**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-QSB**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period endedJune 30, 2002**

 

| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the Transition Period from                 to**

 

**Commission File No. 0-25020**

 

**HERITAGEOAKS 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)      |

 

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

 

YES   ý   NO o

 

Aggregate marketvalue of Common Stock of Heritage Oaks Bancorp at July 23, 2002: $35,648,120.

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate:

 

No par value Common Stock – 2,768,786 sharesoutstanding at July 23,2002.

 

 

----

 

**TABLE OF CONTENTS**

 
| Consolidated Balance Sheets  for periods ended December 31, 2001 and June 30, 2002                       |
|----------------------------------------------------------------------------------------------------------|
|                                                                                                     |
| Consolidated  Statements of Income for the three months ended June 30, 2001 and June 30,  2002           |
|                                                                                                     |
| Consolidated  Statements of Income for the six months ended June 30, 2001 and June 30, 2002              |
|                                                                                                     |
| Consolidated  Statements of Cash Flows for periods ended June 30, 2001 and June 30, 2002                 |
|                                                                                                     |
| Consolidated  Statements of Stockholders’ Equity for periods ended June 30, 2001 and June  30, 2002 |
|                                                                                                     |
| Notes to  Consolidated Condensed Financial Statements                                                    |
|                                                                                                     |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations     |
|                                                                                                     |
| Part 2. Other Information                                                                                |
| Item 1. Legal Proceedings                                                                                |
| Item  2. Changes in Securities and Use of Proceeds                                                       |
| Item 3.  Defaults Upon Senior Securities                                                                 |
| Item  4. Submission of Matters to a Vote of Security Holders                                             |
| Item 5. Other Information                                                                                |
| Item 6.  Exhibits and Reports on Form 8-K                                                                |
|                                                                                                     |
| Signatures                                                                                               |
|                                                                                                     |
| Exhibits                                                                                                 |

 

2

----

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                                              |   | **31-Dec-01** |        | **30-Jun-02**   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|-------------|-----------------|--------|
|                                                                                                                                                              |   | **(1)**       |        | **(Unaudited)** |   |
| ASSETS                                                                                                                                                            |   |          |        |            |   |
| Cash and due  from banks                                                                                                                                          |   | $             | 14,398,048  |            | $      | 19,712,162 |   |
| Federal funds  sold                                                                                                                                               |   | 6,000,000     |        | 18,990,000      |   |
|                                                                                                                                                              |   |          |        |            |   |
| Total cash and  cash equivalents                                                                                                                                  |   | 20,398,048    |        | 38,702,162      |   |
|                                                                                                                                                              |   |          |        |            |   |
| Interest bearing  deposits other banks                                                                                                                            |   | 99,000        |        | 99,000          |   |
|                                                                                                                                                              |   |          |        |            |   |
| Securities  Available for sale                                                                                                                                    |   | 22,028,996    |        | 59,282,870      |   |
| Federal Home  Loan Bank Stock, cost                                                                                                                               |   | 228,300       |        | 1,904,500       |   |
| Loans Held For  Sale                                                                                                                                              |   | 4,082,200     |        | 3,681,075       |   |
| Loans, net                                                                                                                                                        |   | 156,149,885   |        | 166,825,111     |   |
|                                                                                                                                                              |   |          |        |            |   |
| Property,  premises and equipment, net                                                                                                                            |   | 3,620,769     |        | 3,504,627       |   |
| Cash surrender  value life insurance                                                                                                                              |   | 5,143,613     |        | 5,275,536       |   |
| Deferred Tax  Assets                                                                                                                                              |   | 1,257,991     |        | 1,155,159       |   |
| Other assets                                                                                                                                                      |   | 1,875,872     |        | 2,222,207       |   |
|                                                                                                                                                              |   |          |        |            |   |
| TOTAL ASSETS                                                                                                                                                      |   | $             | 214,884,674 |            | $      | 282,652,247 |   |
|                                                                                                                                                              |   |          |        |            |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                        |   |          |        |            |   |
| LIABILITIES                                                                                                                                                       |   |          |        |            |   |
| Deposits:                                                                                                                                                         |   |          |        |            |   |
| Demand,  non-interest bearing                                                                                                                                     |   | $             | 69,824,137  |            | $      | 91,905,617 |   |
| Savings, NOW,  and money market deposits                                                                                                                          |   | 76,564,209    |        | 79,371,263      |   |
| Time deposits of  $100,000 or more                                                                                                                                |   | 7,181,312     |        | 8,155,378       |   |
| Time deposits  under $100,000                                                                                                                                     |   | 42,015,107    |        | 37,824,986      |   |
| Total deposits                                                                                                                                                    |   | 195,584,765   |        | 217,257,244     |   |
|                                                                                                                                                              |   |          |        |            |   |
| Other borrowed  money                                                                                                                                             |   | 1,894,811     |        | 38,000,000      |   |
| Securities Sold  under Agreement to Repurchase                                                                                                                    |   | 137,293       |        | 430,530         |   |
| Company  Obligated Preferred Securities of Subsidiary Trust Holding Floating Rate  Junior Subordinated Deferred Interest Debentures                               |   | 0             |        | 8,000,000       |   |
| Other  liabilities                                                                                                                                                |   | 1,391,024     |        | 1,439,120       |   |
| Total  liabilities                                                                                                                                                |   | 199,007,893   |        | 265,126,894     |   |
|                                                                                                                                                              |   |          |        |            |   |
| Stockholders’  equity                                                                                                                                        |   |          |        |            |   |
| Common stock, no  par value; 20,000,000 shares authorized; issued and outstanding 1,297,880 and  2,768,786 for December 31, 2001 and June 30, 2002, respectively. |   | 7,535,495     |        | 9,327,348       |   |
| Accumulated  other comprehensive income                                                                                                                           |   | (154,836      | )           | 189,496         |   |
| Retained  earnings                                                                                                                                                |   | 8,496,122     |        | 8,008,509       |   |
| Total  stockholders’ equity                                                                                                                                  |   | 15,876,781    |        | 17,525,353      |   |
|                                                                                                                                                              |   |          |        |            |   |
| TOTAL  LIABILITIES & STOCKHOLDERS’ EQUITY                                                                                                                |   | $             | 214,884,674 |            | $      | 282,652,247 |   |

 

----

(1)  These numbers have been derived from theaudited financial statements.

See notes tocondensed financial statements

 

3

----

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Forthe three months ended June 30,**

 
|                                                       |   | **2001**        |      | **2002**        |   |
|------------------------------------------------------------|--------|-----------------|-----------|-----------------|--------|
|                                                       |   | **(Unaudited)** |      | **(Unaudited)** |   |
| Interest Income:                                           |   |            |      |            |   |
|                                                       |   |            |      |            |   |
| Interest and  fees on loans                                |   | $               | 3,312,484 |            | $      | 3,162,626 |   |
| Investment  securities                                     |   | 192,941         |      | 589,529         |   |
| Federal funds  sold and commercial paper                   |   | 147,131         |      | 63,877          |   |
| Time  certificates of deposit                              |   | 4,430           |      | 1,530           |   |
| Total interest  income                                     |   | 3,656,986       |      | 3,817,562       |   |
|                                                       |   |            |      |            |   |
| Interest  Expense:                                         |   |            |      |            |   |
|                                                       |   |            |      |            |   |
| Now accounts                                               |   | 143,409         |      | 61,374          |   |
| MMDA accounts                                              |   | 55,420          |      | 42,463          |   |
| Savings accounts                                           |   | 59,385          |      | 12,092          |   |
| Time deposits of  $100,000 or more                         |   | 100,079         |      | 38,346          |   |
| Other time  deposits                                       |   | 587,180         |      | 279,455         |   |
| Other borrowed  funds                                      |   | 12,592          |      | 394,514         |   |
| Total interest  expense                                    |   | 958,065         |      | 828,244         |   |
|                                                       |   |            |      |            |   |
| Net Interest  Income Before Prov. for Possible Loan Losses |   | 2,698,921       |      | 2,989,318       |   |
| Provision for  loan losses                                 |   | 150,000         |      | 150,000         |   |
| Net interest  income after provision for loan losses       |   | 2,548,921       |      | 2,839,318       |   |
|                                                       |   |            |      |            |   |
| Non-interest  Income:                                      |   |            |      |            |   |
| Service charges  on deposit accounts                       |   | 288,134         |      | 326,365         |   |
| Other income                                               |   | 834,853         |      | 471,520         |   |
| Total  Non-interest Income                                 |   | 1,122,987       |      | 797,885         |   |
|                                                       |   |            |      |            |   |
| Non-interest  Expense:                                |   |            |      |            |   |
| Salaries and  employee benefits                            |   | 1,129,929       |      | 1,284,100       |   |
| Occupancy and  equipment                                   |   | 372,138         |      | 410,089         |   |
| Other expenses                                             |   | 1,376,637       |      | 983,345         |   |
| Total  Noninterest Expenses                                |   | 2,878,704       |      | 2,677,534       |   |
| Income before  provision for income taxes                  |   | 793,204         |      | 959,669         |   |
| Provision for  applicable income taxes                     |   | 274,508         |      | 328,249         |   |
| Net Income                                                 |   | $               | 518,696   |            | $      | 631,420 |   |
|                                                       |   |            |      |            |   |
| Earnings per  share:    (See note #4)       |   |            |      |            |   |
| Basic                                                      |   | $               | 0.19      |            | $      | 0.23 |   |
| Fully Diluted                                              |   | $               | 0.18      |            | $      | 0.21 |   |

 

See notes tocondensed financial statements

 

4

----

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATED STATEMENTS OF INCOME**

**For thesix months ended June 30,**

 
|                                                       |   | **2001**        |      | **2002**        |   |
|------------------------------------------------------------|--------|-----------------|-----------|-----------------|--------|
|                                                       |   | **(Unaudited)** |      | **(Unaudited)** |   |
| Interest Income:                                           |   |            |      |            |   |
|                                                       |   |            |      |            |   |
| Interest and  fees on loans                                |   | $               | 6,754,873 |            | $      | 6,270,975 |   |
| Investment  securities                                     |   | 413,233         |      | 860,153         |   |
| Federal funds  sold and commercial paper                   |   | 210,630         |      | 102,237         |   |
| Time certificates  of deposit                              |   | 6,960           |      | 2,320           |   |
| Total interest  income                                     |   | 7,385,696       |      | 7,235,685       |   |
|                                                       |   |            |      |            |   |
| Interest  Expense:                                         |   |            |      |            |   |
|                                                       |   |            |      |            |   |
| Now accounts                                               |   | 348,372         |      | 121,040         |   |
| MMDA accounts                                              |   | 138,580         |      | 71,855          |   |
| Savings accounts                                           |   | 136,456         |      | 23,329          |   |
| Time deposits of  $100,000 or more                         |   | 138,088         |      | 78,602          |   |
| Other time  deposits                                       |   | 1,283,029       |      | 593,688         |   |
| Other borrowed  funds                                      |   | 52,364          |      | 447,931         |   |
| Total interest  expense                                    |   | 2,096,889       |      | 1,336,445       |   |
|                                                       |   |            |      |            |   |
| Net Interest  Income Before Prov. for Possible Loan Losses |   | 5,288,807       |      | 5,899,240       |   |
| Provision for  loan losses                                 |   | 300,000         |      | 285,000         |   |
| Net interest  income after provision for loan losses       |   | 4,988,807       |      | 5,614,240       |   |
|                                                       |   |            |      |            |   |
| Non-interest  Income:                                      |   |            |      |            |   |
| Service charges  on deposit accounts                       |   | 566,221         |      | 642,578         |   |
| Investment  securities (losses), net                       |   | -1,606          |      | 0               |   |
| Other income                                               |   | 2,396,588       |      | 937,423         |   |
| Total  Non-interest Income                                 |   | 2,961,203       |      | 1,580,001       |   |
|                                                       |   |            |      |            |   |
| Non-interest  Expense:                                |   |            |      |            |   |
| Salaries and  employee benefits                            |   | 2,195,744       |      | 2,541,161       |   |
| Occupancy and  equipment                                   |   | 881,451         |      | 849,739         |   |
| Other expenses                                             |   | 3,158,783       |      | 1,965,030       |   |
| Total  Noninterest Expenses                                |   | 6,235,978       |      | 5,355,930       |   |
| Income before  provision for income taxes                  |   | 1,714,032       |      | 1,838,311       |   |
| Provision for  applicable income taxes                     |   | 598,918         |      | 638,670         |   |
| Net Income                                                 |   | $               | 1,115,114 |            | $      | 1,199,641 |   |
|                                                       |   |            |      |            |   |
| Earnings per  share:    (See note #4)       |   |            |      |            |   |
| Basic                                                      |   | $               | 0.41      |            | $      | 0.44 |   |
| Fully Diluted                                              |   | $               | 0.38      |            | $      | 0.40 |   |

 

See notes tocondensed financial statements

 

5

----

** **

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Periods ended June 30,**

** **
|                                                                                |   | **2001**        |       | **2002**        |   |
|-------------------------------------------------------------------------------------|--------|-----------------|------------|-----------------|--------|
|                                                                                |   | **(Unaudited)** |       | **(Unaudited)** |   |
| **Cash Flows from Operating Activities**                                            |   |            |       |            |   |
| Net income                                                                          |   | $               | 1,115,114  |            | $      | 1,199,641 |   |
| Adjustments to reconcile net income to  net cash provided by operating activities   |   |            |       |            |   |
| Net cash provided by operating activities                                           |   |            |       |            |   |
| Depreciation and amortization                                                       |   | 449,937         |       | 309,979         |   |
| Provision for possible loan losses                                                  |   | 300,000         |       | 285,000         |   |
| Realized (gain) loss on sales of available-for-sale securities, net                 |   | (1,606          | )          | 0               |   |
| Gain on sales of property, premise and equipment                                    |   | 0               |       | 17,332          |   |
| Amortization of premiums/discounts on investment securities, net                    |   | (66,141         | )          | 11,010          |   |
| (Increase)/decrease in loans held for sale                                          |   | (378,723        | )          | 0               |   |
| (Increase)/decrease in deferred tax asset                                           |   | (14,242         | )          | 102,832         |   |
| (Increase)/decrease in other assets                                                 |   | (816,726        | )          | (478,359        | )      |
| Increase/(decrease) in other liabilities                                            |   | (371,663        | )          | 392,428         |   |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                                       |   | 215,950         |       | 1,839,863       |   |
| **Cash Flows From Investing Activities**                                            |   |            |       |            |   |
| Purchase of securities available-for-sale                                           |   | 0               |       | (41,537,414     | )      |
| Proceeds from sales of securities available-for-sale                                |   | 551,532         |       | 0               |   |
| Proceeds from principal reductions and maturities of securities  available-for-sale |   | 2,234,641       |       | 2,596,330       |   |
| Proceeds from sale of other real estate owned                                       |   |            |       |            |   |
| Increase in loans, net                                                              |   | (2,845,892      | )          | (10,559,000     | )      |
| Purchase of property, premises and equipment, net                                   |   | (129,632        | )          | (211,169        | )      |
| **NET CASH USED IN INVESTING ACTIVITIES**                                           |   | (189,351        | )          | (49,711,253     | )      |
| **Cash Flows From Financing Activities**                                            |   |            |       |            |   |
| Increase in deposits, net                                                           |   | $               | 5,645,884  |            | $      | 21,672,479 |   |
| Net increase/(decrease) in other borrowings                                         |   | (650,000        | )          | 36,398,426      |   |
| Proceeds from sale of Trust Preferred Securities                                    |   | 0               |       | 8,000,000       |   |
| Proceeds from exercise of stock options                                             |   | 68,584          |       | 111,004         |   |
| Cash paid in lieu of fractional shares                                              |   | (4,680          | )          | (6,405          | )      |
| Cash dividends paid or declared                                                     |   |            |       |            |   |
| **NET CASH PROVIDED BY FINANCING ACTIVITIES**                                       |   | 5,059,788       |       | 66,175,504      |   |
| **Net Increase in Cash and Cash Equivalents**                                       |   | 5,086,387       |       | 18,304,114      |   |
| **Cash and Cash Equivalents**, Beginning of year                                    |   | 24,035,534      |       | 20,398,048      |   |
| **Cash and Cash Equivalents**, End of year                                          |   | $               | 29,121,921 |            | $      | 38,702,162 |   |

 

See notes to condensed financial statements

 

 

6

----

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**June 30,2001 and June 30, 2002**

**(Unaudited)**

 
|                                                                               |   | **Shares  Outstanding** |       | **Common  Stock** |          | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Income** |       | **Total  Stockholders’  Equity** |        |
|------------------------------------------------------------------------------------|--------|-------------------------|------------|-------------------|---------------|------------------------|--------|-----------------------------------------------|------------|---------------------------------------|-------------|
| Balance January  1, 2001                                                           |   | 1,224,999               |       | $                 | 6,305,233     |                   | $      | 7,291,140                                     |       | $                                     | (141,364    | ) | $ | 13,455,009 |   |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Exercise of  Stock Options                                                         |   | 11,442                  |       | 68,584            |          | 0                      |   |                                          |       | 68,584                                |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Stock dividend-  5%                                                                |   | 61,439                  |       | 1,136,621         |          | (1,136,621             | )      |                                          |       | 0                                     |        |
| Cash paid to  Shareholders’ in Lieu of fractional shares on 5% Stock Dividend |   |                    |       |              |          | (4,680                 | )      |                                          |       | (4,680                                | )           |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Comprehensive  Income                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Net Income                                                                         |   |                    |       |              |          | 1,115,114              |   |                                          |       | 1,115,114                             |        |
| Unrealized  Security Holding Gains/(Losses) ‘(net of $61,884 tax)             |   |                    |       |              |          |                   |   | 92,825                                        |       | 92,825                                |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Total other  comprehensive Income                                                  |   |                    |       |              |          |                   |   |                                          |       | 1,207,939                             |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| **Balance  June 30, 2001**                                                         |   | **1,297,880**           | ** ** | **$**             | **7,510,438** | ** **             | **$**  | **7,264,953**                                 | ** ** | **$**                                 | **(48,539** | **)** | **#REF!** | ** ** |
|                                                                                    |        |                         |            |                   |               |                        |        |                                               |            |                                       |             |  |  |  |  |

 
|                                                                               |   | **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                                                         |   | 21,865                  |       | 111,004           |          | 0                      |   |                                          |       | 111,004                               |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Stock dividend-  5%                                                                |   | 64,648                  |       | 1,680,849         |          | (1,680,849             | )      |                                          |       | 0                                     |        |
| Cash paid to  Shareholders’ in Lieu of fractional shares on 5% Stock Dividend |   |                    |       |              |          | (6,405                 | )      |                                          |       | (6,405                                | )           |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Stock Split- 2  for 1                                                              |   | 1,384,393               |       |              |          |                   |   |                                          |       |                                  |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Comprehensive  Income                                                              |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Net Income                                                                         |   |                    |       |              |          | 1,199,641              |   |                                          |       | 1,199,641                             |        |
| Unrealized  Security Holding Gains/(Losses)   ‘(net of $126,330 tax)          |   |                    |       |              |          |                   |   | 344,332                                       |       | 344,332                               |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Total other  comprehensive Income                                                  |   |                    |       |              |          |                   |   |                                          |       | 1,543,973                             |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| **Balance  June 30, 2002**                                                         |   | **2,768,786**           | ** ** | **$**             | **9,327,348** | ** **             | **$**  | **8,008,509**                                 | ** ** | **$**                                 | **189,496** | ** ** | **$** | **17,525,353** | ** ** |

 

7

----

 

Note 1: CONSOLIDATED FINANCIAL STATEMENTS

 

In the opinion of Management, the unaudited consolidated condensedfinancial statements contain all (consisting of only normal recurringadjustments) adjustments necessary to present fairly the Company’s consolidatedfinancial position at June 30, 2002 and the results of cash flows for the sixmonths ended June 30, 2001 and 2002 and the results of operations for the threeand six months ended June 30, 2001 and 2002.

 

Certain information and footnote disclosures normally presented infinancial statements prepared in accordance with generally accepted accountingprinciples have been omitted.  Theseinterim consolidated condensed financial statements should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s 2001 Annual Report to 

shareholders.  The results forthe three and six months ended June 30, 2001 and 2002 may not necessarily beindicative of the operating results for the full year.

 

Note 2: INVESTMENT SECURITIES 

 

In accordance with SFAS No. 115 “Accounting for Certain Investments inDebt and Equity Securities” , which addresses the accounting for investments inequity securities that have readily determinable fair values and forinvestments in all debt securities, securities are classified in threecategories and accounted for as follows: debit and equity securities that thecompany has the positive intent and ability to hold to maturity are classifiedas  held-to-maturity and are measured atamortized cost; debt and equity securities 

bought and held principally for the purpose of selling in the near termare classified as trading securities and are measured at fair value, withunrealized 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 unrealized gains andlosses, net of applicable taxes, reported in a separate component ofstockholders’ equity.  Any gains andlosses on sales of investments are computed on a specific identification basis.

 

The amortized cost and fair values of investment securities availablefor sale at June 30, 2002 and December 31, 2001 were: 

 

**June 30, 2002**

 
|                                                      |   | **Amortized  Cost** |           | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** |         |
|-----------------------------------------------------------|--------|---------------------|----------------|------------------------------|--------|-------------------------------|------------|-----------------|--------------|
| Obligations of  U.S. government agencies and corporations |   | $                   | 908,282        |                         | $      | —                        |       | $               | (28,919      | ) | $ | 879,363 |   |
| Mortgage-backed  securities                               |   | 52,267,740          |           | 331,618                      |   | (106,430                      | )          | 52,492,928      |         |
| Obligations of  State and Political Subdivisions          |   | 5,782,385           |           | 178,019                      |   | (58,463                       | )          | 5,901,941       |         |
| Other Securities                                          |   | 8,638               |           | 0                            |   | 0                             |       | 8,638           |         |
| **TOTAL**                                                 |   | **$**               | **58,967,045** | ** **                   | **$**  | **509,637**                   | ** ** | **$**           | **(193,812** | **)** | **$** | **59,282,870** | ** ** |

 

**December 31, 2001**

 
|                                                      |   | **Amortized  Cost** |           | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** |         |
|-----------------------------------------------------------|--------|---------------------|----------------|------------------------------|--------|-------------------------------|------------|-----------------|--------------|
| Obligations of  U.S. government agencies and corporations |   | $                   | 979,772        |                         | $      | —                        |       | $               | (35,199      | ) | $ | 944,573 |   |
| Mortgage-backed  securities                               |   | 15,574,820          |           | 26,449                       |   | (222,406                      | )          | 15,378,863      |         |
| Obligations of  State and Political Subdivisions          |   | 5,723,827           |           | 81,670                       |   | (108,575                      | )          | 5,696,922       |         |
| Other Securities                                          |   | 8,638               |           | 0                            |   | 0                             |       | 8,638           |         |
| **TOTAL**                                                 |   | **$**               | **22,287,057** | ** **                   | **$**  | **108,119**                   | ** ** | **$**           | **(366,180** | **)** | **$** | **22,028,996** | ** ** |

 

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Note 3: Loans andReserve for Possible Loan Losses

 

Majorclassifications of loans were:
|                                     |   | **December 31,  2001** |        | **June 30,  2002** |   |
|------------------------------------------|--------|------------------------|-------------|--------------------|--------|
|                                     |   |                   |        |               |   |
| Commercial,  financial, and agricultural |   | $                      | 40,608,210  |               | $      | 40,615,526 |   |
| Real  estate-construction                |   | 23,449,044             |        | 30,664,445         |   |
| Real  estate-mortgage                    |   | 90,823,606             |        | 95,732,036         |   |
| Installment  loans to individuals        |   | 3,171,805              |        | 2,539,651          |   |
| All other loans  (including overdrafts)  |   | 419,622                |        | 140,757            |   |
|                                     |   | 158,472,287            |        | 169,692,415        |   |
|                                     |   |                   |        |               |   |
| Less - deferred  loan fees               |   | (578,332               | )           | (784,838           | )      |
| Less - reserve  for possible loan losses |   | (1,744,070             | )           | (2,082,466         | )      |
|                                     |   |                   |        |               |   |
| Total loans                              |   | $                      | 156,149,885 |               | $      | 166,825,111 |   |
|                                     |   |                   |        |               |   |
| Loans Held For  Sale                     |   | $                      | 4,082,200   |               | $      | 3,681,075 |   |

 

Concentration of Credit Risk

 

At June 30, 2002, approximately $126.4 million of the Bank’s loanportfolio was collateralized by various forms of real estate.  Such loans are generally made to borrowerslocated in San Luis Obispo County.  TheBank attempts to reduce its concentration of credit risk by making loans whichare diversified by project type.  Whilemanagement believes that the collateral presently securing this portfolio isadequate, there can be no assurances that significant deterioration in theCalifornia real estate market would not expose the Bank to significantlygreater credit risk.

 

Loans on nonaccrual status totaled $1,494,602 and $1,506,496 atDecember 31, 2001 and June 30, 2002, respectively.  Interest income that would have been recognized on non-accrualloans if they had performed in accordance with the terms of the loans wasapproximately $142,952 and $67,602 for the period ended December 31, 2001 andJune 30, 2002, respectively.

 

An analysis of the changes in the reserve for possible loan losses isas follows:

 
|                                        |   | **December 31,  2001** |      | **June 30,  2002** |   |
|---------------------------------------------|--------|------------------------|-----------|--------------------|--------|
|                                        |   |                   |      |               |   |
| Balance at  beginning of year               |   | $                      | 1,320,518 |               | $      | 1,744,070 |   |
| Additions  charged to operating expense     |   | 600,000                |      | 285,000            |   |
| Loans charged  off                          |   | (180,732               | )         | (73,550            | )      |
| Recoveries of  loans previously charged off |   | 4,284                  |      | 126,946            |   |
| Balance at end  of year                     |   | $                      | 1,744,070 |               | $      | 2,082,466 |   |
|                                             |        |                        |           |                    |        |  |  |  |

 

At June 30, 2002, the Bank was contingently liable for letters ofcredit accommodations made to its customers totaling $1,697,126 and undisbursedloan commitments in the amount of $46,850,000. The Bank makes commitments to extend credit in the normal course ofbusiness to meet the financing needs of its customers.  Commitments to extend credit are agreementsto lend to a customer as long as there is no violation of any conditionestablished in the contract. Commitments generally have fixed expiration dates or other terminationclauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawnupon, the total outstanding commitment amount does not necessarily representfuture cash requirements.  Standbyletters of credit written are conditional commitments issued by the Bank toguarantee the performance of a customer to a third party.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loan facilitiesto customers.

The Bank anticipates no losses as a result of such transactions.

 

9

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In accordance with Financial Accounting Standards Board (FASB)Statement No. 114, Accounting by Creditors for Impairment of a Loan”, 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.

 

Management believes that the allowance for credit losses at June 30,2002 is prudent and warranted, based on information currently available.  However, no prediction of the ultimate levelof loans charged-off in future years can be made with any certainty.

 

Note 4: Earnings Per Share

 

The basic earnings per share are based on the weighted average numberof shares outstanding before any dilution from common stock equivalents. Diluted earnings per share reflects the potential dilution that couldoccur if secrutities or other contracts to issue common stock were exercised orconverted into common stock or resulted in the issuance of common stock thatthen shared in the earnings of the entity. 

 

On July 19, 2002, the Company announced that the Board of Directors ofthe Company approved a  two-for-onestock split.  The record date for thestock split will be August 2, 2002 and the pay date is scheduled for August 15,2002.  Holders of shares of common stockof Heritage Oaks Bancorp will be issued one additional share of common stockfor each share of common stock owned on the record date of August 2, 2002.

 

Share information has been retroactively adjusted for the two-for-onestock split.

 

The total number of share used for calculating basic eanings per sharefor the three months ended June 30, 2001 and 2002, were 2,729,978 and2,762,895, respectively. The total number of shares used for calculatingdiluted earnings per share for the three months ended June 30, 2001 and 2002were 2,963,978 and 2,999,586, respectively.

 

The total number of share used for calculating basic eanings per sharefor the six months ended June 30, 2001 and 2002, were  2,719,790 and 2,744,080, respectively. The total number of sharesused for calculating diluted earnings per share for the six months ended June30, 2001 and 2002 were 2,934,510 and 3,002,014, respectively.

 

 

**Certain statements contained in this Quarterly Report on Form10-QSB (“Quarterly Report”), including,**

 

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**without limitation, statements containing the words“believes”, “anticipates”, “intends”, “expects”, and words of similar impact,constitute “forward-looking statements” within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities and Exchange Actof 1934. Such forward-looking statements involve known and unknown risks,uncertainties and other factors that may cause the actual results, performanceor achievements of the Company to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements. Such factors include, among others, the following:general economic and business conditions in those areas in which the Companyoperates, demographic changes, competition, fluctuations in interest rates,changes in business strategy or development plans, changes in governmentalregulation, credit quality, the availability of capital to fund the expansionof the Company’s business, economic, political and global changes arising fromthe terrorist attacks of September 11, 2001 and their aftermath****and other factors referenced in the Company’s filings withthe SEC. The Company disclaims any obligation to update any such factors or topublicly announce the results of any revisions to any of the forward-lookingstatements contained herein to reflect future events or developments.**

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

Heritage Oaks Bancorp (the “Company”)commenced operations on November 15, 1994 with the acquisition of Heritage OaksBank (the “Bank”).  Each shareholder ofthe Bank received one share of stock in the Company in exchange for each shareof Heritage Oaks Bank stock owned.  TheBank became a wholly owned subsidiary of the Company.  The Bank is the only active bank subsidiary owned by the Company.On April 10, 2002, Heritage Oaks Capital Trust I, a non-bank subsidiary, wasformed and is a wholly owned subsidiary of the Company.

 

SUMMARY OF FINANCIAL RESULTS

 

As of June 30, 2002, total consolidatedassets of Heritage Oaks Bancorp were $282.7 million compared to $214.9 millionat December 31, 2001. This reflects an increase of $67.8 million or 31.5%.

 

On April 10, 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 an applicable exemption fromregistration under the Securities Act of 1933, as amended (the “Act”), and havenot been registered under the Act. Sandler O’Neill assisted the Company in the placement of the trustpreferred securities. The securities may not be offered or sold in the UnitedStates absent registration or an applicable exemption from registrationrequirements.

 

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 $8.0million accounts for approximately 4% of the increase in total assets.

 

As the result of the issuance of $8.0million in trust preferred securities, on April 11, 2002, the Companydown-streamed $5.2 million to the Bank in the form of Tier I Capital. Thisenabled the Bank to implement a leveraging strategy of $38 million whereby theBank borrowed $38 million from the Federal Home Loan Bank (FHLB) and purchasedapproximately $40 million in investment securities. The purchased investmentsecurities serve as collateral for the borrowing. This $38 million leveragingstrategy accounts for approximately 56% of the increase in total assets.

 

The remaining increase in total assets ofapproximately $21.8 million or 10.1% is the result of continued growth indeposits at the nine offices of the Bank.

 

Total cash and due from banks at June 30,2002 was $19.7 million, up from $14.4 million at December 31, 2001. This lineitem will vary depending on cash letters from the previous night and actualcash on hand in the branches. The balance in the Fed account had a closingbalance of $7.0 million to meet the target for Reserve Requirements.

 

Total net loans at June 30, 2002 were $166.8million compared to $156.1 million at December 31, 2001. This represents anincrease of $10.7 million or 6.8%.

 

11

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Securities available for sale, which arecarried at market value, were $59.3 million at June 30, 2002 compared to $22.0million at December 31, 2001. This significant increase is the result of theleverage strategy implemented during April 2002.  As a result of the trust preferred transaction, the Companydown-streamed $5.2 million to the Bank in the form of Tier I Capital. Toleverage this, the Bank borrowed $38 million from the Federal Home Loan Bank(FHLB) and purchased approximately $20 million in 0% risked weighted adjustablerate securities and $20 million in 20% risk weighted hybrid adjustable rateU.S. Agency securities.

 

Federal funds sold were $19.0 million atJune 30, 2002 and $6.0 million at December 31, 2001.

 

Total deposits were  $217.3 million at June 30, 2002 compared to$195.6 at December 31, 2001. This represents an increase of $21.7 million or 11.1%. Demand deposits grewby $22.1 million or 31.6% from year-end. Approximately $12.7 million or 6.5% ofthat growth is the result of increased title company balances due to robustmortgage activity. The remainder is growth throughout the nine-branch system.Savings NOW and money market deposits increased by $2.8 million or 3.7% andtime deposits of >$100,000 increased by $1.0 million or 13.6%. The Bankbelieves that the declining returns in the stock market in general are creatinga “flight to safety” to FDIC insured deposits. However, time deposits of <$100,000 decreased by $4.2 million. Thedecrease in this category is primarily due to maturities during the secondquarter 2002 of higher rate time deposits that did not renew at the lowerrates. With increased liquidity as the result of core deposit growth, timedeposits were priced such that Management was aware that these balances woulddecrease.

 

Core deposits (time deposits less than$100,000, demand, and savings) gathered in the local communities served by theBank continue to be the Bank’s primary source of funds for loans andinvestments.  Core deposits of $209.1million represent 96.2% of total deposits at June 30, 2002. The Company doesnot purchase funds through deposit brokers.

 

The Company had a $2 million loan withPacific Coast Bankers Bank that carried an outstanding balance of $1,894,811and $1,792,720 on December 31, 2001 and April 10, 2002, respectively. This loanwas paid in full on April 11, 2002 using a portion of the proceeds from thetrust preferred transaction.

 

The Bank has established borrowing lineswith the Federal Home Loan Bank (FHLB) of approximately $42.4 million and $1.7million secured by securities and certain loans, respectively. At June 30,2002, the Bank had borrowings of $38 million against those lines with aremaining borrowing capacity of approximately $6.1 million.

 

RECENT EVENTS

 

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 will beAugust 2, 2002 and the pay date is scheduled for August 15, 2002.  Holders of shares of common stock ofHeritage Oaks Bancorp will be issued one additional share of common stock foreach share of common owned on the record date of August 2, 2002.

 

A Press Release was issued on July 19, 2002.

 

RESULTS OF OPERATIONS

 

The Company reported net income for the sixmonths ending June 30, 2002 of $1,199,641 compared to $1,115,114 for thesame period in 2001. This represents an increase of $84,527 or 7.6%. Per shareearnings on a diluted basis for the six months ending June 30, 2002 and June30, 2001 were $0.40 and $0.38, respectively. Basic per share earnings for thesix months ending June 30, 2002 and June 30, 2001 were $0.44 and $0.41,respectively.

 

Net income for the three monthsending June 30, 2002 was $631,420, compared to $518,696 for the 

 

12

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same period in 2001.  This represents an increase of $112,724 or21.7%. Per share earnings on a diluted basis for the three months ending June30, 2002 and June 30, 2001 were $0.21 and $0.18, respectively. Basic per shareearnings for the three months ending June 30, 2002 and June 30, 2001 were $0.23and $0.19, respectively.

 

**Allearnings per share stated in this document are reflective of the two-for-onestock split declared on July 19, 2002.**

 

The following discussion highlights changesin certain items in the consolidated statements of income.

 

Net interest income

 

Net interest income, the primary componentof the net earnings of a financial institution, refers to the differencebetween the interest paid on deposits and borrowings, and the interest earnedon loans and investments.  The netinterest margin is the amount of net interest income expressed as a percentageof average earning assets.  Factorsconsidered in the analysis of net interest income are the composition andvolume of earning assets and interest-bearing liabilities, the amount ofnon-interest bearing liabilities and non-accrual loans, and changes in marketinterest rates.

 

Net interest income for the six monthsending June 30,2002 was $5,899,240 as compared to $5,288,807 for the sameperiod in 2001. This represents an improvement of $610,433 or 11.5%. As apercentage of average earning assets, the net interest margin for the first sixmonths of 2002 decreased to 5.53% from 6.47% in the same period one yearearlier. The Bank still maintains a very favorable net interest margin eventhough there has been a 475 basis point decrease in prime rate from January2001 through December 2001. During the first six months of 2001, prime ratedropped from 9.50% to 6.75% while prime rate has been 4.75% for the entire sixmonths of 2002. Approximately 81% of the loan portfolio is tied to prime thatis impacted immediately whenever there is a change to prime while interestbearing liabilities, specifically Time Certificate of Deposits re-price at thetime of maturity. For the first six months of 2002, the average yield oninterest earning assets decreased 219 basis points from the same period in 2001while the average rate on interest bearing liabilities dropped only 176 basispoints for the same period.

 

Average interest earning assets for the sixmonths ending June 30, 2002 were $213.3 million compared to $163.5 millionfor the same period in 2001. This represents an increase of $49.8 million or30.5%. Average loans increased $25.8 million, however, due to the interest rateenvironment, interest income and fees on loans actually decreased $483,898 forthe first six months of 2002 compared to the same period in 2001.  Average outstanding investments for the sixmonths ending June 30, 2002 were $24 million higher than the same period in2001. This produced increased interest income of $333,887 for 2002 over 2001.Average interest-bearing liabilities for the six months ending June 30, 2002were $144.1 million compared to $115.5 million for the same period in 2001.This represents and increase of $28.6 million of which, $18.1 is in borrowings.Average interest rates on interest-bearing liabilities decreased to 1.87% forthe first six months of 2002 compared to 3.63% for the same period in 2001.

 

Net interest income for the three monthsending June 30, 2002 was $2,989,318 compared to $2,698,921 for the same periodin 2001. This represents an increase of $290,397 or 10.8%. Interest incomeincreased $160,576, mostly driven by higher outstanding balances in theinvestment portfolio. Interest expense for this three month period was $828,244at June 30, 2002 compared to $958,065 at June 30, 2001.

 

13

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**AVERAGEBALANCE SHEET INFORMATION FOR JUNE 30,**

**(dollars in thousands)**

 
|                                             |   | **2001**             |       | **2002**                 |       |
|--------------------------------------------------|--------|----------------------|------------|--------------------------|------------|
|                                             |   | **Average  Balance** |       | **Avg Yield  Rate Paid** |       | **Amount  Interest** |   | **Average  Balance** |   | **Avg Yield  Rate Paid** |   | **Amount  Interest** |   |
| Interest Earning  Assets:                        |   |                 | ** ** |                     | ** ** |   | ** ** |   |   |   |   |   | ** ** |
| Time deposits  with other banks                  |   | $                    | 198        |                     | 7.07       | % | $ | 7 |   | $ | 99 |   | 4.07 | % | $ | 2 |   |
| Investment  securities taxable                   |   | 9,195                |       | 5.87                     | %          | 270 |   | 30,186 |   | 4.84 | % | 724 |   |
| Investment  securities non-taxable               |   | 6,017                |       | 4.75                     | %          | 143 |   | 5,795 |   | 4.84 | % | 139 |   |
| Federal funds  sold                              |   | 9,195                |       | 4.59                     | %          | 211 |   | 12,451 |   | 1.62 | % | 100 |   |
| Loans (1) (2)                                    |   | 138,910              |       | 9.73                     | %          | 6,755 |   | 164,748 |   | 7.68 | % | 6,271 |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Total interest  earning assets                   |   | 163,515              |       | 9.03                     | %          | 7,386 |   | 213,279 |   | 6.84 | % | 7,236 |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Allowance for possible  loan losses              |   | -1,469               |       |                     |       |   |   | -1,946 |   |   |   |   |   |
| Non-earning  assets:                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Cash and due  from banks                         |   | 14,315               |       |                     |       |   |   | 17,042 |   |   |   |   |   |
| Property,  premises and equipment                |   | 2,938                |       |                     |       |   |   | 3,585 |   |   |   |   |   |
| Other assets                                     |   | 4,862                |       |                     |       |   |   | 8,918 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| TOTAL ASSETS                                     |   | $                    | 184,161    |                     |       |   |   |   | $ | 240,878 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Interest  -bearing liabilities:                  |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Savings/NOW/money  market                        |   | 62,328               |       | 2.00                     | %          | 623 |   | 77,738 |   | 0.56 | % | 216 |   |
| Time deposits                                    |   | 51,876               |       | 5.48                     | %          | 1,421 |   | 46,980 |   | 2.88 | % | 672 |   |
| Other borrowings                                 |   | 1,286                |       | 8.09                     | %          | 52 |   | 19,427 |   | 4.65 | % | 448 |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |   | 115,490              |       | 3.63                     | %          | 2,096 |   | 144,145 |   | 1.87 | % | 1,336 |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:               |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Demand deposits                                  |   | 52,255               |       |                     |       |   |   | 74,806 |   |   |   |   |   |
| Other  liabilities                               |   | 2,086                |       |                     |       |   |   | 1,480 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Total  liabilities                               |   | 169,831              |       |                     |       |   |   | 220,431 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Trust Preferred  Securities                      |   | 0                    |       |                     |       |   |   | 4,000 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Stockholders’  equity                       |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Common stock                                     |   | 7,112                |       |                     |       |   |   | 8,708 |   |   |   |   |   |
| Retained  earnings                               |   | 7,296                |       |                     |       |   |   | 7,840 |   |   |   |   |   |
| Valuation  Allowance Investments                 |   | (78                  | )          |                     |       |   |   | (101 | ) |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Total  stockholders’ equity                 |   | 14,330               |       |                     |       |   |   | 16,447 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                    | 184,161    |                     |       |   |   |   | $ | 240,878 |   |   |   |   |   |
|                                             |   |                 |       |                     |       |   |   |   |   |   |   |   |   |
| Net Interest  Income                             |   |                 |       |                     |       | $ | 5,290 |   |   |   |   |   | $ | 5,900 |   |
| Net Interest  Margin (3)                         |   |                 |       | 6.47                     | %          |   |   |   |   | 5.53 | % |   |   |

 

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**(1)  Nonaccrual loans have been included in totalloans.**

**(2)  Loan fees of $310,365 and $327,048 for 2001and 2002, respectively, have been included in the interest income computation.**

**(3)  Net interest income has been calculated bydividing the net interest income by total earning assets.**

 

The preceding table sets forth averagebalance sheet information, interest income and expense, average yields andrates and net interest income and margin for the six months ended June 30, 2001and 2002.

 

Non-interestIncome

 

Non-interest income for the six monthsending June 30, 2002 was $1,580,001 compared to $2,961,203 for the same periodin 2001. That represents a decrease of $1,381,202 or 46.6%. Non-interest income

 

14

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consists of bankcard merchant fees,automatic teller machine (“ATM”) transactions, mortgage origination fees andother fees and service charges on deposit accounts.

 

During 2001, the Bank was divesting itselfof the off-premise ATM Networks commonly referred to as HOAK (retail sites) andNANS (gaming sites). The HOAK sites were sold during the first quarter of 2001,while the gaming sites consisted of four remaining locations as of June 30,2001. As of June 30, 2002, there were two NANS sites remaining. For the sixmonths ending June 30, 2002 income from this line of business was $88,455compared to $1,344,770 for the same period in 2001. While this constitutes alarge variance, it should be noted that the expense related to these networkswas $55,507 for the first six months ending June 30, 2002 compared to$1,321,819 for the same period in 2001. The total ATM income for 2001 includesthe gross revenue obtained in the sale of the HOAK Network that was consummatedon March 31, 2001. Most of the revenue obtained in that transaction was offsetby related expense.

 

Service charge income on deposit accountsincreased from $566,221 during the first six months of 2001 to $642,578 for thesix months ending June 30, 2002. This increase in service charges is a resultof the Bank’s growth in the number of branches and deposit accounts. The Bankacquired four branch offices from Westamerica Bank on November 9, 2001. Threeof the branches were consolidated with existing branch offices of the Bank withone branch remaining open.

 

Bankcard merchant fees were $62,985 for thefirst six months of 2002 and $57,431 for the same period in 2001.

 

Income obtained from mortgage originationfees were $273,381 for the first six months of 2002 compared to $285,455 forthe same period in 2001.

 

Non-interest income for the three monthsending June 30, 2002 was $797,885 compared to $1,122,987 for the same period in2001. That represents a decrease of $325,102 or 29.04%.

 

Income from ATM transaction fees were$45,142 for the three months ending June 30, 2002 compared to $456,916 for thesame period in 2001. The same explanation applies in regard to the Bankdivesting itself of this line of business as is stated above for the six monthsending June 30, 2002.

 

Income from service charges on depositaccounts income was $326,365 for the three months ending June 30, 2002 comparedto $288,134 for the same period in 2001.

 

Bankcard merchant fees were $35,822 for thethree months ending June 30, 2002 compared to $31,734 for the same period in2001.

 

Mortgage origination fees were $131,353 forthe three months ending June 30, 2002 compared to $162,149 for the same periodin 2001.

 

Non-Interest Expense

 

Non-interest expense was $5,355,930 and$6,235,978 for the six months ending June 30, 2002 and the same periodin 2001, respectively. Salaries and employee benefits expense were $2,541,161and $2,195,744 for the six months ending June 30, 2002 and 2001,respectively.  Full time equivalentemployees were 109 at June 30, 2002 compared to 91 at June 30, 2001. Occupancyand equipment costs decreased to $849,739 for the six months ending June 30,2002 from $881,451 for the same period of 2001. Expense associated with the ATMnetwork was $55,507 and $1,321,819 for the six months ending June 30, 2002 and2001, respectively. This was referred to above in the non-interest incomesection as it applies to the Bank divesting itself of this line of business.Expense associated with all other non-interest expense categories was$1,909,523 and $1,836,964 for the six months ending June 30, 2002 and 2001,respectively. The increase in other expense is primarily associated with thegrowth of the Bank.

 

Non-interest expense was $2,677,534 and$2,878,704 for the three months ending June 30, 2002 and the same periodin 2001, respectively. Salaries and employee benefits expense were $1,284,100and 

 

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$1,129,929 for the three months ending June30, 2002 and 2001, respectively. Occupancy and equipment costs increased to$410,089 for the three months ending June 30, 2002 from $372,138 for the sameperiod in 2001. Expense associated with the ATM network was $28,592 and$447,391 for the three months ending June 30, 2002 and 2001, respectively. Thevariance in this category is the result of the Bank divesting itself of thisline of business. Expense associated with all other non-interest expensecategories was $954,753 and $929,246 for the three months ending June 30, 2002and 2001, 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 Santa Barbara County accountingfor the remaining approximately 62%. The moderate climate allows a year roundgrowing season for numerous vegetable and fruits. Vineyards and cattle ranchesalso contribute largely to the local economy. Vineyards in production havegrown significantly over the past several years throughout the Company’sservice area. Access to numerous recreational activities, including lakes,mountains and beaches, provide a relatively stable tourist industry from manyareas including the Los Angeles/Orange County basin, the San Francisco Bay areaand the 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.  

 

CAPITAL

 

On April 10, 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 an applicable exemption fromregistration under the Securities Act of 1933, as amended (the “Act”), and havenot been registered under the Act. Sandler O’Neill assisted the Company in the placement of the trustpreferred securities. The securities may not be offered or sold in the UnitedStates absent registration or an applicable exemption from registrationrequirements.

 

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 interestpayments pursuant to terms of the agreement, then the Company may not (i)declare or pay any dividends or distributions on, or redeem, purchase, acquireor make a liquidation payment with respect to any of the Company’s capitalstock, or (ii) make any payment of principal of or premium, if any, or intereston or repay, repurchase or redeem any debt securities of the Company that rankpari passu with or junior in interest to the Debt Securities, **other than,**among other items**,**a dividend in the form of stock,warrants, options or other rights in the same stock as that on which thedividend is being paid or ranks pari passu with or junior to such stock. Theprohibition on payment of dividends and payments on pari passu or junior debtalso applies in the case of an event of default under the agreements.

 

The Company used the proceeds from the saleof the securities for general corporate purposes, including the repayment ofoutstanding indebtedness of $1,792,720 on April 11, 2002 and capitalcontributions to the Bank for future growth.

 

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

 

The Company’s total stockholders equity was$17,525,353 at June 30, 2002 compared to $15,876,781 at December 31, 2001.  The increase in capital was from net incomeof $1,199,641, $111,004 from stock options exercised, $344,332 net change inother comprehensive income related to unrealized security holding gain, net oftax and $($6,405) in cash paid in lieu of fractional shares as the result ofthe 5% stock dividend distributed on March 29, 2002.

 

Capital ratios for commercial banks in theUnited States are generally calculated using nine different formulas.  These calculations are referred to as the“Leverage Ratio” and two “risk based” calculations known as: “Tier One RiskBased 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 Ratio calculation simplydivides common stockholders equity (reduced by any Goodwill a bank may have) bythe total average assets of the bank. In the Tier One Risk Based Capital Ratio, the numerator is the same asthe leverage ratio, but the denominator is the total “risk-weighted assets” ofthe bank.  Risk weighted assets aredetermined by segregating all the assets and off balance sheet exposures intodifferent risk categories and weighing them by a percentage ranging from 0%(lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio again uses “risk-weighted assets” inthe denominator, but expands the numerator to include other capital itemsbesides equity such as a limited amount of the loan loss reserve, long-termcapital debt, preferred stock and other instruments.

 

Summarized below are the Bank’s and Company’scapital ratios at June 30, 2002:

 
|                               |   | **Regulatory  Standard**    |   |                  |   |                     |   |
|------------------------------------|--------|-----------------------------|--------|-----------------------|--------|--------------------------|--------|
|                               |   | **Adequately  Capitalized** |   | **Well  Capitalized** |   | **Heritage  Oaks  Bank** |   | **Heritage  Oaks  Bancorp** |   |
| Leverage Ratio                     |   | 4.00                        | %      | 5.00                  | %      | 8.85                     | %      | 8.51 | % |
|                               |   |                        |   |                  |   |                     |   |   |   |
| Tier One Risk  Based Captial Ratio |   | 4.00                        | %      | 6.00                  | %      | 11.76                    | %      | 11.27 | % |
|                               |   |                        |   |                  |   |                     |   |   |   |
| Total Risk Based  Captial Ratio    |   | 8.00                        | %      | 10.00                 | %      | 12.82                    | %      | 13.75 | % |

 

Approximately $5.2 million and $2.8 millionof the trust preferred securities are accounted for as Tier I and Tier IICapital, respectively, for purposes of calculating Regulatory Capital.

 

It is the intent of Management to maintaina  “Well Capitalized” status.

 

LIQUIDITY

 

The objective of liquidity management is toensure the continuous availability of funds to meet the demands of depositors,investors and borrowers.  Asset liquidityis primarily derived from loan payments and the maturity of other earningassets.  Liquidity from liabilities isobtained primarily from the receipt of new deposits.  The Bank’s Asset Liability Committee (ALCO) is responsible formanaging the on-and off-

 

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balance sheet commitments to meet the needsof customers while achieving the Bank’s financial objectives. ALCO meetsregularly to assess the projected funding requirements by reviewing historicalfunding patterns, current and forecasted economic conditions, and individualcustomer funding needs.  Depositsgenerated from Bank customers serve as the primary source of liquidity.  The Bank has credit arrangements withcorrespondent banks that serve as a secondary liquidity source in the amount of$5 million. During the first six months of 2002, the average funds borrowedfrom correspondent banks was $31,492.

 

As of July 1999, the bank became a member ofthe Federal Home Loan Bank (FHLB) of San Francisco. Certain securities andloans were pledged as collateral during the first quarter of 2000. The averagefunds borrowed through these facilities during the first six months of 2002 was$18 million. Using its borrowing capacity at the FHLB, the Bank initiated a leveragestrategy in April 2002 that is discussed under “Summary of Financial Results”within this document.

 

The Bank manages its liquidity bymaintaining a majority of its investment portfolio in federal funds sold andother liquid investments.  At June 30,2002, the ratio of liquid assets to deposits and other liabilities was 16.7%.The ratio of gross loans to deposits, another key liquidity ratio, was 78.9% atJune 30, 2002.

 

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, which 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.  In addition, inflationaffects the growth of total assets by increasing the level of loan demand, andmay potentially adversely affect the Bank’s capital adequacy because loangrowth in inflationary periods may increase more rapidly than capital.  The effect on inflation during the periodended June 30, 2002 has not been significant to the Bank’s financial positionor result of operations.

 

PART2.  OTHER INFORMATION

 

ITEM1.  LEGAL PROCEEDINGS

 

The Company is not aware of any legalproceeding against it that will have a material effect on the Company’sfinancial statements.

 

ITEM2.  CHANGES IN SECURITIES AND USE OFPROCEEDS

 

a)               The Company has nothing to report

 

b)              and c) 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 of interest,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.

 

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TheCompany is reflecting the trust preferred securities as financing debt on itsconsolidated balance sheet.

 

Ifthe Company elects to defer interest payments pursuant to terms of theagreement, 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.

 

TheCompany used the proceeds from the sale of the securities for general corporatepurposes, including the repayment of outstanding indebtedness of $1,792,720 onApril 11, 2002 and capital contributions to the Bank for future growth.

 

TheCompany issued a press release announcing the sale on April 10, 2002.

 

d)              The Company has nothing to report.

 

ITEM3.  DEFAULTS UPON SENIOR SECURITIES

 

The Company has nothing to report.

 

ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS

 

The Company has nothing to report.

 

ITEM5.  OTHER INFORMATION

 

On July 19 the Company announced that theBoard of Directors approved a two-for-one stock split for shareholders ofrecord as of August 2, 2002.  The paydate is scheduled for August 15, 2002.

 

 

ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)          Exhibits:

 

Exhibit99.1 Certification of Chief Executive Officer pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

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Exhibit99.2 Certification of Chief Financial Officer pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

        (b)                                 Reports on Form 8-K:

 

TheCompany filed the announcement of the sale of $8.0 million of trust preferredsecurities on Form 8-K with the SEC on April 15, 2002.

 

 

SIGNATURES

 

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

 

HERITAGE OAKS BANCORP

 

DATE: August 12, 2002

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

 

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