiable intangible asset” when more liabilities are acquired thanassets, such as in a branch purchase that is a business combination, will nolonger apply. Previously recorded core deposit intangibles must continue to beamortized.

 

The Bank acquiredfour branch offices from Westamerica Bank in November 2001. The premium,net  of fair value for certain assetsacquired, was fully accounted for as core deposit intangibles. This coredeposit intangible has and will continue to be amortized over a period of tenyears.

 

12

----

 

**Certain statements contained in this Quarterly Report on Form10-QSB (“Quarterly Report”), including, without limitation, statementscontaining the words “believes”, “anticipates”, “intends”, “expects”, and wordsof similar impact, constitute “forward-looking statements” within the meaningof Section 27A of the Securities Act of 1933 and Section 21E of the Securitiesand Exchange Act of 1934. Such forward-looking statements involve known andunknown risks, uncertainties and other factors that may cause the actualresults, performance or achievements of the Company to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements. Such factors include, among others, thefollowing: general economic and business conditions in those areas in which theCompany operates, demographic changes, competition, fluctuations in interestrates, changes in business strategy or development plans, changes ingovernmental regulation, credit quality, the availability of capital to fundthe expansion of the Company’s business, economic, political and global changesarising from the terrorist attacks of September 11, 2001 and their aftermath****and other factors referenced in the Company’s filingswith the SEC. (Refer to the Company’s December 31, 2002 10-KSB, ITEM 1.Description of Business.) The Company disclaims any obligation to update anysuch factors or to publicly announce the results of any revisions to any of theforward-looking statements contained herein to reflect future events ordevelopments.**

 

**ITEM 2.****    ****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Heritage OaksBancorp (the “Company”) commenced operations on November 15, 1994 with theacquisition of Heritage Oaks Bank (the “Bank”).  Each shareholder of the Bank received one share of stock in theCompany in exchange for each share of Heritage Oaks Bank stock owned.  The Bank became a wholly owned subsidiary ofthe Company.  The Bank is the onlyactive financial subsidiary owned by the Company. In April 2002, the Companyformed Heritage Oaks Capital Trust I (the “Trust”). The Trust is a statutory businesstrust formed under the laws of the State Of Delaware and is wholly-owned by theCompany.

 

**RECENT EVENTS**

 

On February 12, 2003, the Bank and HBECorporation entered into a Construction Agreement for the branch officebuilding that will be located on thecorner of Niblick and South River Roads in Paso Robles, Ca.  It is the intent of the Bank to build a fullservice branch on this parcel and to relocate the existing “Woodland” office,that is currently located at 171 Niblick Road, Paso Robles, Ca.  At this time, the Bank anticipates that thebuilding will be approximately 5,000 square feet in size and will open sometimein the fourth quarter of 2003 or first quarter of 2004.

 

On April 3, 2003, the Bank entered into a“Purchase and Sale Agreement and Joint Escrow Instructions”  to purchase real property located at 500 13thStreet, Paso Robles, Ca. This property is located directly adjacent to theBank’s Headquarters. The proposed purchase price is $1.1 million. The Bank has60 days to perform due diligence that will include an expression of authorizationfrom the City of Paso Robles as to the Bank’s desired use of the property. Itis the Bank’s intention to remodel and expand the existing building located onthe site to allow for the consolidation of all Administrative functions of theBank within the new facility.

 

**FINANCIAL CONDITION**

 

As of March 31,2003, total consolidated assets of Heritage Oaks Bancorp were $333.7 millioncompared to $337.3 million at December 31, 2002. This represents a decrease of1.1%. The components of this decrease are discussed below.

 

Cash and Due From Banks

 

Total cash and due from banks at March 31,2003 was $21.1 million, down from $25.3 million at

 

13

----

 

December 31, 2002. This line item will varydepending on cash letters from the previous night and actual cash on hand inthe branches. The balance in the Fed account had a closing balance of $9.6million to meet the target for Reserve Requirements.

 

Loans

 

Total net loans at March 31, 2003 were$205.2 million compared to $187.3 million at December 31, 2002. This representsan increase of 9.5%. For the three months ending March 31, 2003, commercial,financial and agriculture loans decreased by $.5 million or 1.3%, real estate-construction loans increased by$8.4 million or 20.7%, real estate-mortgage loans increased by $10.2 million or9.5% and installment loans to individuals decreased by $.1 million or 5.2%.

 

Low net growth inagricultural loans is attributed to the refinance of several development loansthrough the Farmer Mac program. This program is a long-term mortgage productthat offers low interest rates on producing agricultural real estate. Wecontinue to use this product to payoff our development loans and also tofinance homes on acreage. With the current oversupply of wine grapes, vineyarddevelopment has decreased significantly hence new development loan requestshave also diminished.  Commercial loangrowth has been impacted by the economic slowdown with most companies hesitantto request funds for plant expansion, new equipment, etc. Loan growth in thisarea has been flat.

 

The large increasein real estate-construction loans can be attributed to several largeconstruction projects financed in 2002 that are continuing to fund and to newprojects financed in 2003. They include a condominium project in the amount of$5.3 million that will payoff as units are sold; an office building in theamount of nearly $4 million, a hotel for $4 million, two medical officestotaling $3.3 million, a strip center in the amount of $2.75 million and a RVpark in the amount of $1.6 million. Many of the properties are pre-leased priorto construction startup. Upon completion of construction, the properties forwhich the Bank is willing to offer permanent financing are granted loans withmonthly principal and interest payments based on a term of not more thanfifteen years with not more than a twenty-five year amortization. These loanshave a variable rate of interest that may be fixed for the initial two to threeyears.

 

There are twocategories of loan concentration at March 31, 2003. These categories arereported monthly to the Bank’s Director Loan Committee. The two categories are1) construction and land loans and 2) motel/hotel loans. Construction and landloans total approximately $40.3 million. This represents 152.97% of the Bank’sTier 1 capital. The projects are spread throughout our market area and rangefrom single family residences to large commercial projects. The largest projectrepresents approximately 10% of the total construction and land loansoutstanding. Construction projects are inspected regularly to ensure progressis in line with funds drawn on specific loans. Motel /hotel loans totalapproximately $39.1 million and represent 146.23% of the Bank’s Tier 1 capital.These loans are also spread throughout our market area with no concentration inany one community. All motel/hotel loans are performing as agreed with zerodelinquencies. The majority of operators have indicated that occupancy ratesare between 60%-70% representing a decrease of about 3%-7%. However, daily roomrates are up. The overall effect on profits and cash flow has been minimal andhas had no impact on the customer’s ability to repay.

 

Loans held forsale were $5 million at March 31, 2003 compared to $8.2 million at December 31,2002. Typically, loans held for sale are sold within 30 days of funding.

 

Securities

 

The Companymanages its securities portfolio to provide a source of both liquidity andearnings. The Bank has an asset/liability committee that develops currentinvestment policies based upon its operating needs and market circumstance. TheBank’s investment policy is formally reviewed and approved annually by itsboard of directors. The asset/liability committee of the Bank is responsible forreporting and monitoring compliance with the investment policy. Reports areprovided to the Bank’s board of directors on a regular basis.

 

14

----

 

Securitiesavailable-for-sale are carried at fair value, with related unrealized net gainsor losses, net of deferred income taxes, recorded as an adjustment to equitycapital. As of March 31, 2003, net unrealized gains were $438,153 compared toan unrealized gain of $562,359 at December 31, 2002.

 

Securities available-for-saledecreased to $59.2 million at March 31, 2003 from $65.4 million at December 31,2002. This represents a decrease of $6.2 million or 9.6%. With the interestrate environment remaining at historic lows, prepayments on Mortgage BackedSecurities (MBS) have accelerated to nearly $8.5 million during the first threemonths of 2003. During the first quarter of 2003, the Bank sold two MBSsecurities with principal outstanding balances of approximately $7.4 million.These securities were replaced with two Collateralized Mortgage Obligation(CMO) securities in the total amount of approximately $10 million. Thesetransactions were executed as the result of an analysis on interest ratesensitivity and to better position the investment portfolio  for future interest rate movements of eitherup or down.

 

As the result of the issuance of $8.0million in trust preferred securities, in April 2002, the Company down-streamed$5.2 million to the Bank in the form of Tier I Capital. This enabled the Bankto implement an investment strategy whereby the Bank borrowed $38 million fromthe Federal Home Loan Bank (FHLB) and purchased approximately $40 million ininvestment securities. The purchased investment securities serve as collateralfor the borrowing. The Bank made this decision knowing that it would improvethe return on average equity by increasing the net interest income in absoluteterms even though it would reduce the return on average assets and the netinterest margin as a percentage. Prior to investing, the Bank performedextensive due diligence in assessing the interest rate and market value risk ofthis strategy including the performance in various interest rate scenarios ofup and down 100, 200 and 300 basis points. Management believes that the 300basis points variances would not have a material effect on the overall interestrate and market value risk to the Company.

 

At March 31, 2003, available-for-salesecurities in the portfolio included obligations of state and politicalsubdivisions, obligations of US government agencies and corporations andmortgaged backed securities issued by various agencies.

 

All fixed and adjustable rate mortgage poolscontain a certain amount of risk related to the uncertainty of prepayments ofthe underlying mortgages. Interest rate changes have a direct impact uponprepayment rates. The Bank uses computer simulation models to test the averagelife, duration, market volatility and yield volatility of adjustable ratemortgage pools under various interest rate assumptions to monitor volatility.Stress tests are performed quarterly.

 

Federal Funds Sold

 

Federal funds soldwere $27.3 million at March 31, 2003 compared to $37 million at December 31,2002. The decrease of $9.7 million is the direct result of the Bank repaying$9.5 million in borrowings to the Federal Home Loan Bank (FHLB) on February 22,2003. The primary reason for retaining these large over night investments isdue to the volatile nature of certain deposit relationships that are related tothe current robust mortgage business. These relationships are discussed in moredetail under “Deposits and Borrowed Funds”.

 

Deposits and Borrowed Funds

 

Totaldeposits were $269.1 million at March 31, 2003 compared to $264.2 million atDecember 31, 2002. This represents an increase of $4.9 million or 13.4%. The Bank believes that the decliningreturns in the stock market in general are creating a “flight to safety” toFDIC insured deposits.

 

Demand deposits of $113.1million at March 31, 2003 increased $6.5 million or 6.1% compared to $106.6million at December 31, 2002. This growth is attributed to the Bank’s presencewithin its primary market area and continued marketing efforts. Demand depositbalances held by three, long time customers of the Bank that transact inmortgage related business account for

 

15

----

 

approximately 22% of totaldeposits and 52% of Demand Deposits. The balances in these accounts remainedsubstantially the same at March 31, 2003 compared to December 31, 2002. Thesevolatile account relationships are included in the volatile liabilitydependency report that the Bank produces on a monthly basis. Management and theBoard of Directors of the Bank are keenly aware that if and when the mortgagemarket conditions change, these relationships will be negatively impacted. Thisis the primary reason for the large balances maintained in over night investingin Federal Funds Sold.

 

Savings, NOW and moneymarket deposits were $109.8 million at March 31, 2003 compared to $112.6 millionat December 31, 2002. This represents a decrease of $2.8 million or 2.6%.Savings accounts actually increased by $.8 million, while NOW and money marketaccounts decreased by $.5 million and $3.1 million, respectively. In August2002, the Bank began to offer a personal insured money market account with theintent to raise deposits that otherwise generally reside in non-financialinvestment companies. The Bank offered a competitive introductory rate and hasbeen successful in increasing these balances from approximately $33.3 millionat December 31, 2002 to $35.1 million at March 31, 2003. The already existingbusiness insured money market account product decreased by $5 million for theperiod ending March 31, 2003. Management believes that part of this variance isdue to corporate tax filings due the middle of March each year.

 

Time deposits of>$100,000 increased by $.4 million or .4%. Time deposits of <$100,000increased by $.8 million or 9.7%.

 

Coredeposits (time deposits less than $100,000, demand, and savings) gathered inthe local communities served by the Bank continue to be the Bank’s primarysource of funds for loans and investments. Core deposits of $260.5 million represented 96.8% of total deposits atMarch 31, 2003. The Company does not purchase funds through deposit brokers.

 

The Bank has established borrowing lineswith the Federal Home Loan Bank (FHLB) of approximately $1.6 million and $32.0million secured by loans and securities, respectively. At March 31, 2003, theBank had borrowings of $28.5 million against those lines. The $28.5 millionborrowing consists of $9.5 million maturing in April 2004 and $19 millionmaturing in April 2005. On February 22, 2003, the Bank repaid $9.5 million tothe FHLB that matured on April 24, 2003. The cost of the pre-payment penaltyplus lost opportunity income in the form of Fed Funds Sold resulted in lessthan $500 of cost to the Bank.

 

The Bank utilizes securities sold underrepurchase agreements as a source of funds. The Bank had $118,146 in securities sold under repurchase agreements atMarch 31, 2003 compared to $257,737 at December 31, 2002.

 

Capital Resources

 

On March 4, 2003,the Company announced that the Board of Directors of the Company approved a 5%stock dividend. The record date for the stock dividend was March 14, 2003 andthe pay date was March 28, 2003. A press release was issued on March 4, 2003.

 

On July 19, 2002, the Board of Directors ofthe Company declared a two for one (2 for 1) stock split.  The record date for the stock split wasAugust 2, 2002 and the pay date was August 15, 2002.  Holders of shares of common stock of Heritage Oaks Bancorp wereissued one additional share of common stock for each share of common owned onthe record date of August 2, 2002. A Press Release was issued on July 19, 2002.

 

In April 2002, the Company completed itsoffering of trust preferred securities in the amount of $8.0 million. Thesecurities were issued by a special purpose business trust formed by theCompany and were sold to a pooled investment vehicle sponsored by SandlerO’Neill & Partners, L.P. and Salomon Smith Barney Inc. in a privatetransaction. The securities were sold pursuant to

 

16

----

 

an applicable exemption from registration under the Securities Act of1933, as amended (the “Act”), and have not been registered under the Act.  Sandler O’Neill assisted the Company in theplacement of the trust preferred securities. The securities may not be offeredor sold in the United States absent registration or an applicable exemptionfrom registration requirements.

 

The $8.0 million in trust preferredsecurities have a floating rate of interest, which is reset semi-annually,equal to 6-month LIBOR plus 3.70%.  Thefloating rate, however, may not exceed 11.0% for the first five years.

 

The Company is reflecting the trustpreferred securities as financing debt on its consolidated balance sheet.

 

If the Company elects to defer interest payments pursuant to terms ofthe agreement, then the Company may not (i) declare or pay any dividends ordistributions on, or redeem, purchase, acquire or make a liquidation paymentwith respect to any of the Company’s capital stock, or (ii) make any payment ofprincipal of or premium, if any, or interest on or repay, repurchase or redeemany debt securities of the Company that rank pari passu with or junior ininterest to the Debt Securities, **otherthan,**among other items**,**adividend in the form of stock, warrants, options or other rights in the samestock as that on which the dividend is being paid or ranks pari passu with orjunior to such stock. The prohibition on payment of dividends and payments onpari passu or junior debt also applies in the case of an event of default underthe agreements.

 

The Company used the proceeds from the sale of the securities forgeneral corporate purposes, including the repayment of outstanding indebtednessof $1.8 million on April 11, 2002 and capital contributions to the Bank forfuture growth.

 

The Company issued a press releaseannouncing the sale on April 10, 2002.

 

The Company’s totalstockholders equity was $20,560,821 at March 31, 2003 compared to $19,813,470at December 31, 2002. The increase in capital was from net income of $824,569,$50,240 from stock options exercised, $124,206 net change in othercomprehensive income related to unrealized security holding gain, net of taxand $3,252 in cash paid in lieu of fractional shares as the result of the 5%stock dividend distributed on March 28, 2003.

 

Capital ratios forcommercial banks in the United States are generally calculated using severaldifferent formulas.  These calculationsare referred to as the “Leverage Ratio” and two “risk based” calculations knownas: “Tier One Risk Based Capital Ratio” and the “Total Risk Based Capital Ratio.”   These standards were developed throughjoint efforts of banking authorities from 12 different countries around theworld.  The standards essentially takeinto account the fact that different types of assets have different levels ofrisk associated with them.  Further,they take into account the off-balance sheet exposures of banks when assessingcapital adequacy.

 

The Leverage Ratiocalculation simply divides common stockholders equity (reduced by any Goodwilla bank may have) by the total average assets of the bank.  In the Tier One Risk Based Capital Ratio,the numerator is the same as the leverage ratio, but the denominator is thetotal “risk-weighted assets” of the bank. Risk weighted assets are determined by segregating all the assets andoff balance sheet exposures into different risk categories and weighing them bya percentage ranging from 0% (lowest risk) to 100% (highest risk).  The Total Risk Based Capital Ratio againuses “risk-weighted assets” in the denominator, but expands the numerator toinclude other capital items besides equity such as a limited amount of the loanloss reserve, long-term capital debt, preferred stock and other instruments.

 

17

----

 

 

Summarized below are theBank’s and Company’s capital ratios at March 31, 2003:

 
|                              |   | **Regulatory  Standard**    |   |                  |   |                     |   |
|-----------------------------------|--------|-----------------------------|--------|-----------------------|--------|--------------------------|--------|
|                              |   | **Adequately  Capitalized** |   | **Well  Capitalized** |   | **Heritage  Oaks  Bank** |   | **Heritage  Oaks  Bancorp** |   |
| Leverage Ratio                    |   | 4.00                        | %      | 5.00                  | %      | 8.10                     | %      | 8.22 | % |
|                              |   |                        |   |                  |   |                     |   |   |   |
| Tier One Risk Based Captial Ratio |   | 4.00                        | %      | 6.00                  | %      | 10.63                    | %      | 10.80 | % |
|                              |   |                        |   |                  |   |                     |   |   |   |
| Total Risk Based Captial Ratio    |   | 8.00                        | %      | 10.00                 | %      | 11.69                    | %      | 12.55 | % |

 

For the Company,approximately $6.3 million and $1.7 million of the trust preferred securitiesare accounted for as Tier I and Tier II Capital, respectively, for purposes ofcalculating Regulatory Capital.

 

**RESULTS OF OPERATIONS FOR THETHREE MONTHS ENDED MARCH 31, 2002 AND 2003**

 

Netincome for the three months ending March 31, 2003 was $824,569, compared to$568,220 for the same period in 2002. This represents an increase of $256,349or 45.1%. Per share earnings on a diluted basis for the three months endingMarch 31, 2003 and 2002 were $.26 and $.18, respectively. Basic per shareearnings for the three months ending March 31, 2003 and 2002 were $.28 and$.20, respectively.

 

Thefollowing discussion highlights the components of the significant increase inearnings.

 

Net Interest Income

 

Netinterest income, the primary component of the net earnings of a financialinstitution, refers to the difference between the interest paid on deposits andborrowings, and the interest earned on loans and investments.  The net interest margin is the amount of net****interest income expressed as a percentage of averageearning assets.  Factors considered inthe analysis of net interest income are the composition and volume of earningassets and interest-bearing liabilities, the amount of non-interest bearingliabilities and non-accrual loans, and changes in market interest rates.

 

Netinterest income for the three months ending March 31, 2003 was $3,344,479compared to $2,909,922 for the same period in 2002. This represents an increaseof $434,557 or 14.9%. Interest income was $4,281,411 and $3,418,123 for thethree months ending March 31, 2003 and 2002, respectively. Increased interestincome was primarily the result of higher average loan and investmentsecurities balances outstanding for the comparative periods of time.  Interest expense for this three month periodwas $936,932 at March 31, 2003 compared to $508,201 at March 31, 2002. Interestexpense increased due to the borrowing with the FHLB and interest on the trustpreferred securities.

 

Thetable on the next page sets forth the average balance sheet information,interest income and expense, average yields and rates and net interest incomeand margin for the three months ended March 31, 2003 and 2002.

 

18

----

 

**AVERAGE BALANCE SHEET INFORMATION FOR MARCH 31,**

 
|                                                                                                                                                                              |   | **2003**             |    | **2002**                     |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|---------|------------------------------|--------|
| **(dollars in thousands)**                                                                                                                                                        |   | **Average  Balance** |    | **Average Yield  Rate Paid** |   | **Amount  Interest** |   | **Average  Balance** |   | **Average Yield  Rate Paid** |   | **Amount  Interest** |   |
| Interest Earning Assets:                                                                                                                                                          |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Time deposits with other banks                                                                                                                                                    |   | $                    | 497     |                         | 2.41   | % | $ | 3 |   | $ | 99 |   | 4.04 | % | $ | 1 |   |
| Investment securities taxable                                                                                                                                                     |   | 51,465               |    | 3.33                         | %      | 429 |   | 16,100 |   | 5.02 | % | 202 |   |
| Investment securities non-taxable                                                                                                                                                 |   | 9,387                |    | 4.56                         | %      | 107 |   | 5,794 |   | 4.76 | % | 69 |   |
| Federal funds sold                                                                                                                                                                |   | 22,391               |    | 1.20                         | %      | 67 |   | 9,037 |   | 1.68 | % | 38 |   |
| Loans(1)(2)                                                                                                                                                                       |   | 202,590              |    | 7.26                         | %      | 3,675 |   | 163,015 |   | 7.63 | % | 3,108 |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total interest earning assets                                                                                                                                                     |   | 286,330              |    | 5.98                         | %      | 4,281 |   | 194,045 |   | 7.05 | % | 3,418 |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Allowance for possible loan losses                                                                                                                                                |   | (2,400               | )       |                         |   |   |   | (1,887 | ) |   |   |   |   |
| Non-earning assets:                                                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                                                                                                                                           |   | 19,548               |    |                         |   |   |   | 16,441 |   |   |   |   |   |
| Property, premises and equipment                                                                                                                                                  |   | 4,574                |    |                         |   |   |   | 3,611 |   |   |   |   |   |
| Other assets                                                                                                                                                                      |   | 9,554                |    |                         |   |   |   | 8,687 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| TOTAL ASSETS                                                                                                                                                                      |   | $                    | 317,606 |                         |   |   |   |   | $ | 220,897 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                                                                                                                                                   |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Savings/NOW/money market                                                                                                                                                          |   | 110,028              |    | 0.70                         | %      | 193 |   | 76,021 |   | 0.53 | % | 100 |   |
| Time deposits                                                                                                                                                                     |   | 45,979               |    | 2.44                         | %      | 280 |   | 47,854 |   | 2.96 | % | 354 |   |
| Other borrowings                                                                                                                                                                  |   | 34,330               |    | 5.41                         | %      | 464 |   | 7,942 |   | 2.67 | % | 53 |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                                                                                                                                |   | 190,337              |    | 1.97                         | %      | 937 |   | 131,817 |   | 1.54 | % | 507 |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities:                                                                                                                                                 |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                                                                                                                                   |   | 95,183               |    |                         |   |   |   | 71,121 |   |   |   |   |   |
| Other liabilities                                                                                                                                                                 |   | 3,756                |    |                         |   |   |   | 1,568 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total liabilities                                                                                                                                                                 |   | 289,276              |    |                         |   |   |   | 204,506 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Securities Sold under Agreement to Repurchase Company Obligated  Preferred Securities of Subsidiary Trust Holding Floating Rate Junior  Subordinated Deferred Interest Debentures |   | 8,000                |    |                         |   |   |   | 0 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                                                                                                                                                         |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Common stock                                                                                                                                                                      |   | 9,973                |    |                         |   |   |   | 8,095 |   |   |   |   |   |
| Retained earnings                                                                                                                                                                 |   | 9,900                |    |                         |   |   |   | 8,384 |   |   |   |   |   |
| Valuation Allowance Investments                                                                                                                                                   |   | 457                  |    |                         |   |   |   | (88 | ) |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total stockholders’ equity                                                                                                                                                   |   | 20,330               |    |                         |   |   |   | 16,391 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                   |   | $                    | 317,606 |                         |   |   |   |   | $ | 220,897 |   |   |   |   |   |
|                                                                                                                                                                              |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Net Interest Income                                                                                                                                                               |   |                 |    |                         |   | $ | 3,344 |   |   |   |   |   | $ | 2,911 |   |
| Net Interest Margin(3)                                                                                                                                                            |   |                 |    | 4.67                         | %      |   |   |   |   | 6.00 | % |   |   |

 

----

**(1)****        ****Nonaccrual loans have beenincluded in total loans.**

**(2)****        ****Loan fees of $241,199 and$137,978 for 2003 and 2002, respectively, have been included in the interestincome computation.**

**(3)****        ****Net interest income hasbeen calculated by dividing the net interest income by total earning assets.**

 

The hypothetical impacts of sudden interestrate movements applied to the Bank’s asset and liability balances are modeledmonthly. The results of this movement indicate how much of the Bank’s netinterest income is “at risk” from various sudden rate changes. Althoughinterest rates normally would not change in this sudden manner, this exerciseis valuable in identifying risk exposures. The results for the Bank’s March 31,2003 balances indicate that the Bank’s net interest income at risk over a oneyear time horizon from a 1% and 2% rate movement are within normal expectationsfor such sudden changes.

 
|                          |   | **Rates Down  2%** |   | **Rates Down  1%** |   | **Rates Up  1%** |   | **Rates Up  2%** |   |
|-------------------------------|--------|--------------------|--------|--------------------|--------|------------------|--------|------------------|--------|
|                          |   |               |   |               |   |             |   |             |   |
| Change in Net Interest Income |   | (8.66              | )%     | (5.22              | )%     | 6.33             | %      | 12.45            | %      |

 

It is important tonote that the above table is a summary of several forecasts and actual resultsmay vary. The forecasts are based on estimates and assumptions of managementthat may turn

 

19

----

 

out to be differentand may change over time. Factors effecting these estimates and assumptionsinclude, but are not limited to 1) competitor behavior, 2) economic conditionsboth locally and nationally, 3) actions taken by the Federal Reserve Board, 4)customer behavior and 5) management’s responses.  Changes that vary significantly from the assumptions andestimates may have significant effects on the Bank’s net interest income.Therefore, the results of this analysis should not be relied upon as indicativeof actual future results.

 

Non-interestIncome

 

Non-interest income for the three months ending March 31, 2003 was$901,280 compared to $782,116 for the same period in 2002. That represents anincrease of $119,164 or 15.2%.

 

Income from service chargeson deposit accounts income was $390,473 for the three months ending March 31,2003 compared to $316,213 for the same period in 2002. This increase is theresult of 1) a revised service charge schedule that became effective in August2002 and 2) overall deposit growth.

 

Bankcard merchant fees were $18,632 for the three months ending March31, 2003 compared to $27,163 for the same period in 2002. When the Bank soldthe merchant portfolio in September 1999, the compensation provisions calledfor payment of certain basis points on the gross sales. In September 2002,pursuant to the agreement, the basis points paid to the Bank were reduced. Thiswill continue until August 2004 at which time the compensation will berenegotiated. Management does not believe that this change in revenue streamwill have a material impact on the Company.

 

Mortgage origination feeswere $189,962 for the three months ending March 31, 2003 compared to $142,028for the same period in 2002.

 

Non-Interest  Expense

 

Non-interestexpense was $2,868,723 and $2,678,396 for the three months ending March 31,2003 and 2002, respectively. This represents an increase of $190,327 or 7.1%.

 

Salaries andemployee benefits expense were $1,503,300 and $1,257,061 for the three monthsending March 31, 2003 and 2002, respectively. This represents an increase of$246,239 or 19.6%. Increased salary and related employer tax expense accountsfor approximately $146,000 of the overall increase. The remainder of thevariance is attributed to, but not limited to, increases in employee benefitscategories such as Group Health Insurance, Bonus and training.

 

Occupancy andequipment costs decreased to $389,503 for the three months ending March 31,2003 from $439,650 for the same period of 2002. This represents a decrease of$50,147 or 11.4%. There was a small decrease in nearly every line item (i.e.Rental Costs, Small FF&E Purchases, Miscellaneous Computer Purchases, FFEDepreciation, etc) within this category that accounts for the overall decrease.No one line item had a significant variance.

 

Expense associatedwith the ATM network was $0 and $26,915 for the three months ending March 31,2003 and 2002, respectively.

 

Expense associatedwith all other non-interest expense categories was $975,920 and $954,770 forthe three months ending March 31, 2203 and 2002, respectively.

 

Local Economy

 

The economy in the Company’s service area isbased primarily on agriculture, tourism, light industry, oil and retail trade.Services supporting these industries have also developed in the areas ofmedical, financial and educational. The population in the two county areascomprising the Company’s service area, according to the U.S. Bureau of theCensus, was estimated at July 2001 to be approximately 655,600. San Luis ObispoCounty represents about 38% of this total with

 

20

----

 

Santa Barbara County accounting for theremaining approximately 62%. The moderate climate allows a year round growingseason for numerous vegetable and fruits. Vineyards and cattle ranches alsocontribute largely to the local economy. Vineyards in production have grownsignificantly over the past several years throughout the Company’s servicearea. Access to numerous recreational activities, including lakes, mountainsand beaches, provide a relatively stable tourist industry from many areasincluding the Los Angeles/Orange County basin, the San Francisco Bay area andthe San Joaquin Valley. Principally due to the diversity of the variousindustries in the Company’s service area, the area, while not immune fromeconomic fluctuations, does tend to enjoy a more stable level of economicactivity from many other areas of California.

 

The CentralCoast’s leading industry is the production of wine grapes and production ofpremium quality wines. Over the past two years, production of new vineyard landhas led to an over capacity of wine grapes. Excess production of wine grapes has led to a decrease in prices ofgrapes sold and in some cases, the inability of farmers to sell grapes at anyprice.  Wineries on the other hand arepurchasing grapes at existing contract prices and in some cases, below contractprices. Wineries are becoming select in the quality of grapes purchases, askingfarmers to thin crops to produce a higher quality fruit.

 

The Bank recognized in 2000 that there would be overcapacity in the production of wine grapes in our market area. As a result,efforts were made to move a significant portion of the vineyard developmentloan portfolio out of the Bank and into the government sponsored Farmer Macprogram. Because of these actions on the part of the Bank, it is the opinion ofManagement that there would not be any negative impact from the current stateof the wine grape industry.

 

Liquidity

 

The objective of liquiditymanagement is to ensure the continuous availability of funds to meet thedemands of depositors, investors and borrowers.  Asset liquidity is primarily derived from loan payments and thematurity of other earning assets. Liquidity from liabilities is obtained primarily from the receipt of newdeposits.  The Bank’s Asset LiabilityCommittee (ALCO) is responsible for managing the on-and off-balance sheetcommitments to meet the needs of customers while achieving the Bank’s financialobjectives. ALCO meets regularly to assess the projected funding requirementsby reviewing historical funding patterns, current and forecasted economicconditions, and individual customer funding needs.  Deposits generated from Bank customers serve as the primarysource of liquidity.  The Bank hascredit arrangements with correspondent banks that serve as a secondaryliquidity source in the amount of $5 million. During the first three months of2003 there was no borrowing from correspondent banks.

 

As of July 1999, the bankbecame a member of the Federal Home Loan Bank of San Francisco. Certainsecurities and loans are pledged as collateral. The average funds borrowedthrough these facilities during the first three months of 2003 was $34.2million.

 

The Bank manages itsliquidity by maintaining a majority of its investment portfolio in federalfunds sold and other liquid investments. At March 31, 2003, the ratio of liquid assets to deposits and otherliabilities was 23.0%. The ratio of net loans to deposits, another keyliquidity ratio, was 76.2% at March 31, 2003.

 

Inflation

 

The assets and liabilities of a financialinstitution are primarily monetary in nature. As such they represent obligations to pay or receive fixed anddeterminable amounts of money that are not affected by future changes inprices.  Generally, the impact ofinflation on a financial institution is reflected by fluctuations in interestrates, the ability of customers to repay debt and upward pressure on operatingexpenses.  During the two-year periodended December 31, 2002 and through the first three months of 2003 thefluctuation in interest rates creating narrowing net interest margins has beensignificant to the Bank’s financial position and results of operations.However, inflation has not been a factor in the customer’s ability to repaydebt or in upward

 

21

----

 

pressure on operation expenses.

#### ** **

#### **Item 3. Controls and Procedures**

 

Background of Bank’s and Company’s InternalControls/Audits

 

The Bank is the sole financial subsidiary of the Company. The Bank hasin place extensive policies and operating procedures for loans, operations,accounting and compliance. Loans are audited twice a year for asset quality byan external firm not affiliated with the Bank’s CPA. An external complianceaudit of loan regulations is scheduled to be performed annually by an externalaudit company that is not affiliated with the Bank’s CPA. All other complianceregulations are audited at least annually by the internal auditor. Operatingpolicies and procedures are audited at least annually by the internal auditor.All audits, whether internal or external are reported directly to the AuditCommittee of the Bank and subsequently to the Audit Committee and Board ofDirectors of the Company.

 

The Audit Committees of the Bank and Company maintain an audit calendarprepared by the internal auditor for planning purposes. This audit calendar issubmitted to the Board of the Bank and the Company for approval. Annually theCompany engages an external Certified Public Accounting firm to perform anindependent audit conducted in accordance with generally accepted auditingstandards.

 

Monthly certifications are performed by various departments and arereviewed and approved by a member of Senior Management. These certificationsdocument that the assets and liabilities of the Bank, as well as othernon-balance sheet areas (i.e. cashiers check supplies, safekeeping, etc) are inbalance. Department certifications are due by the 10th business dayof the following month. Many balance sheet accounts are balanced daily in thenormal routine of processing transactions that are applied to the un-postedgeneral ledger accounts.

 

The Bank has in place a rigorous training program that is fullydocumented and active throughout the year. Regular training includes compliancewith regulations, product knowledge and operating policies and procedures.Training is also provided for all new products or changes in methods ofoperation.

 

The Officers Loan Committee meets on a weekly basis as does SeniorManagement. The meetings provide an environment for current and meaningfulcommunication between the various departments of the Bank and is a forum todiscuss material actions and/or events.

 

Daily, the CEO and CFO review the Bank’s consolidated balance sheet andincome statement for unusual postings. The relative non-complex and stablenature of the Bank’s business allows for these officers to detect anomalies andquestion them that same day. Because of this daily scrutiny, inadvertent materialentries are corrected immediately and rarely occur on the last day of the monthor quarter. Such anomalies are generally the case of a miss-encoded item thatthe department is already aware and not that of intentional misrepresentation.Historically, quarterly changes to the Bank’s balance sheet have beenre-slotting of un-posted account loan and deposit amounts and suspense items tothe appropriate categories within the general ledger. These entries, whether ornot material, are researched and submitted to the Controller for adjustmentwithin general ledger accounts for Call Report purposes.

 

Formation of Disclosure Controls and ProceduresOfficer Committee

 

The Disclosure Controls and Procedures Officer Committee (the“Committee”) has the responsibility for considering the materiality ofinformation (a material fact) and determining disclosure obligations on atimely basis. The Committee has implemented disclosure controls and proceduresthat meet the standards established by the new rules. These controls andprocedures will be reviewed and adopted by the audit committee of the Companyand the Bank. The Committee will consist of members of the Officer PlanningMeeting that meets weekly.

 

22

----

 

Control and Procedures

 

The Committee meets on the last Thursday ofthe quarter. Members are to provide information that is documented within theQuarterly Control and Procedures Report. This report contains attestations and,where applicable, documentation in regard to the following:

 

1.                                                   Internal Controls have been reviewed withinthe past 90 days

2.                                                   Concern about weaknesses in internal control

3.                                                   Events that may require disclosure

4.                                                   Internal Fraud/Defalcation

5.                                                   Potential Material Losses

6.                                                   New Off-Balance Sheet Arrangements

7.                                                   Material Amounts not reflected on thegeneral ledger

8.                                                   Material trends in operation of any Bankunit

 

The report is completed, signed andpresented to the CEO and CFO prior to completing the first draft of thequarterly 10-QSB.  Because materialissues may occur between regularly scheduled quarterly meetings, this report isto be generated by the appropriate Officers at anytime when warranted. The CEOand CFO will consult with the Company’s Disclosure Policy Committee todetermine any action that is necessary.

 

Evaluationof disclosure controls and procedures

 

(a)  Within 90 days prior to the date of thisreport, the Company carried out an evaluation, under the supervision and withthe participation of its management, including the Company’s Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures pursuant toExchange Act Rule 13a-14. Based upon that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to the Company (including its consolidated subsidiaries)required to be included in the Company’s periodic SEC filings.

 

(b)  Subsequent to the date ofthis evaluation, there have been no changes in the Company’s internal controlsor in other factors that could significantly affect these controls, and nodiscoveries of any significant deficiencies or material weaknesses in suchcontrols that would require the Company to take corrective actions.

 

#### **PART2.  OTHER INFORMATION**

 

ITEM 6.      EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  Exhibits:

 

**Exhibit 10.32****                      **A ConstructionAgreement dated February 12, 2003 between Heritage Oaks Bank and HBE FinancialFacilities, a Division of HBE Corporation, filed with the SEC in the March 31,2003 10QSB.

 

**Exhibit 99.1** Certification of Chief Executive Officer

pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002

 

**Exhibit 99.2** Certification of Chief Financial Officer

pursuant to Section 906 of the Sarbanes-Oxley Actof 2002

 

(b)                                Reports on Form 8-K:

 

TheCompany filed the announcement of a 5% stock dividend on Form 8-K, Item 5 withthe SEC on March 4, 2003.

 

23

----

 

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 thereunto dulyauthorized.

 

HERITAGE OAKS BANCORP

 

DATE: May 6, 2003

 

 
|   | /s/ Lawrence P. Ward     |   |
|--------|--------------------------|--------|
|   | Lawrence P. Ward         |
|   | President                |
|   | Chief Executive Officer  |
|   |                     |
|   |                     |
|   | /s/ Margaret A. Torres   |   |
|   | Margaret A. Torres       |
|   | Chief Financial Officer  |
|   | Executive Vice President |

 

24

----

 

**CERTIFICATIONS**

 

I, Lawrence P. Ward, ChiefExecutive Officer, certify that:

 
| 1.     | I have reviewed this  quarterly report on Form 10-QSB of Heritage Oaks Bancorp;                                                                                                                                                                                                                                                                                                                     |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.     | Based on my knowledge,  this quarterly report does not contain any untrue statement of a material  fact or omit to state a material fact necessary to make the statements made,  in light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this quarterly report;                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.     | Based on my knowledge, the  financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.     | The registrant’s other  certifying officers and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | a) | designed such disclosure  controls and procedures to ensure that material information relating to the  registrant, including its consolidated subsidiaries, is made known to us by  others within those entities, particularly during the period in which this  quarterly report is being prepared; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | b) | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to filing date of this quarterly report (the  “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | c) | presented in this  quarterly report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |   |
| 5.     | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and audit committee of registrant’s  board of directors (or persons performing the equivalent function);                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | a) | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | b) | any fraud, whether or not  material, that involves management or other employees who have a significant  role in the registrant’s internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |   |
| 6.     | The registrant’s other  certifying officers and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |

 

 

Date:  May 6, 2003

 
|   | /s/ Lawrence P. Ward    |   |
|--------|-------------------------|--------|
|   | Lawrence P. Ward        |
|   | Chief Executive Officer |

 

25

----

 

**CERTIFICATIONS**

 

I, Margaret A. Torres,Chief Financial Officer, certify that:

 
| 7.     | I have reviewed this  quarterly report on Form 10-QSB of Heritage Oaks Bancorp;                                                                                                                                                                                                                                                                                                                     |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 8.     | Based on my knowledge,  this quarterly report does not contain any untrue statement of a material  fact or omit to state a material fact necessary to make the statements made,  in light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this quarterly report;                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 9.     | Based on my knowledge,  the financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.    | The registrant’s other  certifying officers and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | a) | designed such disclosure  controls and procedures to ensure that material information relating to the  registrant, including its consolidated subsidiaries, is made known to us by  others within those entities, particularly during the period in which this  quarterly report is being prepared; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | b) | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to filing date of this quarterly report (the  “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | c) | presented in this  quarterly report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 11.    | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and audit committee of registrant’s  board of directors (or persons performing the equivalent function);                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | a) | all significant deficiencies  in the design or operation of internal controls which could adversely affect  the registrant’s ability to record, process, summarize and report financial  data and have identified for the registrant’s auditors any material  weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                | b) | any fraud, whether or not  material, that involves management or other employees who have a significant  role in the registrant’s internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |   |
| 12.    | The registrant’s other  certifying officers and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |

 

 

Date:     May 6, 2003

 
|   | /s/ Margaret A. Torres  |   |
|--------|-------------------------|--------|
|   | Margaret A. Torres      |
|   | Chief Financial Officer |

 

26

----

 

# **WHERE YOU CAN FIND MORE INFORMATION**

 

Under the Securities Exchange Act of 1934Sections 13 and 15(d), periodic and current reports must be filed with the SEC.The Company electronically files the following reports with the SEC: Form 10-K(Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Report of Unscheduled MaterialEvents), and Form DEF 14A (Proxy Statement). The Company may file additionalforms. The SEC maintains an Internet site, www.sec.gov, in which all formsfiled electronically may be accessed. Additionally, all forms filed with theSEC and additional shareholder information is available free of charge on theCompany’s website: www.heritageoaksbank.com

 

The Company posts these reports to itswebsite as soon as reasonably practicable after filing them with the SEC.  None of the information on or hyperlinkedfrom the Company’s website is incorporated into this Annual Report on Form10-QSB.

 

**Exhibit Index**

 
| Exhibit  10.32 |   | A  Construction Agreement dated February 12, 2003 between Heritage Oaks Bank and  HBE Financial Facilities, a Division of HBE Corporation, filed with the SEC  in the March 31, 2003 10QSB. |
|----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 99.1   |   | Certification of Chief  Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                        |
| Exhibit 99.2   |   | Certification of Chief Financial Officer, pursuant  to Section 906 the the Sarbanes-Oxley Act of 2002                                                                                       |

 

27

----