###### **SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

 

##### **FORM 10-QSB**

 

 

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

 

**For the quarterly period ended September 30,2001**

 

o**  TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Transition Period from           to  ___**

 

**Commission File No. 0-25020**

 

##### **HERITAGE OAKS BANCORP**

(Exact name ofregistrant 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 check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12)months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast ninety (90) days.

YES ý     NO o

 

Aggregate market value of Common Stock of HeritageOaks Bancorp at October 15, 2001: $30,500,180.

 

Indicate thenumber of shares outstanding of each of the issuer's classes of common stock,as of the latest practicable date:

 

**No par value Common Stock - 1,297,880 sharesoutstanding at October 15, 2001.**

## ** **

## ** **

## ** **

## **TABLE OF CONTENTS**

 

 
| Consolidated Balance Sheets  as of December 31, 2000 and September 30, 2001                                                  |                                                                                        |   |
|------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|--------|
|                                                                                                                         |                                                                                        |   |
| Consolidated  Statements of Income for the three months ended September 30, 2000 and  September 30, 2001           |                                                                                        |   |
|                                                                                                                         |                                                                                        |   |
| Consolidated Statements  of Income for the nine months ended September 30, 2000 and  September 30, 2001            |                                                                                        |   |
|                                                                                                                         |                                                                                        |   |
| Consolidated  Statements of Cash Flows for nine months ended September 30, 2000 and  September 30, 2001            |                                                                                        |   |
|                                                                                                                         |                                                                                        |   |
| Consolidated  Statements of Stockholders’ Equity for periods ended September 30, 2000 and  September 30, 2001 |                                                                                        |   |
|                                                                                                                         |                                                                                        |   |
| 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**                                                                       |   |
|                                                                                                                         |                                                                                        |   |
| Signatures                                                                                                                   |                                                                                        |
|                                                                                                                              |                                                                                             |        |  |

 

 

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                       |   | **12/31/2000** |        | **09/30/2001**  |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------|-------------|-----------------|--------|
| ASSETS                                                                                                                                     |   | **(1)**        |        | **(Unaudited)** |   |
| Cash and due from banks                                                                                                                    |   | $              | 19,435,534  |            | $      | 16,759,764 |   |
| Federal funds sold                                                                                                                         |   | 4,600,000      |        | 9,175,000       |   |
|                                                                                                                                       |   |           |        |            |   |
| Total cash and cash equivalents                                                                                                            |   | 24,035,534     |        | 25,934,764      |   |
|                                                                                                                                       |   |           |        |            |   |
| Interest bearing deposits other banks                                                                                                      |   | 198,000        |        | 198,000         |   |
|                                                                                                                                       |   |           |        |            |   |
| Securities Available for sale                                                                                                              |   | 16,212,505     |        | 13,225,279      |   |
| Securities held to maturity (see note 2)                                                                                                   |   | 0              |        | 0               |   |
| Federal Home Loan Bank Stock, cost                                                                                                         |   | 381,600        |        | 225,300         |   |
| Loans Held For Sale                                                                                                                        |   | 2,474,542      |        | 2,618,600       |   |
| Loans, net (see note 3)                                                                                                                    |   | 133,680,029    |        | 147,551,578     |   |
|                                                                                                                                       |   |           |        |            |   |
| Property, premises and equipment, net                                                                                                      |   | 3,062,815      |        | 2,657,362       |   |
| Other real estate owned                                                                                                                    |   | 0              |        | 0               |   |
| Cash surrender value life insurance                                                                                                        |   | 1,369,549      |        | 2,609,736       |   |
| Other assets                                                                                                                               |   | 2,673,451      |        | 2,521,951       |   |
|                                                                                                                                       |   |           |        |            |   |
| TOTAL ASSETS                                                                                                                               |   | $              | 184,088,025 |            | $      | 197,542,570 |   |
|                                                                                                                                       |   |           |        |            |   |
| LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                       |   |           |        |            |   |
| Deposits:                                                                                                                                  |   |           |        |            |   |
| Demand, non-interest bearing                                                                                                               |   | $              | 51,821,233  |            | $      | 66,665,704 |   |
| Savings, NOW, and money market deposits                                                                                                    |   | 63,715,930     |        | 67,895,547      |   |
| Time deposits of $100,000 or more                                                                                                          |   | 7,659,791      |        | 5,079,098       |   |
| Time deposits under $100,000                                                                                                               |   | 44,499,935     |        | 39,667,575      |   |
| Total deposits                                                                                                                             |   | 167,696,889    |        | 179,307,924     |   |
|                                                                                                                                       |   |           |        |            |   |
| Other borrowed money                                                                                                                       |   | 1,050,000      |        | 1,300,000       |   |
| Securities Sold under Agreement to Repurchase                                                                                              |   | 0              |        | 0               |   |
| Other liabilities                                                                                                                          |   | 1,886,127      |        | 1,418,168       |   |
| Total liabilities                                                                                                                          |   | 170,633,016    |        | 182,026,092     |   |
|                                                                                                                                       |   |           |        |            |   |
| Stockholders' equity                                                                                                                       |   |           |        |            |   |
| Common stock, no par value;                                                                                                                |   |           |        |            |   |
| 20,000,000 shares authorized; issued  and outstanding 1,224,999 and 1,297,880 for December 31, 2000 and September  30, 2001, respectively. |   | 6,305,233      |        | 7,510,439       |   |
| Accumulated other comprehensive income                                                                                                     |   | (141,364       | )           | 116,582         |   |
| Retained earnings                                                                                                                          |   | 7,291,140      |        | 7,889,457       |   |
| Total stockholders' equity                                                                                                                 |   | 13,455,009     |        | 15,516,478      |   |
|                                                                                                                                       |   |           |        |            |   |
| TOTAL LIABILITIES & STOCKHOLDERS' EQUITY                                                                                               |   | $              | 184,088,025 |            | $      | 197,542,570 |   |

----

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

See notes toconsolidated financial statements

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Forthe three months ended September 30,**

 
|                                                       |   | **2000**        |      | **2001**        |   |
|------------------------------------------------------------|--------|-----------------|-----------|-----------------|--------|
|                                                       |   | **(Unaudited)** |      | **(Unaudited)** |   |
| Interest Income:                                           |   |            |      |            |   |
|                                                       |   |            |      |            |   |
| Interest and fees on loans                                 |   | $               | 3,330,366 |            | $      | 3,332,310 |   |
| Investment securities                                      |   | 231,582         |      | 175,504         |   |
| Federal funds sold and commercial paper                    |   | 77,228          |      | 90,707          |   |
| Time certificates of deposit                               |   | 2,743           |      | 3,335           |   |
| Total interest income                                      |   | 3,641,919       |      | 3,601,856       |   |
|                                                       |   |            |      |            |   |
| Interest Expense:                                          |   |            |      |            |   |
|                                                       |   |            |      |            |   |
| Now accounts                                               |   | 216,693         |      | 122,068         |   |
| MMDA accounts                                              |   | 79,908          |      | 50,046          |   |
| Savings accounts                                           |   | 76,010          |      | 35,373          |   |
| Time deposits of $100,000 or more                          |   | 76,020          |      | 49,877          |   |
| Other time deposits                                        |   | 595,411         |      | 489,899         |   |
| Other borrowed funds                                       |   | 32,812          |      | 20,398          |   |
| Total interest expense                                     |   | 1,076,854       |      | 767,661         |   |
|                                                       |   |            |      |            |   |
| Net Interest Income Before Prov. for Possible Loan Losses  |   | 2,565,065       |      | 2,834,195       |   |
| Provision for loan losses                                  |   | 105,000         |      | 150,000         |   |
| Net interest income after provision for loan losses        |   | 2,460,065       |      | 2,684,195       |   |
|                                                       |   |            |      |            |   |
| Non-interest Income:                                       |   |            |      |            |   |
| Service charges on deposit accounts                        |   | 295,422         |      | 310,083         |   |
| Investment securities gains (losses), net                  |   | 0               |      | 0               |   |
| Other income                                               |   | 1,185,177       |      | 626,284         |   |
| Total Non-interest Income                                  |   | 1,480,599       |      | 936,367         |   |
|                                                       |   |            |      |            |   |
| Non-interest  Expense:                                |   |            |      |            |   |
| Salaries and employee benefits                             |   | 1,091,684       |      | 1,110,518       |   |
| Occupancy and equipment                                    |   | 399,754         |      | 411,347         |   |
| Other expenses                                             |   | 1,432,540       |      | 1,073,474       |   |
| Total Noninterest Expenses                                 |   | 2,923,978       |      | 2,595,339       |   |
| Income before provision for income taxes                   |   | 1,016,686       |      | 1,025,223       |   |
| Provision for applicable income taxes                      |   | 383,148         |      | 400,721         |   |
| Net Income                                                 |   | $               | 633,538   |            | $      | 624,502 |   |
|                                                       |   |            |      |            |   |
| Earnings per share:     (See  note #4) |   |            |      |            |   |
| Basic                                                      |   | $               | 0.49      |            | $      | 0.48 |   |
| Fully Diluted                                              |   | $               | 0.46      |            | $      | 0.45 |   |

 

See notes to consolidated financialstatements

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Forthe nine months ended September 30,**

 
|                                                             |   | **2000**        |      | **2001**        |   |
|------------------------------------------------------------------|--------|-----------------|-----------|-----------------|--------|
|                                                             |   | **(Unaudited)** |      | **(Unaudited)** |   |
| Interest Income:                                                 |   |            |      |            |   |
|                                                             |   |            |      |            |   |
| Interest and fees on loans                                       |   | $               | 9,160,714 |            | $      | 10,087,184 |   |
| Investment securities                                            |   | 770,236         |      | 588,736         |   |
| Federal funds sold and commercial paper                          |   | 149,855         |      | 301,337         |   |
| Time certificates of deposit                                     |   | 7,965           |      | 10,295          |   |
| Total interest income                                            |   | 10,088,770      |      | 10,987,552      |   |
|                                                             |   |            |      |            |   |
| Interest Expense:                                                |   |            |      |            |   |
|                                                             |   |            |      |            |   |
| Now accounts                                                     |   | 567,398         |      | 470,440         |   |
| MMDA accounts                                                    |   | 168,603         |      | 188,626         |   |
| Savings accounts                                                 |   | 228,625         |      | 171,829         |   |
| Time deposits of $100,000 or more                                |   | 308,050         |      | 187,965         |   |
| Other time deposits                                              |   | 1,476,234       |      | 1,772,926       |   |
| Other borrowed funds                                             |   | 223,462         |      | 72,763          |   |
| Total interest expense                                           |   | 2,972,372       |      | 2,864,549       |   |
|                                                             |   |            |      |            |   |
| Net Interest Income Before Prov. For Possible Loan Losses        |   | 7,116,398       |      | 8,123,003       |   |
| Provision for loan losses                                        |   | 219,000         |      | 450,000         |   |
| Net interest income after provision for loan losses              |   | 6,897,398       |      | 7,673,003       |   |
|                                                             |   |            |      |            |   |
| Non-interest Income:                                             |   |            |      |            |   |
| Service charges on deposit accounts                              |   | 795,807         |      | 876,295         |   |
| Investment securities gains (losses), net                        |   | -2,188          |      | -1,606          |   |
| Other income                                                     |   | 3,450,799       |      | 3,022,879       |   |
| Total Non-interest Income                                        |   | 4,244,418       |      | 3,897,568       |   |
|                                                             |   |            |      |            |   |
| Non-interest  Expense:                                      |   |            |      |            |   |
| Salaries and employee benefits                                   |   | 3,134,555       |      | 3,306,262       |   |
| Occupancy and equipment                                          |   | 1,262,062       |      | 1,294,799       |   |
| Other expenses                                                   |   | 4,190,606       |      | 4,230,257       |   |
| Total Noninterest Expenses                                       |   | 8,587,223       |      | 8,831,318       |   |
| Income before provision for income taxes                         |   | 2,554,593       |      | 2,739,253       |   |
| Provision for applicable income taxes                            |   | 881,481         |      | 999,639         |   |
| Net Income                                                       |   | $               | 1,673,112 |            | $      | 1,739,614 |   |
|                                                             |   |            |      |            |   |
| Earnings per share:      (See  note #4) |   |            |      |            |   |
| Basic                                                            |   | $               | 1.30      |            | $      | 1.34 |   |
| Fully Diluted                                                    |   | $               | 1.22      |            | $      | 1.25 |   |

 

See notes to consolidated financialstatements.

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

**Periods ended September 30,**

 
|                                                                                                |   | **2000**        |       | **2001**        |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------------|------------|-----------------|--------|
|                                                                                                |   | **(Unaudited)** |       | **(Unaudited)** |   |
| **Cash Flows from Operating Activities**                                                            |   |            |       |            |   |
| Net income                                                                                          |   | $               | 1,673,112  |            | $      | 1,739,614 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities                   |   |            |       |            |   |
| Net cash provided by operating activities                                                           |   |            |       |            |   |
| Depreciation and amortization                                                                       |   | 531,823         |       | 650,965         |   |
| Provision for possible loan losses                                                                  |   | 219,000         |       | 450,000         |   |
| Provision for possible OREO losses                                                                  |   | 0               |       | 0               |   |
| Realized (gain) loss on sales of available-for-sale  securities, net                                |   | 2,188           |       | 1,606           |   |
| Gain on sales of property, premise and equipment                                                    |   | 0               |       | 0               |   |
| Amortization of premiums/discounts on investment  securities, net                                   |   | (106,525        | )          | (97,681         | )      |
| (Increase)/decrease in loans held for sale                                                          |   | (1,516,468      | )          | (144,058        | )      |
| (Increase)/decrease in deferred tax asset                                                           |   | 85,210          |       | 80,839          |   |
| (Increase)/decrease in other assets                                                                 |   | (264,922        | )          | 70,661          |   |
| Increase/(decrease) in other liabilities                                                            |   | 175,675         |       | (738,125        | )      |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                                                       |   | 799,093         |       | 2,013,821       |   |
| **Cash Flows From Investing Activities**                                                            |   |            |       |            |   |
| Purchase of securities held-to-maturity                                                             |   |            |       |            |   |
| Purchase of mortgage-backed securities held-to-maturity                                             |   |            |       |            |   |
| Purchase of securities available-for-sale                                                           |   | 0               |       | 0               |   |
| Purchase of mortgage-backed securities available-for-sale                                           |   | 0               |       | 0               |   |
| Proceeds from principal reductions and maturities of  securities held-to-maturity                   |   | 0               |       | 0               |   |
| Proceeds from principal reductions and maturities of  mortgage-backed securities held-to-maturity   |   | 0               |       | 0               |   |
| Proceeds from sales of securities available-for-sale                                                |   | 1,000,000       |       | 560,700         |   |
| Proceeds from principal reductions and maturities of  securities available-for-sale                 |   | 654,500         |       | 1,236,292       |   |
| Proceeds from sales of mortgage-backed securities  available-for-sale                               |   | 0               |       | 0               |   |
| Proceeds from principal reductions and maturities of  mortgage-backed securities available-for-sale |   | 1,478,846       |       | 1,814,421       |   |
| Net change in interest bearing deposits in other financial  institutions                            |   | 177,255         |       | 156,300         |   |
| Purchase of life insurance policies                                                                 |   | (47,445         | )          | (1,240,187      | )      |
| Proceeds from sale of other real estate owned                                                       |   |            |       |            |   |
| Recoveries on loans previously written off                                                          |   | 0               |       | 0               |   |
| Increase in loans, net                                                                              |   | (25,081,194     | )          | (14,321,549     | )      |
| Purchase of property, premises and equipment, net                                                   |   | (265,211        | )          | (245,512        | )      |
| **NET CASH USED IN INVESTING ACTIVITIES**                                                           |   | (22,083,249     | )          | (12,039,535     | )      |
| **Cash Flows From Financing Activities**                                                            |   |            |       |            |   |
| Increase in deposits, net                                                                           |   | $               | 26,619,533 |            | $      | 11,611,035 |   |
| Net increase/(decrease) in other borrowings                                                         |   | (2,211,000      | )          | 250,000         |   |
| Net (decrease)/increase in notes payable                                                            |   | 0               |       | 0               |   |
| Proceeds from exercise of stock options                                                             |   | 85,766          |       | 68,584          |   |
| Cash paid in lieu of fractional shares                                                              |   | (3,923          | )          | (4,675          | )      |
| Cash dividends paid or declared                                                                     |   |            |       |            |   |
| **NET CASH PROVIDED BY FINANCING ACTIVITIES**                                                       |   | 24,490,376      |       | 11,924,944      |   |
| **Net (Decrease)/Increase in Cash and Cash  Equivalents**                                           |   | 3,206,220       |       | 1,899,230       |   |
| **Cash  and Cash Equivalents, Beginning of year**                                                   |   | 18,359,073      |       | 24,035,534      |   |
| **Cash and Cash Equivalents, End of year**                                                          |   | $               | 21,565,293 |            | $      | 25,934,764 |   |
|                                                                                                |   | $               | 21,565,293 |            | $      | 25,934,764 |   |

 

See notes to condensed financial statements

 

**HERITAGEOAKS BANCORP**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS' EQUITY**

**September30, 2000 and September 30, 2001**

**(Unaudited)**

 
|                                                                          |   |            |       |       |          |         |   | **Accumulated**   |       |              |   |
|-------------------------------------------------------------------------------|--------|-----------------|------------|------------|---------------|--------------|--------|-------------------|------------|-------------------|--------|
|                                                                          |   |            |       |       |          |         |   | **Other**         |       | **Total**         |   |
|                                                                          |   | **Shares**      |       | **Common** |          | **Retained** |   | **Comprehensive** |       | **Stockholders'** |   |
|                                                                          |   | **Outstanding** |       | **Stock**  |          | **Earnings** |   | **Income**        |       | **Equity**        |   |
| Balance January 1, 2000                                                       |   | 1,144,282       |       | $          | 5,288,179     |         | $      | 5,912,823         |       | ($658,840         | )      | $ | 10,542,162 |   |
|                                                                          |   |            |       |       |          |         |   |              |       |              |   |
| Exercise of Stock Options                                                     |   | 20,933          |       | 85,766     |          | 0            |   |              |       | 85,766            |   |
|                                                                          |   |            |       |       |          |         |   |              |       |              |   |
| Cash dividends paid                                                           |   | 0               |       | 0          |          | 0            |   |              |       | 0                 |   |
|                                                                          |   |            |       |       |          |         |   |              |       |              |   |
| Stock dividend- 5%                                                            |   | 57,452          |       | 861,780    |          | (861,780     | )      |              |       | 0                 |   |
| Cash paid to Shareholders' in Lieu  of fractional shares on 4% Stock Dividend |   |            |       |       |          | (3,923       | )      |              |       | (3,923            | )      |
|                                                                          |   |            |       |       |          |         |   |              |       |              |   |
| Comprehensive Income                                                          |   |            |       |       |          |         |   |              |       |              |   |
| Net Income                                                                    |   |            |       |       |          | 1,673,112    |   |              |       | 1,673,112         |   |
| Unrealized Security Holding  Gains/(Losses) '(net of $44,167 tax)             |   |            |       |       |          |         |   | 240,752           |       | 240,752           |   |
| Less Reclassification Adjustment for  Losses (net of $875 tax)                |   |            |       |       |          |         |   | (1,313            | )          | (1,313            | )      |
|                                                                          |   |            |       |       |          |         |   |              |       |              |   |
| Total other comprehensive Income                                              |   |            |       |       |          |         |   |              |       | 1,912,551         |   |
|                                                                          |   |            |       |       |          |         |   |              |       |              |   |
| **Balance September 30, 2000**                                                |   | **1,222,667**   | ** ** | **$**      | **6,235,725** | ** **   | **$**  | **6,720,232**     | ** ** | **($419,401**     | **)**  | **$** | **12,536,556** | ** ** |

 
|                                                                          |   |            |       |       |          |         |   | **Accumulated**   |       |              | ** **  |
|-------------------------------------------------------------------------------|--------|-----------------|------------|------------|---------------|--------------|--------|-------------------|------------|-------------------|-------------|
|                                                                          |   |            |       |       |          |         |   | **Other**         |       | **Total**         | ** **  |
|                                                                          |   | **Shares**      |       | **Common** |          | **Retained** |   | **Comprehensive** |       | **Stockholders'** | ** **  |
|                                                                          |   | **Outstanding** |       | **Stock**  |          | **Earnings** |   | **Income**        |       | **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            |        |
|                                                                          |   |            |       |       |          |         |   |              |       |              |        |
| Cash dividends paid                                                           |   | 0               |       | 0          |          | 0            |   |              |       | 0                 |        |
|                                                                          |   |            |       |       |          |         |   |              |       |              |        |
| 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 |   |            |       |       |          | (4,675       | )      |              |       | (4,675            | )           |
|                                                                          |   |            |       |       |          |         |   |              |       |              |        |
| Comprehensive Income                                                          |   |            |       |       |          |         |   |              |       |              |        |
| Net Income                                                                    |   |            |       |       |          | 1,739,614    |   |              |       | 1,739,614         |        |
| Unrealized Security Holding  Gains/(Losses) '(net of $171,964 tax)            |   |            |       |       |          |         |   | 257,946           |       | 257,946           |        |
|                                                                          |   |            |       |       |          |         |   |              |       |              |        |
| Total other comprehensive Income                                              |   |            |       |       |          |         |   |              |       | 1,997,560         |        |
|                                                                          |   |            |       |       |          |         |   |              |       |              |        |
| **Balance September 30, 2001**                                                |   | **1,297,880**   | ** ** | **$**      | **7,510,438** | ** **   | **$**  | **7,889,458**     | ** ** | **$**             | **116,582** | ** ** | **$** | **15,516,478** | ** ** |
|                                                                               |        |                 |            |            |               |              |        |                   |            |                   |             |  |  |  |  |

 

See notes to consolidated financialstatements

 

Note 1:CONSOLIDATED FINANCIAL STATEMENTS

 

In the opinion ofManagement, the unaudited consolidated financial statements contain all(consisting of only normal recurring adjustments) adjustments necessary topresent fairly Heritage Oaks Bancorp’s (the “Company”) onsolidated financialposition at December 31, 2000 and September 30, 2001, and the results of cashflows for the nine months ended September 30, 2000 and 2001 and the results ofoperations for the three and nine months ended September 30, 2000 and 2001.

 

Certaininformation and footnote disclosures normally presented in financial statementsprepared in accordance with generally accepted accounting principles have beenomitted.  These interim consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and notes thereto included in the Company’s 2000 AnnualReport to shareholders.  The results forthe three and nine months ended September 30, 2000 and 2001 may not necessarilybe indicative of the operating results for the full year.

 

Note 2:INVESTMENT SECURITIES

 

The Companyadopted Statement of Financial Accounting Standards (SFAS)  No. 115 “Accounting for Certain Investmentsin Debt and Equity Securities “ onJanuary 1, 1994, which addresses theaccounting for investments in equity securities that have readily determinablefair values and for investments 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 thepurpose of selling in the near term are classified as trading securities andare measured at fair value, with unrealized gains and losses included in earnings;,debt and equity securities not classified as either held-to-maturity or tradingsecurities are deemed as available-for-sale and are measured at fair value,with unrealized gains and losses, net of applicable taxes, reported in aseparate component of stockholders’ equity. Any gains and losses on sales of investments are computed on a specificidentification basis.

 

The amortizedcost and fair values of investment securities available for sale at September30, 2001 and December 31, 2000:

 
| **September  30, 2001**                                  |   |          |           | **Gross**      |   | **Gross**      |       |          |   |
|----------------------------------------------------------|--------|---------------|----------------|----------------|--------|----------------|------------|---------------|--------|
|                                                     |   | **Amortized** |           | **Unrealized** |   | **Unrealized** |       | **Fair**      |   |
|                                                     |   | **Cost**      |           | **Gains**      |   | **Losses**     |       | **Value**     |   |
| Obligations of U.S. government agencies and corporations |   | $             | 998,185        |           | $      | 0              |       | ($38,949      | )      | $ | 959,236 |   |
| Mortgage-backed securities                               |   | 6,329,027     |           | 74,584         |   | (56,070        | )          | 6,347,541     |   |
| Obligations of State and Political Subdivisions          |   | 5,695,127     |           | 227,621        |   | (12,884        | )          | 5,909,864     |   |
| Other Securities                                         |   | 8,638         |           | 0              |   | 0              |       | 8,638         |   |
| **TOTAL**                                                |   | **$**         | **13,030,977** | ** **     | **$**  | **302,205**    | ** ** | **($107,903** | **)**  | **$** | **13,225,279** | ** ** |

 
| **December 31, 2000**                                    |   |          |           | **Gross**      | ** ** | **Gross**      | ** ** |          | ** ** |
|----------------------------------------------------------|--------|---------------|----------------|----------------|------------|----------------|------------|---------------|------------|
|                                                     |   | **Amortized** | ** **     | **Unrealized** |       | **Unrealized** |       | **Fair**      | ** ** |
|                                                     |   | **Cost**      | ** **     | **Gains**      |       | **Losses**     |       | **Value**     | ** ** |
| Obligations of U.S. government agencies and corporations |   | $             | 2,392,808      |           | $          | 0              |       | ($76,721      | )          | $ | 2,316,087 |   |
| Mortgage-backed securities                               |   | 7,958,658     |           | 6,468          |       | (239,825       | )          | 7,725,301     |       |
| Obligations of State and Political Subdivisions          |   | 6,088,006     |           | 90,786         |       | (16,313        | )          | 6,162,479     |       |
| Other Securities                                         |   | 8,638         |           | 0              |       | 0              |       | 8,638         |       |
| **TOTAL**                                                |   | **$**         | **16,448,110** | ** **     | **$**      | **97,254**     | ** ** | **($332,859** | **)**      | **$** | **16,212,505** | ** ** |

 

Note 3: Loans and Reserve for PossibleLoan Losses

 

Major classifications of loans were:

 
|                                    |   | **December 31,** |        | **September 30,** |   |
|-----------------------------------------|--------|------------------|-------------|-------------------|--------|
|                                    |   | **2000**         |        | **2001**          |   |
| Commercial, financial, and agricultural |   | $                | 42,931,015  |              | $      | 41,759,765 |   |
| Real estate-construction                |   | 18,599,452       |        | 19,483,569        |   |
| Real estate-mortgage                    |   | 70,550,560       |        | 85,198,990        |   |
| Installment loans to individuals        |   | 3,246,214        |        | 3,104,984         |   |
| All other loans (including overdrafts)  |   | 160,779          |        | 173,999           |   |
|                                    |   | 135,488,020      |        | 149,721,307       |   |
|                                    |   |             |        |              |   |
| Less - deferred loan fees               |   | (487,473         | )           | (568,056          | )      |
| Less - reserve for possible loan losses |   | (1,320,518       | )           | (1,601,673        | )      |
|                                    |   |             |        |              |   |
| Total loans                             |   | $                | 133,680,029 |              | $      | 147,551,578 |   |
|                                    |   |             |        |              |   |
| Loans Held For Sale                     |   | $                | 2,474,542   |              | $      | 2,618,600 |   |

 

Concentration ofCredit Risk

 

At September 30,2001, approximately $104,682,559  of theHeritage Oaks Bank's ( the "Bank") loan portfolio was collateralizedby various forms of real estate.  Suchloans are generally made to borrowers located in San Luis Obispo County.  The Bank attempts to reduce itsconcentration of credit risk by making loans which are diversified by projecttype.  While management believes thatthe collateral presently securing this portfolio is adequate, there can be noassurances that significant deterioration in the California real estate marketwould not expose the Bank to significantly greater credit risk.

 

Loans onnonaccrual status totaled $991,230 and $514,605 at December 31, 2000, andSeptember 30 2001, respectively. Interest income that would have been recognized on non-accrual loans ifthey had performed in accordance with the terms of the loans was approximately$115,603 and  $75,242 for the periodended December 31, 2000 and September 30, 2001, respectively.

An analysis of the changes in thereserve for possible loan losses is as follows:

 
|                                       |   | **December 31,** |      | **September 30,** |   |
|--------------------------------------------|--------|------------------|-----------|-------------------|--------|
|                                       |   | **2000**         |      | **2001**          |   |
| Balance at beginning of year               |   | $                | 1,241,016 |              | $      | 1,320,518 |   |
| Additions charged to operating expense     |   | 519,000          |      | 450,000           |   |
| Loans charged off                          |   | (458,920         | )         | (171,433          | )      |
| Recoveries of loans previously charged off |   | 19,422           |      | 2,588             |   |
| Balance at end of period                   |   | $                | 1,320,518 |              | $      | 1,601,673 |   |

 

At September 30,2001, the Bank was contingently liable for letters of credit accommodationsmade to its customers totaling $1,081,921 and undisbursed loan commitments inthe amount of $36,324,000.  The Bankmakes commitments to extend credit in the normal course of business to meet thefinancing needs of its customers. Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  Since many of the commitmentsare expected to expire without being drawn upon, the total outstandingcommitment amount does not necessarily represent future cash requirements.  Standby letters of credit written areconditional commitments issued by the Bank to guarantee the performance of acustomer to a third party.  The creditrisk involved in issuing letters of credit is essentially the same as thatinvolved in extending loan facilities to customers.  The Bank anticipates no losses as a result of such transactions.

 

In accordancewith Financial Accounting Standards Board Statement No. 114, "Accountingby Creditors for Impairment of a Loan", the allowance for credit lossesrelated to loans that are identified for evaluation  is based on discounted cash flows using the loan's initial effectinterest rate or the fair value of the collateral for certain collateraldependent loans.

 

Managementbelieves that the allowance for credit losses at September 30, 2001 is prudentand 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: EarningsPer Share:

 

Basic earningsper share are based on the weighted average number of shares outstanding beforeany  dilution from common stockequivalents.  Diluted earnings per shareincludes common stock equivalents from the effect of the exercise of stockoptions.  The total number of sharesused for calculating basic and diluted earnings per share for the three monthsended September 30, 2001 was 1,298,126 and 1,390,796, respectively.  The total number of shares used for calculatingbasic and diluted earnings per share for the three months ended September 30,2000 was 1,292,935 and 1,377,257, respectively. The total number of shares usedfor calculating basic and diluted earnings per share for the nine months endedSeptember 30, 2001 was 1,295,165 and 1,390,218, respectively.  The total number of shares used forcalculating basic and diluted earnings per share for the nine months endedSeptember 30, 2000 was 1,287,009 and 1,371,403, respectively. 

 

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

 

Heritage OaksBancorp (the "Company") commenced operations on November 15, 1994with the acquisition of Heritage Oaks Bank (the "Bank").  Each shareholder of the Bank received oneshare of stock in the Company in exchange for each share of Heritage Oaks Bankstock owned.  The Bank became a whollyowned subsidiary of the Company.  TheBank is the only active subsidiary owned by the Company.

 

**SUMMARY OF FINANCIAL RESULTS**

 

As of September30, 2001, total consolidated assets of Heritage Oaks Bancorp were $197,542,570compared to $184,088,025 at December 31, 2000. This moderate growth of 7.31%,compared to more than 18% growth for the same period in 2000, is reflective ofthe continued economic downturn throughout 2001.

 

Total cash atSeptember 30, 2001 was $16,759,764. The large cash balance reflects multiplebranch offices and cash needed to fund the Banks automatic teller machine (ATM)network.  As of September 30, 2001, theBank was operating approximately 5 off-premise ATMs in this network.

 

Total net loansat September 30, 2001 were $147,551,578 compared to $133,680,029 at December31, 2000. This represents an increase of 10.38%. Loan demand has beeninconsistent throughout the year with a net decrease in the first three monthsof 2001 of 9.97% and an increase of 1.95% in the first six months of 2001.Theincrease experienced in the third quarter has subsided and Managementanticipates that demand for the remainder of the year will be slow.

 

Securitiesavailable for sale, which are carried at market value, were $13,225,279 atSeptember 30, 2001 compared to $16,212,505 at December 31, 2000. Securitieshave decreased through maturity and principal cash flow pay down to supplyfunds for loan demand.

 

Federal fundssold were $9,175,000 at September 30, 2001 and $4,600,000 at December 31, 2000.

Total depositswere  $179,307,924 at September 30, 2001compared to $167,696,889at December 31, 2000, which represents an increase of 6.92%. Demanddeposits have grown $14.8 million or 28.65% from year-end 2000. Approximately 73% of that growth is theresult of increased title company activity while the remainder is growththroughout the eight-branch system. Time deposits of >$100,000 and<$100,000 have decreased by $2.5 million and $4.8 million, respectively. Therelatively low cost interest bearing deposits other than time deposits haveincreased by more than $4.1 million. This change in the deposit mix has enabledthe Bank to reduce its cost of funds to offset lower rates on earning assets asthe result of the Federal Reserve Bank’s actions in reducing rates by 350 basispoints since January 1, 2001.

 

Core deposits (time deposits less than $100,000, demand, and savings)gathered in the local communities served by the Bank continue to be the Bank'sprimary source of funds for loans and investments.  Core deposits of $174,228,826 represented 97.2% of total depositsat September 30, 2001. The Company does not purchase funds through depositbrokers.

 

The Company has a $2 million revolving line of credit available withPacific Coast Bankers Bank. At September 30, 2001, the balance of borrowedfunds on this line was $1,300,000 compared to $1,050,000 at December 31, 2000.

 

The Bank has established borrowing lines with theFederal Home Loan Bank (FHLB) of approximately $3.1 million and $2.8 millionsecured by securities and certain loans, respectively. At September 30, 2001,the Bank had no borrowings against those lines.

 

**RESULTS OF OPERATIONS**

 

The Company reported net income for the nine months endedSeptember 30, 2001 of $1,739,614 compared to $1,673,112 for the same period in2000. Per share earnings on a diluted basis for the nine months endingSeptember 30, 2001 and September 30, 2000 were $1.25 and $1.22, respectively.Basic per share earnings for the nine months ending September 30, 2001 andSeptember 30, 2000 were $1.34 and $1.30, respectively.

 

Net income for the three months ending September 30, 2001 was$624,502, compared to $633,538 for the same period in 2000.

 

Increased year-to-date earnings are the result of the Bank’s efforts tomaintain a favorable net interest margin during the very challenging ratereduction environment experienced this year. In addition to this, operatingexpenses have increased by only 2.84% while total assets have increased 7.31%.

 

The following discussion highlights changes in certain items in theconsolidated statements of income.

 

# **NetInterest Income**

 

Net interest income, the primary component of the net earnings of afinancial institution, refers to the difference between the interest paid ondeposits and borrowings, and the interest earned on loans and investments.  The net interest margin is the amount of netinterest 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.

Net interest income for the nine months ending September 30, 2001was $8,123,003 compared to $7,116,398 for the same period in 2000. Thisrepresents an improvement of $1,006,605 or 14.14%. As a percentage of averageearning assets, the net interest margin for the first nine months of 2001decreased to 6.51% from 6.72% for the same period one year earlier.  The decrease in the net interest margin isdue to the numerous actions of the Federal Reserve Bank to lower interest ratesby 350 basis points throughout 2001. Approximately 60% of the loan portfolio istied to prime that is impacted immediately whenever there is a change to primewhile interest bearing liabilities, specifically Time Certificates of Depositre-price at the time of maturity. For the first nine months of 2001, theaverage yield on interest earning assets decreased 70 basis points from thesame period in 2000 while the average rate on interest bearing liabilitiesdecreased by 45 basis points for the same period in 2000. The increase in netinterest income for the nine months ending September 30, 2001 compared to thesame period in 2000 is due to the volume increase of $24.8 million in averageinterest earning assets at an average rate of 8.85% while interest bearingliabilities increased by $9.9 million at an average rate of 3.32%.

 

Net interest income for the three months ending September 30, 2001was $2,834,195 compared to $2,565,065 for the same period in 2000. Thisrepresents an increase of $269,130 or 10.49%. Interest income was $3,601,856and $3,641,919 for the three months ending September 30, 2001 and 2000,respectively. Interest expense for this three month period was $767,661 atSeptember 30, 2001 compared to $1,076,854 at September 30, 2000.

 

 

**AVERAGE BALANCE SHEET INFORMATION FORSEPTEMBER 30,**

** **

**(dollarsin thousands)**
|                                        |   | **2001**    |    | **2000**          |   |
|---------------------------------------------|--------|-------------|---------|-------------------|--------|
|                                        |   | **Average** |    | **Average Yield** |   | **Amount** |   | **Average** |   | **Average Yield** |   | **Amount** |   |
| Interest Earning Assets:                    |   | **Balance** |    | **Rate Paid**     |   | **Interest** |   | **Balance** |   | **Rate Paid** |   | **Interest** |   |
| Time deposits with other banks              |   | $           | 198     |              | 6.75   | % | $ | 10 |   | $ | 170 |   | 6.29 | % | $ | 8 |   |
| Investment securities taxable               |   | 8,734       |    | 5.77              | %      | 377 |   | 11,438 |   | 6.29 | % | 538 |   |
| Investment securities non-taxable           |   | 5,946       |    | 4.77              | %      | 212 |   | 6,142 |   | 5.07 | % | 233 |   |
| Federal funds sold                          |   | 9,496       |    | 4.24              | %      | 301 |   | 3,206 |   | 6.26 | % | 150 |   |
| Loans (1) (2)                               |   | 141,604     |    | 9.52              | %      | 10,087 |   | 120,238 |   | 10.19 | % | 9,160 |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Total interest earning assets               |   | 165,978     |    | 8.85              | %      | 10,987 |   | 141,194 |   | 9.55 | % | 10,089 |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Allowance for possible loan losses          |   | (1,498      | )       |              |   |   |   | (1,293 | ) |   |   |   |   |
| Non-earning assets:                         |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                     |   | 13,922      |    |              |   |   |   | 16,306 |   |   |   |   |   |
| Property, premises and equipment            |   | 2,855       |    |              |   |   |   | 3,325 |   |   |   |   |   |
| Other assets                                |   | 5,141       |    |              |   |   |   | 4,120 |   |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| TOTAL ASSETS                                |   | $           | 186,398 |              |   |   |   |   | $ | 163,652 |   |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Interest -bearing liabilities:              |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Savings/NOW/money market                    |   | 63,906      |    | 1.74              | %      | 831 |   | 56,596 |   | 2.28 | % | 965 |   |
| Time deposits                               |   | 50,032      |    | 5.24              | %      | 1,961 |   | 44,273 |   | 5.39 | % | 1,784 |   |
| Other borrowings                            |   | 1,289       |    | 7.57              | %      | 73 |   | 4,426 |   | 6.74 | % | 223 |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities          |   | 115,227     |    | 3.32              | %      | 2,865 |   | 105,295 |   | 3.77 | % | 2,972 |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities:           |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Demand deposits                             |   | 54,627      |    |              |   |   |   | 45,334 |   |   |   |   |   |
| Other liabilities                           |   | 1,989       |    |              |   |   |   | 1,492 |   |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Total liabilities                           |   | 171,843     |    |              |   |   |   | 152,121 |   |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Stockholders' equity                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Common stock                                |   | 7,245       |    |              |   |   |   | 6,235 |   |   |   |   |   |
| Retained earnings                           |   | 7,340       |    |              |   |   |   | 5,933 |   |   |   |   |   |
| Valuation Allowance Investments             |   | (30         | )       |              |   |   |   | (637 | ) |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Total stockholders' equity                  |   | 14,555      |    |              |   |   |   | 11,531 |   |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| TOTAL LIABILITIES AND STOCKHOLDERS'  EQUITY |   | $           | 186,398 |              |   |   |   |   | $ | 163,652 |   |   |   |   |   |
|                                        |   |        |    |              |   |   |   |   |   |   |   |   |   |
| Net Interest Income                         |   |        |    |              |   | $ | 8,122 |   |   |   |   |   | $ | 7,117 |   |
| Net Interest Margin (3)                     |   |        |    | 6.51              | %      |   |   |   |   | 6.72 | % |   |   |

 

----

**(1)           Nonaccrual loans have been includedin total loans.**

**(2)           Loan feesof $457,773 and $432,073 for2001 and 2000, respectively, have been included inthe interest income computation.**

**(3)           Net interest income has beencalculated by dividing the net interest income by total earning assets.**

 

 

The precedingtable sets forth the average balance sheet information, interest income andexpense, average yields and rates and net interest income and margin for thenine months ended September 30, 2001 and 2000.

 

**Non-interest Income**

 

Non-interestincome for the nine months ending September 30, 2001 was $3,897,568 compared to$4,244,418 for the same period in 2000. That represents a decrease of $346,850or 8.17%. Non-interest income consists of bankcard merchant fees, automaticteller machine (ATM) transactions, mortgage origination and other fees andservice charges on deposit accounts. Service charges on deposit accountsincreased from $795,807 during the first nine months of 2000 to $876,295 forthe nine months ending September 30, 2001. This increase in servicecharges is a result of the Bank’s growth in deposit accounts. Bankcard merchantfees were $93,962 for the nine months ending September 30, 2001 compared to$86,818 for the same period in 2000. Because of the favorable rate for mortgagerefinancing during 2001, mortgage origination fees were $429,180 compared to$200,035 for the nine months ending September 30, 2001 and 2000, respectively.

 

ATM transactionfees and interchange income were $1,937,732 during the nine months endedSeptember 30, 2001 compared to $2,741,168 during the same period for 2000. TheBank receives income for each transaction. For the past nine months, the Bankhas been divesting itself of the off-premise ATM Networks commonly referred toas HOAK (retail sites) and NANS (gaming sites). The total ATM income for 2001includes the gross revenue obtained in the sale of the HOAK Network that wasconsummated on March 31, 2001. Most of the revenue obtained in that sale wasoffset by related expenses. (See Non-Interest Expense in this document)As of this writing, there are no HOAK sites in operation for the Bank and threeremaining NANS sites.

 

Non-interestincome for the three months ended September 30, 2001 was $936,367 compared to$1,480,599 for the same period in 2000. That represents a decrease of $544,232or 36.76%. Service charge income was $310,083 for the three months endedSeptember 30,2001 and $295,422 for the same period in 2000. ATM transactionfees and interchange income were $242,243 during the three months endedSeptember 30, 2001 compared to $920,350 during the same period for 2000. Incomefrom bankcard merchant fees was $35,560 for the three months ended September 30,2001 compared to $31,978 for the same period during 2000.

 

**Other Expense**

 

Non-interestexpense was $8,831,318 and $8,587,223 for the nine months ended September 30,2001 and the same period in 2000, respectively. Salaries and employee benefitsexpense were $3,306,262 and $3,134,555 for the nine months ended September 30,2001 and 2000, respectively. This represents an increase of $171,707 or 5.48%.Full time equivalent employees were 92 at September 30, 2001 compared to 89 atSeptember 30, 2000. Occupancy and equipment costs were $1,294,799 for the ninemonths ending September 30, 2001 compared to $1,262,062 for the same period in2000. Expense associated with the ATM network was $1,475,122 and $1,908,809 forthe nine months ending September 30, 2001 and 2000, respectively. Expenseassociated with all other non-interest expense categories was $2,755,135 and$2,281,797 for the nine months ended September 30, 2001 and 2000, respectively.The increase in other expense is primarily associated with 1) data processingcosts that increased by 17% due to new bank products (internet banking) anddeposit account growth and; 2) attorney costs for the pending four branchacquisition scheduled for November 9, 2001.

Non-interestexpense was $2,595,339 and $2,923,978 for the three months ending September 30,2001 and the same period in 2000, respectively. Salaries and employee benefitsexpense were $1,110,518 and $1,091,684 for the three months ending September30, 2001 and 2000, respectively. Occupancy and equipment costs grew to $411,347for the three months ending September 30, 2001 from $399,754 for the sameperiod of 2000. Expense associated with the ATM network was $153,303 and$632,051 for the three months ending September 30, 2001 and 2000, respectively.Expense associated with all other non-interest expense categories was $920,171and $800,489 for the three months ending September 30, 2001 and 2000,respectively.

 

# **LocalEconomy**

 

The economy in theCompany’s service area is based primarily on agriculture, tourism, lightindustry, oil and retail trade. Services supporting these industries have alsodeveloped in the areas of medical, financial and educational. The population inthe two county areas comprising the Company’s service area, according to theU.S. Bureau of the Census, was estimated at July 1999 to be approximately644,000. San Luis Obispo County represents about 37% of this total with SantaBarbara County accounting for the remaining approximately 63%. The moderateclimate allows a year round growing season for numerous vegetable and fruits.Vineyards and cattle ranches also contribute largely to the local economy.Vineyards in production have grown significantly over the past several yearsthroughout the Company’s service area. Access to numerous recreational activities,including lakes, mountains and beaches, provide a relatively stable touristindustry from many areas including the Los Angeles/Orange County basin, the SanFrancisco Bay area and the San Joaquin Valley. Principally due to the diversityof the various industries in the Company’s service area, the area, while notimmune from economic fluctuations, does tend to enjoy a more stable level ofeconomic activity from many other areas of California.

**Capital**

 

The Company's total stockholders equity was $15,516,478 atSeptember 30, 2001 compared to $13,455,009 at December 31, 2000.  The increase in capital was from net incomeof $1,739,614, $68,584 from stock options exercised, $257,946 net change inother comprehensive income related to unrealized security holding gain, net oftax and $($4,675) in cash paid in lieu of fractional shares as the result ofthe 5% stock dividend distributed on March 30, 2001.

 

Capital ratios for commercial banks in the United States aregenerally calculated using nine different formulas.  These calculations are referred to as the "LeverageRatio" and two "risk based" calculations known as: "TierOne 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 Ratio calculation simply divides commonstockholders equity (reduced by any Goodwill a bank may have) by the totalaverage assets of the bank.  In the TierOne Risk Based Capital Ratio, the numerator is the same as the leverage ratio,but the denominator is the total "risk-weighted assets" of thebank.  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-weightedassets" in the denominator, but expands the numerator to include other capitalitems besides equity such as a limited amount of the loan loss reserve,long-term capital debt, preferred stock and other instruments.

Summarized beloware the bank's and the company’s capital ratios at September 30, 2001:

 
|                              |   | **Well Capitalized**    |   | **Heritage**  |   | **Heritage**     |   |
|-----------------------------------|--------|-------------------------|--------|---------------|--------|------------------|--------|
|                              |   | **Regulatory Standard** |   | **Oaks Bank** |   | **Oaks Bancorp** |   |
| Leverage Ratio                    |   | 5.00                    | %      | 8.17          | %      | 8.07             | %      |
| Tier One Risk Based Capital Ratio |   | 6.00                    | %      | 9.45          | %      | 9.33             | %      |
| Total Risk Based Capital Ratio    |   | 10.00                   | %      | 10.43         | %      | 10.30            | %      |

 

It is the intent ofManagement to maintain a  “WellCapitalized” status.

 

# **Liquidity**

 

The objective ofliquidity management is to ensure the continuous availability of funds to meetthe demands 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 nine months of2001, the average funds borrowed from correspondent banks was $20,513.

 

As of July 1999, thebank became a member of the Federal Home Loan Bank of San Francisco. Certainsecurities and loans were pledged as collateral during the first quarter of2000. The average funds borrowed through these facilities during the first ninemonths of 2001 was $351,648.

 

The Bank manages itsliquidity by maintaining a majority of its investment portfolio in federalfunds sold and other liquid investments. At September 30, 2001, the ratio ofliquid assets to deposits and other liabilities was 13.38%. The ratio of grossloans to deposits, another key liquidity ratio, was 84.66% at September 30,2001.

# **Inflation**

 

The assets andliabilities of a financial institution are primarily monetary in nature.  As such, they represent obligations to payor receive fixed and determinable amounts of money, which are not affected byfuture changes in prices.  Generally,the impact of inflation on a financial institution is reflected by fluctuationsin interest rates, the ability of customers to repay debt and upward pressureon operating expenses.  In addition,inflation affects the growth of total assets by increasing the level of loandemand, and may potentially adversely affect the Bank's capital adequacybecause loan growth in inflationary periods may increase more rapidly thancapital.  The effect on inflation duringthe period ended September 30, 2001 has not been significant to the Bank'sfinancial position or result of operations.

 

# **CaliforniaEnergy Crisis**

 

The recent California energy crisis has resulted in higherenergy costs to consumers, who have also seen disruptions in service and faceuncertainty about the future availability and cost of power.  Various legislative, regulatory and legalremedies to the California crisis are being pursued, but their outcome isuncertain and far-reaching and the solution is not likely to be immediate.  Continued deterioration of the Californiaenergy resources could have a material adverse affect on the Company’scustomers, which may result in adverse affects in the Company’s business,financial condition and results of operations.

 

As of this writing, the Company has not experienced negativeimpacts as the result of the California energy situation. As a proactive stepthe Bank has included the energy issue as a line item in the calculation forthe Loan Loss Reserve

 

PART 2.  OTHERINFORMATION

ITEM 1.  LEGALPROCEEDINGS

 

The Company is not aware of any legal proceeding against it thatwill have a material effect on the Company’s financial statements.

 

ITEM 2.   CHANGES INSECURITIES AND USE OF PROCEEDS

 

The Company has nothing to report.

 

ITEM 3.   DEFAULTS UPONSENIOR SECURITIES

 

The Company has nothing to report.

 

ITEM 4.   SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

 

The Company has nothing to report.

 

ITEM 5.   OTHER INFORMATION

 

Heritage Oaks Bank (“Bank”), banking subsidiary of Heritage OaksBancorp (“Company”) entered into a Branch Purchase and Assumption Agreement asof July 16, 2001 with Westamerica Bank to purchase the assets of and assume theliabilities of its four branches in San Luis Obispo County. In addition, theBank is acquiring all of Westamerica’s interests in the real estate for each ofthe Branches, whether leased or owned. This was subject to a separate RealProperty Purchase Agreement (both agreements are collectively referred to asthe “Agreements”). The terms and conditions of the transaction are contained inthe June 30, 2001 10QSB as exhibits.

 

The Branches are located in Paso Robles, Arroyo Grande, San LuisObispo and Morro Bay. The transaction is expected to close during the fourthquarter of 2001.

 

ITEM 6.   EXHIBITS ANDREPORTS ON FORM 8-K

 

The Company has nothing to report.

 

 

**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: October 31, 2001

 

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