**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 

**ý****  QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thequarterly period ended September 30, 2002**

 

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

 

**For the Transition Periodfrom          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)      |

 

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

YES   ý     NO   o

 

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 – 2,773,498 sharesoutstanding at October 7, 2002.

 

 

----

 

## **TABLE OF CONTENTS**

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

 

2

----

 

**PART 1. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                                                   |   | **31-Dec-01** |        | **30-Sep-02**   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|-------------|-----------------|--------|
|                                                                                                                                                                   |   | **(1)**       |        | **(Unaudited)** |   |
| ASSETS                                                                                                                                                                 |   |          |        |            |   |
| Cash and due from banks                                                                                                                                                |   | $             | 14,398,048  |            | $      | 21,823,275 |   |
| Federal funds sold                                                                                                                                                     |   | 6,000,000     |        | 53,390,000      |   |
|                                                                                                                                                                   |   |          |        |            |   |
| Total cash and cash equivalents                                                                                                                                        |   | 20,398,048    |        | 75,213,275      |   |
|                                                                                                                                                                   |   |          |        |            |   |
| Interest bearing deposits other banks                                                                                                                                  |   | 99,000        |        | 99,000          |   |
|                                                                                                                                                                   |   |          |        |            |   |
| Securities Available for sale                                                                                                                                          |   | 22,028,996    |        | 62,566,332      |   |
| Federal Home Loan Bank Stock, cost                                                                                                                                     |   | 228,300       |        | 1,925,700       |   |
| Loans Held For Sale                                                                                                                                                    |   | 4,082,200     |        | 6,430,743       |   |
| Loans, net                                                                                                                                                             |   | 156,149,885   |        | 173,867,007     |   |
|                                                                                                                                                                   |   |          |        |            |   |
| Property, premises and equipment, net                                                                                                                                  |   | 3,620,769     |        | 4,409,888       |   |
| Cash surrender value life insurance                                                                                                                                    |   | 5,143,613     |        | 5,344,982       |   |
| Deferred Tax Assets                                                                                                                                                    |   | 1,257,991     |        | 1,010,924       |   |
| Other assets                                                                                                                                                           |   | 1,875,872     |        | 2,268,223       |   |
|                                                                                                                                                                   |   |          |        |            |   |
| TOTAL ASSETS                                                                                                                                                           |   | $             | 214,884,674 |            | $      | 333,136,074 |   |
|                                                                                                                                                                   |   |          |        |            |   |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                              |   |          |        |            |   |
| LIABILITIES                                                                                                                                                            |   |          |        |            |   |
| Deposits:                                                                                                                                                              |   |          |        |            |   |
| Demand, non-interest bearing                                                                                                                                           |   | $             | 69,824,137  |            | $      | 103,972,222 |   |
| Savings, NOW, and money market deposits                                                                                                                                |   | 76,564,209    |        | 115,867,793     |   |
| Time deposits of $100,000 or more                                                                                                                                      |   | 7,181,312     |        | 8,158,364       |   |
| Time deposits under $100,000                                                                                                                                           |   | 42,015,107    |        | 37,663,456      |   |
| Total deposits                                                                                                                                                         |   | 195,584,765   |        | 265,661,835     |   |
|                                                                                                                                                                   |   |          |        |            |   |
| Other borrowed money                                                                                                                                                   |   | 1,894,811     |        | 38,000,000      |   |
| Securities Sold under Agreement to Repurchase                                                                                                                          |   | 137,293       |        | 647,413         |   |
| Company Obligated Preferred Securities of Subsidiary Trust Holding  Floating Rate Junior Subordinated Deferred Interest Debentures                                     |   | 0             |        | 8,000,000       |   |
| Other liabilities                                                                                                                                                      |   | 1,391,024     |        | 2,203,037       |   |
| Total liabilities                                                                                                                                                      |   | 199,007,893   |        | 314,512,285     |   |
|                                                                                                                                                                   |   |          |        |            |   |
| Stockholders’ equity                                                                                                                                              |   |          |        |            |   |
| Common stock, no par value; 20,000,000 shares authorized; issued and  outstanding 1,297,880 and 2,773,498 for December 31, 2001 and September 30,  2002, respectively. |   | 7,535,495     |        | 9,349,695       |   |
| Accumulated other comprehensive income                                                                                                                                 |   | (154,836      | )           | 590,010         |   |
| Retained earnings                                                                                                                                                      |   | 8,496,122     |        | 8,684,084       |   |
| Total stockholders’ equity                                                                                                                                        |   | 15,876,781    |        | 18,623,789      |   |
|                                                                                                                                                                   |   |          |        |            |   |
| TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY                                                                                                                      |   | $             | 214,884,674 |            | $      | 333,136,074 |   |

 

----

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

 

See notes to condensed financial statements

 

3

----

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF INCOME**

**For the three months ended September 30,**

 
|                                                      |          | **2001**        |      | **2002**        |   |
|-----------------------------------------------------------|---------------|-----------------|-----------|-----------------|--------|
|                                                      |          | **(Unaudited)** |      | **(Unaudited)** |   |
| Interest Income:                                          |          |            |      |            |   |
|                                                      |          |            |      |            |   |
| Interest and fees on loans                                |          | $               | 3,332,310 |            | $      | 3,328,561 |   |
| Investment securities                                     |          | 175,504         |      | 692,015         |   |
| Federal funds sold and commercial paper                   |          | 90,707          |      | 139,955         |   |
| Time certificates of deposit                              |          | 3,335           |      | 1,039           |   |
| Total interest income                                     |          | 3,601,856       |      | 4,161,570       |   |
|                                                      |          |            |      |            |   |
| Interest Expense:                                         |          |            |      |            |   |
|                                                      |          |            |      |            |   |
| Now accounts                                              |          | 122,068         |      | 52,858          |   |
| MMDA accounts                                             |          | 50,046          |      | 187,242         |   |
| Savings accounts                                          |          | 35,373          |      | 12,210          |   |
| Time deposits of $100,000 or more                         |          | 49,877          |      | 43,114          |   |
| Other time deposits                                       |          | 489,899         |      | 268,081         |   |
| Other borrowed funds                                      |          | 20,398          |      | 498,121         |   |
| Total interest expense                                    |          | 767,661         |      | 1,061,626       |   |
|                                                      |          |            |      |            |   |
| Net Interest Income Before Prov. for Possible Loan Losses |          | 2,834,195       |      | 3,099,944       |   |
| Provision for loan losses                                 |          | 150,000         |      | 150,000         |   |
| Net interest income after provision for loan losses       |          | 2,684,195       |      | 2,949,944       |   |
|                                                      |          |            |      |            |   |
| Non-interest Income:                                      |          |            |      |            |   |
| Service charges on deposit accounts                       |          | 310,083         |      | 381,765         |   |
| Investment securities gains (losses), net                 |          | 0               |      | -19,903         |   |
| Other income                                              |          | 626,284         |      | 546,534         |   |
| Total Non-interest Income                                 |          | 936,367         |      | 908,396         |   |
|                                                      |          |            |      |            |   |
| Non-interest  Expense:                               |          |            |      |            |   |
| Salaries and employee benefits                            |          | 1,110,518       |      | 1,368,413       |   |
| Occupancy and equipment                                   |          | 411,347         |      | 397,796         |   |
| Other expenses                                            |          | 1,073,474       |      | 989,332         |   |
| Total Noninterest Expenses                                |          | 2,595,339       |      | 2,755,541       |   |
| Income before provision for income taxes                  |          | 1,025,223       |      | 1,102,799       |   |
| Provision for applicable income taxes                     |          | 400,721         |      | 427,225         |   |
| Net Income                                                |          | $               | 624,502   |            | $      | 675,574 |   |
|                                                      |          |            |      |            |   |
| Earnings per share:                                       | (See note #4) |            |      |            |   |   |
| Basic                                                     |          | $               | 0.23      |            | $      | 0.24 |   |
| Fully Diluted                                             |          | $               | 0.21      |            | $      | 0.23 |   |
|                                                           |               |                 |           |                 |        |  |  |  |

 

See notes to consolidated financialstatements

 

4

----

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF INCOME**

**For the nine months ended September 30,**

 
|                                                      |          | **2001**        |       | **2002**        |   |
|-----------------------------------------------------------|---------------|-----------------|------------|-----------------|--------|
|                                                      |          | **(Unaudited)** |       | **(Unaudited)** |   |
| Interest Income:                                          |          |            |       |            |   |
|                                                      |          |            |       |            |   |
| Interest and fees on loans                                |          | $               | 10,087,184 |            | $      | 9,599,536 |   |
| Investment securities                                     |          | 588,736         |       | 1,552,168       |   |
| Federal funds sold and commercial paper                   |          | 301,337         |       | 242,192         |   |
| Time certificates of deposit                              |          | 10,295          |       | 3,359           |   |
| Total interest income                                     |          | 10,987,552      |       | 11,397,255      |   |
|                                                      |          |            |       |            |   |
| Interest Expense:                                         |          |            |       |            |   |
|                                                      |          |            |       |            |   |
| Now accounts                                              |          | 470,440         |       | 173,898         |   |
| MMDA accounts                                             |          | 188,626         |       | 259,097         |   |
| Savings accounts                                          |          | 171,829         |       | 35,539          |   |
| Time deposits of $100,000 or more                         |          | 187,965         |       | 121,716         |   |
| Other time deposits                                       |          | 1,772,926       |       | 861,769         |   |
| Other borrowed funds                                      |          | 72,763          |       | 946,052         |   |
| Total interest expense                                    |          | 2,864,549       |       | 2,398,071       |   |
|                                                      |          |            |       |            |   |
| Net Interest Income Before Prov. for Possible Loan Losses |          | 8,123,003       |       | 8,999,184       |   |
| Provision for loan losses                                 |          | 450,000         |       | 435,000         |   |
| Net interest income after provision for loan losses       |          | 7,673,003       |       | 8,564,184       |   |
|                                                      |          |            |       |            |   |
| Non-interest Income:                                      |          |            |       |            |   |
| Service charges on deposit accounts                       |          | 876,295         |       | 1,024,343       |   |
| Investment securities gains (losses), net                 |          | -1,606          |       | -19,903         |   |
| Other income                                              |          | 3,022,879       |       | 1,483,957       |   |
| Total Non-interest Income                                 |          | 3,897,568       |       | 2,488,397       |   |
|                                                      |          |            |       |            |   |
| Non-interest  Expense:                               |          |            |       |            |   |
| Salaries and employee benefits                            |          | 3,306,262       |       | 3,909,574       |   |
| Occupancy and equipment                                   |          | 1,294,799       |       | 1,247,535       |   |
| Other expenses                                            |          | 4,230,257       |       | 2,954,362       |   |
| Total Noninterest Expenses                                |          | 8,831,318       |       | 8,111,471       |   |
| Income before provision for income taxes                  |          | 2,739,253       |       | 2,941,110       |   |
| Provision for applicable income taxes                     |          | 999,639         |       | 1,065,895       |   |
| Net Income                                                |          | $               | 1,739,614  |            | $      | 1,875,215 |   |
|                                                      |          |            |       |            |   |
| Earnings per share:                                       | (See note #4) |            |       |            |   |   |
| Basic                                                     |          | $               | 0.64       |            | $      | 0.68 |   |
| Fully Diluted                                             |          | $               | 0.59       |            | $      | 0.63 |   |
|                                                           |               |                 |            |                 |        |  |  |  |

 

See notes to consolidated financialstatements

 

5

----

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Periods ended September 30,**

 
|                                                                                                |   | **2001**        |       | **2002**        |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------------|------------|-----------------|--------|
|                                                                                                |   | **(Unaudited)** |       | **(Unaudited)** |   |
| **Cash Flows from Operating Activities**                                                            |   |            |       |            |   |
| Net income                                                                                          |   | $               | 1,739,614  |            | $      | 1,875,215 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities                   |   |            |       |            |   |
| Net cash provided by operating activities                                                           |   |            |       |            |   |
| Depreciation and amortization                                                                       |   | 650,965         |       | 484,298         |   |
| Provision for possible loan losses                                                                  |   | 450,000         |       | 435,000         |   |
| Realized (gain) loss on sales of available-for-sale securities, net                                 |   | 1,606           |       | 19,903          |   |
| Gain on sales of property, premise and equipment                                                    |   | 0               |       | 0               |   |
| Amortization of premiums/discounts on investment securities, net                                    |   | (97,681         | )          | 111,372         |   |
| (Increase)/decrease in loans held for sale                                                          |   | (144,058        | )          | (2,348,543      | )      |
| (Increase)/decrease in deferred tax asset                                                           |   | 80,839          |       | (247,069        | )      |
| (Increase)/decrease in other assets                                                                 |   | 70,661          |       | (593,720        | )      |
| Increase/(decrease) in other liabilities                                                            |   | (738,125        | )          | 1,556,859       |   |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                                                       |   | 2,013,821       |       | 1,293,315       |   |
| **Cash Flows From Investing Activities**                                                            |   |            |       |            |   |
| Purchase of securities available-for-sale                                                           |   | 0               |       | 0               |   |
| Purchase of mortgage-backed securities available-for-sale                                           |   | 0               |       | (48,491,881     | )      |
| Proceeds from sales of securities available-for-sale                                                |   | 560,700         |       | 1,389,750       |   |
| Proceeds from principal reductions and maturities of securities  available-for-sale                 |   | 1,236,292       |       | 0               |   |
| 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 |   | 1,814,421       |       | 6,492,656       |   |
| Net change in interest bearing deposits in other financial  institutions                            |   | 156,300         |       | (1,697,400      | )      |
| Purchase of life insurance policies                                                                 |   | (1,240,187      | )          | 0               |   |
| Proceeds from sale of other real estate owned                                                       |   |            |       |            |   |
| Recoveries on loans previously written off                                                          |   | 0               |       | 0               |   |
| Increase in loans, net                                                                              |   | (14,321,549     | )          | (17,717,122     | )      |
| Purchase of property, premises and equipment, net                                                   |   | (245,512        | )          | (1,273,417      | )      |
| **NET CASH USED IN INVESTING ACTIVITIES**                                                           |   | (12,039,535     | )          | (61,297,414     | )      |
| **Cash Flows From Financing Activities**                                                            |   |            |       |            |   |
| Increase in deposits, net                                                                           |   | $               | 11,611,035 |            | $      | 70,077,070 |   |
| Net increase/(decrease) in other borrowings                                                         |   | 250,000         |       | 38,510,120      |   |
| Net (decrease)/increase in notes payable                                                            |   | 0               |       | (1,894,811      | )      |
| Proceeds from issuance of Trust Preferred Securities                                                |   |            |       | 8,000,000       |   |
| Proceeds from exercise of stock options                                                             |   | 68,584          |       | 133,352         |   |
| Cash paid in lieu of fractional shares                                                              |   | (4,675          | )          | (6,405          | )      |
| Cash dividends paid or declared                                                                     |   | 0               |       | 0               |   |
| **NET CASH PROVIDED BY FINANCING ACTIVITIES**                                                       |   | 11,924,944      |       | 114,819,326     |   |
| **Net (Decrease)/Increase in Cash and Cash Equivalents**                                            |   | 1,899,230       |       | 54,815,227      |   |
| **Cash and Cash Equivalents**, Beginning of year                                                    |   | 24,035,534      |       | 20,398,048      |   |
| **Cash and Cash Equivalents**, End of year                                                          |   | $               | 25,934,764 |            | $      | 75,213,275 |   |

 

See notes to condensed financial statements

 

6

----

 

**HERITAGE OAKS BANCORP**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**September 30, 2001 and September 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                                |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| 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** | ** ** |

 
|                                                                               |   | **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                                                          |   | 26,552                  |       | 133,352           |          | 0                      |   |                                          |       | 133,352                               |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| 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                                                               |   | 1,384,418               |       |              |          |                   |   |                                          |       |                                  |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Comprehensive Income                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Net Income                                                                         |   |                    |       |              |          | 1,875,215              |   |                                          |       | 1,875,215                             |        |
| Unrealized Security Holding Gains/(Losses) '(net of $393,340 tax)                  |   |                    |       |              |          |                   |   | 744,846                                       |       | 744,846                               |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| Total other comprehensive Income                                                   |   |                    |       |              |          |                   |   |                                          |       | 2,620,061                             |        |
|                                                                               |   |                    |       |              |          |                   |   |                                          |       |                                  |        |
| **Balance September 30, 2002**                                                     |   | **2,773,498**           | ** ** | **$**             | **9,349,696** | ** **             | **$**  | **8,684,083**                                 | ** ** | **$**                                 | **590,010** | ** ** | **$** | **18,623,789** | ** ** |

 

7

----

 

**Note 1.  CONSOLIDATED FINANCIAL STATEMENTS**

 

In the opinion ofManagement, the un-audited consolidated condensed financial statements containall (consisting of only normal recurring adjustments) adjustments necessary topresent fairly Heritage Oaks Bancorp’s (the “Company”) consolidated financialposition at September 30, 2002 and results of cash flows for the nine monthsended September 30, 2001 and 2002 and the results of operation for the threeand nine months ended September 30, 2001 and 2002.

 

Certaininformation and footnote disclosures normally presented in financial statementsprepared in accordance with generally accepted accounting principles have beenomitted. These interim consolidated condensed financial statements should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s 2001 Annual Report to shareholders. Theresults for the three and nine months ended September 30, 2001 and 2002 may notnecessarily be indicative of the operating results for the full year.

 

### **Note2.   INVESTMENT SECURITIES**

 

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

 

The amortized cost and fair values ofinvestment securities available for sale at September 30, 2002 and December 31,2001:

 
| **September 30, 2002**                                   |   | **Amortized  Cost** |           | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** |        |
|----------------------------------------------------------|--------|---------------------|----------------|------------------------------|--------|-------------------------------|------------|-----------------|-------------|
|                                                     |   |                |           |                         |   |                          |       |            |        |
| Obligations of U.S. government agencies and corporations |   | $                   | 841,154        |                         | $      | 1,600                         |       | $               | (19,319     | ) | $ | 823,435 |   |
| Mortgage-backed securities                               |   | 54,947,069          |           | 609,698                      |   | (37,337                       | )          | 55,519,430      |        |
| Obligations of State and Political Subdivisions          |   | 5,786,121           |           | 428,708                      |   | 0                             |       | 6,214,829       |        |
| Other Securities                                         |   | 8,638               |           | 0                            |   | 0                             |       | 8,638           |        |
| **TOTAL**                                                |   | **$**               | **61,582,982** | ** **                   | **$**  | **1,040,006**                 | ** ** | **$**           | **(56,656** | **)** | **$** | **62,566,332** | ** ** |

 
| **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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### **Note3.   LOANS AND ALLOWANCE FOR LOAN LOSSES**

 

Major classifications of loans were:

 
|                                    |   | **December 31,  2001** |        | **September 30,  2002** |   |
|-----------------------------------------|--------|------------------------|-------------|-------------------------|--------|
|                                    |   |                   |        |                    |   |
| Commercial, financial, and agricultural |   | $                      | 40,608,210  |                    | $      | 40,848,310 |   |
| Real estate-construction                |   | 23,449,044             |        | 34,755,912              |   |
| Real estate-mortgage                    |   | 90,823,606             |        | 98,619,489              |   |
| Installment loans to individuals        |   | 3,171,805              |        | 2,351,288               |   |
| All other loans (including overdrafts)  |   | 419,622                |        | 328,613                 |   |
|                                    |   | 158,472,287            |        | 176,903,612             |   |
|                                    |   |                   |        |                    |   |
| Less - deferred loan fees               |   | (578,332               | )           | (804,039                | )      |
| Less - allowance for loan losses        |   | (1,744,070             | )           | (2,232,566              | )      |
|                                    |   |                   |        |                    |   |
| Total loans                             |   | $                      | 156,149,885 |                    | $      | 173,867,007 |   |
|                                    |   |                   |        |                    |   |
| Loans Held For Sale                     |   | $                      | 4,082,200   |                    | $      | 6,430,743 |   |

 

Concentration of Credit Risk

At September 30,2002, approximately $ 133.3 million of the Bank’s loan portfolio wascollateralized by various forms of real estate. Such loans are generally madeto borrowers located in San Luis Obispo and Santa Barbara Counties. The Bankattempts to reduce its concentration of credit risk by making loans which arediversified by project type. While Management believes that the collateralpresently securing this portfolio is adequate, there can be no assurances thatsignificant deterioration in the California real estate market would not exposethe Bank to significantly greater credit risk.

 

At September 30,2002, the Bank was contingently liable for letters of credit accommodationsmade to its customer totaling approximately $1.8 million and un-disbursed loancommitments in the approximate amount of $56.3 million. The Bank makes commitments to extend credit in the normalcourse of business to meet the financing needs of its customers. Commitments toextend credit are agreement to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. Since many of the commitments are expected to expire withoutbeing drawn upon, the total outstanding commitment amount does not necessarilyrepresent 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 credit risk involved in issuing letters ofcredit is essentially the same as that involve in extending loan facilities tocustomers. The Bank anticipates no losses as a result of such transactions.

 

Allowance for Loan Losses

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

 

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An analysis of the changesin the allowance for loan losses is as follows:

 
|                                       |   | **December 31,  2001** |      | **September 30,  2002** |   |
|--------------------------------------------|--------|------------------------|-----------|-------------------------|--------|
|                                       |   |                   |      |                    |   |
| Balance at beginning of year               |   | $                      | 1,320,518 |                    | $      | 1,744,070 |   |
| Additions charged to operating expense     |   | 600,000                |      | 435,000                 |   |
| Loans charged off                          |   | (180,732               | )         | (73,549                 | )      |
| Recoveries of loans previously charged off |   | 4,284                  |      | 127,046                 |   |
| Balance at end of period                   |   | $                      | 1,744,070 |                    | $      | 2,232,567 |   |

 

The Bankrecognized that credit losses will be experienced and the risk of loss willvary with, among other things, general economic conditions; the type of loanbeing made; the creditworthiness of the borrower over the term of the loan andin the case of a collateralized loan, the quality of the collateral for suchloan. The allowance for loan loss represents the Bank’s estimate of theallowance necessary to provide for probable incurred losses in the portfolio.In making this determination, the Bank analyzes the ultimate collectibility ofthe loans in its portfolio by incorporating feedback provided by internal loanstaff, an independent loan review function, and information provided byexaminations performed by regulatory agencies. The Bank makes monthlyevaluations as to the adequacy of the allowance for loan losses.

 

The analysis of the allowance for loanlosses is comprised of three components; specific credit allocation; generalportfolio allocation; and subjectively by determined allocation. EffectiveJanuary 1, 1995, the Bank adopted Statement of Financial Accounting StandardsNo.114, Accounting by Creditors for Impairment of a Loan (SFAS 114), as amendedby SFAS No. 118, Accounting by Creditors for Impairment of a Loan - IncomeRecognition and Disclosures. These pronouncements provide that when it isprobable that a creditor will be unable to collect all amounts due inaccordance with the terms of the loan that such loan is deemed impaired.Impaired loans are accounted for differently in that the amount of theimpairment is measured and reflected in the records of the creditor. The allowance for credit losses related toloans that are identified for evaluation in accordance with Statement 114 isbased on discounted cash flows using the loan’s initial effect interest rate orthe fair value of the collateral for certain collateral dependent loans. Thegeneral portfolio allocation consists of an assigned reserve percentage basedon the credit rating of the loan. The subjective portion is determined based onloan history and the Bank’s evaluation of various factors including currenteconomic conditions and trends in the portfolio including delinquencies andimpairment, as well as changes in the composition of the portfolio.

 

The allowance forloan losses is based on estimate, and ultimate losses will vary from currentestimates. These estimates are reviewed monthly, and as adjustments, eitherpositive or negative, become necessary, a corresponding increase or decrease ismade in the provision for loan losses. The methodology used to determine theadequacy of the allowance for possible loan losses for the third quarter of2002 is consistent with prior periods.

 

The Bank’sprovision for loan losses was $150,000 for the third quarter of 2002, comparedto the same amount for the same period in 2001. For the nine months endingSeptember 30, 2002, the provision for losses was $435,000 compared to $450,000for the same period in 2001.

 

The allowance forloan losses as a percentage of total net loans was 1.24% as of September 30,2002 and 1.09% as of December 31, 2001. Management believes that the allowancefor credit losses at September 30, 2002 is prudent and warranted, based oninformation currently available.

 

Non-Accrual and Non-Performing Loans

Loan onnon-accrual status totaled $1,494,602 and $1,802,932 at December 31, 2001 andSeptember 30, 2002, respectively. Typically, these loans have adequatecollateral protection and/or personal guaranties to provide a source ofrepayment to the Bank. Most of the loans on non-accrual are related to

 

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several commercialloans that are being addressed by specific workout plans at this time. Interestincome that would have been recognized on non-accrual loans if they hadperformed in accordance with the terms of the loans was approximately $142,952and $ 123,250 for the period ended December 31, 2001 and September 30, 2002,respectively.

 

Non-performingloans include non-accrual loans and accruing loans that are 90 days or moredelinquent. The Bank had no loans that were 90 days or more delinquent atSeptember 30, 2002 and December 31, 2001 that were still accruing interest.

 

Non-performingloans were .70% and .54% of total assets as of December 31, 2001 and September30, 2002, respectively. The allowance for loan loss to non-performing loans was1.17x and 1.24x at December 31, 2001 and September 30, 2002, respectively.

 

### **Note4.   EARNINGS PER SHARE**

 

Basic earnings pershare are based on the weighted average number of shares outstanding before anydilution from common stock equivalents. Diluted earnings per share reflects thepotential dilution that could occur if securities or other contract to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shares in the earnings of the entity.

 

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

 

Share informationhas been retroactively adjusted for the two-for-one stock split.

 

The total numberof shares used for calculating basic earnings per share for the three monthsended September 30, 2001 and 2002, were 2,715,226 and 2,770,024, respectively.The total number of shares used for calculating diluted earnings per share forthe three months ended September 30, 2001 and 2002, were 2,973,819 and2,998,197, respectively.

 

The total numberof shares used for calculating basic earnings per share for the nine monthsended September 30, 2001 and 2002, were 2,718,147 and 2,751,160, respectively.The total number of shares used for calculating diluted earnings per share forthe nine months ended September 30, 2001 and 2002, were 2,948,498 and3,000,046.

 

### **Note5.   PREMISE**

 

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

 

### **Note6.   ISSUANCE OF TRUST PREFERRED SECURITIES**

 

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

 

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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 an investment 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.

### ** **

### **Note7.   RECENT LEGISLATIVE ACTIVITYSARBANES-OXLEY ACT OF 2002**

 

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

 

On August 28, 2002, in accordance with Section 302 of the Act, theSecurities and Exchange Commission (the “SEC”) adopted final rules that requirean issuer’s principal executive and principal financial officer to certify thecontents, including the financial and other information, of the issuer’squarterly and annual reports. The rules became effective on August 29, 2002. Inaddition, the SEC adopted previously proposed rules requiring issuers tomaintain, and regularly evaluate the effectiveness of control and proceduresdesigned to ensure that the information required in reports filed under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedon a timely basis.

 

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

 

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

 

**Note 8.   RecentAccounting Pronouncements**

 

At its August 7Board meeting, the FASB approved, in principle, Statement 147 which willreplace certain paragraphs in Statement 72, “Accounting for CertainAcquisitions of Banking or Thrift Institutions”. The new guidance was effectiveon September 30, 2002. The requirement in Statement 72 to recognize (andamortize) an “unidentifiable intangible asst” when more liabilities areacquired than assets, such as in a branch purchase that is a businesscombination, will no longer apply. Previously recorded core deposit intangiblesmust continue to be amortized.

 

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

 

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

 

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

 

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

 

**FINANCIAL CONDITION**

 

As of September30, 2002, total consolidated assets of Heritage Oaks Bancorp were $333.1million compared to $214.9 million at December 31, 2001. This represents anincrease of 55.0%. The components of this increase are discussed below.

 

##### Cash and Due From Banks

Total cash and due from banks at September30, 2002 was $21.8 million, up from $14.4 million at December 31, 2001. Thisline item will vary depending on cash letters from the previous night andactual cash on hand in the branches. The balance in the Fed account had aclosing balance of $8.7 million to meet the target for Reserve Requirements.

 

##### Loans

Total net loans at September 30, 2002 were$173.9 million compared to $156.1 million at December 31, 2001. This representsan increase of 11.4%. For the nine months ending September 30, 2002,commercial, financial and agriculture loans increased by $.2 million or .6%, real estate-construction loans increased by$11.3 million or 48.2%, real estate-mortgage loans increased by $7.8 million or8.6% and installment loans to individuals decreased by $.89 million or 25.9%.

 

Low net growth inagricultural loans is attributed to the refinance of several development loansthrough the Farmer Mac program. This program is a long-term mortgage productthat offers low interest rates on producing agricultural real estate. Wecontinue to use this product to payoff our development loans and also tofinance homes on acreage.

 

The large increasein real estate-construction loans can be attributed to several largeconstruction projects financed since the beginning of 2002. They include acondominium project in the amount

 

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of $5.3 millionthat will payoff as units are sold; an office building in the amount of nearly$4 million, a hotel for $4 million and two medical offices totaling $3.3million. The large construction loans typically have take-out commitments bythe Bank in the form of a variable rate loan with 25 year amortizations with a10 to 15 year maturity.

 

Loans held forsale increased to $6.4 million at September 30, 2002 from $4.1 million atDecember 31, 2001. Typically, loans held for sale are sold within 30 days offunding.

 

##### Securities

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

 

Securitiesavailable-for-sale are carried at fair value, with related unrealized net gainsor losses, net of deferred income taxes, recorded as an adjustment to equitycapital. As of September 30, 2002, net unrealized gains increased $744,846 froman unrealized loss of $154,836 at December 31, 2001 to an unrealized gain of$590,010.

 

Securitiesavailable-for-sale increased to $62.6 million at September 30, 2002 from $22.0million at December 31, 2001. This represents an increase of $40.6 million or184.0%. As the result ofthe issuance of $8.0 million in trust preferred securities, in April 2002, theCompany down-streamed $5.2 million to the Bank in the form of Tier I Capital.This enabled the Bank to implement an investment strategy whereby the Bankborrowed $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. The Bank made this decisionknowing that it would improve the return on average equity by increasing thenet interest income in absolute terms even though it would reduce the return onaverage assets and the net interest margin as a percentage. Prior to investing,the Bank performed extensive due diligence in assessing the interest rate andmarket value risk of this strategy including the performance in variousinterest rate scenarios of up and down 100, 200 and 300 basis points.Management believes that the 300 basis points variances would not have amaterial effect on the overall interest rate and market value risk to theCompany.

 

At September 30, 2002, available-for-salesecurities in the portfolio included obligations of state and politicalsubdivisions, obligations of US government agencies and corporations and mortgagedbacked securities issued by various agencies.

 

All fixed and adjustable rate mortgage poolscontain a certain amount of risk related to the uncertainty of prepayments ofthe underlying mortgages. Interest rate changes have a direct impact upon prepaymentrates. The Bank uses computer simulation models to test the average life,duration, market volatility and yield volatility of adjustable rate mortgagepools under various interest rate assumptions to monitor volatility. Stresstests are performed quarterly.

 

##### Federal Funds Sold

Federal funds soldwere $53.4 million at September 30, 2002 compared to $6.0 million at December31, 2001. The significant increase is the direct result of increased deposits.The primary reason for retaining these large over night investments is due tothe volatile nature of certain deposit relationships that are related to thecurrent robust mortgage business. These relationships are discussed in moredetail under “Deposits and Borrowed Funds”.

 

##### Deposits and Borrowed Funds

Totaldeposits were  $265.7 million atSeptember 30, 2002 compared to $195.6 million at December 31, 2001. Thisrepresents an increase of $70.1 million or 35.8%. Approximately $32.7

 

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million or 46.6% of depositgrowth is the result of increased demand deposits held by three, long timecustomers of the Bank that transact in mortgage related business’. One of therelationships added additional account locations during the year that accountsfor approximately $10 million of the increase. These volatile accountrelationships are included in the volatile liability dependency report that theBank produces on a monthly basis. Management and the Board of Directors of theBank are keenly aware that if and when the mortgage market conditions change,these relationships will be impacted. This is the primary reason for the largebalances maintained in over night investing in Federal Funds Sold.

 

In August 2002, the Bankbegan to offer a personal insured money market account with the intent to raisedeposits that otherwise generally reside in non-financial investment companies.The Bank offered a competitive introductory rate and was successful inprocuring approximately $31.2 million in deposits. In addition, the already existingbusiness insured money market account product increased by $10.0 millionthroughout 2002.  The Bank believes thatthe declining returns in the stock market in general are creating a “flight tosafety” to FDIC insured deposits.  Timedeposits of >$100,000 increased by $1.0 million or 13.6%. However, timedeposits of <$100,000 decreased by $4.4 million or 10.4%. The decrease inthis category is primarily due to maturities during the third quarter 2002 ofhigher rate time deposits that did not renew at the lower rates. With increasedliquidity as the result of non time deposit growth, time deposits were pricedsuch that Management was aware that these balances would decrease.

 

Coredeposits (time deposits less than $100,000, demand, and savings) gathered inthe local communities served by the Bank continue to be the Bank’s primarysource of funds for loans and investments. Core deposits of $257.5 million represented 96.9% of total deposits atSeptember 30, 2002. The Company does not purchase funds through depositbrokers.

 

AtDecember 31, 2001, the Company had a $1.9 million loan with Pacific CoastBankers Bank that was paid in full upon the issuance of the trust preferredsecurities in April 2002.

 

The Bank has established borrowing lineswith the Federal Home Loan Bank (FHLB) of approximately $1.6 million and $43.1million secured by loans and securities, respectively. At September 30, 2002,the Bank had borrowings of $38 million against those lines. The $38 millionborrowing consists of $9.5 million maturing in April 2003 and 2004 and $19million maturing in April 2005.

 

The Bank utilizes securities sold underrepurchase agreements as a source of funds. The Bank had $647,413 in securities sold under repurchase agreements atSeptember 30, 2002 compared to $137,293 at December 31, 2001.

 

##### Capital Resources

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

 

A Press Release was issued on July 19, 2002.

 

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

 

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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 $1.8 million on April 11, 2002 and capitalcontributions to the Bank for future growth.

 

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

 

The Company’s totalstockholders equity was $18,623,789 at September 30, 2002 compared to$15,876,781 at December 31, 2001. The increase in capital was from net incomeof $1,875,215, $133,352 from stock options exercised, $744,846 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 of the5% stock dividend distributed on March 29, 2002.

 

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

 

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

 

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Summarized below are the Bank’s andCompany’s capital ratios at September 30, 2002:

 
|                              |   | **Regulatory  Standard**    |   |                  |   |                     |   |
|-----------------------------------|--------|-----------------------------|--------|-----------------------|--------|--------------------------|--------|
|                              |   | **Adequately  Capitalized** |   | **Well  Capitalized** |   | **Heritage  Oaks  Bank** |   | **Heritage  Oaks  Bancorp** |   |
|                              |   |                        |   |                  |   |                     |   |   |   |
| Leverage Ratio                    |   | 4.00                        | %      | 5.00                  | %      | 7.92                     | %      | 7.60 | % |
|                              |   |                        |   |                  |   |                     |   |   |   |
| Tier One Risk Based Captial Ratio |   | 4.00                        | %      | 6.00                  | %      | 11.15                    | %      | 10.71 | % |
|                              |   |                        |   |                  |   |                     |   |   |   |
| Total Risk Based Captial Ratio    |   | 8.00                        | %      | 10.00                 | %      | 12.20                    | %      | 13.06 | % |

 

For the Company,approximately $5.2 million and $2.8 million of the trust preferred securitiesare accounted for as Tier I and Tier II Capital, respectively, for purposes ofcalculating Regulatory Capital.

 

**RESULTS OF OPERATIONS FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002**

 

TheCompany reported net income for the nine months ended September 30, 2002of $1,875,215 compared to $1,739,814 for the same period in 2001. Per share earningson a diluted basis for the nine months ending September 30, 2002 and September30, 2001 were $.63 and $.59, respectively. Basic per share earnings for thenine months ending September 30, 2002 and September 30, 2001 were $.68 and$.64, respectively.

 

Netincome for the three months ending September 30, 2002 was $675,574,compared to $624,502 for the same period in 2001. Per share earnings on adiluted basis for the three months ending September 30, 2002 and September 30,2001 were $.23 and $.21, respectively. Basic per share earnings for the threemonths ending September 30, 2002 and September 30, 2001 were $.24 and $.23,respectively.

 

Themodest increased year-to-date earnings are the result of the Bank’s efforts tomaintain a favorable net interest margin during the very challenging interestrate environment experienced this year. In addition to this, the efficiencyratio for the Company was 70.60% and 73.5% for the nine months ending September30, 2002 and 2001, respectively.

 

Thefollowing discussion highlights changes in certain items in the consolidatedstatements of income.

 

# **Net Interest Income**

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

 

Netinterest income for the nine months ending September 30, 2002 was$8,999,184 compared to $8,123,003 for the same period in 2001. This representsan improvement of $876,181 or 10.8%. As a percentage of average earning assets,the net interest margin for the first nine months of 2002 decreased to 5.17%from 6.51% for the same period one year earlier. The Bank still maintains a net interestmargin that Management believes to be favorable even though there has

 

17

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been a 475 basis pointdecrease in prime rate from January 2001 through December 2001. During thefirst nine months of 2001, prime rate dropped from 9.50% to 6.00% while primerate has been 4.75% for the entire nine months of 2002. Approximately 81% of the loan portfolio is tied to prime of which 26% isimpacted immediately whenever there is a change to prime while interest bearingliabilities, specifically Time Certificates of Deposit re-price at the time ofmaturity. For the first nine months of 2002, the average yield on interestearning assets decreased 229 basis points from the same period in 2001 whilethe average rate on interest bearing liabilities decreased by 128 basis pointsfrom the same period in 2001. The increase in net interest income for the ninemonths ending September 30, 2002 compared to the same period in 2001 is due tothe volume increase of $66.3 million in average interest earning assets at anaverage rate of 6.56% while interest bearing liabilities increased by $42.2million at an average rate of 2.04%.

 

Netinterest income for the three months ending September 30, 2002 was$3,099,944 compared to $2,834,195 for the same period in 2001. This representsan increase of $265,749 or 9.4%. Interest income was $4,161,570 and $3,01,856for the three months ending September 30, 2002 and 2001, respectively. Increasedinterest income was primarily the result of higher investment securitiesbalances outstanding for the entire three months. Interest expense for thisthree month period was $1,061,626 at September 30, 2002 compared to $767,661 atSeptember 30, 2001. Interest expense increased due to the increased borrowingwith the FHLB and interest on the trust preferred securities.

 

Thetable on the following page sets forth the average balance sheet information,interest income and expense, average yields and rates and net interest incomeand margin for the nine months ended September 30, 2002 and 2001.

 

18

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**AVERAGE BALANCE SHEET INFORMATION FOR SEPTEMBER 30,**

**(dollars in thousands)**

 
|                                                                                                                               |   | **2001**             |    | **2002**                     |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|---------|------------------------------|--------|
|                                                                                                                               |   | **Average  Balance** |    | **Average Yield  Rate Paid** |   | **Amount  Interest** |   | **Average  Balance** |   | **Average Yield  Rate Paid** |   | **Amount  Interest** |   |
| Interest Earning Assets:                                                                                                           |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Time deposits with other banks                                                                                                     |   | $                    | 198     |                         | 6.75   | % | $ | 10 |   | $ | 135 |   | 2.97 | % | $ | 3 |   |
| Investment securities taxable                                                                                                      |   | 8,734                |    | 5.77                         | %      | 377 |   | 39,100 |   | 4.61 | % | 1,349 |   |
| Investment securities non-taxable                                                                                                  |   | 5,946                |    | 4.77                         | %      | 212 |   | 5,839 |   | 4.79 | % | 209 |   |
| Federal funds sold                                                                                                                 |   | 9,496                |    | 4.24                         | %      | 301 |   | 19,270 |   | 1.64 | % | 236 |   |
| Loans(1)(2)                                                                                                                        |   | 141,604              |    | 9.52                         | %      | 10,087 |   | 167,886 |   | 7.65 | % | 9,600 |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total interest earning assets                                                                                                      |   | 165,978              |    | 8.85                         | %      | 10,987 |   | 232,230 |   | 6.56 | % | 11,397 |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Allowance for possible loan losses                                                                                                 |   | (1,498               | )       |                         |   |   |   | (2,016 | ) |   |   |   |   |
| Non-earning assets:                                                                                                                |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                                                                                            |   | 13,922               |    |                         |   |   |   | 17,986 |   |   |   |   |   |
| Property, premises and equipment                                                                                                   |   | 2,855                |    |                         |   |   |   | 3,772 |   |   |   |   |   |
| Other assets                                                                                                                       |   | 5,141                |    |                         |   |   |   | 9,207 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| TOTAL ASSETS                                                                                                                       |   | $                    | 186,398 |                         |   |   |   |   | $ | 261,179 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Interest -bearing liabilities:                                                                                                     |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Savings/NOW/money market                                                                                                           |   | 63,906               |    | 1.74                         | %      | 831 |   | 84,770 |   | 0.74 | % | 469 |   |
| Time deposits                                                                                                                      |   | 50,032               |    | 5.24                         | %      | 1,961 |   | 46,751 |   | 2.81 | % | 983 |   |
| Other borrowings                                                                                                                   |   | 1,289                |    | 7.57                         | %      | 73 |   | 25,878 |   | 4.89 | % | 946 |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                                                                                 |   | 115,227              |    | 3.32                         | %      | 2,865 |   | 157,399 |   | 2.04 | % | 2,398 |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities:                                                                                                  |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                                                                                    |   | 54,627               |    |                         |   |   |   | 79,794 |   |   |   |   |   |
| Other liabilities                                                                                                                  |   | 1,989                |    |                         |   |   |   | 1,642 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total liabilities                                                                                                                  |   | 171,843              |    |                         |   |   |   | 238,835 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Securities Sold under Agreement to Repurchase                                                                                      |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Company Obligated Preferred Securities of Subsidiary Trust Holding  Floating Rate Junior Subordinated Deferred Interest Debentures |   | 0                    |    |                         |   |   |   | 5,333 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Stockholders’ equity                                                                                                          |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Common stock                                                                                                                       |   | 7,245                |    |                         |   |   |   | 8,917 |   |   |   |   |   |
| Retained earnings                                                                                                                  |   | 7,340                |    |                         |   |   |   | 7,989 |   |   |   |   |   |
| Valuation Allowance Investments                                                                                                    |   | (30                  | )       |                         |   |   |   | 105 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Total stockholders’ equity                                                                                                    |   | 14,555               |    |                         |   |   |   | 17,011 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                    |   | $                    | 186,398 |                         |   |   |   |   | $ | 261,179 |   |   |   |   |   |
|                                                                                                                               |   |                 |    |                         |   |   |   |   |   |   |   |   |   |
| Net Interest Income                                                                                                                |   |                 |    |                         |   | $ | 8,122 |   |   |   |   |   | $ | 8,999 |   |
| Net Interest Margin(3)                                                                                                             |   |                 |    | 6.51                         | %      |   |   |   |   | 5.17 | % |   |   |

 

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**(1)  Nonaccrualloans have been included in total loans.**

**(2)  Loan fees of$457,773 and $529,104 for2001 and 2002, respectively, have been included in theinterest income computation.**

**(3)  Net interestincome has been calculated by dividing the net interest income by total earningassets.**

 

Non-interestIncome

Non-interest income for thenine months ending September 30, 2002 was $2,488,397 compared to$3,897,568 for the same period in 2001. That represents a decrease of$1,409,171 or 36.2%. Non-interest income 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 wasdivesting itself of the off-premise ATM Networks commonly referred to as HOAK(retail sites) and NANS (gaming sites). The HOAK sites were sold during thefirst quarter of 2001, while the gaming sites consisted of three remaininglocations as of September 30, 2001. As of September 30, 2002, there is one NANSsites remaining. For the nine months ending September 30, 2002 income from thisline of business was $111,773 compared to

 

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$1,935,019 for the sameperiod in 2001. While this constitutes a large variance, it should be notedthat the expense related to these networks was $73,161 for the first ninemonths ending September 30, 2002 compared to $1,475,122 for the same period in2001. The total ATM income for 2001 includes the gross revenue obtained in thesale of the HOAK Network that was consummated on March 31, 2001. Most of therevenue obtained in that transaction was offset by related expense.

 

Service charge income ondeposit accounts increased from $876,295 during the first nine months of 2001to $1,024,343 for the nine months ending September 30, 2002. This increase inservice charges is a result of the Bank’s growth in the number of branches anddeposit accounts. The Bank acquired four branch offices from Westamerica Bankon November 9, 2001. Three of the branches were consolidated with existingbranch offices of the Bank with one branch remaining open.

 

Bankcard merchant fees were$103,200 for the first nine months of 2002 and $93,962 for the same period in2001.

 

Income obtained frommortgage origination fees were $495,758 for the first nine months of 2002compared to $429,180 for the same period in 2001.

 

Non-interest income for thethree months ending September 30, 2002 was $908,396 compared to $936,367for the same period in 2001. That represents a decrease of $27,971 or 3.0%.

 

Income from ATM transactionfees were $23,318 for the three months ending September 30, 2002 compared to$242,243 for the same period in 2001. The same explanation applies in regard tothe Bank divesting itself of this line of business as is stated above for thenine months ending September 30, 2002.

 

Income from service chargeson deposit accounts income was $381,765 for the three months ending September30, 2002 compared to $310,083 for the same period in 2001.

 

Bankcard merchant fees were$40,215 for the three months ending September 30, 2002 compared to $35,560 forthe same period in 2001.

 

Mortgage origination feeswere $222,377 for the three months ending September 30, 2002 compared to$143,724 for the same period in 2001.

 

OtherExpense

Non-interestexpense was $8,111,471 and $8,831,318 for the nine months endedSeptember 30, 2002 and the same period in 2001, respectively. This represents adecrease of $719,847 or 8.2%.

 

Expense associatedwith the ATM network was $73,161 and $1,475,122 for the nine monthsending September 30, 2002 and 2001, respectively. 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 three remaining locations as of September30, 2001. As of September 30, 2002, there is one NANS sites remaining.

 

Salaries andemployee benefits expense were $3,909,574 and $3,306,262 for the nine monthsended September 30, 2002 and 2001, respectively. This represents an increase of$603,312 or 18.3%. Full time equivalent employees were 92 at September 30, 2001compared to 111 at September 30, 2002. In November 2001, the Bank acquired fourbranch offices from Westamerica Bank. 16 of the 19 employees acceptedemployment with the Bank and were placed in various branches and departments ofthe Bank. In additional to increased salaries, there has been a 17% increase ingroup health costs.

 

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Occupancy andequipment costs were $1,247,535 for the nine months ending September 30,2002 compared to $1,294,799 for the same period in 2001. This decrease is afactor of the sale of the HOAK ATM network in March 2001and scheduleddepreciation along with additions in the normal course of business.

 

Expense associatedwith all other non-interest expense categories was $2,881,201 and $2,755,135for the nine months ended September 30, 2002 and 2001, respectively.This represents an increase of 4.6%.

 

Non-interestexpense was $2,755,541 and $2,595,339 for the three months endingSeptember 30, 2002 and the same period in 2001, respectively. This representsan increase of $160,202 or 6.2%.

 

Salaries and employeebenefits expense were $1,368,413 and $1,110,518 for the three monthsending September 30, 2002 and 2001, respectively. Occupancy and equipment costsdecreased to $397,796 for the three months ending September 30, 2002from $411,347 for the same period of 2001. Expense associated with the ATMnetwork was $17,654 and $153,303 for the three months ending September30, 2002****and 2001,respectively. Expense associated with all other non-interest expense categorieswas $971,678 and $920,171 for the three months ending September 30, 2002and 2001, respectively.

 

# **LocalEconomy**

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.

 

The Central Coast’s leading industry is the productionof wine grapes and production of premium quality wines. Over the past twoyears, production of new vineyard land has led to an over capacity of winegrapes.  Excess production of winegrapes has led to a decrease in prices of grapes sold and in some cases, theinability of farmers to sell grapes at any price.  Wineries on the other hand are purchasing grapes at existingcontract prices and in some cases, below contract prices. Wineries are becomingselect in the quality of grapes purchases, asking farmers to thin crops toproduce a higher quality fruit.

 

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

 

# **Liquidity**

The objective of liquiditymanagement is to ensure the continuous availability of funds to meet thedemands of depositors, investors and borrowers.  Asset liquidity is primarily derived from loan payments and thematurity of other earning assets. Liquidity from liabilities is obtained primarily

 

21

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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 of2002, the average funds borrowed from correspondent banks was $20,879.

 

As of July 1999, the bankbecame a member of the Federal Home Loan Bank of San Francisco. Certainsecurities and loans are pledged as collateral. The average funds borrowedthrough these facilities during the first nine months of 2002 was $24.7million.

 

The Bank manages its liquidity by maintaining amajority of its investment portfolio in federal funds sold and other liquidinvestments.  At September 30, 2002, theratio of liquid assets to deposits and other liabilities was 24.1%. The ratioof net loans to deposits, another key liquidity ratio, was 67.9% at September30, 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 September 30, 2002 has not been significant to the Bank’s financialposition or result of operations.

 

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

 

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

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

 

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

 

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

 

The Bank has in place a rigorous training program that is fullydocumented and active throughout

 

22

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the year. Regular training includes compliance with regulations,product knowledge and operating policies and procedures. Training is alsoprovided for all new products or changes in methods of operation.

 

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

 

Daily, the CEO and CFO review the Bank’s consolidated balance sheet andincome statement for unusual postings. The relative non-complex and stablenature of the Bank’s business allows for these officers to detect anomalies andquestion them that same day. Because of this daily scrutiny, inadvertentmaterial entries are corrected immediately and rarely occur on the last day ofthe month or quarter. Such anomalies are generally the case of a miss-encodeditem that the department is already aware and not that of intentionalmisrepresentation. Historically, quarterly changes to the Bank’s balance sheethave been re-slotting of un-posted account loan and deposit amounts andsuspense items to the appropriate categories within the general ledger. Theseentries, whether or not material, are researched and submitted to theController for adjustment within general ledger accounts for Call Reportpurposes.

 

Formation of Disclosure Controls and ProceduresOfficer Committee

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

 

Control and Procedures

The Committee will meet on the last Thursdayof the quarter. Members are to provide information that is documented withinthe Quarterly Control and Procedures Report. This report contains attestationsand, where applicable, documentation in regard to the following:

 

1.                                                   Internal Controls have been reviewed withinthe past 90 days

2.                                                   Concern about weaknesses in internal control

3.                                                   Events that may require disclosure

4.                                                   Internal Fraud/Defalcation

5.                                                   Potential Material Losses

6.                                                   New Off-Balance Sheet Arrangements

7.                                                   Material Amounts not reflected on thegeneral ledger

 

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

 

a) Evaluation of disclosure controls and procedures

Withinthe 90 days prior to the date of this report, the Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures. Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to the Company (including its consolidatedsubsidiaries) required to be included in the Company’s periodic SEC filings.

 

23

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b)Changes in internal controls

Therewere no significant changes in the Company’s internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof their evaluation.

 

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

 

ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

 

(a)           Exhibits:

 

**Exhibit 99.1** Certification of Chief Executive Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

**Exhibit 99.2** Certification of Chief Financial Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

**Exhibit 10.29** Money Access Services Processing Agreement forATM processing, signed on October 3, 2002

 

(b)           Reports on Form 8-K:

 

TheCompany filed the announcement of a two-for-one stock split on Form 8-K, Item 5with the SEC on July 19, 2002.

 

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 24, 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 |   |   |

 

24

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**CERTIFICATIONS**

 

I, Lawrence P. Ward, Chief ExecutiveOfficer, certify that:

 

1.               I have reviewed this quarterly report onForm 10-QSB of Heritage Oaks Bancorp;

 

2.               Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.               The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)              designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly report isbeing prepared;

b)             evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to filing date of this quarterly report (the “Evaluation Date”); and

c)              presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and audit committee of registrant’s board of directors (or personsperforming the equivalent function);

 

a)              all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)             any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.               The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date:  October 8, 2002

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

 

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**CERTIFICATIONS**

 

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

 

7.               I have reviewed this quarterly report onForm 10-QSB of Heritage Oaks Bancorp;

 

8.               Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

9.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

10.         The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)              designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b)             evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to filing date of this quarterly report (the “Evaluation Date”); and

c)              presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

11.         The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and audit committee of registrant’s board of directors (or personsperforming the equivalent function);

 

a)              all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)             any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

12.         The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date:    October 8, 2002

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

 

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###### **ExhibitIndex**

 

Exhibit10.29                              Money Access Services Processing Agreementfor ATM processing, signed October 3, 2002

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

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

 

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