-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QopQdHNB3ATyxHoQ+jsIdRLR1cyyZhl9SeK3LjgvsHNzo6tbMjfLgScDcnuabup/ WawtjnhekGpidoMlo+A4PQ== 0000912057-00-013966.txt : 20000329 0000912057-00-013966.hdr.sgml : 20000329 ACCESSION NUMBER: 0000912057-00-013966 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HERITAGE OAKS BANCORP CENTRAL INDEX KEY: 0000921547 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 953763629 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 000-25020 FILM NUMBER: 580744 BUSINESS ADDRESS: STREET 1: 545 12TH ST CITY: PASO ROBLES STATE: CA ZIP: 93446 BUSINESS PHONE: 8052395200 MAIL ADDRESS: STREET 2: 545 12TH ST CITY: PASO ROBLES STATE: CA ZIP: 93446 10KSB40 1 10KSB40 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the Year ended DECEMBER 31, 1999 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-25020 HERITAGE OAKS BANCORP (Exact name of registrant as specified in its charter) STATE OF CALIFORNIA 77-0388249 (State or other jurisdiction of (I.R.S. Identification employee incorporation or organization) No.) 545 12TH STREET, PASO ROBLES, CALIFORNIA 93446 (805) 239-5200 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED Common Stock, (no par value) None Indicate by check mark whether the registrant (1) has filed all reports required to be riled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB /X/. Registrant's revenue for 1999 was $15,400,259. The aggregate market value of the voting stock held by non-affiliates of the Registrant at March 1st, 2000 was $11,861,346. As of March 1st, 2000, the Registrant had 1,144,282 shares of Common Stock outstanding. The following documents are incorporated by reference in Part III, Items 9 through 12 of Registrant's definitive proxy statement for the 2000 annual meeting of shareholders. Transitional Small Business Disclosure Format (check one) Yes / / No /X/ TABLE OF CONTENTS PART I Page Item 1. Description of Business 3 - 11 Item 2. Description of Properties 11 - 12 Item 3. Legal Proceedings 12 Item 4. Submission of Matters to a Vote of Security Holders 12 PART II Item 5. Market for Registrant's Common Equity and Related Stockholders Matters 13 - 14 Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 - 27 Item 7. Financial Statements 28-F-34 Item 8. Changes and Disagreements with Accountants on Accounting and Financial Disclosure 28 PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; 28 Item 10. Executive Compensation 28 Item 11. Security Ownership of Certain Beneficial Owners and Management 28 Item 12. Certain Relationships and Related Transactions 28 Item 13. Exhibits and Reports on Form 8-K 28 - 30
2 PART I ITEM 1. DESCRIPTION OF BUSINESS General Heritage Oaks Bancorp (the "Company") is a California corporation organized in 1994 to act as the bank holding company of Heritage Oaks Bank (the "Bank"). In 1994, the Company acquired all of the outstanding common stock of the Bank in a holding company formation transaction. Other than holding the shares of the Bank, the Company conducts no significant activities, although it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), the Company's principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. Banking Services The Bank was licensed by the California Department of Financial Institutions (ADFI) and commenced operation in January 1983. As a California state bank, the Bank is subject to primary supervision, examination and regulation by the DFI and the Federal Deposit Insurance Corporation (AFDIC). The Bank is also subject to certain other federal laws and regulations. The deposits of the Bank are insured by the FDIC up to the applicable limits thereof. The Bank is not a member of the Federal Reserve System. At December 31, 1999, the Company had approximately $147.3 million in assets, $102.4 million in net loans, $132.9 million in deposits, and $10.5 million in stockholders' equity. The Bank is headquartered in Paso Robles with a branch office in Paso Robles, two branches in San Luis Obispo, one branch office in Cambria, a loan production office in Arroyo Grande, one branch located in Santa Maria and a branch located in Atascadero. The Bank conducts a commercial banking business in San Luis Obispo County, Northern Santa Barbara County and Southern Monterey County, including accepting demand, savings and time deposits, and making commercial, real estate, SBA, agricultural, credit card, and consumer loans. It also offers installment note collection, issues cashiers checks and money orders, sells travelers checks, and provides bank-by-mail, night depository, safe deposit boxes, and other customary banking services. The Bank does not offer trust services or international banking services and does not plan to do so in the near future. On January 13, 2000, the Bank opened a full service branch office in Arroyo Grande, California. Concurrent with this, the Bank closed the loan production office in the same city and included it in the new full service branch office. The Bank's operating policy since its inception has emphasized small business commercial and retail banking. Most of the Bank's customers are retail customers, farmers and small to medium-sized businesses. The Bank takes real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery and equipment as collateral for loans. The areas in which the Bank has directed virtually all of its lending activities are (i) commercial and agricultural loans, (ii) installment loans, (iii) construction loans, and (iv) other real estate loans or commercial loans secured by real estate. As of December 31, 1999, these four categories accounted for approximately 36.89%, 2.67%, 12.23% and 48.07% respectively, of the Bank's loan portfolio. As of December 31, 1999, $62,805,191 or 60.3% of the Bank's $104,152,682 in gross loans consisted of interim construction and real estate loans, primarily for single family residences or for commercial development. Commercial and agricultural loans grew $.2 million (approximately .50%) between year-end 1998 and year-end 1999. See AItem 6 - Management's Discussion and Analysis of Financial Condition and Results of Operations. Most of the Bank's deposits are attracted by local promotional activities and advertising in the local media. A material portion of the Bank's deposits have not been obtained from a single person or a few persons, the loss of any one or more 3 of which would have a materially adverse effect on the business of the Bank. As of December 31, 1999, the Bank had approximately 11,630 deposit accounts consisting of non-interest bearing (demand), interest-bearing demand and money market accounts with balances totaling $81.6 million for an average balance per account of approximately $7,016; 5,012 savings accounts with balances totaling $13.5 million for an average balance per account of approximately $2,694; and 1,260 time certificate of deposit accounts with balances totaling $37.8 million, for an average balance per account of approximately $30,000. The principal sources of the Banks revenues are (i) interest and fees on loans, (ii) interest on investments, (iii) service charges on deposit accounts and other charges and fees, (iv) ATM transaction fees, sponsorship fees and interchange income, (v ) mortgage origination fees and (vi) miscellaneous income. For the year ended December 31, 1999, these sources comprised 54.7%, 9.7%, 4.9%, 20.3%, 1.9% and 8.5%, respectively, of the Bank's total operating income. The Bank has arranged to install 82 cash dispensing machines for the purpose of dispensing cash, 14 of which are on Native American lands where bingo games and other gaming operations are conducted, with the remaining 68 at other commercial locations, and at the Bank's 8 offices. The Bank receives a transaction fee for each completed transaction on the cash dispensing machines at all off premise locations. In regard to the Native American sites, in previous years, the Bank shared a portion of the fees with two individuals who had helped to make these arrangements and with the tribes on whose lands the cash dispensing machines are installed. During September 1996, the Bank bought out the interest of one of the individuals. During April 1997, the Bank bought out the interest of the other individual. In prior years, the Bank only received the net earnings from the surcharge revenue received from the gaming network. After the Bank had purchased the interest of the two individuals, it then assumed all direct costs and received all of the revenue net of the amounts that are still paid to the tribes on whose land the casinos are located. The contract buy-outs were fully amortized over a period of 18 and 36 months. The total amortization expense for 1999 was approximately $90,000. The Company has also caused to be incorporated a proposed subsidiary, CCMS Systems, Inc. which is currently inactive and has not been capitalized. The Company has no present plans to activate the proposed subsidiary. The Bank has not engaged in any material research activities relating to the development of new services or the improvement of existing bank services. There has been no significant change in the types of services offered by the Bank since its inception. The Bank has no present plans regarding "a new line of business" requiring the investment of a material amount of total assets. Most of the Banks business originates from San Luis Obispo, Northern Santa Barbara and Southern Monterey Counties and there is no emphasis on foreign sources and application of funds. The Banks business, based upon performance to date, does not appear to be seasonal. Management of the Bank is unaware of any material effect upon the Banks capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulations. The Bank holds no patents, licenses (other than licenses obtained from bank regulatory authorities), franchises or concessions. When the Company uses or incorporates by reference in this Annual Report on Form 10-KSB ("Annual Report") the words "anticipate", "estimate", "expect", "project", "intend", "commit", "believe" and similar expressions, the Company intends to identify forward-looking statements. Such statements are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. Employees As of February 1, 2000, the Bank had a total of 92 full-time equivalent employees. The management of the Bank believes that its employee relations are satisfactory. The Company has only one salaried employee (the internal auditor). The Company's officers all hold similar positions at the Bank and receive compensation from the Bank. 4 Competition The banking and financial services business in California generally, and in the Banks market area specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. The Bank's business is concentrated in its service area, which encompasses San Luis Obispo County, Northern Santa Barbara County and Southern Monterey County. In order to compete with other financial institutions in its service area, the Bank relies principally upon local advertising programs; direct personal contact by officers, directors, employees, and shareholders; and specialized services such as courier pick-up and delivery of non-cash banking items. The Bank emphasizes to its customers the advantages of dealing with a locally owned and community oriented institution. The Bank also seeks to provide special services and programs for individuals in its primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, tools of the trade or expansion of practices or businesses. Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns. They also perform services, such as trust services, international banking, discount brokerage and insurance services that the Bank is not authorized or prepared to offer currently. The Bank has made arrangements with its correspondent banks and with others to provide such services for its customers. For borrowers requiring loans in excess of the Bank's legal lending limits, the Bank has offered, and intends to offer in the future, such loans on a participating basis with its correspondent banks and with other independent banks, retaining the portion of such loans which is within its lending limits. As of December 31, 1999, the Bank's legal lending limits to a single borrower and such borrower's related parties were $1,680,150 on an unsecured basis and $2,800,250 on a fully secured basis based on regulatory capital of $11,201,002. Commercial banks compete with savings and loan associations, credit unions, other financial institutions, securities and brokerage firms, and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions. In recent years competition for cash dispensing machines on Native American lands in connection with gaming operations has increased. Further competition for ATM machines at retail sites has also increased creating reduced profit margins. The Bank is becoming less reliant on ATM generated revenue than in previous years and the trend is expected to continue in this direction. Effect of Governmental Policies and Recent Legislation Banking is a business that depends on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank's portfolio comprise the major portion of the Bank's earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and growth of the Bank are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment. The commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas 5 influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted. From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies. For example, legislation has been introduced in Congress that would repeal the current statutory restrictions on affiliations between commercial banks and securities firms. See "Financial Modernization Act". Supervision and Regulation The Company and the Bank is extensively regulated under both federal and state law. Set forth below is a summary description of certain laws that relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. The Company The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is registered as such with, and subject to the supervision of, the Federal Reserve Board. The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may conduct examinations of bank holding companies and their subsidiaries. The Company is required to obtain the approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. The Company is prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may, subject to the prior approval of the Federal Reserve Board, engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. See discussion under "Financial Modernization Act" below for additional information. The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates when the Federal Reserve Board determines that the activity or the control or the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the Federal Reserve Board's regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe and unsound manner. 6 In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and filed reports and proxy statements pursuant to such Act with the Securities and Exchange Commission (ASEC) The Bank The Bank is chartered under the laws of the State of California and its deposits are insured by the FDIC to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the DFI and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Banks business and condition. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes relate to many aspects of the Banks operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. Further, the Bank is required to maintain certain levels of capital. Capital Standards The Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, non-cumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 4%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 4%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. 7 Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends. The following table presents the amounts of regulatory capital and the capital ratios for the Bank and the Company, compared to its minimum regulatory capital requirements as of December 31, 1999. DECEMBER 31, 1999 BANK COMPANY MINIMUM ACTUAL ACTUAL CAPITAL REQUIREMENTS LEVERAGE RATIO 7.22% 7.62% 4.0% TIER 1 RISK-BASED RATIO 9.60% 9.80% 4.0% TOTAL RISK-BASED RATIO 10.75% 10.89% 8.0% Under applicable regulatory guidelines, the Bank was considered "Well Capitalized" at December 31, 1998. Under existing regulations of the Federal Reserve Board, the capital ratios of the bank holding company with total assets of less than $150 million, such as the Company, are deemed to be the same as those of the Bank. On January 1, 1998 legislation became effective which, among other things, gave the power to the DFI to take possession of the business and properties of a bank in the event that the tangible shareholders' equity of the bank is less than the greater of (i) 4% of the banks total assets or (ii) $1,000,000. Prompt Corrective Action and Other Enforcement Mechanisms Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An insured depository institution generally will be classified in the following categories based on capital measures indicated below: "WELL CAPITALIZED" "ADEQUATELY CAPITALIZED" Total risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and Leverage ratio of 5%. Leverage ratio of 4%. "UNDERCAPITALIZED" "SIGNIFICANTLY UNDERCAPITALIZED" Total risk-based capital less than 8%; Total risk-based capital less than 6%; Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or Leverage ratio less than 4%. Leverage ratio less than 3%. "CRITICALLY UNDERCAPITALIZED" Tangible equity to total assets less than 2%.
An institution that, based upon its capital levels, is classified as "well capitalized," "adequately capitalized" or 8 undercapitalized" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as "critically undercapitalized" unless its capital ratio actually warrants such treatment. The law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if, after such transaction, the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions. An insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized. Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the 9 regulator. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. Premiums for Deposit Insurance All deposits of the Bank are insured by the FDIC through the Bank Insurance Fund (ABIF) which are subject to FDIC insurance assessment. The amount of FDIC assessment paid by individual insured depository institutions is based upon their relative risk as measured by regulatory capital ratios and certain other factors. During 1995, the FDIC significantly reduced premium rates assessed on deposits insured by the BIF. As a result of its AWell Capitalized status, the Bank paid $30,515 in 1999. Financial Modernization Legislation On November 12, 1999, the President signed into law the Gramm-Leach-Bliley Act, or GLB Act, which significantly changed the regulatory structure and oversight of the financial services industry. The GLB Act revises the Bank Holding Company Act of 1956 and repeals the affiliation provisions of the Glass-Steagall Act of 1933, prohibiting a qualifying holding company, called a financial holding company, to engage in a full range of financial activities, including banking, insurance, and securities activities, as well as merchant banking and additional activities that are "financial in nature" or "complementary" to such financial activities. The GLB Act thus provides expanded financial affiliation opportunities for existing bank holding companies and permits various non-bank financial services providers to acquire banks by allowing bank holding companies to engage in activities such as securities underwriting, and underwriting and brokering of insurance products. The GLB Act also expands passive investments by financial holding companies in any type of company, financial or non-financial, through merchant banking and insurance company investments. In order for a bank holding company to qualify as a financial holding company, its subsidiary depository institutions must be "well-capitalized" and "well-managed" and have at least a "satisfactory" Community Reinvestment Act rating. The GLB Act also reforms the regulatory framework of the financial services industry. Under the GLB Act, financial holding companies are subject to primary supervision by the Federal Reserve Board while current federal and state regulators of financial holding company regulated subsidiaries such as insurers, broker-dealers, investment companies and banks generally retain their jurisdiction and authority. In order to implement its underlying purposes, the GLB Act preempts state laws restricting the establishment of financial affiliations authorized or permitted under the GLB Act, subject to specified exceptions for state insurance regulators. With regard to securities laws, the GLB Act removes the current blanket exemption for banks from the broker-dealer registration requirements under the Securities Exchange Act of 1934, amends the Investment Company Act of 1940 with respect 11 to bank common trust fund and mutual fund activities, and amends the Investment Advisers Act of 1940 to require registration of banks that act as investment advisers for mutual funds. The GLB Act also includes provisions concerning subsidiaries of national banks, permitting a national bank to engage in most financial activities through a financial subsidiary, provided that the bank and its depository institution affiliates are "well capitalized" and "well managed" and meet certain other qualification requirements relating to total assets, subordinated debt, capital, risk management, and affiliate transactions. With respect to subsidiaries of state banks, new activities as "principal" would be limited to those permissible for a national bank financial subsidiary. The GLB Act requires a state bank with a financial subsidiary permitted under the GLB Act as well as its depository institution affiliates to be "well capitalized," and also subjects the bank to the same capital, risk management and affiliate transaction rules as applicable to national banks. The provisions of the GLB Act relating to financial holding companies become effective 120 days after its enactment, or about March 15, 2000, excluding, the federal preemption provisions, which became effective on the date of enactment. The GLB Act will likely increase competition in the markets in which the Company operates, although it is difficult to assess the impact that such increased competition may have on the Company's operations. The Company currently meets all the requirements for financial holding company status. However, the Company does not expect to elect financial holding company status unless and until it intends to engage in any of the expanded activities under the GLB Act which require such status. Unless and until it elects such status, the Company will only be permitted to engage in non-banking activities that were permissible for bank holding companies as of the date of the enactment of the GLB Act. Community Reinvestment Act The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of "outstanding." "satisfactory," "needs to improve" or "substantial noncompliance." At its last examination by the FDIC, the Bank received a CRA rating of "Satisfactory." Accounting Change From time to time the Financial Accounting Standards Board (AFASB) issues pronouncements which govern the accounting treatment for the Company's financial statements. For a description of the recent pronouncements applicable to the Company (see the Notes to the Financial Statements included in Item 7 of this Report). The FASB recently proposed for comment a change in the accounting rules relating to mergers and acquisitions. Specifically, the Apooling method of accounting for mergers would be eliminated. Financial institutions often prefer to account for mergers using this method and many of the mergers in the financial institutions industry in the last several years have been accounted for using the pooling method. The impact of such accounting change, if adopted, on mergers and acquisitions involving financial institutions and upon the Company and the value of its Common Stock can not presently be predicted. 11 Potential Enforcement Actions Commercial banking organizations, such as the Company and the Bank, may be subject to potential enforcement actions by the Federal Reserve Board, the DFI and the FDIC for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. ITEM 2. DESCRIPTION OF PROPERTIES The Bank and the Company occupy a permanent headquarters facility that is located at 545 Twelfth Street, Paso Robles, Ca. The purchase price for the headquarters, was approximately $1,000,000 for the building and land. This building has approximately 9,000 square feet of space and off-street parking. The Bank has remodeled this building at an approximate cost of $300,000. The Bank has a non-banking office, located at 600 Twelfth Street, Paso Robles (directly across from its present headquarters) which was purchased by the Bank on December 23, 1986, for approximately $400,000 from an unaffiliated party. In June of 1994, the Bank opened a branch at 171 Niblick Rd., Paso Robles, Ca. The Bank leases this 1,400 square foot branch for $2,135 per month. On February 24, 2000, the Bank renewed the lease for an additional five-year term. On June 26, 1997 the Bank executed a lease for its branch office at 297 Madonna Road, San Luis Obispo. The branch was previously located in premises that were acquired from La Cumbre Savings, which lease expired in 1997. The new branch lease is for 6,200 square feet of which the Bank subleases approximately 58% to another firm and uses 42%. The other firm pays 58% of the rent and expenses and the Bank pays 42%. The rent under the lease for the entire space starts at $6,200/month for the first year; $6,280/month for the next two years; $7,750/month for the next two years the rent is then repriced in year six of the lease to 95% of the prevailing fair market value and then increases each year thereafter at the greater of the consumer price index or 2.5% until the lease expires on June 30, 2009. The Bank opened a branch office at 1135 Santa Rosa Street in downtown San Luis Obispo, Ca in April 1996. The Bank is leasing a building containing approximately 5,618 square feet for $5,555 per month for the next four years. The lease payment will increase by approximately $500 per month during the next 4 years. The lease will expire on February 28, 2001 at which time the Bank has an option to renew the lease for an additional 5 years. On February 21, 1997, the Bank acquired the Cambria branch of Wells Fargo Bank located at 1276 Tamson Drive, Cambria. The Bank leases this 2,916 square foot branch for $2,208 per month, subject to adjustments for cost of living increases and certain pass-throughs. The lease will expire in 2004 at which time the Bank has an option to renew the lease for two additional five-year terms. On August 26, 1998, the Company purchased property located at 9900 El Camino Real, Atascadero. The purchase price was $271,160. The Company entered into a contract with Sabaloni Construction to construct a building with a total of 3,500 square feet of floor space. The total cost of improvements was $440,765 plus furniture and fixtures. On April 1, 1999, the Company entered into a five-year lease agreement, with three five year options to renew, with the Bank at the rate of $4,725 per month or $1.35 per square foot. Comparatives were obtained to ensure that the lease amount was at fair market value. 12 On November 1, 1998, the bank entered into a 10 year lease with an unaffiliated party to lease property known as 1660 South Broadway, Santa Maria, Ca. The lease calls for monthly payments based on a triple net price of $1.15 per square foot or $5,395 per month. The rent will adjust each November by the Consumer Price Index or a maximum of 6%. The lease will expire on October 31, 2008, with the banking having three five year options to renew. On October 14, 1999 the bank entered into a 18 month Sublease with an unaffiliated party to lease property located at 1360 Grand Avenue, Arroyo Grande, Ca. The lease calls for monthly payment based on a triple net price of $1.00 per square foot or $3,375 per month. It is the bank's intention to enter into a longer-term lease when the sublease expires. ITEM 3. LEGAL PROCEEDINGS The Bank is, from time to time, subject to various pending and threatened legal actions which arise out of the normal course of its business. Neither the Company nor the Bank is a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company's or the Bank's business) and no such proceedings are known to be contemplated. There are no material proceedings adverse to the Company or the Bank to which any director, officer, affiliate of the Company or 5% shareholder of the Company or the Bank, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or Bank is a party, and none of the above persons has a material interest adverse to the Company or the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1999. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information There is a limited over-the-counter market for the Company's Common Stock. The Company's Common Stock is not listed on any exchange or market. However, Maguire Investments, Inc., Hoefer & Arnett, Inc., Pacfic Crest Securities and Sutro & Co. make a market in the Company's Common Stock. Certain information concerning the Common Stock is reported on the NASDAQ electronic bulletin board under the symbol AHEOP. The information in the following table indicates the high and low bid prices of the Company's Common Stock for each quarterly period during the last two years based upon information provided by Maguire Investments, Inc., Hoefer & Arnett, Inc., Pacific Crest Securities and Sutro & Co. These prices do not include retail mark-ups, mark-downs or commission. 13
Quarter Ended Bid Prices 1998 Low High March 31 $13.50 $16.00 June 30 15.75 16.75 September 30 16.00 17.75 December 31 16.00 17.00 1999 Low High March 31 $16.25 $16.25 June 30 16.25 17.00 September 30 16.00 16.75 December 31 15.75 16.75
Holders As of March 1, 2000, there were approximately 585 holders of the Company's Common Stock. There are no other classes of equity outstanding. Dividends The Company is a legal entity separate and distinct from the Bank. The Company's shareholders are entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available therefore, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law also provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets two conditions, which generally stated are as follows: (i) the corporation's assets equal at least 1-1/4 times its liabilities, and (ii) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and before interest expenses for the two preceding fiscal years was less than the average of the corporation's interest expenses for such fiscal years, then the corporation's current assets must equal at least 1-1/4 times its current liabilities. The ability of the Company to pay a cash dividend depends largely on the Bank's ability to pay a cash dividend to the Company. The payment of cash dividends by the Bank is subject to restrictions set forth in the California Financial Code (the "Financial Code"). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank's retained earnings; or (b) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the DFI, make a distribution to its shareholders in an amount not exceeding the greater of (x) its retained earnings; (y) its net income for its last fiscal year; or (z) its net income for its current fiscal year. In the event that the DFI determines that the shareholders' equity of a bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the DFI may order the bank to refrain from making a proposed distribution. The FDIC may also restrict the payment of dividends if such payment would be deemed unsafe or unsound or if after the payment of such dividends, the Bank would be included in one of the "undercapitalized" categories for capital adequacy purposes pursuant to federal law. (See, "Item 1 - Description of Business - Prompt Corrective Action and Other Enforcement Mechanisms.") Additionally, while the Federal Reserve Board has no general restriction with respect to the payment of cash dividends by an adequately capitalized bank to its parent holding company, the Federal Reserve Board might, under certain circumstances, place restrictions on the ability of a particular bank to pay dividends based upon peer group averages and the performance and maturity of the particular bank, or object to management fees to be paid by a subsidiary bank to its holding company 14 on the basis that such fees cannot be supported by the value of the services rendered or are not the result of an arm's length transaction. Under these provisions and considering minimum regulatory capital requirements, the amount available for distribution from the Bank to the Company was approximately $2,548,502 at December 31, 1999. The following table sets forth the per share amount and month of payment for all cash dividends paid since January 1, 1997 (Per share information has been retroactively adjusted for the three-for-two stock split paid on November 5, 1997):
Month Paid Amount Per Share February, 1997 $ .33 February, 1998 $ .50
On January 28, 1999, the Board of Directors declared a 4% stock dividend, in lieu of a cash dividend, for shareholders of record as of February 15, 1999. The stock dividend was distributed on February 26, 1999. Whether or not stock dividends or any cash dividends will be paid in the future will be determined by the Board of Directors after consideration of various factors. The Company's profitability and regulatory capital ratios in addition to other financial conditions will be key factors considered by the Board of Directors in making such determinations regarding the payment of dividends by the Company. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is an analysis of the financial condition and results of operations of the Company for the two years ended December 31, 1999. The analysis should be read in connection with the consolidated financial statements and notes thereto appearing elsewhere in this report. On November 15, 1994, the Company acquired all of the assets and assumed all of the liabilities of the Bank. Each shareholder of the Bank received one share of stock in the Company in exchange for one share of Bank stock. The Bank became a wholly owned subsidiary of the Company. The Bank is the only active subsidiary owned by the Company. EARNINGS OVERVIEW The Company reported net income for 1999 of $1,430,928. This was a 6.3% increase from the $1,346,595 reported in 1998. Net income reported for 1998 represented an increase of $85,531 or 6.8% more than 1997 net income of $1,261,064. Basic earnings per share were $1.27, $1.24 and $1.18 at December 31, 1999, 1998 and 1997, respectively. Diluted earnings per share were $1.15, $1.13 and $1.11 at December 31, 1999, 1998 and 1997, respectively. RETURN ON EQUITY AND ASSETS
DECEMBER 31, 1998 1999 ---- ---- Return on Average Assets 1.24% 1.07% Return on Average Equity 16.11% 14.87% Average Equity to
15 Average Assets Ratio 8.04% 7.78% Return on Average Interest Bearing Assets 5.94% 6.42% Average Loans to Average Deposits 65.84% 71.20%
NET INTEREST INCOME AND INTEREST MARGIN Net interest income, the primary component of the net earnings of a financial institution, refers to the difference between the interest paid on deposits and borrowings, and the interest earned on loans and investments. The net interest margin is the amount of net interest income expressed as a percentage of average earning assets. Factors considered in the analysis of net interest income are the composition and volume of earning assets and interest-bearing liabilities, the amount of non-interest bearing liabilities and nonaccrual loans, and changes in market interest rates. Net interest income before provision for possible loan losses for 1999 was $7,312,558, an increase of $1,866,193 or 34.3% more than the $5,446,365 in 1998. The increase in net interest income for 1999 compared to 1998 was attributable to a $22,163,000 increase in average earning assets at an average rate of 8.7%. The average interest-bearing liabilities for 1999 increased by $9,818,000. The increase in net interest income resulted primarily from the large increase in interest earning assets over the increase in interest bearing liabilities. The average rate paid on interest bearing liabilities in 1999 was 3.05% compared to 3.37% in 1998. Average non-interest bearing demand deposits increased by $15,027,000 over 1998. Other low cost deposits such as savings, now and money market accounts grew an average $6,208,000 with a weighted average rate of 2.08%. The higher cost time deposits increased an average of $3,447,000. These changes reflect a major effort by the Bank to adjust its liability mix to increase its level of demand deposits and savings accounts. Total income on the loan portfolio increased from $6,459,394 in 1998 to $8,424,833 in 1999. This was due to an increase in average loans of $21,844,000. The average yield on earning assets was 8.71% for both 1999 and 1998. The average yield on interest bearing liabilities was 3.05% for 1999, compared to 3.37% for 1998. The net interest margin was 6.42% in 1999 compared to 5.94% in 1998. The table on the following page sets forth the average balance sheet information, interest income and expense, average yields and rates and net interest income and margin for the years ended December 31, 1999 and 1998. The average balance of non-accruing loans has been included in loan totals. 16
1999 1998 (DOLLARS IN THOUSANDS) AVERAGE AVERAGE YIELD AMOUNT AVERAGE AVERAGE YIELD AMOUNT Interest Earning Assets: BALANCE RATE PAID INTEREST BALANCE RATE PAID INTEREST --------- ------------- -------- ------- ------------- -------- Time deposits with other banks $409 5.38% $22 $425 5.65% $24 Investment securities taxable 15,977 5.86% 937 17,522 6.04% 1,058 Investment securities non-taxable 6,505 4.77% 310 5,266 4.80% 253 Federal funds sold 4,390 5.01% 220 3,749 5.25% 197 Loans (1) (2) 86,578 9.73% 8,425 64,734 9.98% 6,459 ------- ----- ------ ----- Total interest earning assets 113,859 8.71% 9,914 91,696 8.71% 7,991 ------- ----- ------ ----- Allowance for possible loan losses (1,150) (974) Non-earning assets: Cash and due from banks 14,984 11,993 Property, premises and equipment 3,045 2,245 Other assets 3,558 3,258 ------ ------ TOTAL ASSETS $134,296 $108,218 ======== ======== Interest -bearing liabilities: Savings/NOW/money market 54,717 2.08% 1,137 48,509 2.35% 1,142 Time deposits 29,370 4.69% 1,377 25,923 5.16% 1,338 Other borrowings 1,267 6.87% 87 1,104 5.80% 64 ----- ----- ------ ----- Total interest-bearing liabilities 85,354 3.05% 2,601 75,536 3.37% 2,544 ------ ----- ------ ----- Non-interest bearing liabilities: Demand deposits 37,472 22,445 Other liabilities 1,343 1,876 ------ ------ Total liabilities 124,169 99,857 ------- ------ Stockholders' equity Common stock 5,148 4,232 Retained earnings 5,299 4,468 Valuation Allowance Investments (320) (339) ------- ------ Total stockholders' equity 10,127 8,361 ------- ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $134,296 $108,218 ======== ======== Net Interest Income $7,313 $5,447 ====== ====== Net Interest Margin (3) 6.42% 5.94%
(1) Nonaccrual loans have been included in total loans. (2) Loan fees of $483 and $312 for 1999 and 1998, respectively, have been included in the interest income computation. (3) Net interest income has been calculated by dividing the net interest income by total earning assets. Note: All average balances have been computed using daily balances. 17
RATE/VOLUME ANALYSIS 1999 1998 ---- ---- Average Average Average Average Increase (decrease) in: Bal/Vol Rate Total Bal/Vol Rate Total Interest income: Loans (1) $2,180 ($215) $1,965 $1,154 ($201) $953 Investment securities taxable (93) (28) (121) 115 44 159 Investment securities non-taxable (2): 90 (3) 87 189 6 195 Taxable equivalent adjustment (2): (31) 1 (30) (67) (2) (69) Interest-bearing deposits (1) (1) (2) 14 (1) 13 Federal funds sold 34 (10) 24 60 (5) 55 ------ ------ ----- ------ ------ ------- Total 2,179 (256) 1,923 1,465 (159) 1,306 Interest expense: Savings, now, money market 146 (151) (5) 156 (64) 92 Time deposits 178 (139) 39 192 40 232 Other borrowings 9 14 23 8 - 8 ------ ------ ----- ------ ----- ------- Total 333 (276) 57 356 (24) 332 ------ ------ ----- ------ ----- ------- Increase (decrease) in net Interest income $1,846 $20 $1,866 $1,109 ($135) $974 ======= ==== ======= ======= ====== =====
(1) Loan fees of $483 and $312 for 1999 and 1998, respectively have been included in the interest income computation. (2) Adjusted to a fully taxable equivalent basis using a tax rate of 34%. Note A: Average balances of all categories in each period were included in the volume computations. Note B: Average yield rates in each period were used in rate computations. Any change attributable to changes in both volume and rate which cannot be segregated has been allocated. Non-Interest Income Non-interest income consists of bankcard merchant fees, automatic teller machines ("ATM") transactions, and other fees, service charges, and gains on other real estate owned. Non-interest income for 1999 was $5,444,241 compared to $6,360,803 for 1998. The primary decrease in non-interest income is attributable to ATM transaction fees, ATM interchange income, and ATM sponsorship fees. These fees decreased by $1,128,978 from 1998. ATM transaction fees, interchange income, and sponsorship fees were $3,133,847 for 1999 compared to $4,262,825 for 1998. During the fourth quarter of 1998, 6 ATMs in a particular gaming facility were shut down due to the owner's change in operating policy. These machines were removed creating lost revenue opportunity for the remainder of 1998 of approximately $125,000. Gross revenue in 1999 was further impacted by increased competition resulting in re-negotiation of certain gaming agreements. Profit margins decreased, however, all gaming sites remain acceptably profitable. In previous years the Bank shared a portion of the gaming fees with two individuals who had helped to make these arrangements and with the tribes on whose lands the cash dispensing machines are installed. During September 1996, the Bank bought out the interest of one of the individuals. During April 1997, the Bank bought out the interest of the other individual. In prior years, the Bank only received the net earnings from the surcharge revenue received from the gaming network. After the bank had purchased the interest of the two individuals, it then assumed all direct costs and received 18 all of the revenue net of the amounts that are still paid to the tribes on whose land the casinos are located. The contract buy-outs were amortized over a period of 18 to 36 months, with the final amortized amount of approximately $90,000 in 1999. The competition relating to ATM machines at retail sites has also increased creating reduced profit margins. With this in mind, the Bank is utilizing upcoming ATM equipment lease terminations in the months of March, October, November and December of 2000 to reduce overhead and retain only the most profitable sites. The Bank is becoming less reliant on ATM generated revenue than in previous years and the trend is expected to continue in this direction. The net earnings from all ATM operations before deducting for overhead expenses and salaries were $1,053,720, $1,506,032, and $1,493,778, for the years ended December 31, 1999, 1998, and 1997, respectively. During 1999, certain cities in California passed local laws prohibiting Surcharging by financial institutions at ATMs located within their municipalities. To counteract these actions, there has been considerable efforts put forth by financial institutions represented by numerous banking organizations. These efforts have resulted in a delay in any implementation of these laws. Even though the Bank is confident that such laws will not be able to be implemented, the Bank took action to divest itself of ownership in seven sites located in San Francisco, California. The Bank assigned the site agreements to a marketing firm while retaining the servicing. This resulted in no change to the net revenue stream of these seven sites. Bankcard merchant fees were $623,930 in 1999 compared to $757,380 in 1998. Up until September 1999, the Bank accounted for merchant bankcard transactions by posting the gross revenue to income that was offset by expenses contained within the "Other Expense" category. In September 1999, the Bank entered into an agreement to sell the merchant agreements to the existing processor, whereby the Bank would no longer incur liability for transactions and would receive net income monthly based on net sales volumes. For 1998, net income (loss) from this line of business was ($107,590) while in 1999, the Bank posted positive net income of $50,606. Non-Interest Expenses Non-interest expense increased to $10,406,243 for 1999 from $9,568,547 in 1998, primarily due to the Banks growth. During the first quarter of 1999, the Bank opened a denovo, full service branch office in Santa Maria, California and Atascadero, California. During the fourth quarter, the Bank was in process of opening a full service, denovo branch office in Arroyo Grande, California. This office opened on January 13, 2000. Salaries and employee benefit expenses were $3,562,023 and $2,892,921 for 1999 and 1998 respectively. Full time equivalent employees were 92 for 1999 and 68 for 1998. The increase in salary and benefit expense is due to increased staffing attributable to the Banks branch office growth during the year. The ratio of "assets per employee, one of the measures of operational efficiency, was $1,601,465 and $1,924,245 for 1999, and 1998 respectively. Occupancy, furniture and equipment expenses were $1,484,919 during 1999, compared to $923,207 incurred in 1998. The new branches along with preparation for Year 2000 compliance resulted in a significant portion of the increase in equipment expense for 1999. Other expenses decreased to $5,359,301 in 1999 as compared to $5,752,419 in 1998. The decrease in other expenses reflects costs associated with growth of the Bank, and $676,666 decrease in cost associated with the ATM network. Bankcard merchant expenses were $573,324 for 1999, compared to $864,970 for 1998. The decrease was the result of selling the portfolio in September 1999. Instead of accounting for gross revenue and gross expense, the Bank now receives net income based on the net sales volumes. The total net income for 1999 was $50,606, compared to a net loss of ($107,590) for 1998. Provision for Income Taxes The provision for income taxes was $754,128 for 1999 compared to $728,026 in 1998. The decrease in the provision is the result of tax-exempt investments. The Bank's effective tax rate was 34.5% and 35.1% in 1999 and 1998, respectively. Provision and Allowance for Credit Losses The allowance for credit losses is based upon management's evaluation of the adequacy of the existing allowance for outstanding loans. This allowance is increased by provisions charged to expense and reduced by loan charge-offs net of recoveries. Management determines an appropriate provision based upon loan growth during the period, a comprehensive grading and review formula for loans outstanding and historical loss experience. In addition, management periodically reviews the condition of the 19 loan portfolio including the value of security interest related to portfolio loans and the economic circumstances which may affect the value of portfolio loans to determine the adequacy of the allowance. The evaluation of the allowance is reviewed by management and reported on an ongoing basis to the Company's Loan Committee, Audit Committee and Board of Directors. A provision for credit losses of $165,500 and $164,000 was expended for 1999 and 1998, respectively. Net loan charge-offs (loans charged off, net of loans recovered) were ($5,981) in 1999 and $24,749 during 1998, respectively. The allowance for credit losses as a percent of total gross loans at year-end 1999 and 1998 was 1.19% and 1.47%, respectively. Monitoring of all credits enables management to analyze any inherent risks in the portfolio which may result from changes in economic conditions. The following table summarizes the analysis of the allowance for loan losses as of December 31, 1999 and 1998. ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
1999 1998 ---- ---- BALANCE AT BEGINNING OF PERIOD $1,069,535 $930,284 CHARGE-OFFS: COMMERCIAL, FINANCIAL AND AGRICULTURAL 7,623 32,431 REAL ESTATE- CONSTRUCTION - - REAL ESTATE-MORTGAGE - - INSTALLMENT LOANS TO INDIVIDUALS: MONEY PLUS 6,592 - CREDIT CARDS - 6,801 OTHER INSTALLMENT - 6,045 ------- ------- TOTAL CHARGE-OFFS 14,215 45,277 ------- ------- RECOVERIES: COMMERCIAL, FINANCIAL AND AGRICULTURAL 19,682 8,632 REAL ESTATE- CONSTRUCTION - - REAL ESTATE-MORTGAGE - - INSTALLMENT LOANS TO INDIVIDUALS: - MONEY PLUS - 25 CREDIT CARDS - 5,160 OTHER INSTALLMENT 514 6,711 ------- ------- TOTAL RECOVERIES 20,196 20,528 ------- ------- NET CHARGE-OFFS (5,981) 24,749 ADDITIONS CHARGED TO OPERATIONS 165,500 164,000 ------- ------- BALANCE AT END OF PERIOD 1,241,016 1,069,535 ========== ========= GROSS LOANS AT END OF PERIOD $ 104,273,064 $ 72,840,372 RATIO OF NET CHARGE-OFFS DURING THE YEAR TO AVERAGE LOANS OUTSTANDING -0.01% 0.30% RATIO OF RESERVES TO GROSS LOANS 1.19% 1.47% RATIO OF NON-PERFORMING LOANS TO THE ALLOWANCE FOR CREDIT LOSSES 72.91% 93.17%
The Bank adopted SFAS No. 114 (as amended by SFAS No. 118), AAccounting by Creditors for Impairment of a Loan on January 1, 1996. In accordance with SFAS No. 114, those loans identified as impaired are measured on the present value of expected future cash flows, discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the creditor will not be able to collect all contractual principal and interest payments due in accordance with terms of the loan agreement. 20 Loans are placed on non-accrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction on the loan principal balance. Included in non- performing loans for the last three years is a loan for $747,069. This loan is secured by real estate with an appraised value of approximately $1,500,000. Even though this loan is on a non-accrual status, management does not believe that there will be any loss of the principal due. The following table summarizes the analysis of the allowance for loan losses as of December 31, 1999 and ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
1999 1998 ---- ---- BALANCE AT BEGINNING OF PERIOD $1,069,535 $930,284 CHARGE-OFFS: COMMERCIAL, FINANCIAL AND AGRICULTURAL 7,623 32,431 REAL ESTATE- CONSTRUCTION - - REAL ESTATE-MORTGAGE - - INSTALLMENT LOANS TO INDIVIDUALS: MONEY PLUS 6,592 - CREDIT CARDS - 6,801 OTHER INSTALLMENT - 6,045 ------- ------- TOTAL CHARGE-OFFS 14,215 45,277 ------- ------- RECOVERIES: COMMERCIAL, FINANCIAL AND AGRICULTURAL 19,682 8,632 REAL ESTATE- CONSTRUCTION - -
In evaluating the allowance for the credit losses, management takes into consideration the composition of its loan portfolio, loan growth during the period, risk and collectibility of loans, and economic conditions. The allowance is maintained at a sufficient level to cover all potential loan charge-offs in addition to a cumulative, annual amount based upon the factors outlined above. Management utilizes an internal loan classification system to grade portfolio loans as a part of its analysis of the adequacy of the allowance. In addition, management periodically reviews the condition of the loan portfolio including the value of security interests related to the portfolio loan to determine the adequacy of the allowance. The evaluation of the adequacy of the allowance is reviewed by management and reported on an ongoing basis to the Bank's Loan Committee, Audit Committee and Board of Directors. Local Economy According to the 1999 San Luis Obispo County Economic Outlook, prepared by the UCSB Economic Forecast Project, the apparent slowdown of the U.S. economy has not obviously influenced the local San Luis Obispo County economy, yet. The healthy rate of U.S. economic growth during 1998 has been interrupted, predominantly by events and financial problems abroad. Consumer confidence and spending, industrial production, and employment growth have been sliding recently. The publication goes on to say that to date, however, the local economy has not experienced any pronounced weakness in any particular sector. Growth in employment, resident spending, tourism spending, and income have remained solid. Residential building activity is currently higher than any year of the 1990s. The home sales market is especially strong. At this point, the San Luis Obispo County economy does not appear affected by the spreading international weakness. A five year expansion of the California economy, the seven year expansion of the U.S. economy, the unprecedented returns from financial and equity markets, and the steady growth of visitor travel along the central coast of California, are the principal reasons for the current prosperity of San Luis Obispo County. According to this study, more job opportunities, and an increase in migration to San Luis Obispo County, resulting in higher demand for housing are also responsible for increased economic growth this year. The continuing health of the San Luis Obispo County economy is confirmed by a variety of indicators. The recent evidence is both clear and consistent. Employment growth is quite healthy, visitor spending continues to rise, and retail markets are recording 21 solid gains. Because there is little new commercial building, available office and industrial space is evaporating. The farm sector set another record for both crop sales in 1997 and employment in 1998, and per capita income continued to rise to historical highs. Just since 1995, the number of jobs in Agriculture has doubled; to over 6,300 in the County and average wages for farm workers jumped 11% in 1998. The Bank's branch locations have been located to take advantage of this growing economy, as evidenced by the two de novo branches opened during the first quarter of 1999 and more recently on January 13, 2000 in Arroyo Grande. FINANCIAL CONDITION ANALYSIS Total assets of the Company were $147,299,268 at December 31, 1999 compared to $131,168,498 in 1998. A major portion of the Banks loans are adjustable. Approximately 73% of the loans are adjustable. The majority of those loans that reprice are tied to changes in the prime rate. If interest rates change, the yield on these loans will also change. A 1.00% increase in the prime rate would increase net interest income approximately $769,731 a year and a 1.00% decrease in the prime rate would decrease net interest income by $158,098 a year. The following table summarizes the composition of the loan portfolio as of December 31, 1999 and 1998: COMPOSITION OF LOAN PORTFOLIO
1999 1998 ---- ---- AMOUNT PERCENT AMOUNT PERCENT ---------- ------- ---------- ------- COMMERCIAL, FINANCIAL AND AGRICULTURAL $ 38,419,611 36.89% $ 38,220,932 53.69% REAL ESTATE- CONSTRUCTION 12,741,477 12.23% 8,357,701 11.74% REAL ESTATE-MORTGAGE 50,063,714 48.07% 21,672,158 30.44% INSTALLMENT LOANS TO INDIVIDUALS 2,786,034 2.67% 2,611,325 3.67% ALL OTHER LOANS (INCLUDING OVERDRAFTS) 141,846 0.14% 323,493 0.45% ----------- ---------- TOTAL LOANS, GROSS 104,152,682 100.00% 71,185,609 100.00% DEFERRED LOAN FEES (485,474) (313,032) RESERVE FOR POSSIBLE LOAN LOSSES (1,241,016) (1,069,535) ----------- ---------- TOTAL LOANS, NET $ 102,426,192 $ 69,803,042 ============== ============ LOANS HELD FOR SALE $120,382 $1,654,765
Net loans totaled $102,426,192 at December 31, 1999, compared to $69,803,042 at December 31, 1998. Loans increased during the year as the result of the new branch offices in expanded market areas for the bank. To capture market share in these new areas, the Bank hired three additional commercial loan officers, all of whom had previously worked in these markets. The primary growth was approximately $28,391,556 in real estate related loans. 22 The following are the approximate maturities and sensitivity to change in interest rates for the loans at December 31, 1999:
AFTER ONE DUE WITHIN YEAR BUT AFTER LOAN CATEGORY ONE YEAR WITHIN FIVE FIVE YEARS TOTAL (In thousands) Commercial, Financial and Agricultural $ 25,864 $ 5,483 $ 7,072 $ 38,419 Real Estate-Construction 12,252 490 - 12,742 Real Estate-Mortgage 25,562 13,804 10,818 50,184 Installment Loans to Individuals 156 1,807 823 2,786 All Other Loans (including overdrafts) 142 - - 142 --------- --------- --------- ---------- Totals $ 63,976 $ 21,584 $ 18,713 $ 104,273 ========= ========= ========= ========= INTEREST RATE PROVISION: Predetermined Rates $ 6,236 $ 6,617 $ 12,979 $ 25,832 Floating or Adjustable Rates 57,740 14,967 5,734 78,441 --------- --------- --------- ---------- Totals $ 63,976 $ 21,584 $ 18,713 $ 104,273 ========= ========= ========= ==========
RISK ELEMENTS: Risk elements on loans are presented in the following table for December 31: 1999 1998 ---- ---- Non-Accrual Loans (Impaired Loans) $904,773 $934,389 Accruing Loans Past Due 90 Days 0 0 Restructured Loans 0 396,506 Interest Excluded on Non-Accrual Loans 91,207 103,164 Interest Recognized on Non-Accrual Loans and Troubled Debt Restructured Loans 165,000 31,723
At December 31, 1999, the Bank had no foreign loans outstanding. The Bank did not have any concentrations of loans except as disclosed above. The Banks management is responsible for monitoring loan performance which is done through various methods, including a review of loan delinquencies and personal knowledge of customers. Additionally, the Bank, maintains both a watch list of loans which, for a variety of reasons, management believes requires regular review as well as an internal loan classification process. Semi-annually, the loan portfolio is also reviewed by an experienced, outside loan reviewer not affiliated with the Bank. A list of delinquencies, the watch list, loan grades and the outside loan review are reviewed regularly by the Board of Directors. Except as set forth in the preceding table, there are no loans which management has serious doubts as to the borrower's ability to comply with present loan repayment terms. The Bank has a non-accrual policy which requires a loan greater than 90 days past due to be placed on non-accrual status unless such loan is well-collateralized and in the process of collection. When loans are placed on non-accrual status, all uncollected interest accrued is reversed from earnings. Once on non-accrual status, interest on a loan is only recognized on a cash basis. Loans may be returned to accrual status if management believes that all remaining principal and interest is fully collectible and 23 there has been at least six months of sustained repayment performance since the loan was placed on non-accrual. If a loan's credit quality deteriorates to the point that collection of principal is believed by management to be doubtful and the value of collateral securing the obligation is sufficient the Bank generally takes steps to protect and liquidate the collateral. Any loss resulting from the difference between the loan balance and the fair market value of the property is recognized by a charge to the reserve for loan losses. When the property is held for sale after foreclosure, it is subject to a periodic appraisal. If the appraisal indicates that the property will sell for less than its recorded value, the Bank recognizes the loss by a charge to non-interest expense. Total Cash and Due from Banks Total cash and due from banks decreased from $17,239,179 at December 31, 1998 to $17,159,073 at December 31, 1999. The large amount of cash and due from banks is to fund the operations of the Banks ATM networks. If the Bank were to sell these networks, the portion of this cash would then be invested in securities and loans, subject to the Bank's liquidity policy limitations. Other Earning Assets Other earning assets are comprised of Federal Funds sold (funds lent on a short-term basis to other banks), investment securities and short term certificates of deposit at other financial institutions. These assets are maintained for short-term liquidity needs of the Bank, collateralization of public deposits, and diversification of the earning asset mix. Other earning assets decreased to $20,634,059 at December 31, 1999 compared to $36,988,232 at December 31, 1998. The decrease in 1999 is a direct factor of the strong loan demand and funding throughout the year. Other earning assets represented 16.5% of the earning asset portfolio at December 31, 1999, compared to 33.7% in 1998. On December 31, 1998, one particular customer of the bank had an extraordinary deposit of approximately $5 million. These excess funds that remained on deposit for less than one week, are reflected in Fed Funds Sold on December 31, 1998. The following table summarizes the composition of other earning assets at December 31: COMPOSITION OF OTHER EARNING ASSETS
1999 1998 AMOUNT PERCENT AMOUNT PERCENT Held-to-Maturity Investments $ - 0.00% $ 15,758,151 42.60% Available-For-Sale Investments 19,058,804 92.37% 12,863,106 34.78% Federal Funds Sold 1,200,000 5.82% 7,700,000 20.82% Certificates of Deposit 375,255 1.82% 666,975 1.80% ------------- ------------- Total Other Earning Assets $ 20,634,059 100.00% $ 36,988,232 100.00% ============= =============
24 The Amortized cost, fair value, and maturities at December 31, 1999 are as follows:
SECURITIES AVAILABLE-FOR-SALE SECURITIES HELD-TO-MATURITY AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE Due in One Year or Less $ 1,663,526 $ 1,662,918 $ - $ - Due after One Year through Five Years 2,728,424 2,681,029 - - Due after Five Years through Ten Years 1,527,622 1,491,207 - - Due after Ten Years 4,377,751 3,940,635 - - Mortgage-backed Securities 9,494,832 8,887,715 - - ---------- ---------- ----------- ---------- Total $ 19,792,155 $ 18,663,504 $ - $ - ============ ============= =========== ==========
Deposits Total deposits increased to $132,961,573 at December 31, 1999. Total deposits at December 31, 1998 were $119,407,706. The addition of the two new branch offices during the first quarter of 1999 accounted for approximately $10,000,000 of the deposit growth. The following table sets forth information for the last two fiscal years regarding the composition of deposits at December 31, and the average rates paid on each of these categories: COMPOSITION OF DEPOSITS
1999 1998 AVERAGE AVERAGE BALANCE RATE PAID BALANCE RATE PAID Non-Interest Bearing Demand $ 39,901,884 0.00% $ 38,672,576 0.00% Interest Bearing Demand 35,058,015 1.85% 34,601,620 2.19% Savings 13,537,416 2.18% 11,592,945 2.40% Money Market 6,655,897 3.11% 5,410,316 3.21% Time Deposits 37,808,361 4.69% 29,130,249 5.16% -------------- -------------- Total Deposits $ 132,961,573 2.07% $ 119,407,706 2.56% ============== ==============
Set forth below is a maturity schedule of domestic time certificates of deposits of $100,000 and over at December 31, 1999. 25 TIME DEPOSITS $100,000 AND OVER: - -------------------------------- (DOLLARS IN THOUSANDS) LESS THAN 3 MONTHS $ 4,626 3 TO 12 MONTHS 5,871 OVER 1 YEAR 100 TOTAL $ 10,597
Capital The Company's total stockholders equity was $10,542,162 as of December 31, 1999 compared to $9,436,670 as of December 31, 1998. The increase in capital during 1999 was due to net income of $1,430,928, ($3,025) cash paid to stockholders in lieu of fractional shares on a 4% stock dividend paid February 26,1999, stock options exercised in the amount of $148,263 and a decrease in the valuation allowance for investments of ($470,674). The valuation allowance was a result of the company's adoption of SFAS No. 115 "Accounting for Certain Investment in Debt and Equity Securities." Capital ratios for commercial banks in the United States are generally calculated using 3 different formulas. These calculations are referred to as the "Leverage Ratio" and two "risk based" calculations known as: "Tier One Risk Based Capital Ratio" and the "Total Risk Based Capital Ratio." These standards were developed through joint efforts of banking authorities from 12 different countries around the world. The standards essentially take into account the fact that different types of assets have different levels of risk associated with them. Furthermore, they take into account the off-balance sheet exposures of banks when assessing capital adequacy. The Leverage Ratio calculation simply divides common stockholders= equity (reduced by any Goodwill a bank may have) by the total 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 the total "risk-weighted assets" of the bank. Risk weighted assets are determined by segregating all the assets and off balance sheet exposures into different risk categories and weighting them by a percentage ranging from 0% (lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio again uses "risk-weighted assets" in the denominator, but expands the numerator to include other capital items besides equity such as a limited amount of the loan loss reserve, long-term capital debt, preferred stock and other instruments. Summarized below are the Bank's and Company's capital ratios at December 31, 1999.
Minimum Regulatory Heritage Heritage Capital Requirements Oaks Bank Oaks Bancorp Leverage Ratio 4.00% 7.22% 7.62% Tier One Risk Based Capital Ratio 4.00% 9.60% 9.80% Total Risk Based Capital Ratio 8.00% 10.75% 10.89%
Generally speaking, the primary source of new capital will be generated from retained earnings. However, to provide for instances when retained earnings may not keep pace with asset growth, additional sources of capital need to be made available. To that end, on September 11, 1998, Heritage Oaks Bancorp executed a Promissory Note for a $2 million line of credit with Pacific Coast Bankers= Bank. On September 8, 1999, the Company requested that the revolving nature be extended for an additional year. This request was granted resulting in a Change in Terms Agreement. The characteristics of the note are as follows: -Collateralized with 339,332 shares of Heritage Oaks Bank common stock -Maturity of August 15, 2005. -Interest only for first year of quarterly payments -Subsequent payments to be fully amortized to maturity based on outstanding balance owed. On September 28, 1998, October 30, 1998 and December 30, 1998, the Bancorp drew on the line for $200,000, $200,000 and $350,000, respectively. On January 29, 1999 and February 26, 1999, the Company drew $50,000 and $50,0000, respectively. On March 19, 1999 and May 21, 1999, the Company repaid principal on the line of $350,000 and $200,000, respectively. On 26 September 29, 1998, October 30, 1998, December 30, 1998 and December 31, 1998, Bancorp invested $150,000, $200,000, $300,000 and $50,000, respectively, in Heritage Oaks Bank as paid in Capital, Surplus. In addition to this and pursuant to the Strategic Plan, the Board of Directors is reviewing other sources of capital for the bank. Liquidity The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors, investors and borrowers. Asset liquidity is primarily derived from loan payments and the maturity of other earning assets. Liquidity from liabilities is obtained primarily from the receipt of new deposits. The Bank's Asset Liability Committee (ALCO) is responsible for managing the on-and off-balance sheet commitments to meet the needs of customers while achieving the Bank's financial objectives. ALCO meets regularly to assess the projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual customer funding needs. Deposits generated from Bank customers serve as the primary source of liquidity. The Bank has credit arrangements with correspondent banks that serve as a secondary liquidity source in the amount of $5,500,000. The Bank has also established a borrowing line of approximately $3,700,000 with the Federal Reserve Bank of San Francisco whereby the Bank has pledged certain loans as collateral for short-term borrowings. The Bank also has established certain repurchase agreements that allow for borrowing using securities pledged as collateral. The Bank became a member of the Federal Home Loan Bank (FHLB) in July 1999. As of December 31,1999, the Bank had not pledged collateral or utilized any of the services of the FHLB. The Bank manages its liquidity by maintaining a majority of its investment portfolio in federal funds sold and other liquid investments. At December 31, 1999, the ratio of liquid assets not pledged for collateral and other purposes to deposits and other liabilities was 22.4% compared to 26.3% in 1998. At December 31, 1999 and December 31, 1998, the Bank had borrowings of securities sold under agreement to repurchase in the amount of $2,211,000 and $0, respectively. The ratio of gross loans to deposits, another key liquidity ratio, was 78.0% at year end 1999 compared to 59.6% at December 31, 1998. Inflation The assets and liabilities of a financial institution are primarily monetary in nature. As such they represent obligations to pay or receive fixed and determinable amounts of money that are not affected by future changes in prices. Generally, the impact of inflation on a financial institution is reflected by fluctuations in interest rates, the ability of customers to repay debt and upward pressure on operating expenses. The effect on inflation during the three-year period ended December 31, 1999 has not been significant to the Bank's financial position or results of operations. Outstanding Risks With the Year 2000 As a result of the banking industry's comprehensive Year 2000-readiness preparations, no substantive problems occurred during the date change period. However, while the industry can generally claim success, some associated risks remain. They involve certain critical dates, the expiration of temporary remediation techniques, record retention and customer risk. STATE OF READINESS. The Bank began implementation of its Year 2000 Plan in 1997. It complied with all timeframes associated with that Plan. Testing of the various systems and implementations of compliant systems was substantially complete by early 1999 with all testing completed by year-end. The Company also spent a great deal of time assessing the state of readiness of its customers, especially those to whom it had extended credit, and conducting various public awareness campaigns. There were no significant withdrawals experienced by the Bank as a result of concerns surrounding the Y2K issue. There were no disruptions of service experienced by Bank customers because of Y2K related problems. There have been no unusual losses experienced by the Bank as a result of extensions of credit to Bank customers. In summary, there was nothing unusual in the Bank's operations either during the date change rollover, or since that time. Management does not expect any future Y2K related disruptions and no material concerns related to this area exist at this time. COST TO ADDRESS Y2K COMPLIANCE. The total budgeted cost for Y2K compliance was $256,000. As of December 31, 1999, 89 % of this budget was spent. The costs associated with the mailings, questionnaires, seminars and other public awareness campaign activities, which the Company conducted, did not have a material effect on the financial position or results of operations of the Company 27 THE COMPANY'S CONTINGENCY PLANS. The Company completed development of contingency plans in preparation for the Y2K event during 1999. CRITICAL DATES The following are critical dates that may cause system problems. Many of the dates were included in test scenarios. Institutions are to review processing results closely. February 29, 2000 Leap year date Included in Testing March 31, 2000 End of first quarter of 2000 Included in Testing October 10, 2000 First date to require eight-digit field Included in Testing December 31, 2000 Last date of year January 1, 2001 First date of year December 31, 2001 Ensure 365-day year
TEMPORARY REMEDIATION TECHNIQUES The company and its mission critical vendors did not utilize temporary remediation techniques. RECORDS RETENTION Each institution is to retain the documentation of its Year 2000 efforts to demonstrate it has satisfied its fiduciary, contractual and regulatory responsibilities. CUSTOMER RISK In 1998, the Federal Financial Institution Council issued guidance to institutions about the Year 2000's potential impact on customers. The statement provided guidelines for controlling both general and specific risks related to borrowers, depositors and capital markets/asset management counterparties. Management is to continue to monitor the potential customer risk for the remainder of the year 2000. In April of 1998, the Company initiated a credit risk assessment program, with loan officers completing a Year 2000 questionnaire for all new and renewed credits in amounts over $150,000.00. These questionnaires were designed to provide the Company's management with information by which it could evaluate the borrower's awareness of and sensitivity to Year 2000 risk. Questionnaires are reviewed and discussed at weekly Officer Loan Committee meetings and are further reviewed by Credit Administration and Senior Lender to ascertain Year 2000 risk associated with the credit. As a result of this review, $135,721 has been allocated to the Company's loan loss provision as of December 31, 1999. In addition, legal Year 2000 issues are included in significant commitment letters and loan documentation for certain borrowers. Finally, on loan participations purchased, the Company requires assurances from the lead lender that it has obtained a Year 2000 questionnaire from the borrower and also that the lead lender is satisfactorily progressing toward Year 2000 compliance. 28 ITEM 7. FINANCIAL STATEMENTS HERITAGE OAKS BANCORP AND SUBSIDIARIES DECEMBER 31, 1999, 1998 AND 1997 CONTENTS INDEPENDENT AUDITORS' REPORT................................................F-1 FINANCIAL STATEMENTS Consolidated Balance Sheets December 31, 1999 and 1998..............................................F-2 Consolidated Statements of Income For the Years Ended December 31, 1999, 1998 and 1997....................F-3 Consolidated Statement of Changes in Stockholders' Equity For the Years Ended December 31, 1999, 1998 and 1997....................F-4 Consolidated Statements of Cash Flows For the Years Ended December 31, 1999, 1998 and 1997....................F-5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS..................................F-7
29 INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders Heritage Oaks Bancorp and Subsidiaries Paso Robles, California We have audited the accompanying consolidated balance sheets of Heritage Oaks Bancorp and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income and changes in stockholders' equity and statements of cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Heritage Oaks Bancorp as of December 31, 1999 and 1998, the results of their operations and changes in their stockholders' equity and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. /S/ VAVRINEK, TRINE, DAY & CO., LLP Vavrinek, Trine, Day & Co., LLP Rancho Cucamonga, California February 2, 2000 F-1- HERITAGE OAKS BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998
ASSETS 1999 1998 ------------------- ------------------- Cash and due from banks (Note #1M) $17,159,073 $17,239,179 Federal funds sold 1,200,000 7,700,000 ------------------- ------------------- Total Cash and Cash Equivalents 18,359,073 24,939,179 Interest-bearing deposits in other financial institutions 375,255 666,975 Investment securities (Notes #1D and #2) Available-for-sale 18,663,504 12,863,106 Held-to-maturity 15,758,151 Federal Home Loan Bank Stock, at cost 395,300 Loans held for sale (Notes #1F and #3) 120,382 1,654,765 Loans, net of deferred fees and allowance for loan losses of $1,726,490 and $1,382,568 at December 31, 1999 and 1998, respectively (Notes #1E and 3) 102,426,192 69,803,041 Property premises and equipment, net (Notes #1H and #6) 3,427,289 2,447,385 Net deferred tax asset (Notes #1J and #7) 1,168,983 563,699 Cash surrender value of life insurance (Note #14) 1,305,787 1,020,576 Other assets 1,057,503 1,451,621 ------------------- ------------------- Total Assets $147,299,268 $131,168,498 =================== =================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits Demand non-interest bearing 39,901,884 38,672,576 Savings, NOW and money market deposits 55,251,328 51,604,881 Time deposits of $100,000 or more (Note #21) 10,596,650 4,673,298 Time deposits under $100,000 (Note #21) 27,211,711 24,456,951 ------------------- ------------------- Total Deposits 132,961,573 119,407,706 Notes payable (Note #9) 350,000 750,000 Securities sold under agreements to repurchase 2,211,000 Other liabilities 1,234,533 1,574,122 ------------------- ------------------- Total Liabilities 136,757,106 121,731,828 ------------------- ------------------- COMMITMENTS AND CONTINGENCIES (Note #8) Stockholders' Equity Common stock, no par value; 20,000,000 shares authorized; 1,144,282 and 1,069,791 shares issued and outstanding for 1999 and 1998, respectively 5,288,179 4,470,170 Retained earnings 5,912,823 5,154,666 Accumulated other comprehensive income (658,840) (188,166) ------------------- ------------------- Total Stockholders' Equity 10,542,162 9,436,670 ------------------- ------------------- Total Liabilities and Stockholders' Equity $147,299,268 $131,168,498 =================== ===================
The accompanying notes are an integral part of these financial statements. F-2- HERITAGE OAKS BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 ----------------- --------------- --------------- INTEREST INCOME Interest and fees on loans (Note #1E) $ 8,424,833 $ 6,459,394 $ 5,505,740 Interest on Investment Securities (Note #1D) U.S. Treasury Securities 1,032 27,396 51,472 Obligations of U.S. Government Agencies 812,696 907,482 777,718 Corporate Bonds, Mutual Funds, Commercial Paper 110,467 123,003 69,907 Obligations of State and Political Subdivisions 310,436 253,148 126,916 Interest on time deposits with other banks 29,971 23,515 11,016 Interest on Federal funds sold 220,170 196,727 142,484 Interest on other securities 3,888 ----------------- --------------- --------------- Total Interest Income 9,913,493 7,990,665 6,685,253 ----------------- --------------- --------------- INTEREST EXPENSE Interest on savings, NOW and money market deposits 1,136,841 1,142,163 1,049,847 Interest on time deposits in denominations of $100,000 or more 292,401 204,986 112,009 Interest on time deposits under $100,000 1,084,896 1,133,271 993,941 Other 86,797 63,880 56,453 ----------------- --------------- --------------- Total Interest Expense 2,600,935 2,544,300 2,212,250 ----------------- --------------- --------------- Net interest income before provision for possible loan losses 7,312,558 5,446,365 4,473,003 Provision for Possible Loan Losses 165,500 164,000 164,000 ----------------- --------------- --------------- 7,147,058 5,282,365 4,309,003 ----------------- --------------- --------------- NON-INTEREST INCOME Service charges on deposit accounts 757,448 690,710 559,874 Investment securities gain/(loss), net 10,504 (16,719) Other (Note #12) 4,686,793 5,659,589 4,423,027 ----------------- --------------- --------------- Total Non-interest Income 5,444,241 6,360,803 4,966,182 ----------------- --------------- --------------- NON-INTEREST EXPENSES Salaries and employee benefits 3,562,023 2,892,921 2,402,600 Equipment expenses 790,862 382,316 275,745 Occupancy expenses 694,057 540,891 506,472 Other expenses (Note #12) 5,359,301 5,752,419 4,047,572 ----------------- --------------- --------------- Total Non-interest Expenses 10,406,243 9,568,547 7,232,389 ----------------- --------------- --------------- Income Before Provision for Income Taxes 2,185,056 2,074,621 2,042,796 Provision for Income Taxes (Notes #1J and #7) 754,128 728,026 781,732 ----------------- --------------- --------------- Net Income $ 1,430,928 $ 1,346,595 $ 1,261,064 ================= =============== =============== Earnings Per Share (Notes #1O and #16) Basic $ 1.27 $ 1.24 $ 1.18 ================= =============== =============== Diluted $ 1.15 $ 1.13 $ 1.11 ================= =============== ===============
The accompanying notes are an integral part of these financial statements. F-3- HERITAGE OAKS BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Common Stock --------------------- Number of Comprehensive Retained Shares Amount Income Earnings ---------- ---------- ------------- ------------ BALANCE, January 1, 1997 675,296 $4,089,245 $3,405,995 Exercise of stock options 15,868 91,241 Cash dividends paid - $.33 per share (337,787) Three-for-two stock split 345,462 Cash paid to stockholders in lieu of fractional shares on three-for-two stock split (1,351) Comprehensive income Net income $ 1,261,064 1,261,064 Unrealized security holding gains (net of $37,563 tax) 49,896 plus reclassification adjustments for gains (net of $5,852 tax) 10,867 ------------- Total comprehensive income $ 1,321,827 ---------- ---------- ============= ------------ BALANCE, December 31, 1997 1,036,626 4,180,486 4,327,921 Exercise of stock options 33,165 289,684 Cash dividends paid - $.50 per share (519,850) Comprehensive income Net income $ 1,346,595 1,346,595 Unrealized security holding gains (net of $141,588 tax) 199,991 less reclassification adjustments for losses (net of $3,676 tax) (6,828) ------------- Total comprehensive income $ 1,539,758 ---------- ---------- ============= ------------ BALANCE, December 31, 1998 1,069,791 4,470,170 5,154,666 Exercise of stock options 31,832 148,263 Stock dividends paid - 4% 42,659 669,746 (669,746) Cash paid to stockholders in lieu of fractional shares on 4% stock dividend (3,025) Comprehensive income Net income $ 1,430,928 1,430,928 Unrealized security holding losses (net of $344,368 tax) (470,674) ------------- Total comprehensive income $ 960,254 ---------- ---------- ============= ------------ BALANCE, December 31, 1999 1,144,282 $5,288,179 $5,912,823 ========== ========== ============
Accumulated Other Comprehensive Stockholders' Income Equity -------------- ------------- Balance, January 1, 1997 $ (442,092) $ 7,053,148 Exercise of stock options 91,241 Cash dividends paid - $.33 per share (337,787) Three-for-two stock split Cash paid to stockholders in lieu of fractional shares on three-for-two stock split (1,351) Comprehensive income Net income 1,261,064 Unrealized security holding gains (net of $37,563 tax) 49,896 49,896 plus reclassification adjustments for gains (net of $5,852 tax) 10,867 10,867 -------------- ------------- Total comprehensive income Balance, December 31, 1997 (381,329) 8,127,078 Exercise of stock options 289,684 Cash dividends paid - $.50 per share (519,850) Comprehensive income Net income 1,346,595 Unrealized security holding gains (net of $141,588 tax) 199,991 199,991 less reclassification adjustments for losses (net of $3,676 tax) (6,828) (6,828) Total comprehensive income -------------- ------------- Balance, December 31, 1998 (188,166) 9,436,670 Exercise of stock options 148,263 Stock dividends paid - 4% Cash paid to stockholders in lieu of fractional shares on 4% stock dividend (3,025) Comprehensive income Net income 1,430,928 Unrealized security holding losses (net of $344,368 tax) (470,674) (470,674) Total comprehensive income -------------- ------------- Balance, December 31, 1999 $ (658,840) $10,542,162
The accompanying notes are an integral part of these financial statements. F-4- HERITAGE OAKS BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 ---------------- --------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $1,430,928 $1,346,595 $1,261,064 Adjustments to reconcile net income to net cash provided by operating activities Net cash provided by operating activities Depreciation and amortization 658,998 427,759 351,303 Provision for possible loan losses 165,500 164,000 164,000 Provision for possible OREO losses 7,369 Realized (gain) loss on sales of available-for-sale securities, net (10,504) 16,719 Amortization of premiums/discounts on investment securities, net (235,382) (161,672) (74,194) (Increase)/decrease in loans held for sale 1,534,383 (1,159,415) 120,650 Increase in deferred tax asset (269,788) (135,000) (Increase)/decrease in other assets 394,118 3,359 (145,068) Increase/(decrease) in other liabilities (339,589) (68,565) 257,944 ---------------- --------------- ---------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 3,339,168 413,926 1,952,418 ---------------- --------------- ---------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities held-to-maturity (3,607,551) (3,976,013) Purchase of mortgage-backed securities held-to-maturity (6,143,140) (2,080,158) Purchase of securities available-for-sale (14,335,101) (10,098,137) (1,500,000) Purchase of mortgage-backed securities available-for-sale (2,532,299) (696,825) (3,355,847) Proceeds from sales of securities held-to-maturity 1,250,000 Proceeds from principal reductions and maturities of securities held-to-maturity 2,379,076 2,125,000 Proceeds from principal reductions and maturities of mortgage-backed securities held-to-maturity 3,013,646 534,864 Proceeds from sales of securities available-for-sale 2,978,217 4,431,186 3,483,281 Proceeds from principal reductions and maturities of securities available-for-sale 18,065,264 Proceeds from sales of mortgage-backed securities available-for-sale 733,835 Proceeds from principal reductions and maturities of mortgage-backed securities available-for-sale 4,815,584 1,763,715 184,441 Purchase of deposits with other banks 291,720 (56,856) (510,119) Purchase of life insurance policies (285,211) (50,258) (240,398) Proceeds from sale of other real estate owned 54,631 Recoveries on loans previously written off 20,196 20,528 43,208 Increase in loans, net (32,808,847) (15,785,435) (5,507,489) Purchase of property, premises and equipment, net (1,638,902) (802,433) (667,915) ---------------- --------------- ---------------- NET CASH USED IN INVESTING ACTIVITIES (25,429,379) (24,844,018) (10,217,145) ---------------- --------------- ----------------
The accompanyning notes are an integral part of these financial statements. F-5- HERITAGE OAKS BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1998 1998 1997 ---------------- --------------- ---------------- CASH FLOWS FROM FINANCING ACTIVITIES Increase in deposits, net $13,553,867 $35,858,049 $11,558,359 Net increase/(decrease) in other borrowings 2,211,000 (4,730,000) Net (decrease)/increase in notes payable (400,000) 750,000 Proceeds from exercise of stock options 148,263 289,684 91,241 Cash paid in lieu of fractional shares (3,025) Cash dividends paid or declared (519,850) (339,138) ---------------- --------------- ---------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 15,510,105 36,377,883 6,580,462 ---------------- --------------- ---------------- NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (6,580,106) 11,947,791 (1,684,265) CASH AND CASH EQUIVALENTS, Beginning of year 24,939,179 12,991,388 14,675,653 ---------------- --------------- ---------------- CASH AND CASH EQUIVALENTS, End of year $18,359,073 $24,939,179 $12,991,388 ================ =============== ================ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest paid $ 2,649,170 $ 2,383,618 $ 2,445,815 Income taxes paid $ 716,000 $ 976,129 $ 847,000 SUPPLEMENTAL DISCLOSURES OF NON-CASH FLOW INFORMATION Change in other comprehensive income $ (470,674) $ 193,163 $ 60,763 Transfer of loan to other real estate owned through foreclosure - $ 62,000 Transfer of held-to-maturity securities to avaliable-for-sale 15,758,151 - -
The accompanying notes are an integral part of these financial statements. F-6- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 Note #1 - Summary of Significant Accounting Policies The accounting and reporting policies of Heritage Oaks Bancorp (the Company) and subsidiaries conform to generally accepted accounting principles and to general practices within the banking industry. A summary of the Company's significant accounting and reporting policies consistently applied in the preparation of the accompanying financial statements follows: A. PRINCIPLES OF CONSOLIDATION --------------------------- The consolidated financial statements include the Company and its wholly owned subsidiaries, Heritage Oaks Bank and CCMS Systems, Inc. Intercompany balances and transactions have been eliminated. B. NATURE OF OPERATIONS -------------------- The Bank has been organized with two primary operating segments, which consist of the Bank and the Bank's Electronic Funds Transfer (EFT) Department. The segments are identified as such based upon the percentage of operating net income, management responsibility, and the types of products and services offered. The Bank operates seven branches and one loan production office within San Luis Obispo County. The Bank offers traditional banking products such as checking, savings and certificates of deposit, as well as mortgage loans and commercial and consumer loans to customers who are predominately small to medium-sized businesses and individuals. The EFT Department has installed automatic teller machines located in retail outlets and gaming facilities and point of sale machines located in retail outlets. Income is based upon total customer usage of the machines and the applicable transaction charge. C. USE OF ESTIMATES ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review F-7- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 the Bank's allowances for losses on loans and foreclosed real estate. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change. NOTE #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued D. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES," which addresses the accounting for investments in equity securities that have readily determinable fair values and for investments in all debt securities. Securities and mortgage-backed securities are classified in three categories and accounted for as follows: debt, equity, and mortgage-backed securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and are measured at amortized cost; debt and equity securities bought and held principally for the purpose of selling in the near term are classified as trading securities and are measured at fair value, with unrealized gains and losses included in earnings; debt and equity securities not classified as either held-to-maturity or trading securities are deemed as available-for-sale and are measured at fair value, with unrealized gains and losses, net of applicable taxes, reported in a separate component of stockholders' equity. Gains or losses on sales of investment securities and mortgage-backed securities are determined on the specific identification method. Premiums and discounts are amortized or accreted using the interest method over the expected lives of the related securities. E. LOANS AND INTEREST ON LOANS --------------------------- Loans are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees and unearned discounts. The Bank recognizes loan origination fees to the extent they represent reimbursement for initial direct costs, as income at the time of loan boarding. The excess of fees over costs, if any, is deferred and credited to income over the term of the loan. In accordance with SFAS No. 114, (as amended by SFAS No. 118), "ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN," those loans identified as "impaired" are measured on the present value of expected future cash flows, discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the creditor will not be able to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Loans are placed on nonaccrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. F-8- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 All loans on nonaccrual are measured for impairment. The Bank applies the measurement provision of SFAS No. 114 to all loans in its portfolio. All loans are generally charged off at such time the loan is classified as a loss. NOTE #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued F. LOANS HELD FOR SALE ------------------- Loans held for sale are carried at the lower of aggregate cost or market value, which is determined by the specified value in the commitments. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. G. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change. H. PROPERTY, PREMISES AND EQUIPMENT Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives, which ranges from three to ten years for furniture and fixtures and forty years for buildings. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the improvements of the remaining lease term, whichever is shorter. Expenditures for betterments or major repairs are capitalized and those for ordinary repairs and maintenance are charged to operations as incurred. Total depreciation expense for the reporting periods ending December 31, 1999, 1998 and 1997 were approximately $659,000, $428,000, and $351,000, respectively. I. OTHER REAL ESTATE OWNED Other real estate owned, which represents real estate acquired through foreclosure, is stated at the lower of the carrying value of the loan or the estimated fair market value less estimated selling costs of the related real estate. Loan balances in excess of the fair market value of the real estate acquired at the date of acquisition are charged against the allowance for loan losses. Any subsequent declines F-9- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 in estimated fair value, operation income, and gains or losses on disposition of such properties are expensed or charged to current operations. Note #1 - Summary of Significant Accounting Policies, Continued J. INCOME TAXES Provisions for income taxes are based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and include deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred taxes are computed on the liability method as prescribed in SFAS No. 109, "Accounting for Income Taxes." K. COMPREHENSIVE INCOME BEGINNING IN 1998, THE BANK ADOPTED SFAS NO. 130, "REPORTING COMPREHENSIVE INCOME", WHICH REQUIRES THE DISCLOSURE OF COMPREHENSIVE INCOME AND ITS COMPONENTS. CHANGES IN UNREALIZED GAIN (LOSS) ON AVAILABLE-FOR-SALE SECURITIES NET OF INCOME TAXES IS THE ONLY COMPONENT OF ACCUMULATED OTHER COMPREHENSIVE INCOME FOR THE BANK. L. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks and federal funds sold. Generally, federal funds are sold for one day periods. M. CASH AND DUE FROM BANKS Banking regulations require that all banks maintain a percentage of their deposits as reserves in cash or on deposit with the Federal Reserve Bank. The Bank complied with the reserve requirements as of December 31, 1999. The Bank maintains amounts due from banks that exceed federally insured limits. The Bank has not experienced any losses in such accounts. N. RECLASSIFICATIONS Certain amounts in the 1998 and 1997 financial statements have been reclassified to conform to the 1999 presentation. O. EARNINGS PER SHARE (EPS) Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. F-10- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 Note #1 - Summary of Significant Accounting Policies, Continued P. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard was originally effective for 2000. In June 1999, the FASB issued SFAS No. 137, "ACCOUNTING FOR DERIVATIVES INSTRUMENTS AND HEDGING ACTIVITIES - DEFERRAL OF THE EFFECTIVE DATE OF FASB STATEMENT NO. 133". This Statement establishes the effective date of SFAS 133 for 2001. During 1999, the Bank adopted SFAS 133. NOTE #2 - INVESTMENT SECURITIES At December 31, 1999 and 1998, the investment securities portfolio was comprised of securities classified as available-for-sale and held-to-maturity, in accordance with SFAS No. 115, resulting in investment securities available-for-sale being carried at fair value and investment securities held-to-maturity being carried at cost, adjusted for amortization of premiums and accretions of discounts, and fair market value adjustments for securities transferred from available-for-sale. The amortized cost and fair values of investment securities available-for-sale at December 31, 1999, were:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------ --------------- ----------------- ----------------- Obligations of U.S. Government agencies and corporations $3,642,261 $(138,788) $3,503,473 Mortgage-backed securities 9,494,832 $3,294 (610,411) 8,887,715 Obligations of state and political subdivisions 6,651,262 4,119 (386,865) 6,268,516 Other securities 3,800 3,800 ------------------ --------------- ----------------- ----------------- Total $19,792,155 $7,413 $(1,136,064) $18,663,504 ================== =============== ================= =================
Available-for-sale securities in the amount of $2,089,375 were transferred to held-to-maturity during 1994. The unrealized loss of $330,165 net of tax of $137,098 was reflected in a separate component of stockholders' equity and was being amortized over the remaining life of the securities as a yield adjustment. During 1999 all securities were transferred from held-to-maturity to available-for-sale upon implementation of SFAS No. 133. There were no investment securities held-to-maturity at December 31, 1999. F-11- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #2 - INVESTMENT SECURITIES, (CONTINUED) The amortized cost and fair values of investment securities available-for-sale at December 31, 1998, were:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------ --------------- --------------- ------------------ Obligations of U.S. Government agencies and corporations $1,650,875 $163,545 $1,814,420 Mortgage-backed securities 3,286,605 2,903 $(214,455) 3,075,053 Commercial paper 7,969,833 7,969,833 Other securities 3,800 3,800 ------------------ --------------- --------------- ------------------ Total $12,911,113 $166,448 $(214,455) $12,863,106 ================== =============== =============== ==================
The amortized cost and fair values of investment securities held-to-maturity at December 31, 1998, were:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------ --------------- --------------- ----------------- U.S. Treasury securities $98,777 $(777) $98,000 Obligations of U.S. government agencies and corporations 1,235,905 $25,798 (132) 1,261,571 Mortgage-backed securities 8,168,695 283,004 (12,759) 8,438,940 Obligations of state and political subdivisions 6,254,774 14,059 (8,337) 6,260,496 ------------------ --------------- --------------- ----------------- Total $15,758,151 $322,861 $(22,005) $16,059,007 ================== =============== =============== =================
The amortized cost and fair values of investment securities available-for-sale at December 31, 1999, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities Available-for-Sale ------------------------------------- Amortized Cost Fair Value ------------------ ------------------ Due in one year or less $1,663,526 $1,662,918 Due after one year through five years 2,728,424 2,681,029 Due after five years through ten years 1,527,622 1,491,207 Due after ten years 4,377,751 3,940,635 Mortgage-backed securities 9,494,832 8,887,715 ------------------ ------------------ Total Securities $19,792,155 $18,663,504 ================== ==================
F-12- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #2 - INVESTMENT SECURITIES, (CONTINUED) Proceeds from sales and maturities of investment securities available-for-sale during 1999, 1998 and 1997, were $2,978,217, $4,431,186, and $3,483,281, respectively. There were no gross gains or losses in 1999. In 1998, gross losses and gross gains on these sales were $9,970; and $13,365, respectively. In 1997, gross losses on these sales were $16,719; there were no gross gains. Proceeds from maturities and sales of investment securities held-to-maturity during 1999, 1998 and 1997, were $0, $2,379,076, and $3,375,000, respectively. There were no gains or losses on those sales and maturities in 1999, 1998 and 1997. Proceeds from sales and maturities and principal reductions of mortgage-backed securities in 1999, 1998 and 1997, were $4,815,584, $5,511,196 and $719,305, respectively. Gross gains on these sales during 1998 were $7,041. There were no gross gains or losses on these sales during 1999 and 1997. Unrealized losses on investment securities and mortgage-backed securities included in shareholders' equity net of tax at December 31, 1999, 1998 and 1997 were $658,840, $188,166, $381,329, respectively. Securities having a carrying value of approximately $5,115,000 and $2,249,000 and a fair value of approximately $5,115,000 and $2,261,000 at December 31, 1999 and 1998, respectively, were pledged to secure public deposits and for other purposes as required by law. Note #3 - Loans Major classifications of loans were:
1999 1998 ------------------- ----------------- Commercial, financial and agricultural $38,419,611 $38,220,932 Real Estate - construction 12,741,477 8,357,701 Real Estate - mortgage 50,063,714 21,672,158 Installment loans to individuals 2,786,034 2,611,325 All other loans (including overdrafts) 141,846 323,493 ------------------- ----------------- 104,152,682 71,185,609 Less: Deferred loan fees (485,474) (313,033) Less: Allowance for loan losses (1,241,016) (1,069,535) ------------------- ----------------- Total Loans $102,426,192 $69,803,041 =================== ================= Loans held for sale $120,382 $1,654,765 =================== =================
F-13- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #3 - LOANS, (CONTINUED) Concentration of Credit Risk At December 31, 1999, approximately $62,805,000 of the Bank's loan portfolio was collateralized by various forms of real estate. Such loans are generally made to borrowers located in San Luis Obispo County. The Bank attempts to reduce its concentration of credit risk by making loans which are diversified by project type. While management believes that the collateral presently securing this portfolio is adequate, there can be no assurances that significant deterioration in the California real estate market would not expose the Bank to significantly greater credit risk. The following is a summary of the investment in impaired loans, the related allowance for loan losses, and income recognized thereon as of December 31:
1999 1998 ---------------- ------------------- Impaired loans with a valuation allowance $904,773 $902,669 Impaired loans without a valuation allowance 93,807 ---------------- ------------------- Total impaired loans $904,773 $996,476 ================ =================== Valuation allowance related to impaired loans $122,847 $117,285 ================ =================== 1999 1998 1997 ---------------- ------------------- ----------------- Average recorded investment in impaired loans $914,298 $1,028,128 $955,187 ================ =================== ================= Cash receipts applied to reduce principal balance $28,691 $5,023 $ - ================ =================== ================= Interest income recognized for cash payments $ - $20,226 $ - ================ =================== =================
The provisions of SFAS No. 114 and SFAS No. 118 permit the valuation allowance reported above to be determined on a loan-by-loan basis or by aggregating loans with similar risk characteristics. Because the loans currently identified as impaired have unique risk characteristics, the valuation allowance was determined on a loan-by-loan basis. Nonaccruing loans totaled $904,773 and $934,389 at December 31, 1999 and 1998, respectively. As of December 31, 1999 and 1998, all loans on nonaccrual were classified as impaired. If interest on nonaccrual loans had been recognized at the original interest rates, interest income would have increased $91,207, $103,164, and $94,762 in 1999, 1998 and 1997, respectively. No additional funds are committed to be advanced in connection with impaired loans. F-14- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 At December 31, 1999 and 1998, the Bank had no loans past due 90 days or more in interest or principal and still accruing interest. At December 31, 1999, loans totaling approximately $165,000 were classified as troubled debt restructurings. NOTE #4 - ALLOWANCE FOR LOAN LOSSES Transactions in the allowance for loan losses are summarized as follows:
1999 1998 1997 ---------------- ---------------- ---------------- Balance, Beginning of year $1,069,535 $930,284 $771,925 Additions charged to operating expense 165,500 164,000 164,000 Loans charged off (14,215) (45,277) (48,849) Recoveries of loans previously charged off 20,196 20,528 43,208 ---------------- ---------------- ---------------- Balance, End of year $1,241,016 $1,069,535 $ 930,284 ================ ================ ================
Note #5 - Related Party Transactions The Bank has entered into loan and deposit transactions with certain directors and executive officers of the Company. These loans were made and deposits were taken in the ordinary course of the Bank's business and, in management's opinion, were made at prevailing rates and terms. An analysis of loans to directors and executive officers is as follows:
1999 1998 ----------------- ----------------- Outstanding Balance, Beginning of year $698,732 $322,130 Additional loans made 218,911 548,264 Repayments (625,103) (148,785) Loans sold (22,877) ----------------- ----------------- Outstanding Balance, End of year $292,540 $698,732 ================= =================
Deposits from related parties held by the Bank at December 31, 1999 and 1998 amounted to approximately $2,026,000 and $1,841,000, respectively. F-15- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #6 - PROPERTY, PREMISES AND EQUIPMENT Property, premises and equipment consisted of the following:
1999 1998 ------------------ ------------------ Land $ 668,877 $ 671,070 Building and improvements 3,009,455 2,294,000 Furniture and equipment 3,795,974 2,755,760 Construction in Progress 135,663 ------------------ ------------------ 7,474,306 5,856,493 Less: Accumulated depreciation and amortization 4,047,017 3,409,108 ------------------ ------------------ Total $3,427,289 $2,447,385 ================== ==================
The Company leases land, buildings, and equipment under noncancelable operating leases expiring at various dates through 2009. The following is a schedule of future minimum lease payments based upon obligations at year-end.
Year Ending December 31, Amount - -------------------------- ----------------- 2000 $ 580,989 2001 591,264 2002 385,903 2003 331,333 2004 302,124 More than 5 years 1,052,145 ----------------- Total $3,243,758 =================
Total expenditures charged for leases for the reporting periods ended December 31, 1999, 1998 and 1997, were $345,582, $312,467 and $309,034, respectively. F-16- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #7 - INCOME TAXES The current and deferred amounts of the provision (benefit) for income taxes were:
Year Ending December 31, --------------------------------------------------- 1999 1998 1997 --------------- --------------- ---------------- Federal Income Tax Current $ 655,522 $474,820 $551,554 Deferred (133,240) 2,557 (3,143) --------------- --------------- ---------------- Total Federal Taxes 522,282 477,377 548,411 --------------- --------------- ---------------- State Franchise Tax Current 276,364 250,293 236,760 Deferred (44,518) 356 (3,439) --------------- --------------- ---------------- Total State Franchise Tax 231,846 250,649 233,321 --------------- --------------- ---------------- Total Income Taxes $ 754,128 $728,026 $781,732 =============== =============== ================
The principal items giving rise to deferred taxes were:
1999 1998 1997 --------------- --------------- --------------- Use of different depreciation for tax purposes $ (29,948) $ 29,374 $15,100 Difference in loan loss provision for tax purposes (67,855) 59,991 32,781 Differences arising from changes in accruals (83,831) 51,762 (35,621) Other, net 3,876 (138,214) (18,802) --------------- --------------- --------------- Total $(177,758) $ 2,913 $(6,542) =============== =============== ===============
The provision for taxes on income differed from the amounts computed using the federal statutory tax rate of 34 percent as follows:
1999 1998 1997 -------- -------- -------- Amount Percent Amount Percent Amount Percent -------- --------- -------- --------- -------- -------- Tax provision at federal statutory tax rate $ 742,919 34.0 $ 705,371 34.0 $ 694,551 34.0 State income taxes, net of federal income tax benefit 153,019 7.0 148,335 7.1 146,060 7.2 Tax exempt income and Other, Net (141,810) (6.5) (125,680) (6.0) (58,879) (2.9) ------------ ---------- ------------- --------- ----------- ---------- Total Tax Provision $ 754,128 34.5 $ 728,026 35.1 $ 781,732 38.3 ============ ========== ============= ========= ============ =========
F-17- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #7 - INCOME TAXES, (CONTINUED) The net deferred tax asset is determined as follows:
(In Thousands) -------------------------- 1999 1998 -------------------------- Deferred Tax Assets Reserves for loan losses $ 423 $ 353 Fixed Assets 67 24 Accruals 318 158 Investment securities valuation 464 132 ------------- ------------- Total Deferred tax assets arising from cumulative timing differences 1,272 667 Valuation allowance* (103) (103) ------------- ------------- Net Deferred Tax Asset $ 1,169 $ 564 ============= =============
*The valuation allowance is estimated based upon amounts less than likely of future realization. NOTE #8 - COMMITMENTS AND CONTINGENCIES The Company is involved in various litigation. In the opinion of management and the Company's legal counsel, the disposition of all such litigation pending will not have a material effect on the Company's financial statements. At December 31, 1999 and 1998, the Bank was contingently liable for letters of credit accommodations made to its customers totaling $530,967 and $889,684, respectively. At December 31, 1999 and 1998, the Bank had undisbursed loan commitments in the amount of $48,235,109 and $26,363,856, respectively. The Bank makes commitments to extend credit in the normal course of business to meet the financing needs of its customers. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total outstanding commitment amount does not necessarily represent future cash requirements. Standby letters of credit written are confidential commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank anticipates no losses as a result of such transactions. F-18- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #9 - NOTES PAYABLE On September 11, 1998, the Bancorp obtained a revolving line of credit in the amount of $2,000,000 through Pacific Coast Bankers' Bank. The note is secured by 339,332 shares of the Bank's stock. The note matures August 15, 2005, and bears interest at a variable rate of 1.00% over the Wall Street Journal prime rate. The outstanding principal balance at December 31, 1999, was $350,000 and the current interest rate was 9.5%. Payments on the note will be fully amortizing to maturity, based on the outstanding balance owed. NOTE #10 - STOCK SPLIT On September 4, 1997, the Board of Directors approved a three-for-two stock split of its common stock. The outstanding shares and related calculations included in these financial statements reflect retroactive adjustments for this stock split. F-19- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 Note #11 - Stock Option Plans At December 31, 1998, the Bank had two stock option plans, which are described below. The Bank applies APB Opinion 25 and related interpretations in accounting for the stock option plans. Accordingly, no compensation costs have been recognized. Had compensation costs for these plans been determined on the fair value at the grant dates consistent with the method prescribed by SFAS No. 123, the Company's net income and earnings per share would have been adjusted to the pro forma amounts indicated below:
1999 1998 1997 ---------------- ---------------- ----------------- Net Income As reported $1,430,928 $1,346,595 $1,261,064 Pro forma $1,373,874 $1,285,931 $1,261,604 Earnings per share As reported $ 1.27 $ 1.24 $ 1.18 Pro forma $ 1.22 $ 1.13 $ 1.18 Earnings per share - As reported $ 1.15 $ 1.13 $ 1.11 assuming dilution Pro forma $ 1.10 $ 1.08 $ 1.11 The Company adopted the Bank's 1990 stock option plan, which is a tandem stock option plan permitting options to be granted either as "Incentive Stock Options" or as Non-Qualified Stock options under the Internal Revenue Code. All outstanding options were granted at prices which equal the fair market value on the day of grant. Options granted vest at a rate of 25 percent per year for four years, and expire no later than ten years from the date of grant. The plan provides for issuance of up to 144,004 shares (after giving retroactive effect for a three-for-two stock split in 1997 and a 4% stock dividend in 1999) of the Company's unissued common stock and is subject to the specific approval of the Board of Directors.
F-20- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #11 - STOCK OPTION PLANS, (CONTINUED) The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for 1997: risk-free rate of 5.78% and dividend yield of 3.22%, expected life of five years; and volatility of 34%. No options were granted during 1998 and 1999. The following tables summarize information about the 1990 stock option plan outstanding at December 31, 1999.
1999 1998 1997 -------------------------- ------------------------- -------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price -------------------------- ------------ ------------ ------------ ------------- Outstanding at beginning of year 72,562 $4.13 103,738 $4.05 124,224 $3.77 Granted 4,268 $10.26 Cancelled (878) $10.26 (584) $10.26 Exercised (28,232) $3.84 (30,592) $3.75 (24,754) $3.68 ------------- ------------ ------------ Outstanding at end of year 43,452 $4.13 72,562 $4.13 103,738 $4.05 ============= ============ ============ Options available for granting at end of year 881 3 3 Options exercisable at year-end 42,293 $3.97 69,947 $ 3.89 99,471 $ 3.78 Weighted-average fair value of options granted during the year - - $2.96
Options Outstanding Options Exercisable Weighted- Weighted- Weighted- Average Average Average Exercise Number Remaining Exercise Number Exercise Price Outstanding Contractual Life Price Exercisable Price $3.68 31,774 3.09 $3.68 31,774 $3.68 $4.16 9,360 0.55 $4.16 9,360 $4.16 $10.26 2,318 7.53 $10.26 1,159 $10.26 ----------------- ---------------- 43,452 2.78 $4.14 42,293 $3.97 ================= ================
F-21- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 The Company adopted the Bank's 1997 stock option plan, which is a tandem stock option plan permitting options to be granted either as "Incentive Stock Options" or as "Non-Qualified Stock Options" under the Internal Revenue Code. All outstanding options were granted at prices which equal the fair market value on the day of the grant. Options granted vest at a rate of 20 percent per year for five years, and expire no later than ten years from the date of grant. The plan provides for issuance of up to 167,491 shares (after giving retroactive effect for a three-for-two stock split in 1997 and a 4% stock dividend in 1999) of the Company's unissued common stock and is subject to the specific approval of the Board of Directors. F-22- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #11 - STOCK OPTION PLANS, (CONTINUED) During 1999, the Board of Directors approved an amendment to the 1997 Stock Option Plan. Under this amendment, the plan provides for issuance of up to 99,254 additional shares of the Company's common stock. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for 1999 and 1998, respectively: risk-free rates of 6.60% and 4.80%, dividend yields of 0% and 10%, expected life of eight years; and volatility of 30%, and 25%. No options were granted for this plan prior to 1997. The following summarizes information about the 1997 stock option plan outstanding at December 31, 1999. These tables have been retroactively adjusted for the 4% stock dividend.
1999 1998 1997 --------------------------- -------------------------- ------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------------- ------------ ------------ ------------ ----------- ------------ Outstanding at beginning of year 135,715 $10.47 144,712 $10.26 Granted 35,500 $16.35 6,760 $14.57 144,712 $10.26 Cancelled (6,240) $10.26 (11,857) $10.26 Exercised (3,660) $10.41 (3,900) $10.26 ------------- ------------ ----------- ------------ Outstanding at end of year 161,315 $11.83 135,715 $10.47 144,712 $10.26 ============= ============ =========== Options available for grant end of year 97,869 27,875 22,779 Options exercisable at year-end 47,714 $10.41 25,791 $ 10.26 - $10.26
Options Outstanding Options Exercisable - ---------------------------------------------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Number Remaining Exercise Number Exercise Price Outstanding Contractual Life Price Exercisable Price - ---------------------- ------------------ ---------------------- -------------- ----------------- ----------------- $10.26 119,155 7.53 $10.26 46,462 $10.26 $15.63 - $16.35 42,160 9.10 $16.26 1,252 $15.82 161,315 7.94 $9.10 47,714 10.41 ================= =================
F-23- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #12 - OTHER INCOME/EXPENSE The following is a breakdown of fees and other income and expenses for the years ended December 31, 1999, 1998 and 1997:
1999 1998 1997 ---------------- ---------------- ---------------- Fees and Other Income ATM transaction fees $ 2,421,635 $ 3,380,117 $ 2,433,051 ATM interchange income 629,711 767,192 808,901 ATM sponsorship fees 82,501 115,516 139,628 Bankcard merchant fees 623,930 757,380 697,159 Mortgage broker fees 290,940 301,988 127,411 Other 638,076 337,396 216,877 ---------------- ---------------- ---------------- $ 4,686,793 $ 5,659,589 $ 4,423,027 ================ ================ ================ Other Expenses Data processing 930,861 801,943 615,809 Advertising and promotional 301,388 217,719 110,418 Regulatory fees 50,517 47,756 28,779 Other professional fees and outside services 392,174 58,144 66,850 Legal fees and other litigation expenses 142,515 187,863 152,351 Stationery and supplies 169,908 107,595 111,942 Bankcard merchant expense 573,324 864,970 604,011 Director fees 174,645 158,476 96,275 ATM costs at gaming sites 1,149,478 2,076,345 1,053,056 ATM costs at retail sites 930,649 680,448 695,118 Other 543,842 551,160 512,963 ---------------- ---------------- ---------------- Total $ 5,359,301 $ 5,752,419 $ 4,047,572 ================ ================ ================
Note #13 - Restriction on Transfers of Funds to Parent There are legal limitations on the ability of the Bank to provide funds to the Company. Dividends declared by the Bank may not exceed, in any calendar year, without approval of the State Banking Department, net income for the year and the retained net income for the preceding two years. Section 23A of the Federal Reserve Act restricts the Bank from extending credit to the Company and other affiliates amounting to more than 20 percent of its contributed capital and retained earnings. During 1999, the Bank paid the parent $705,276 in dividends. F-24- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #14 - SALARY CONTINUATION PLAN The Bank established a salary continuation plan agreement with the President, Chief Financial Officer, Chief Lending Officer, and Chief Administrative Officer, as authorized by the Board of Directors. This agreement provides for annual cash payments for a period not to exceed 15 years, beginning at retirement age 60. In the event of death prior to retirement age, annual cash payments would be made to the beneficiaries for a determined number of years. The present values of the Company's liability under this Agreement were $183,512 and $185,353 at December 31, 1999 and 1998, respectively, and are included in other liabilities in the Company's Consolidated Financial Statements. The Company maintains life insurance policies, which are intended to fund all costs of the plan. The cash surrender values of these life insurance policies totaled $1,305,787 and $1,020,576, at December 31, 1999 and 1998, respectively. NOTE #15 - 401(K) PENSION PLAN During 1994, the Bank established a savings plan for employees which allows participants to make contributions by salary deduction equal to 15% or less of their salary pursuant to section 401(k) of the Internal Revenue Code. Employee contributions are matched up to 25% of the employee's contribution. Employees vest immediately in their own contributions and they vest in the Bank's contribution based on years of service. Expenses of the savings plan were $35,924, $34,619, and $24,048, for the years ended December 31, 1999, 1998 and 1997, respectively. NOTE #16 - EARNINGS PER SHARE (EPS) The following is a reconciliation of net income and shares outstanding to the income and number of shares used to compute EPS. Share information has been retroactively adjusted for the stock dividend as discussed in Note #24.
1999 1998 1997 ------------------------------ ---------------------------- ---------------------------- Net Net Net Income Shares Income Shares Income Shares -------------- --------------- -------------- ------------- -------------- ------------- Net income as reported $1,430,928 $1,346,595 $1,261,064 Shares outstanding at year-end 1,144,282 1,112,583 1,078,091 Impact of weighting shares purchased during the year (18,289) (25,307) (9,096) -------------- --------------- -------------- ------------- -------------- ------------- Used in Basic EPS 1,430,928 1,125,993 1,346,595 1,087,276 1,261,064 1,068,995 Dilutive effect of outstanding stock options 120,225 104,712 66,695 -------------- --------------- -------------- ------------- -------------- ------------- Used in Dilutive EPS $1,430,928 1,246,218 $1,346,595 1,191,988 $1,261,064 1,135,690 ============== =============== ============== ============= ============== =============
F-25- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #17 - REGULATORY MATTERS The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999, that the Company and the Bank meets all capital adequacy requirements to which it is subject. As of the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's category. To be categorized as well-capitalized, the Bank must maintain minimum capital ratios as set forth in the table below. The following table also sets forth the Company's and the Bank's actual regulatory capital amounts and ratios (dollar amounts in thousands): F-26- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #17 - REGULATORY MATTERS, (CONTINUED)
Capital Needed --------------------------------------------------- To Be Well Capitalized Under For Capital Prompt Corrective Actual Regulatory Adequacy Purposes Action Provisions ------------------------ ------------------------ ------------------------ Capital Capital Capital Amount Ratio Amount Ratio Amount Ratio ------------ ----------- ------------- ---------- ------------ ----------- As of December 31, 1999 Total capital to risk-weighted assets: Company $12,415 10.89% $ 9,122 8.0% N/A N/A Bank $11,620 10.75% $ 8,648 8.0% $ 10,810 10.0% Tier 1 capital to risk-weighted assets: Company $11,174 9.80% $ 4,561 4.0% N/A N/A Bank $10,378 9.60% $ 4,324 4.0% $ 6,486 6.0% Tier 1 capital to average assets: Company $11,174 7.62% $ 5,869 4.0% N/A N/A Bank $10,378 7.22% $ 5,747 4.0% $ 7,184 5.0% As of December 31, 1998 Total capital to risk-weighted assets: Company $10,666 12.68% $ 6,728 8.0% N/A N/A Bank $10,342 10.81% $ 7,656 8.0% $ 9,570 10.0% Tier 1 capital to risk-weighted assets: Company $9,568 11.38% $ 3,364 4.0% N/A N/A Bank $9,272 9.69% $ 3,828 4.0% $ 5,742 6.0% Tier 1 capital to average assets: Company $9,568 7.72% $ 4,960 4.0% N/A N/A Bank $9,272 7.55% $ 4,915 4.0% $ 6,144 5.0%
F-27- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 Note #18 - Acquisition of Assets and Liabilities On February 21, 1997, the Bank acquired certain assets and liabilities of the Wells Fargo Bank branch located in Cambria, California. The total assets acquired were $5,255,161, which consisted of $316,610 of leasehold improvements and fixed assets, $4,863,150 of cash and $15,267 of loans. In addition, the Bank also assumed $5,255,161 of deposits. The Bank paid a premium of $60,134 for the deposits. On September 2, 1994, the Bank had paid a premium of $173,102 for a branch acquisition. Both of these premiums are being amortized over a five-year period. Amortization of the premiums for 1999, 1998 and 1997, was $35,107, $46,647, and $43,641, respectively. The remaining unamortized premiums at December 31, 1999, 1998 and 1997, were $27,061, $62,168, $108,815. NOTE #19 - OTHER REAL ESTATE OWNED As discussed in Note #1I, Other Real Estate Owned is carried at the estimated fair value of the real estate. An analysis of the transactions for December 31, 1998, were as follows:
1998 ------------- Balance, Beginning of year $ 62,000 Additions - Sales (62,000) ------------- Balance, End of year $ - =============
There were no Other Real Estate Owned transactions during 1999. NOTE #20 - FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS," requires disclosure of fair value information about all financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank. F-28- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #20 - FAIR VALUE OF FINANCIAL INSTRUMENTS, (CONTINUED) The following table presents the carrying amounts and fair values of financial instruments at December 31, 1999 and 1998. SFAS No. 107, "DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS," defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
1999 1998 ------------------------------ ---------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------ ------------ ----------- ------------ Assets Cash and cash equivalents $ 18,359,073 $ 18,359,073 $24,939,179 $24,939,179 Investment bearing deposits 375,255 375,255 666,975 666,975 Investment and mortgage-backed securities 19,058,804 19,058,804 28,621,257 28,922,113 Loans receivable 104,152,682 108,896,652 70,559,543 70,623,774 Loans held for sale 120,382 120,382 1,654,765 1,654,765 Accrued interest receivable 796,852 796,852 680,859 680,859 Liabilities Non-interest bearing deposits 39,901,884 39,901,884 38,672,576 38,672,576 Interest bearing deposits 93,059,689 93,252,991 80,735,130 80,749,292 Notes Payable 350,000 350,000 750,000 750,000 Repurchase agreements 2,211,000 2,211,000 Accrued interest payable 520,742 520,742 568,977 568,977 Notional Cost to Cede Notional Cost to Cede Amount or Assume Amount or Assume ------------ ------------ ----------- ------------ Off-Balance Sheet Instruments Commitments to extend credit and standby letters of credit $ 40,526,310 $ 405,263 $ 2,723,540 $ 272,535
The following methods and assumptions were used by the Bank in estimating fair value disclosures: - - CASH AND CASH EQUIVALENTS The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values due to the short-term nature of the assets. - - INTEREST BEARING DEPOSITS Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. F-29- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #20 - FAIR VALUE OF FINANCIAL INSTRUMENTS, (CONTINUED) - - INVESTMENT AND MORTGAGE-BACKED SECURITIES Fair values are based upon quoted market prices, where available. - - LOANS AND LOANS HELD FOR SALE For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans (for example, fixed rate commercial real estate and rental property mortgage loans and commercial and industrial loans) are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The carrying amount of accrued interest receivable approximates its fair value. - - DEPOSITS The fair values disclosed for demand deposits (for example, interest-bearing checking accounts and passbook accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value. - - LONG-TERM DEBT - NOTES PAYABLE The fair value disclosed for notes payable is based on carrying amounts. The note is a variable-rated note that reprices frequently. - - REPURCHASE AGREEMENTS The fair value disclosed for repurchase agreements is based on carrying amount. These agreements are short-term and the carrying amount approximates the fair value. - - OFF-BALANCE SHEET INSTRUMENTS Fair values of loan commitments and financial guarantees are based upon fees currently charged to enter similar agreements, taking into account the remaining terms of the agreement and the counterparties' credit standing. F-30- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 Note #21 - Time Deposit Liabilities At December 31, 1999, the Bank had time certificates of deposit with maturity distributions as follows: Due in one year or less $ 36,690,307 Due after one year through three years 958,971 Due after three years 159,083 ---------------- $ 37,808,361 ================
NOTE #22 - OTHER BORROWED MONEY Other borrowed money consisted of the following:
1999 1998 Average Average Balance (1) Balance (1) ---------------- ---------------- Securities sold under agreements to repurchase $ 792,668 $ 738,318 Federal funds purchased 11,507 128,302 ---------------- ---------------- $ 804,175 $ 866,620 ================ ================ The maximum outstanding balance at any month end during the year $2,428,000 $2,002,500 (1) Average balances are computed using the daily balances outstanding during the year.
At December 31, 1999, the book value including accrued interest receivable on securities sold under agreements to repurchase was $2,211,711. The securities dealer has possession of the security during the term of the loan. The Bank may be required to provide additional collateral based upon the fair value of the underlying securities. There was no balance as of December 31, 1998. Interest expense on federal funds purchased was $752, $5,090 and $2,572 and interest expense on securities sold under agreements to repurchase was $42,430, $46,158, and $53,880 for the years ended December 31, 1999, 1998 and 1997, respectively. The Bank has a fed funds borrowing line with a correspondent bank. The credit limit available on that line is $5,500,000. The Bank has pledged approximately $4,708,000 in loans to the Federal Reserve Bank for a borrowing line at the federal discount window. F-31- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #23 - OPERATING SEGMENTS In June 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION," which the Bank has adopted during 1998. The Company has two primary reportable segments. The segments reported herein apply to the Bank and the Bank's EFT Department. The segments are identified as such based upon the percentage of operating net income, management responsibility, and the types of products and services offered. The segments consist of the Bank and four separately classified components within the EFT Department referred to as networks. The Bank offers traditional banking products such as checking, savings, and certificates of deposit, as well as mortgage, commercial, and consumer loans. The EFT Department has installed 82 automatic teller machines located in retail outlets and gaming facilities, and approximately 320 point of sale machines located in retail outlets. Income is based upon total customer usage of the machines and the applicable transaction charge. Income is allocated to the Bank via contractual agreement. The Bank measures segment profit as operating net income which is defined as income before provision for income taxes. Presented below is comparative financial information relating to the Bank's operating segments:
Total EFT Operating Department Bank Segments ------------------ ------------------- ------------------ FISCAL YEAR ENDED DECEMBER 31, 1999 Revenues $4,152,475 $11,205,259 $15,357,734 Depreciation and amortization 133,222 657,640 790,862 Operating income 958,484 1,383,796 2,342,280 Total assets 6,700,862 139,515,240 146,216,102 Total EFT Operating Department Bank Segments ------------------ ------------------- ------------------ FISCAL YEAR ENDED DECEMBER 31, 1998 Revenues $5,085,276 $ 9,266,192 $14,351,468 Depreciation and amortization 2,247 564,806 567,053 Operating income 1,069,050 1,138,141 2,207,191 Total assets 7,999,357 122,610,685 130,610,042
F-32- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997
Total EFT Operating Department Bank Segments ------------------ ------------------- ------------------ FISCAL YEAR ENDED DECEMBER 31, 1997 Revenues $4,094,762 $ 7,556,673 $11,651,435 Depreciation and amortization 463,653 463,653 Operating income 1,367,429 768,322 2,135,751 Total assets 7,408,302 85,833,670 93,241,972
Note #24 - Dividends On January 29, 1998, the Board of Directors declared a cash dividend of $.50 per share to stockholders' of record on February 9, 1998. The dividend paid was $519,850. On January 23, 1997, the Board of Directors declared a cash dividend of $.33 per share (after retroactive adjustment for 1997 stock split) to stockholders' of record on February 7, 1997. The dividend paid was $337,787. On January 28, 1999, the Board of Directors declared a 4% stock dividend payable on February 26, 1999 to stockholders of record on February 15, 1999. Cash was paid in lieu of fractional shares at the rate of $15.70 per share and amounted to $3,025. F-33- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #25 - CONDENSED FINANCIAL INFORMATION OF HERITAGE OAKS BANCORP (PARENT COMPANY) BALANCE SHEETS
1999 1998 ------------------ ------------------ ASSETS Cash $ 115,369 $ 108,161 Prepaid and other assets 336,104 286,723 Property and premises 698,980 406,733 Investment in subsidiary 9,745,842 9,398,102 ------------------ ------------------ Total Assets $10,896,295 $10,199,719 ================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY Notes payable 350,000 750,000 Other Liabilities 4,133 13,049 ------------------ ------------------ Total Liabilities 354,133 763,049 ------------------ ------------------ Stockholders' Equity Common stock 5,288,179 4,470,170 Retained earnings 5,253,983 4,966,500 ------------------ ------------------ Total Stockholders' Equity 10,542,162 9,436,670 ------------------ ------------------ Total Liabilities and Stockholders' Equity $10,896,295 $10,199,719 ================== ==================
F-34- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 NOTE #25 - CONDENSED FINANCIAL INFORMATION OF HERITAGE OAKS BANCORP (PARENT COMPANY), (CONTINUED) STATEMENTS OF INCOME
1999 1998 1997 ------------------ ------------------ ---------------- INCOME Equity in undisbursed income of subsidiary $1,523,690 $1,423,886 $ 1,317,202 Other 42,525 ------------------ ------------------ ---------------- Total Income 1,566,215 1,423,886 1,317,202 ------------------ ------------------ ---------------- EXPENSE Salary expense 30,498 35,284 32,283 Equipment expense 13,180 Other professional fees and outside services 52,024 44,930 22,785 Interest expense 43,615 12,632 Other 60,432 39,724 37,887 ------------------ ------------------ ---------------- Total Expense 199,749 132,570 92,955 ------------------ ------------------ ---------------- Total Operating Income 1,366,466 1,291,316 1,224,247 Tax benefit of parent (64,462) (55,279) (36,817) ------------------ ------------------ ---------------- Net Income $1,430,928 $1,346,595 $ 1,261,064 ================== ================== ================
F-35- HERITAGE OAKS BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 ----------------- ----------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $1,430,928 $1,346,595 $1,261,064 Adjustments to Reconcile Net Income to Net Cash Provided By Operating Activities Depreciation 13,180 Increase in other assets (49,381) (197,699) (31,217) Increase/(decrease) in other liabilities (8,916) 4,399 (24,825) Undistributed income of subsidiary (1,523,690) (1,423,886) (1,317,202) ----------------- ----------------- ----------------- Net Cash Used In Operating Activities (137,879) (270,591) (112,180) ----------------- ----------------- ----------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and premises (305,427) (406,733) ----------------- ----------------- ----------------- CASH FLOWS FROM FINANCING ACTIVITIES Cash dividends declared (519,850) (339,138) Cash dividends received 705,276 665,355 345,985 Cash paid in lieu of fractional shares (3,025) Additional contributed capital (700,000) Increase (decrease) in long-term borrowings (400,000) 750,000 Proceeds from the exercise of options 148,263 289,684 91,241 ----------------- ----------------- ----------------- Net Cash Provided By Financing Activities 450,514 485,189 98,088 ----------------- ----------------- ----------------- NET INCREASE/(DECREASE) IN CASH 7,208 (192,135) (14,092) CASH, Beginning of year 108,161 300,296 314,388 ----------------- ----------------- ----------------- CASH, End of year $ 115,369 $ 108,161 $ 300,296 ================= ================= =================
F-36- ITEM 8. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT The information required by Item 9 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 10. EXECUTIVE COMPENSATION The information required by Item 10 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 11 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 12 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K EXHIBITS: (2.1) PLAN OF REORGANIZATION AND MERGER AGREEMENT DATED AS OF MARCH 22, 1994, INCORPORATED BY REFERENCE FROM EXHIBIT 2 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. (3.1A) ARTICLES OF INCORPORATION INCORPORATED BY REFERENCE FROM EXHIBIT 3.1A TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504 FILED WITH THE SEC ON APRIL, 1994. (3.1B) AMENDMENT TO THE ARTICLES OF INCORPORATION FILED WITH THE SECRETARY OF STATE ON OCTOBER 16, 1997. (3.2) BYLAWS INCORPORATED BY REFERENCE FROM EXHIBIT 3.2 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. (4.1) SPECIMEN FORM OF HERITAGE OAKS BANCORP STOCK CERTIFICATE INCORPORATED BY REFERENCE FROM EXHIBIT 4.1 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504 FILED WITH THE SEC ON APRIL 8, 1994. 30 (10.1) AGREEMENT TO PURCHASE ASSETS AND ASSUME LIABILITIES BETWEEN HERITAGE OAKS BANK AND LA CUMBRE SAVINGS BANK, DATED MARCH 28, 1994, INCORPORATED BY REFERENCE FROM EXHIBIT 10.1 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. *(10.2) 1990 STOCK OPTION PLAN INCORPORATED BY REFERENCE FROM EXHIBIT 10.2 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. *(10.3) FORM OF STOCK OPTION AGREEMENT INCORPORATED BY REFERENCE FROM EXHIBIT 4.2 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. *(10.4) LAWRENCE P. WARD EMPLOYMENT LETTER AGREEMENT, DATED NOVEMBER 17, 1992, INCORPORATED BY REFERENCE FROM EXHIBIT 10.3 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. (10.5) SERVICE AGREEMENT, DATED NOVEMBER 10, 1992, BETWEEN HERITAGE OAKS BANK AND MESCOM ENTERPRISES, INC. DBA NATIVE AMERICAN NETWORK SYSTEM, INCORPORATED BY REFERENCE FROM EXHIBIT 10.4 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. (10.6) LETTER AGREEMENT, DATED OCTOBER 23, 1992, BETWEEN HERITAGE OAKS BANK AND PETER GHEORGHIU, INCORPORATED BY REFERENCE FROM EXHIBIT 10.5 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. (10.7) ITEM PROCESSING AND BACK OFFICES SERVICING AGREEMENT, DATED AUGUST 11, 1993, BETWEEN HERITAGE OAKS BANK AND SYSTEMATICS FINANCIAL SERVICES, INC., INCORPORATED BY REFERENCE FROM EXHIBIT 10.6 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1995. (10.8) DATA PROCESSING AGREEMENT, DATED OCTOBER 1, 1992, BETWEEN HERITAGE OAKS BANK AND CITY NATIONAL INFORMATION SYSTEMS, INCORPORATED BY REFERENCE FROM EXHIBIT 10.7 TO REGISTRATION STATEMENT ON FORM S-4 NO. 33-77504, FILED WITH THE SEC ON APRIL 8, 1994. *(10.9) 401(K) PENSION AND PROFIT SHARING PLAN FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. *(10.10) HERITAGE OAKS BANCORP 1995 BONUS PLAN, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. *(10.11) SALARY CONTINUATION PLAN OF HERITAGE OAKS BANK, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. 31 *(10. 12) SALARY CONTINUATION AGREEMENT WITH LAWRENCE P. WARD, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. *(10. 13) SALARY CONTINUATION AGREEMENT WITH GWEN R. PELFREY, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. *(10. 14) SALARY CONTINUATION AGREEMENT WITH ROBERT E. BLOCH, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. (10.15) WOODLAND SHOPPING CENTER LEASE, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. (10.16) LAGUNA VILLAGE SUBLEASE, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1994. *(10.17) LAWRENCE P. WARD EMPLOYMENT LETTER AGREEMENT, DATED FEBRUARY 27, 1996, FILED WITH THE SEC IN THE COMPANY'S 10KSB REPORT FOR THE YEAR ENDED DECEMBER 31, 1995. (10.18) 1135 SANTA ROSA STREET LEASE, FILED WITH THE SEC IN THE COMPANY'S 10KSB REPORT FOR THE YEAR ENDED DECEMBER 31, 1995. (10.19) PURCHASE AND ASSUMPTION BETWEEN WELLS FARGO BANK, N.A. AND HERITAGE OAKS BANK, DATED AS OF OCTOBER 15, 1996, FILED WITH THE SEC IN THE COMPANY'S 8-K REPORT, DATED DECEMBER 2, 1996. (10.20) LEASE AGREEMENT FOR CAMBRIA BRANCH OFFICE DATED FEBRUARY 21, 1997 FILED WITH THE SEC IN THE COMPANY'S 10KSB REPORTED FOR THE YEAR ENDED DECEMBER 1996. (10.21) 1997 STOCK OPTION PLAN INCORPORATED BY REFERENCE FROM EXHIBIT 4A TO REGISTRATION STATEMENT ON FORM S-8 NO.333-31105 FILED WITH THE SEC ON JULY 11, 1997 AS AMENDED, INCORPORATED BY REFERENCE, FROM REGISTRATION STATEMENT ON FORM S-8, FILE NO. 333-83235 FILED WITH THE SEC ON JULY 20, 1999. (10.22) FORM OF STOCK OPTION AGREEMENT INCORPORATED BY REFERENCE FROM EXHIBIT 4B TO REGISTRATION STATEMENT ON FORM S-8 NO. 333-31105 FILED WITH THE SEC ON JULY 11, 1997. (10.23) MADONNA ROAD LEASE FILED WITH THE SEC IN THE COMPANY'S 10KSB FOR THE YEAR ENDED DECEMBER 31, 1997. (10.24) SANTA MARIA LEASE COMMENCING NOVEMBER 1, 1998. (10.24) SERVICE AGREEMENT WITH ONLINE RESOURCES AND COMMUNICATION CORP. DATED DECEMBER 18, 1998 (INTERNET BANKING PRODUCT FOR CUSTOMERS). (10.25) MASTER DATA PROCESSING AGREEMENT WITH MID WEST PAYMENT SYSTEMS, INC. COMMENCING OCTOBER 1, 1998. 32 (10.26) SALARY CONTINUATION AGREEMENT WITH MARGARET A. TORRES, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1999. (10.27) ATASCADERO BRANCH LEASE ENTERED INTO ON MARCH 31, 1999. FILED WITH THE SEC IN THE COMPANY'S 10KSB REPORTED FOR THE YEAR ENDED DECEMBER 31, 1999. (10.28) SERVICE BUREAU PROCESSING AGREEMENT ENTERED INTO BETWEEN ALLTEL INFORMATIONS SERVICES, INC. AND HERITAGE OAKS BANK, DATED AUGUST 1, 1999. FILED WITH THE SEC IN THE COMPANY'S 10KSB REPORTED FOR THE YEAR ENDED DECEMBER 31, 1999. (21) SUBSIDIARIES OF HERITAGE OAKS BANCORP. HERITAGE OAKS BANK IS THE ONLY SUBSIDIARY OF HERITAGE OAKS BANCORP. (23) CONSENT OF INDEPENDENT ACCOUNTANTS (27) FINANCIAL SCHEDULE *DENOTES MANAGEMENT CONTRACTS, COMPENSATORY PLANS OR ARRANGEMENTS. REPORTS ON FORM 8-K: DURING THE FOURTH QUARTER OF 1999, THE COMPANY DID NOT FILE ANY REPORTS ON FORM 8-K. SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934, THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED. HERITAGE OAKS BANCORP BY: /s/ LAWRENCE P. WARD ---------------------------------- LAWRENCE P. WARD PRESIDENT AND CHIEF EXECUTIVE OFFICER DATED: MARCH 21, 2000 BY: /s/MARGARET A. TORRES ---------------------------------- EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER DATED: MARCH 21, 2000 33 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED. DATED: MARCH 21, 2000 /s/ B.R. BRYANT CHAIRMAN OF THE MARCH 21 , 2000 - -------------------------- BOARD OF B.R. BRYANT DIRECTORS /s/ DONALD H. CAMPBELL VICE CHAIRMAN MARCH 21 , 2000 - -------------------------- OF THE BOARD DONALD H. CAMPBELL OF DIRECTORS /s/ KENNETH DEWAR DIRECTOR MARCH 21 , 2000 - -------------------------- KENNETH DEWAR /s/ DOLORES T. LACEY DIRECTOR MARCH 21 , 2000 - -------------------------- DOLORES T. LACEY /s/ MERLE F. MILLER DIRECTOR MARCH 21 , 2000 - -------------------------- MERLE F. MILLER /s/ JOHN PALLA DIRECTOR MARCH 21 , 2000 - -------------------------- JOHN PALLA /s/ OLE K. VIBORG DIRECTOR MARCH 21 , 2000 - -------------------------- OLE K. VIBORG /s/ LAWRENCE P. WARD DIRECTOR MARCH 21 , 2000 - -------------------------- LAWRENCE P. WARD /s/ DAVID WEYRICH DIRECTOR MARCH 21 , 2000 - -------------------------- DAVID WEYRICH EXHIBIT INDEX 34 EXHIBIT SEQUENTIAL NUMBER DESCRIPTION PAGE NUMBER (10.26) SALARY CONTINUATION AGREEMENT WITH MARGARET A. TORRES, FILED WITH THE SEC IN THE COMPANY'S 10K REPORT FOR THE YEAR ENDED DECEMBER 31, 1999. (10.27) ATASCADERO BRANCH LEASE ENTERED INTO ON MARCH 31, 1999. (10.28) PROCESSING AGREEMENT WITH ALLTEL INFORMATION SERVICES, INC., DATED AUGUST 1, 1999. 23 CONSENT OF INDEPENDENT ACCOUNTANTS 27 FINANCIAL DATA SCHEDULE 35 EX-10.26 2 EXHIBIT 10.26 EXHIBIT (10.26) EXECUTIVE This Agreement is made and entered into this 1 day of February 1999, by and between Heritage Oaks Bank, a bank chartered under the laws of the State of California (the "Employer"), and Margaret Torres, an individual residing in the State of California (hereinafter referred to as the "Executive"). RECITALS WHEREAS, the Executive is an employee of the Employer and is serving as its Executive Vice President - Chief Financial Officer. WHEREAS, the Executive's experience and knowledge of the affairs of the Employer and the banking industry are extensive and valuable; WHEREAS, it is deemed to be in the best interest of the Employer to provide the Executive with certain salary continuation benefits, on the terms and conditions set forth herein, in order to reasonably induce the Executive to remain in the Employer's employment; and WHEREAS, the Executive and the Employer wish to specify in writing the terms and conditions upon which this additional compensatory incentive will be provided to the Executive or to the Executive's spouse or the Executive's designated beneficiaries, as the case may be; NOW, THEREFORE, in consideration of the services to be performed in the future, as well as the mutual promises and covenants contained herein, the Executive and the Employer agree as follows: AGREEMENT 1. TERMS AND DEFINITIONS. 1.1 ADMINISTRATOR. The Employer shall be the "Administrator" and, solely for the purposes of ERISA, the "Fiduciary" of this Agreement where a fiduciary is required by ERISA. 1.2. ANNUAL BENEFIT. The term "Annual Benefit" shall mean the amount determined by first multiplying the sum of Thirty Thousand Dollars 1 ($30,000) by the Applicable Percentage (defined below), and by then subtracting from that amount those additional as may be: (1) required under the other provisions of this Agreement, including, but not limited to, Paragraphs 5 and 6 hereof; (ii) required by reason of lawful order of any regulatory agency or body having jurisdiction over the Employer; and (iii) required in order for the Employer to properly comply with any and all applicable state and federal laws, including, but not limited to income, employment and disability income tax laws (e.g., FICA, FUTA, SDI). 1.3 APPLICABLE PERCENTAGE. The term "Applicable Percentage" shall mean that percentage listed on Schedule "A" attached hereto which is adjacent to the number of complete years (with a "year" being the performance of personal services for or on behalf of he Employer for a period of 365 days) which have elapsed starting from the Effective date of this Agreement and ending on the date payments are to first begin under the terms of this Agreement. Notwithstanding the foregoing or the percentages set forth on Schedule "A", but subject to all other terms and conditions set forth herein, the "Applicable Percentage" shall be: (i) subject to clause (ii) of this Paragraph 1.3, one hundred percent (100%) in the event the Executive dies prior to Retirement as defined in subparagraph 1. I I below; and (ii) notwithstanding the subclause (i) of this Paragraph 1.3, zero percent (0%) the event the Executive takes any action which prevents the Employer from collecting the proceeds of any life insurance policy which the Employer may happen to own at the time of the Executive's death and of which the Employer is the designated beneficiary. 1.4 BENEFICIARY, Excepting the reference made at the end of Paragraphs 1.3 and 1. IO hereof, the term "beneficiary" or "designated beneficiary " shall mean the person or persons whom the Executive shall designate in a Vlid Beneficiary Designation, a copy of which is attached hereto as Exhibit "B", to receive the benefits provided hereunder. A Beneficiary Designate shall be valid only if it is in the form attached hereto and made a part hereof and is received by the Administrator prior to the Executive's death. 1.5 CHANGE IN Control. The term "Change in Control" shall mean, with respect to the Employer or any corporation formed to act as a parent or holding company of the Employer or its stock: (1) a change in control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or in response to any other form or report to the regulatory agencies or governmental authorities having jurisdiction over the Employer or any stock exchange on which the Employer's shares are listed which requires the reporting of a change in control; (ii) any merger, consolidation or reorganization of the any sale lease employer in which the Employer does not survive; (iii) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in fair market value of fifty percent (50%) of the total value of the 2 assets of the Employer, reflected in the most recent balance sheet of the Employer; (iv) a transaction whereby any "person" (as such term is used in the Exchange Act or any individual, corporation, partnership, trust or any other entity becomes the beneficial owner, directly or indirect , or securitie's of the Employer representing twenty-five (25%) or more of the combined voting power of the Employer's then outstanding securities; or (v) a situation where, in any one-year period, individuals who at the beginning of such period constitute the Board of Directors of the Employer cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Employer's shareholders, of each new director is approved by a vote of at least three-quarters (3/4) of the directors then still in office who were directors at the beginning of the period. 1.6 THE CODE. The "Code" shall mean the Internal Revenue Code of 1986, as amended (the "Code"). 1.7 DISABILITY/DISABLED. The term "Disability" or "Disabled" shall have the same meaning given such term in the principal disability insurance policy covering the Executive, which is incorporated herein by reference to the limited extent thereof In the event the Executive is not covered by a disability policy containing a definition of "Disability" or "Disabled," these terms shall mean an illness or incapacity which, having continued for a period of one hundred and eighty (I 80) consecutive days, thereafter prevents the Executive from adequately performing the Executive's regular employment duties. The determination of whether the Executive is Disabled shall be made by an independent physician selected by mutual agreement of the parties. 1.8 EFFECTIVE DATE. The term "Effective Date" shall mean the date upon which this Agreement was entered into by the parties, as first written above. 1.9 ERISA. The term "ERISA" shall mean the Employee Retirement Income I Security Act of 1974, as amended 1.10. LUMP SUM PAYOUT Amount. The term "Lump Sum Payout Amount" (also referred to herein as the "LSPA") shall mean that dollar amount determined by: (a) multiplying (i) the "Designated Dollar Amount" listed on Schedule "C" corresponding to the year in which an event occurs requiring payment of the LSPA to the Executive occurs under this Agreement, by (ii) the "LSPA Percentage" listed on Schedule corresponding to the year in which the event occurs requiring payment of the LSPA to the Executive under this Agreement; and (b) reducing this resulting amount as may be: (i) required under the other provisions of this Agreement, including, but not limited to Paragraph 4.2 (i.e., to take into account any previous Disability payment which may have been paid under the terms of this Agreement), Paragraph 5 and Paragraph 6 hereof, (ii) required by reason of the lawful order of any regulatory agency or body having jurisdiction over the Employer; and (iii) required in order for the Employer to properly comply with any and all applicable state and federal laws, including, but not limited to 3 income, employment and disability income tax laws (e.g., FICA, FUTA,- SDI), partnership, trust or any other entity) becomes the beneficial owner, directly or indirectly, of securities of the Employer representing twenty-five percent (25%) or more of the combined voting power of the Employer's then outstanding securities- or (v) a situation where, in any one-year period, individuals who at the beginning of such period constitute the Board of Directors of the Employer cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Employer's shareholders, of each new director is approved by a vote of at least three quarters (3/4) of the directors then still in office who were directors at the beginning of the period. Notwithstanding the foregoing or the percentages set forth on Schedule "D but subject to all other terms and conditions set forth herein, the "LSPA Percentage" shall be zero percent (04b) in the event the Executive takes any action which. prevents the Employer from collecting the proceeds of any life insurance policy which the Employer may happen to own at the time of the Executive's death and of which the Employer is the designated beneficiary. 1.11. RETIREMENT. The term "Retirement" or "Retires" shall refer to the date on which, after the Executive attains sixty (60) years of age, the Executive acknowledges in writing to Employer to be the last day he will provide any significant personal services, whether as an employee or independent consultant or contractor, to Employer or to, for, or on behalf of, any other business entity conducting, performing or making available to any person or entity banking or other financial services of any kind. For purposes of this Agreement, the phrase "significant personal services" shall mean more THAN ten (10) hours of personal services rendered to one or more individuals or entitles in any thirty (30) day period. 1.12 SURVIVING SPOUSE. The term "Surviving Spouse" shall mean the person, if who shall be legally married to the Executive on the date of the Executive's death. 1.3 TERMINATION FOR CAUSE. The term "Termination for Cause" shall mean termination of the employment of the Executive by reason of any of the following: (A)A termination "for cause" as this term may be defined in any written employment agreement entered into by and between the Employer and the Executive; (B)The willful breach of duty by the Executive in the course of his employment; (C)The habitual neglect by the Executive of his employment responsibilities and duties; (D)The Executive's deliberate violation of any state or federal banking or securities laws, or of the Bylaws, rules, policies or resolutions of the Employer, or of the rules 4 or regulations of the: (i) The California Institute of Banking (ii) Federal Deposit Insurance Corporation; (iii) Securities and Exchange Commission; or (iv) any other regulatory agency or governmental authority having jurisdiction over the Employer; (E)The determination by a state or federal banking agency or other governmental authority having jurisdiction over the Employer that the Executive is not suitable to act in the capacity for which she is employed by the Employer; (F)The Executive is convicted of any felony or a crime involving moral turpitude or a fraudulent or dishonest act; or (G)The Executive discloses without authority any secret or confidential information not otherwise publicly available concerning the Employer or takes any action which the Employer's Board of Directors determines, in its sole discretion and subject to good faith, fair dealing and reasonableness, constitutes unfair competition with or induces any customer to breach any contract with the Employer. 2. SCOPE, PURPOSE AND EFFECT. 2.1. CONTRACT OF EMPLOYMENT. Although this Agreement is intended to provide in the employ of the Executive with an additional incentive to remain Employer, this Agreement shall not be deemed to constitute a contract of employment between the Executive and the Employer nor shall any Provision of this Agreement restrict or expand the right of the Employer to terminate the Executive's employment. This Agreement shall have no impact or effect upon any separate written Employment Agreement which the Executive may have with the Employer, it being the parties' intention and agreement that unless this Agreement is specifically referenced in said Employment Agreement (or any modification thereto), this Agreement (and the Employer's obligations hereunder) shall stand separate and apart and shall have no effect upon, nor be affected by, the terms and provisions of said Employment Agreement. 2.2. FRINGE BENEFIT. The benefits provided by this Agreement are granted by the Employer as a fringe benefit to the Executive and are not a part of any salary reduction plan or any arrangement deferring a bonus or a salary increase. The Executive has no option to take any current payments or bonus in lieu of the benefits provided by this Agreement. 31 PAYMENTS UPON OR AFTER RETIREMENT. 3.1. PAYMENTS UPON RETIREMENT. If the Executive shall remain in the continuous employment of the Employer until attaining sixty (60) of age, the Executive shall be entitled to be paid the Annual Benefit, as defined 5 above, for a period of fifteen (I 5) years, with each Annual Benefit amount to be paid in twelve (12) equal monthly installments (paid on the first day of each month) beginning with the month following the month in which the Executive Retires or upon such later date as may be mutually agreed upon by the Executive and the Employer in advance of said Retirement date. At the Employer's sole and absolute discretion. the Employer may increase the Annual Benefit as and when the Employer determines the same to be appropriate in order to reflect substantial change in the cost of living. Notwithstanding anything contained herein to the contrary, the Employer shall have no obligation hereunder to make any such cost-of-living adjustment. 3.2. PAYMENTS IN THE EVENT, OF DEATH AFTER RETIREMENT. The Employer agrees that if the Executive Retires, but shall die before receiving all of the monthly payments to which he is entitled hereunder, the Employer will continue to make such monthly payments to the Executive's designated beneficiary for the remaining period. If a valid Beneficiary Designation is not in effect, then the remaining amounts due to the Executive under the term of this Agreement shall be paid to the Executive's Surviving spouse. If the Executive leaves no Surviving Spouse, the remaining amounts due to the Executive under the terms of this Agreement shall be paid to the duly qualified personal representative, executor or administrator of the Executive's estate. 4. PAYMENTS IN THE EVENT DEATH OR DISABILITY OCCURS PRIOR TO RETIREMENT 4.1.PAYMENTS IN THE EVENT OF DEATH PRIOR TO RETIREMENT. In the event the Executive should die while actively employed by the Employer at any time after the Effective Date of this Agreement, but prior to attaining sixty (66) years of age or if the Executive chooses to work after attaining sixty (60) years of age, but dies before Retirement, the Employer agrees to pay the Annual Benefit to the Executive's designated beneficiary for a period of fifteen (15) years, with each Annual Benefit amount to be paid in twelve (12) equal monthly installments (paid on the first day of each month), beginning with the month following the month in which the Executive's death occurs. If a valid Beneficiary designation is not in effect, then the remaining amounts due to the Executive under the terms of this Agreement shall be paid to the Executive's Surviving Spouse in the same manner. If the Executive leaves no Surviving Spouse, the remaining amounts due to the Executive under the terms of this Agreement shall be PAID to the duly qualified personal representative, executor or administrator of the Executive's estate. 4.2. PAYMENTS IN THE EVENT OF PERMANENT DISABILITY PRIOR TO RETIREMENT. In the event the Executive becomes Disabled while actively employed by The Employer at any time after the date of this Agreement but prior to Retirement, the Executive shall be entitled to be paid the Annual Benefit, as defined above, for a period of fifteen (I 5)years, with each Annual Benefit amount to be paid in twelve (12) equal monthly installments paid on the first day of each month), beginning with the month following 6 the earlier of (1) the month in which the Executive formally retires after reaching sixty (60) years of age, or (2) the date upon which the Executive is no longer entitled to receive Disability benefits under the Executive's principal Disability Insurance policy (or the date of the Disability if no Disability policy exists), provided that the Executive remains unable to return to and thereafter fulfill the responsibilities associated with the employment position held with The Employer prior to becoming Disabled by reason of such Disability continuing. However, in the event the Executive's Disability should cease and Executive is able to return to and thereafter fulfill the responsibilities associated with the employment position held with the Employer prior to becoming Disabled, the Employer's obligation to make additional payments under this Paragraph shall be suspended until such time as Executive next becomes eligible to receive payments under the terms of this Agreement. In the event the Employer's obligation to make additional payments under this Paragraph is suspended as aforesaid, and the Executive then becomes entitled to receive payments under the terms of the Agreement, the aggregate amount paid prior to suspension shall be treated, notwithstanding anything contained in this Agreement to the contrary, as having satisfied the Employer's payment obligations with respect to that number of initial monthly payments as is equal to the aggregate amount previously paid out under the terms of this Paragraph; provided, however, that the Employer promptly begin making the remaining monthly payments required under this Agreement to the Executive for as long as such payments @Would otherwise be required after proper adjustment has been made for the amounts previously paid to the Executive under this Paragraph. For example, if the Executive receives $10,000 during a period of Disability, and the Executive returns to work (such that future payments are suspended) and then becomes eligible for the Retirement payout option described above (and is entitled to receive $10,000 over the first twelve payments under such option), the Employer shall be entitled to credit the prior payments as having satisfied its obligation to make the first twelve payments due to the Executive provided the Employer pays to the Executive, on the first day of each successive month following the month in which the Retirement occurs (as provided for above), the next monthly payment amount required with respect to the payout option selected, i.e., in this example, the amount to be paid as the first monthly payment under the Retirement option would equal the amount payable under the Retirement option for the thirteenth month (with the second payment equaling the amount payable with respect to the fourteenth month and so on), until such time as the Executive, etc., has received the 168 remaining payments due after making the adjustment for payments made prior to suspension. In the event a Lump Sum Payment Amount is to be paid under Paragraph 5, the SPA shall be reduced as provided for in Paragraph 1. 10 above by the aggregate amounts previously distributed to the Executive under the terms of this Paragraph. 5. PAYMENTS IN THE EVENT EMPLOYMENT IS TERMINATED PRIOR TO RETIREMENT. As indicated in Paragraph 2 above, the Employer reserves the right to terminate the Executive's employment, with or without cause but subject to any written employment agreement which may then exist, at any time prior to the Executive's Retirement. In the event that the 7 employment of the Executive shall be terminated, other than by reason of Disability, Death or Retirement, prior to the Executive's attaining sixty (60) years of age, then this Agreement shall terminate upon the date of such termination of employment; provided, however, that the Executive shall be entitled to the following benefits, which shall be paid in lieu of any other payout options contained herein, depending. upon the circumstances surrounding the Executive's termination: 5.1. TERMINATION WITHOUT CAUSE. If the Executive's employment is terminated by the Employer without cause, the Executive shall be entitled to be paid the Lump Sum Payment Amount, as defined above, within ninety (90) days after the effective date of the Executive's termination, or upon such later date as may be mutually agreed upon by the Executive and the Employer in advance of the effective date of the Executive's termination 5.2. VOLUNTARY TERMINATION BY THE EXECUTIVE. If the Executive's employment is voluntarily terminated by the Executive, the Executive shall be entitled to be paid the Lump Sum Payment Amount, as defined above, within ninety (90) days after the effective date of the Executive's termination, or upon such later date as may be mutually agreed upon by the Executive and the Employer in advance of the effective date of the Executive's termination. 5.3. TERMINATION FOR CAUSE. The Executive agrees that his employment with the Employer is terminated "for cause," as defined in subparagraph 1. 13 of this Agreement, he forfeit any and all rights and benefits he may have under the toughens of this Agreement and shall have no right to be paid any of the amounts which would otherwise be due or paid to the Executive by the Employer pursuant to the terms of this Agreement. 5.4. TERMINATION BY THE EMPLOYER ON ACCOUNT OF OR AFTER A CHANGE IN CONTROL. In the event: (i) the executive's employment with the Employer is terminated by the Employer in conjunction with, or by reason of, a "change in control" (as defined in subparagraph 1.5 above); or (ii) by reason of the. Employer's actions any adverse and material change occurs in the scope of the Executive's position, responsibilities, duties, salary, benefits, or location of employment after a "change in control" (as defined in subparagraph 1.5) occurs or (iii) the Employer causes an event to occur which reasonably constitutes or results in a demotion, a significant diminution of responsibilities or authority, or a constructive termination by forcing a resignation or otherwise) of the Executive's employment after a "change in control." (as defined in subparagraph 1.5) occurs, then the Executive shall be entitled to be paid the Annual Benefit, as defined above, for a period of fifteen (I 5) years, with each Annual Benefit amount to be paid in twelve (12) equal monthly installments paid on the first day of each month), beginning with the month following the month in which the Executive is terminated or the action referred to above occurs. 8 6.ADDITIONAL LIMITATIONS ON THE AMOUNT OF THE ANNUAL BENEFIT. The Executive acknowledges and agrees that the parties have entered into this Agreement based Upon the certain financial and tax accounting assumptions. Accordingly with full knowledge of the potential consequences the Executive agrees that, notwithstanding anything contained herein to the contrary: (i) the amount of the Annual Benefit or the SPA, as the case may be, shall be Limited to that amount of the Annual Benefit or the SPA (determined without regard to this Paragraph 6) which will be deductible by the Employer under the Code in the year in which payment is to. be made to the Executive; (ii) the Annual Benefit or the SPA amount shall be deemed to be the last payment made to the Executive and the first for which an income tax deduction, if any, has been disallowed; and (iii) any compensatory amounts for which a deductions is denied to the Employer shall, at the Employer's elections, serve to first reduce the Employer's obligation to pay the monthly Annual Benefit payments or the SPA to the Executive under the terms of this Agreement. The Executive recognizes that, in this regard, limitations on deductibility may be imposed under, but not limited to, Code Section 280G. Consistent with the foregoing, and in the event that any payment or benefit received or to be received by the Executive, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Employer (together with the Annual Benefit or the SPA, (the "Total Payments"), will not be deductible (in whole or in part) as a result of Code Section 280G, the Annual Benefit or the SPA, as the case may be, shall be reduced until no portion of the Total Payments is nondeductible as a result of Section 28OG of the Code (or the Annual Benefit or SPA is reduced to zero (0)). For purposes of this limitation: (a) No portion of the Total Payments, the receipt or enjoyment of which the Executive shall have effectively waived in writing prior to the date of payment of a SPA or any future Annual Benefit payments, shall be taken into account; (b) No portion of the Total Payments which, in the opinion of the tax counsel selected by the Employer and acceptable to the Executive, does not constitute a "parachute payment" within the meaning of Section 28OG of the Code shall be taken into, account; (c) Future Annual Benefit payments, or the SPA as the case may be, shall be reduced--only to the extent necessary so that the Total Payments (other than those referred to in clauses (a) or above in their entirety) constitute reasonable compensation for services actually rendered within the meaning of Section 28OG of the Code, in the opinion of tax counsel refined to in clause (b) above; and (d) The value of any noncash benefit or any deferred payment or benefit included in the Total Payments shall be determined by the Employer's independent auditor's in accordance with the principles of Section 28OG of the Code. 7. RIGHT TO DETERMINE FUNDING METHODS. The Employer reserves the right to determine, in its sole and absolute discretion, whether, to what extent and by what method, if any, to provide for the payment of the amounts which may be payable to the Executive, the Executive's spouse or the Executive's beneficiaries under the terms of this Agreement. In the 9 event that the Employer elects to fund this Agreement, in whole or in part, through the use of life insurance or annuities, or both, the Employer shall determine the ownership and beneficial interests of any such policy of life insurance or annuity. The Employer further reserves the right, in its sole and absolute discretion, to terminate any such policy, and any other device used to fund its obligations under this Agreement, at any lime, in whole or, in part. Consistent with Paragraph 9 below, neither the Executive, any right, title or the Executive's spouse nor the beneficiaries shall have any right, title or interest in or to any funding source or amount utilized by the Employer pursuant to this Agreement, and any such funding source or amount shall not constitute a security for the performance of the Employer's obligations pursuant to this Agreement. In connection with the foregoing, the Executive agrees to execute such documents and undergo such medical examinations or tests which the Employer may request and which may be reasonably necessary to facilitate any funding for this Agreement including, without limitation, the Employer's acquisition of any policy of insurance or annuity. Furthermore, a refusal by the Executive to consent to, participate in and undergo any such medical examinations or tests shall result in the immediate termination of this Agreement and the immediate forfeiture by the Executive, the Executive's spouse and the Executive's beneficiaries of any and all rights to payment hereunder. Notwithstanding anything contained herein to the contrary, no interest shall accrue or be payable with respect to any of the amounts payable under the terms of this Agreement. 8. CLAIMS PROCEDURE. The Employer shall, but only to the extent necessary to comply with ERISA, be designated as the named fiduciary under this Agreement and shall have authority to control and manage the operation and administration of this Agreement. Consistent therewith, the Employer shall make all determinations as to the rights to benefits under this Agreement. Any decision by the Employer denying a claim by the Executive, the Executive's spouse, or the Executive's beneficiary for benefits under this Agreement shall be stated in writing and delivered or mailed, via registered or certified mail, to the Executive, the Executive's spouse or the Executive's beneficiary, as the case may be. Such decision shall set forth the specific reasons for the denial of a claim. In addition, the Employer shall provide the Executive, the Executive's spouse or the Executive's beneficiary with a reasonable opportunity for a full and fair review of the decision denying such claim. 9. STATUS AS AN UNSECURED GENERAL CREDITOR. Notwithstanding anything contained herein to the contrary: (i) neither the Executive, the Executive's spouse or the Executive's beneficiary shall have any legal or equitable rights, interests or claims in or to any Specific property or assets of the Employer; (ii) none of the Employer's assets shall be held in or under any trust for the benefit of the Executive, the Executive's spouse or the Executive's beneficiaries or held in any way as security for the fulfillment of the obligations of the Employer under this Agreement; (iii) all of the Employer's assets shall be and remain the general unpledged and unrestricted assets of the Employer; (iv) the Employer's obligation under this Agreement shall be that of an unfunded and unsecured promise by the Employers to pay money in the future; and (v) the Executive, the Executive's spouse and the Executive's beneficiaries shall be unsecured general creditors with respect to any benefits which may be payable under the terms of this Agreement. 10 10. MISCELLANEOUS. 10.1 OPPORTUNITY TO CONSULT WITH INDEPENDENT COUNSEL. The Executive acknowledges that he has been afforded the opportunity to consult with independent counsel of his choosing regarding both the benefits granted to him under the terms of this Agreement and the terms and conditions which the Executive's right to these benefits. The Executive further acknowledges that he has read, understands and consents to all of the terms and conditions of this Agreement, and that he enters into this Agreement with a full understanding of its terms and conditions. 10.2. ARBITRATION OF DISPUTES. All claims, disputes and other matters in question arising out of or relating to this Agreement or the breach or interpretation thereof, other than those matters which are to be determined by the Employer in its sole and absolute discretion, shall be resolved by. binding arbitration before a representative member, selected by the mutual agreement of the parties, of the Judicial Arbitration and Mediation Services, Inc. ("JAMS"), presently located at I I I Pine Suite, Suite 710, in San Francisco, California. In the event JAMS is unable or unwilling to conduct the arbitration provided for under THE terms of this Paragraph, or has discontinued its business, the parties agree that a. representative member, selected by the mutual agreement of the parties, of the American. Arbitration Association ("AAA"), presently located at 417 Montgomery Street, in San Francisco, California, shall conduct the binding Arbitration referred to in this Paragraph. Notice of the demand for arbitration shall be filed in writing with the other party to this Agreement and with JAMS (or AAA, if necessary). In no event shall the demand for arbitration be made after the date when institution of legal or equitable proceedings based on such claim, dispute or other matter in question would be barred by the applicable statute of limitations. The arbitration shall be subject to such rules of procedure used or established by JAMS, or if there are NONE, the rules of procedure used or established by AAA. Any award rendered by JAMS or AAA shall be final and binding upon the parties, and as applicable, their respective heirs, beneficiaries, legal representatives, agents, successors and assigns, and may be entered in any court having jurisdiction thereof. The obligation of the parties to arbitrate pursuant to this clause shall be specifically enforceable in accordance with, and shall be conducted consistently with, the provisions of Title 9 of Part 3 of the California Code of Civil Procedure. Any arbitration hereunder shall be conducted in San Francisco, California, unless otherwise agreed to by the parties. 10.3. Attorneys' FEES. In the event of any arbitration or litigation concerning any controversy, claim or dispute between the parties hereto, arising out of or relating to this Agreement or the breach hereof, or the interpretation hereof, the prevailing party shall be entitled to recover from the losing party reasonable expenses, Attorney fees and costs incurred or collection of any judgement or award rendered therein. The "prevailing party" means the party determined by the arbitrator(s) or court, as the 11 case may be, to have most nearly prevailed, even if such party did not prevail in all matters, not necessarily the one in whose favor a judgment is rendered. 10.4. NOTICE. Any notice required or permitted of either the Executive or the Employer under this Agreement shall be deemed to have been duly given, if by personal delivery, upon the date received by the party or its authorized representation; if by facsimile, upon transmission to a telephone number previously provided by the party to whom the facsimile is transmitted as reflected in the records of the party transmitting the facsimile and upon reasonable confirmation of such transmission; and if by mail, on the third day after mailing via, U.S. first class mail, registered or certified postage prepaid and return receipt requested, and addressed to the party at the address given below for the receipt of notices, or such changed address as may be requested in writing by a party. If to the Employer: Heritage Oaks Bank 545 Twelfth Street Paso Robles, CA 93446 Attn: Corporate Secretary If to the Executive: Margaret Torres 2401 Branch Creek Circle #3 Paso Robles, CA 93446 10.5. ASSIGNMENT. Neither the Executive, the Executive's spouse nor any other beneficiary under this Agreement shall have any power or right to transfer, assign, anticipate, hypothecate, modify or otherwise encumber any part or all of the amounts payable hereunder, nor, prior to payment in accordance with the terms of this Agreement, shall any portion of such amounts be: (i) subject to seizure by any creditor of any such beneficiary, by a proceeding at law or in equity, for the payment of any debts, judgments, alimony or separate maintenance obligations which may be owed by the Executive, the Executive's spouse, or any designated beneficiary; or (ii) transferable by operation of law in the event of bankruptcy, insolvency or otherwise. Any such attempted assignment or transfer shall be void and shall terminate this Agreement, and the Employer shall thereupon have no further liability hereunder. 10.6. BINDING EFFECT/MERGER OR REORGANIZATION. This Agreement shall be binding upon and inure to the benefit of the Executive and the Employers and, as applicable, their respective heirs, beneficiaries, legal representatives agents, successors and assigns. Accordingly, the Employer shall not merge or consolidate into or with another corporation, or reorganize or sell substantially all of its assets to another corporation, firm or person, unless and until such succeeding or continuing corporation, firm or person agrees to assume and discharge the obligations of the Employer under this Agreement. Upon the occurrence of such event, the term "Employer" as used in this Agreement shall be deemed to refer to such 12 surviving or successor firm, person, entity of corporation. 10.7. NONWAIVER. The failure of either party to enforce at any time or for any period of time any one or more of the terms or conditions of this Agreement shall not be a waiver of such term(s) or condition(s) of that party's right thereafter to enforce each and every term and condition of this Agreement. 10.8. PARTIAL INVALIDITY. If any term, provision, covenant, or condition of this Agreement is determined by an arbitrator or a court, as the case maybe, to be invalid, void, or unenforceable, such determination shall not render any other term, provision, covenant or condition invalid, void or unenforceable, and the Agreement shall remain in full force and effect notwithstanding such partial invalidity. 10.9. ENTIRE AGREEMENT. This Agreement supersedes any and all other agreements, either oral or in writing, between the parties with respect to the subject matter of this Agreement and contains all of the covenants and agreements between the parties with respect thereto. Each party to this Agreement inducements, promises, or acknowledges that no other representations, agreements, oral or otherwise, have been made by any party, or anyone acting on behalf of any party, which are not set forth herein, and that no other agreement, statement, Or Promise not contained in this Agreement shall be valid or binding on either party. 10.10. MODIFICATIONS. Any modification of this Agreement shall be effective only if it is in writing and signed by each party or such party's authorized representative. 10.11 PARAGRAPH HEADINGS. The paragraph headings used in this Agreement are included solely for the convenience of the parties and shall not affect or be used in connection with the interpretation of this Agreement. 10.12. NO STRICT CONSTRUCTION. The language used in this Agreement shall be deemed to be the language chosen by the parties hereto to express their mutual intent, and no rule of strict construction will be applied against any person. 10.13. GOVERNING LAW. The laws of the State of California, other than those laws denominated choice of law rules, and, where applicable, the rules and regulations of the: (i) Office of the California Superintendent of Banks; (ii) Federal Deposit Insurance 13 Corporation; and (iii) Securities and Exchange Commission shall govern the validity, interpretation, construction and effect of this Agreement. IN WITNESS WTMREOF, the Employer and the Executive have executed this Agreement on the date first above-written in the City of Paso Robles, San Luis Obispo County, California. THE EMPLOYER: THE EXECUTIVE: HERITAGE OAKS BANK By. Dr. R. R. Bryant, Chairman Margaret Torres 14 EX-10.27 3 EXHIBIT 10.27 EXHIBIT 10.27 LEASE Preamble-Parties and Premises Heritage Oaks Bancorp, herein called "Landlord," hereby Leases to Heritage Oaks Bank, herein called "Tenant," those certain premises, herein called "said premises," in that certain building, known as The Atascadero Branch at 9900 El Camino Real, in the City of Atascadero, County of San Luis Obispo, State of California on the following terms and conditions: 1. TERM The initial term of this Lease shall be for the period of five years, commencing April 1, 1999 and ending March 31, 2004. 2. BASIC RENT A. Tenant agrees to pay to Landlord as the basic rent, to be adjusted as provided in Paragraph 3 of this Lease, for the use and occupancy of said premises for the period of April 1, 1999 through March 31, 2004 the sum of four thousand seven hundred and twenty five ($4,725.00) dollars per month. Rent shall be payable without notice or demand and without any deduction, off-set, or abatement, in lawful money of the United States to the Landlord at the mailing address of Landlord, 545 12th Street, Paso 1 Robles, California 93446 or at such other place or places as Landlord may from time to time designate by written notice given to Tenant. B. Tenant agrees to pay a late charge of twenty-five dollars ($25.00) if the rent is not received by the fifth day of each month commencing April 5, 1999. This late charge does not establish a grace period; Landlord may make written demand for payment if the rent is not paid on its due date each month. Landlord and Tenant agree that the charge is presumed to be the damages sustained because of Tenant's late payment of rent, and it is impracticable or extremely difficult to fix actual damages. C. Tenant agrees to pay a service charge of twenty-five dollars ($25.00) if Tenant's bank returns a rent check for insufficient funds. If the bank returns Tenant's rent checks more than once, Landlord may serve 30 days written notice that all future rent be paid in cash or by certified check or money order. 3. RENT ADJUSTMENTS A. Rent Adjustments. Commencing at the same time as any rental commences under this Lease, Tenant shall pay to Landlord that percent of the total cost of the total floor area of the building (here called Adjustments) 1. All real estate taxes and insurance premiums on the Premises, including land, building, and improvements thereon. Said real estate taxes shall include all real estate taxes and assessments that are levied upon and/or assessed against the premises, including any taxes which may be levied on rents. Said insurance shall include all insurance premiums for fire, extended coverage, liability, and any other insurance that Landlord deems necessary on the premises. 2. All costs to maintain, repair and replace common areas, hallways, fax and conference rooms, lobby, parking lot lighting, sidewalks, driveways, landscaping and gardening, rubbish pickup, and other areas or services used in common by the Tenants of the building. 3. Utility costs for common areas. 4. All costs to supervise and administer said common areas, copy and fax room, conference room, lobby, parking lots, sidewalks, driveways, landscaping and gardening, rubbish pickup, and other areas used in common by the Tenants or occupants of the building. Said costs shall include such fees as may be paid to a third party in connection with same and may include a fee to Landlord to supervise and administer same in an amount equal to no more than ten percent (10%) of the total out of pocket costs of Landlord. 4. USE OF PREMISES Said premises shall be used for General Banking Offices by Tenant and for no other use or uses without the express written consent of Landlord. 2 5. PROHIBITED USES Tenant shall not commit or permit the commission of any acts on said premises nor use or permit the use of said premises in any way that: A. Will increase the existing rates for or cause cancellation of any fire, casualty, liability, or other insurance policy insuring the premises or its contents; B. Violates or conflicts with any law, statue, or ordinance, or governmental rule or regulation, whether now in force or hereinafter enacted, governing said premises; C. Obstructs or interferes with the rights of other Tenants or occupants of the premises or injures or annoys them; D. Constitutes the commission of waste on said premises or the commission of maintenance of a nuisance as defined by the laws of the State of California. 6. COMPLIANCE WITH LAW Tenant shall not use the Premises or permit anything to be done in or about the Premises which will in any way conflict with any law, statute, ordinance or governmental rule or regulation now in force or which may hereafter be enacted or promulgated. Tenant shall at its sole cost and expense promptly comply with all laws, statutes, ordinances and governmental rules, regulations or requirements now in force or which may hereafter be in force and with the requirements of any board of fire insurance underwriters or other similar bodies now or hereafter constituted relating to, or affecting the condition, use or occupancy of the Premises, excluding structural changes not related to or affected by Tenant's Improvements or acts. The judgment of any court of competent jurisdiction or the admission of Tenant in thereto or not, that Tenant has violated any law, statute, ordinance or governmental rule, any action, against Tenant, whether Landlord be a part regulation or requirement, shall be conclusive of that fact as between Landlord and Tenant. 7. NO ASSIGNMENT OR SUBLEASING Tenant shall not encumber, assign, or otherwise transfer this Lease, any right or interest in this Lease, or any right or interest in said premises without first obtaining the express written consent of Landlord first. Neither shall Tenant sublet said premises or any part thereof or allow any other persons, other then Tenant's agents and servants, to occupy or use said premises or any part thereof without the prior written consent of Landlord. A consent by Landlord to one assignment, subletting, or occupation and use by another person shall not be deemed to be a consent to any subsequent assignment, subletting, or occupation and use by another person. The consent of Landlord to any assignment of Tenant's interest in this Lease or the subletting by Tenant of said premises shall not be unreasonably withheld. 8. REPAIRS 3 A. By entry hereunder, Tenant shall be deemed to have accepted the premises as being in good sanitary order, condition, and repair. Tenant shall, at Tenant's sole cost and expense, keep the premises and every part thereof in good condition and repair (except as hereinafter provided with respect to Landlord's obligations) including without limitations, the maintenance, replacement and repair of any door, plate glass, window casements, glazing, plumbing, pipes, electric wiring and conduits, heating and cooling system (when there is an air conditioning system) Tenant agrees that Landlord is not and shall in no event be responsible or liable to Tenant for the failure of operation of the heating and/or cooling (air conditioning system), or consequential damages, if any, to Tenant or otherwise, by reason of failure of operation of said systems, if any, on the premises. Tenant shall upon expiration or sooner termination of this Lease, surrender the premises to the Landlord in good condition, broom clean, ordinary wear and tear and damages from causes beyond the reasonable control of Tenant excepted. Any damages to adjacent premises caused by Tenants use of the premises shall be repaired at the sole cost and expense of Tenant. B. Notwithstanding the provisions of Paragraph 8-A herein above, Landlord shall repair and maintain the structural portion of the building, including the exterior walls and roof, unless such maintenance and repairs are caused in part or in whole by the act, neglect, fault or omission of any duty by the Tenant, its agents, servants, employees, invitee's, or any damage caused by breaking and entering, in which case Tenant shall pay to Landlord the actual cost of such maintenance and repairs. Landlord shall also make any structural changes required by any governmental regulation. Landlord shall not be liable for any failure to make such repairs or to perform any maintenance unless such failure shall persist for an unreasonable time after written notice of the need of such repairs or maintenance is given to Landlord by Tenant. Except as may be caused by the gross negligence of Landlord's contractor, if any, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business arising from the making of any repairs, alterations or improvement in or to any portion of the premises or in or to fixtures, appurtenances and equipment therein. However, Landlord shall attempt to minimize any interference with Tenant's use of the premises in the course of any such repairs, maintenance, or structural changes 9. ALTERATIONS AND ADDITIONS A. Tenant shall not make or allow to be made any alterations, additions, or improvements to or of the premises or any part thereof without first obtaining the written consent of Landlord and any alterations, additions, or improvements to or of said premises, including, but not limited to, wall covering, paneling and built-in cabinet work, but excepting moveable furniture and trade fixtures, shall at once become a part of the realty and belong to the Landlord and shall be surrendered with the premises. In the event Landlord consents to the making of any alterations, additions or improvements to the premises by Tenant, the same shall be made by Tenant at Tenant's sole cost and expense. Upon the expiration or sooner termination of the term hereof, Tenant shall upon written 4 demand by Landlord, given at least thirty (30) days prior to the end of the term, at Tenant's sole cost and expense, forthwith and with all due diligence, remove any alterations, additions, or improvements made by Tenant constructed without Landlord's approval, designated by Landlord to be removed, and Tenant shall forthwith and with all due diligence, at its sole cost and expense, repair any damages to the premises caused by such removal. B. All work, alterations, additions or improvements, made or effected by Tenant, pursuant hereto, to be in accordance with applicable codes and permits where required. 10. LIENS Tenant shall keep the premises and the property in which the premises are situated free from any liens arising out of any work performed, materials furnished or obligations incurred by or on behalf of Tenant. Landlord may require, at Landlord's sole option, that Tenant shall provide to Landlord, at Tenant's sole cost and expense, a lien and completion bond in the amount equal to one and one-half (1-1/2) times the estimated cost of any improvements, additions, or alterations in the premises which the Tenant desires to make, to insure Landlord against any liability for mechanic's and materialmen's liens and to insure completion of the work. 11. INSURANCE A. Liability Insurance. Tenant shall, at Tenant's expense, obtain and keep in force during the term of this Lease, a policy of comprehensive public liability insurance insuring Landlord and Tenant against any liability arising out of ownership, use, occupancy or maintenance of the premises and all areas appurtenant thereto. Such insurance shall be in the amount of not less than five hundred thousand dollars ($500,000.00) for any one accident or occurrence. The limit of any such insurance shall not, however, limit the liability of the Tenant hereunder. Tenant may provide this Insurance under a blanket policy provided that said insurance shall have a Landlord's protective liability endorsement attached thereto. If Tenant shall fail to procure and maintain said insurance, Landlord may, but shall not be required to, procure and maintain same, but at the expense of Tenant. Insurance required hereunder shall be in companies rated A or better in "Best's Key rating Guide." Tenant shall deliver to Landlord, prior to right of entry, copies of policies of liability insurance required herein or certificates evidencing the existence and amounts of such insurance with loss payable clauses satisfactory to Landlord. No policy shall be cancelable or subject to reduction to coverage. All such policies shall be written as primary policies not contributing with and not in excess of coverage which Landlord may carry. Landlord shall be named as an additional insured party, as to Landlord's interests, and maintained by Tenant. B. Fire Insurance by Tenant. Tenant shall pay for and maintain in full force and effect during the term of this Lease, a standard form policy or policies of fire, extended coverage and vandalism, and rental value insurance with standard form or extended 5 coverage endorsement covering all exterior glass, whether plate or otherwise, and all interior glass and stock in trade, trade fixtures, equipment, and other personal property located in the premises and used by Tenant in connection with its business. Landlord shall be named as an additional insured party, as to Landlord's interests, under the insurance coverage hereunder required to be provided and maintained by Tenant, without limitation hereby. C. Fire Insurance by Landlord. Landlord shall maintain in full force and effect an insurance policy or policies of fire and extended coverage to protect against damage not less than the replacement value of the structural improvements of the premises. Tenant shall reimburse Landlord for said insurance costs pursuant to Paragraph 3 of this Lease. D. Worker's Compensation Insurance. Tenant shall at all times maintain Worker's Compensation Insurance in compliance with California Law. 12. UTILITIES Tenant shall pay for all water, gas, heat, light, power, sewer charges, telephone services and all other services and utilities supplied to the premises, together with any taxes thereon. If any such services are not separately metered to Tenant, Tenant shall pay a reasonable proportion to be determined by Landlord of all charges jointly metered with other premises. 13. RELEASE AND WAIVER OF SUBROGATION A. So long as the fire insurance on the building, containing the Leased premises, and so long as the fire insurance on the fixtures, goods, wares and merchandise and other property of Tenant, as the case may be, are not affected hereby and so long as the cost of the respective policies are not increased thereby, the Landlord does hereby waive as against Tenant and the Tenant does hereby waive as against Landlord any and all claims and demands, which are the subject of subrogation, for damages, loss or injury to the Leased premises or to the Tenant's fixtures goods, wares and merchandise, and other property as the case may be, which shall be caused by or result from fire or other perils, events or happenings and which are the subject of extended coverage insurance. B. Landlord and Tenant hereby agree that each policy of fire and extended coverage insurance on the Leased premises or on Tenant's fixtures, goods, wares, and merchandise and other property in and upon the Leased premises, now in force or which may hereafter be obtained by Landlord and Tenant shall be made expressly subject to the provisions of this paragraph, and that Landlord's insurers hereunder shall waive any right of subrogation against Tenant and Tenant's insurers hereunder shall waive any right of subrogation against Landlord. 14. HOLD HARMLESS A. Tenant shall indemnify and hold harmless 6 Landlord against and from any and all claims arising from Tenant's use of the premises or from the conduct of its business or from any activity, work, or other things done, permitted or suffered by the Tenant in or about the premises, and shall further indemnify and hold harmless Landlord against and from any and all claims arising from any breach or default in the performance of any obligation on Tenant's part to be performed under the terms of this Lease, or arising from any act or negligence of the Tenant, or any officer, agent, employee, guest, or invitee of Tenant, and from all costs, attorney's fees, and liabilities incurring in or about the defense of any such claim or any action or proceeding brought thereon and in case any action or proceeding be brought against Landlord shall defend the same at Tenant's expense by counsel reasonably satisfactory to Landlord. Tenant, as a material part of the consideration to Landlord hereby assumes all rise of damage to property or injury to persons in, upon or about the premises, from any cause other than Landlord's negligence; and Tenant hereby waives all claims in respect thereof against Landlord, without limitations hereby. Tenant shall give prompt notice to Landlord in case of casualty or accidents in the premises. B. Landlord or its agents shall not be liable for any loss or damages to persons or property resulting from fire, explosion, falling plaster, steam, gas, electricity, water or rain which may leak trom any part ot the premises or from the pipes, appliances, heating/air conditioning or plumbing works therein or about the premises or from the roof, street or subsurface or from any other place resulting from or caused by dampness or any other cause whatsoever, without limitations hereby. Landlord or its agents shall not be liable for interference with light, air, heat, or otherwise, or for any latent defect in the premises, and shall not be liable for failure of any equipment to work, without limitations hereby. 15. SIGN (S) A. No sign, placard, picture, name, advertisement or notice, visible from the exterior of any Tenant's premises shall be inscribed, painted, affixed, or otherwise displayed by any Tenant on any part of the premises without prior written consent of Landlord, and Landlord shall have the right to remove any such sign, placard, picture, name, advertisement or notice at Tenant's expense and without notice to Tenant. If Landlord shall have given such consent at any time, such consent shall be deemed to relate only to the particular sign, placard, picture, name, advertisement or notice so consented to by Landlord and shall not be construed as dispensing with the necessity of obtaining the specific written consent of Landlord with respect to each and every other sign, placard, picture, name, advertisement or notice. Land-lord may adopt and furnish to Tenant uniform rules and regulations which shall be applicable to all Tenants occupying the premises and Tenant agrees to conform to such rules and regulations. All approved signs or lettering on doors shall be printed, painted, affixed or inscribed at the expense of the Tenant by a person approved by Landlord. All signage must comply with applicable governmental regulations. B. Tenant agrees to install all approved signage within thirty (30) days of opening of 7 Tenant's business. If signs are not installed by this date, they may be installed by Landlord at Tenant's expense. 16. CONDEMNATION OF PREMISES Should all or part of said premises be taken by any public or quasi-public agency or entity under the power of eminent domain during the term of this Lease: A. Either Landlord or Tenant may terminate this Lease by giving the other sixty (60) days written notice of termination; provided, however, that Tenant cannot terminate this Lease unless the portion of said premises taken by eminent domain is so extensive as to render the remainder of said premises useless for the uses permitted by this Lease. B. Any and all damages and compensation awarded or paid because of the taking, except for amounts paid Tenant for moving expenses or for damage to any personal property or trade fixtures owned by Tenant, shall belong to Landlord, and Tenant shall have no claim against Landlord or the entity exercising eminent domain power for the value of the unexpired term of this Lease. C. Should only a portion of said premises be taken by eminent domain and neither Landlord nor Tenant terminates this Lease, the rent thereafter payable under this Lease shall be reduced by the same percentage that the floor area of the portion taken by eminent domain bears to the floor area of the entire said premises. 17. NOTICES Except as otherwise expressly provided by law, any and all notices or other communications required or permitted by this Lease or by law to be served on or given to either party hereto by the other party hereto shall be in writing and shall be deemed duly served and given when personally delivered to the party, Landlord or Tenant, to whom it is directed or any managing employee of such party or, in lieu of such personal services, when deposited in the United States mail, first class postage prepaid, addressed to Landlord at 545 12th Street, Paso Robles, Ca. 93446 and to Tenant at 9900 El Camino Real, Atascadero, Ca. 93422 . Either party, Landlord or Tenant, may change its address for purposes of this paragraph by giving written notice of the change to the other party in the manner provided in this paragraph 18. HOLDING OVER If Tenant remains in possession of the premises or any part thereof after the expiration of the term hereof with the express written consent of Landlord, such occupancy shall be a tenancy from month to month at a rental in the amount of the last monthly Basic Rent, plus all charges payable hereunder, and upon all the terms hereof applicable to a month to month tenancy. Tenant agrees to give Landlord a 90 day notice to terminate tenancy. 8 19. ENTRY BY LANDLORD Landlord reserves, and shall at any and all times have, the right to enter the premises to inspect the same, to submit said premises to prospective purchasers or Tenants, to post notices of non-responsibility, to repair the premises and any portion of the building of which the premises are a part that Landlord may deem necessary or desirable, without abatement of rent, and may for that purpose erect scaffolding and other necessary structures where reasonably required by the character of the work to be performed, always providing that the entrance to the premises shall not be unreasonably blocked thereby, and further providing that the business of the Tenant shall not be interfered with unreasonably. Tenant hereby waives any claim for damages for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the premises and any other loss occasioned thereby. For each of the aforesaid purposes, Landlord shall at all times have and retain a key with which to unlock all of the doors in, upon and about the premises, excluding Tenant's vaults, safes and files, and Landlord shall have the right to use any and all means which Landlord may deem proper to open said doors in an emergency, in order to obtain entry to the premises without liability to Tenant except for any failure to exercise due care for Tenant's property and any entry to the premises obtained by Landlord by any of said means or otherwise shall not under any circumstances be construed or deemed to be a forcible or unlawful entry into, or a detainer of, the premises, or any eviction of Tenant from the premises or any portion thereof. 20. ATTORNEY'S FEES Should any litigation be commenced between the parties to this Lease regarding said premises, this Lease, or the rights and duties of either in relation thereto, the party, Landlord or Tenant, prevailing in such litigation shall be entitled, in addition to such other relief as may be granted, to a reasonable sum as and for its attorney's fees in the litigation which shall be determined by the court in such litigation or in a separate action brought for the purpose. 21. TENANT'S DEFAULT The occurrence of any one or more of the following events shall constitute a default and breach of this Lease by Tenant: A. The vacating or abandonment of the premises by Tenant. B. The failure by Tenant to make any payment or rent or other payments required to be made by Tenant hereunder, as and when due, where such failure shall continue for a period of three (3) days after written notice thereafter by Landlord to Tenant. C. The failure by Tenant to observe or perform any of the covenants, conditions, or provisions of this Lease to be observed or performed by the Tenant, other than described in Article 21.B., above, where such failure shall continue for a period of thirty (30) days after written notice thereof by Landlord to Tenant; provided, however, that if the nature of Tenant's default is such that more than thirty (30) days are reasonably required for its cure then Tenant shall not be deemed to be in default if Tenant commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. D. The making by Tenant of any general assignment or general arrangement for the benefit of creditors; or the filing by or against Tenant of a petition 9 to have Tenant adjudicated a bankrupt, or a petition for reorganization or arrangement under any law relating to bankruptcy (unless, in the case of a petition filed against Tenant, the same is dismissed within sixty (60) days) : or the appointment of a trustee or a receiver to take possession of substantially all of Tenant's assets located at the Premises or Tenant's interest in this Lease, where possession of Tenant's interest in this Lease is not restored to Tenant within thirty (30) days; or the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the premises or of Tenant's interest in this Lease, where such seizure is not discharged within thirty (30) days. 22. REMEDIES IN DEFAULT In the above event of any such default or breach by Tenant, Landlord may at any time thereafter, in his sole discretion, and without limiting Landlord in the exercise of a right or remedy whi9h Landlord may have by reason of such default or breach: A. Terminate Tenant's right to possession of the premises by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the premises to Landlord. In such event, Landlord shall be entitled to recover from Tenant all damages incurred by Landlord by reason of Tenant's default including, but not limited to, the cost of recovering possession of the premises; expenses of reletting; including necessary renovation and alteration of the premises; reasonable attorney's fees; the worth at the time of award by the court having jurisdiction thereof of the amount by which the unpaid rent and other charges and Adjustments called for herein for the balance of the term after the time of such award exceeds the amount of such loss for the same period that Tenant proves could be reasonably avoided; and that portion of any Leasing commission paid by Landlord and applicable to the unexpired term of this Lease. Unpaid installments of rent or other sums bear interest from the date of suit at the maximum legal rate; or B. Maintain Tenant's right to possession, in which case this Lease shall continue in effect whether or not Tenant shall have abandoned the premises. In such event Landlord shall be entitled to enforce all of Landlord's rights and remedies under this Lease, including the right to recover the rent and any other charges and Adjustments as may become due hereunder; or C. Pursue any other remedy now or hereafter available to Landlord under the laws of the State of California. 23. DEFAULT BY LANDLORD Landlord shall not be in default unless Landlord fails to perform obligations required of Landlord within a reasonable time, but in no event later than thirty (30) days after written notice by Tenant to Landlord specifying wherein Landlord has failed to perform such obligation; provided, however, that if the nature of Landlord's obligation is such that more than thirty (30) days are required for performance then 10 Landlord shall not be in default if Landlord commences performance within such thirty (30) day period and thereafter diligently prosecutes the same to completion. 24. RECONSTRUCTION A. In the event the premises are damaged by fire or other perils covered by extended coverage insurance, Landlord agrees to forthwith repair same, and this Lease shall remain in full force and effect. Tenant shall be entitled to a proportionate reduction of the Basic Rent from the date of the damage and while such repairs shall reasonably interfere with the business carried on by the Tenant in the premises. If the damage is due to the fault or neglect of Tenant or its employees, there shall be no abatement of rent. B. In the event the premises are damaged as a result of any cause other then the perils covered by fire and extended coverage insurance, then Landlord shall forthwith repair the same, provided the extent of the destruction be less than ten percent (10%) of the then full replacement cost of the premises. In the event the destruction of the premises is to an extent of ten percent (10%) or more of the full replacement cost, then Landlord shall have the option: (1) To repair or restore such damage, this Lease continuing in full force and effect, but the Basic Rent to be proportionately reduced as hereinabove in this Article provided: or (2) To give notice to Tenant at any time within sixty (60) days after such damage, terminating this Lease as of the date specified in such notice, which date shall no less than thirty (30) days and no more than sixty (60) days after the giving of such notice. In the event of giving such notice, this lease shall expire and all interest of the Tenant in the Premises shall terminate on the date so specified in such notice and the rent, reduced by a proportionate amount, based upon the extent, if any, to which such damage materially interfered with the business carried on by the Tenant in the Premises, shall be paid up to the date of such termination. C. Notwithstanding anything to the contrary provided in this Lease, Landlord shall not have the obligation whatsoever to reconstruct or restore the premises when the damage resulting from any casualty under this article occurs during the last six (6) months of the term of this Lease or any extension thereof. D. Landlord shall not be required to repair any injury or damage by fire or other cause, or to make any repairs or replacements of any Leasehold improvements, fixtures, or other personal property of Tenant. 11 E. Except for uninsured losses less than ten percent (10%) as described in 26-B. herein, notwithstanding anything otherwise or to the contrary provided in this Lease( Landlord shall at no time and in no event ever be under obligation or liability to make or effect reconstruction, repairs, or replacement of the subject premises, or portions thereof, or at all, except with and from and to the extent of insurance proceeds received by Landlord in connection with or arising out of any related insured loss, without limitations hereby. 25. PARKING AND COMMON AREAS; RULES AND REGULATIONS A. The Landlord shall keep said automobile parking and common areas in a reasonably neat, clean and orderly condition and shall reasonably repair any damage to the facilities thereof, but all expenses in connection with said automobile parking and common areas shall be charged and prorated in ~he manner as set forth in Paragraph 3 herein. B. Notwithstanding anything otherwise herein contained, the Landlord reserves the right to hereafter, and at any time, execute and effectuate cross parking agreements and/or easements with adjacent property owners, and Tenant hereby expressly consents to such. C. Tenant, for the use and benefit of Tenant, customers, licensees and Sub-Tenants, shall have the non-exclusive right in common with Landlord, and other present and future owners, Tenants and their customers, licensees and Sub-Tenants, to reasonably use said common and parking areas during the entire egress, and automobile parking. D. The Tenant, in the use of common areas and parking areas, agrees to comply with such reasonable rules, regulations, and charges as the Landlord may adopt or require from time to time for the orderly and proper operation of common areas and parking areas. Landlord in his sole discretion reserves the right from time to time to modify said rules. The additions to and modifications of such rules shall be binding upon Tenant upon delivery of a copy thereof to Tenant. Such rules may include, but shall not be limited to the following: (1) The regulation of the storage, removal, and disposal of Tenant's refuse and other rubbish at the sole cost and expense of Tenant; and (2) The limiting and/or restricting of employee parking to limited designated areas or areas at time to time, and in connection herewith, Landlord reserves the right to so limit or restrict employee use of parking facilities and time of parking, and 12 Tenant consents to such and agrees to cooperate with Landlord in connection therewith. (3) All interior common areas (lobby, fax and copy room, conference room, hallways) are non-smoking areas. (4) The last person leaving the building is responsible for locking main door to lobby. Landlord assumes no responsibility for Tenants' losses or vandalism. (5) Washing/Cleaning of vehicle in parking lot is prohibited. 26. TENANT'S PERSONAL PROPERTY Any trade fixtures, signs and other personal property of Tenant not permanently affixed to the Premises shall remain the property of the Tenant. Tenant shall have the right, provided Tenant is not then in default under the terms of this Lease, at any time and from time to time during the term hereof, to remove any and all trade fixtures, signs and other personal property which it may have stored or installed in the Premises. If Tenant is in default, Landlord shall have the right to take exclusive possession of such property and to use the same rent and charge free, and the Landlord, whether or not it takes possession of such property shall have the benefit of any lien thereon permitted under applicable law and, if such possession is taken or such lien is asserted by Landlord in any manner, including, but not limited to, operation of law, Tenant shall not remove or permit the removal of said trade fixtures, signs and other personal property which shall become the property of the Landlord, without further act by either party hereto, unless Landlord elects to require their removal in which case Tenant shall promptly remove the same and restore the Premises to their prior condition at Tenant's expense. 27. OFFSET STATEMENT Tenant shall at any time and from time to time upon not less than twenty (20) days prior written notice from Landlord execute, acknowledge and deliver to Landlord a statement in writing, (a) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease as so modified, is in full force and effect), and the date to which the rent and other charges are paid in advance, if any, and (b) acknowledging that there are not, to Tenant's knowledge, any uncured defaults on the part of Landlord thereunder, or specifying such defaults if any are claimed. Any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Building and of the land on which the Building is situated. If Tenant fails to deliver the offset statement within twenty (20) days, Tenant irrevocably constitutes and appoints Landlord as Tenant's special attorney-in-fact to execute and deliver the statement to any third party on Tenant's behalf. 28. MORTGAGEE PROTECTION Tenant agrees to send to any mortgagees and/or deed of trust holders, by registered mail, a copy of any notice of default served by Tenant upon Landlord, provided that prior to such notice Tenant has been notified, in writing (by way of notice of assignment of rents or otherwise) of the addresses of such mortgagees and/or deed of trust holders. Tenant further agrees that if Landlord shall have failed to cure or commence curing such default within the time provided for in this Lease, 13 any such mortgagees and/or deed of trust holders shall have an additional thirty (30) days within which to cure such default or if such default is not reasonable susceptible of cure within that time, then such additional time as may be reasonably necessary if within such thirty (30) days, any mortgagee and/or deed of trust holder has commenced and is diligently pursuing the remedies necessary to cure such default, (including but not limited to commencement of foreclosure proceeding), in which event this Lease shall not be terminated when such remedies are being diligently pursued. 29. AUTHORITY OF PARTIES AND BINDING EFFECT If Tenant is a corporation each individual executing this Lease on behalf of said corporation represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of said corporation, in accordance with a duly adopted resolution of the board of directors of said corporation or in accordance with the by-laws of said corporation, and this Lease is binding upon said corporation in accordance with its terms. 30. BROKERS Tenant and Landlord warrant that they have had no dealings with any real estate broker or agents in connection with the negotiation of this Lease and it knows of no other real estate broker or agent who is or may be entitled to a commission in connection with this Lease. In connection with this Lease, Tenant and Landlord agree to indemnify and save each other harmless from any claims for commissions by brokers or agents. 31. PLATS AND RIDERS Clauses, plats and riders, if any, signed by the Landlord and the Tenant and endorsed on or affixed to this Lease are a part hereof. 32. MARGINAL HEADINGS The marginal headings and Article titles of the Articles of this Lease are not a part of this Lease and shall have no effect upon the construction or interpretation of any part hereof. 33. SALE OF PREMISES BY LANDLORD In the event of any sale of the Building, Landlord shall be and is hereby entirely freed and relieved of all liability under any and all of its covenants and obligations contained in or derived from this Lease arising out of any act, occurrence or omission 14 occurring after the consummation of such sale; and the purchaser, at such sale or any subsequent sale of the Building shall be deemed, without any further agreement between the parties or their successors in interest or between the parties and any such purchaser, to have assumed and agreed to carry out any and all of the covenants and obligations of the Landlord under this Lease. Nothing herein shall restrict or limit the right of the Landlord to sell, assign transfer or encumber the Building in any way Landlord deems appropriate in its sole discretion. 34. GOVERNING LAW AND VENUE The laws of the State of California shall govern the construction, validity, performance and enforcement of this Lease. Should either party institute legal suit or action for enforcement of any obligation contained herein, it is agreed that the venue of such suit or action shall be in San Luis Obispo, County, California. This Lease shall not be construed either for or against Landlord or Tenant, but this Lease shall be interpreted in accordance with the general tenor of the language in an effort to reach an equitable result. 35. BINDING ON SUCCESSORS AND ASSIGNS This Lease shall be binding on and shall inure to the benefit of the heirs, executors, administrators, successors, and assigns of the parties, Landlord and Tenant, hereto, but nothing in this paragraph shall be construed as a consent by Landlord to any assignment of this Lease or any interest therein by Tenant except as provided in Paragraph 7 of this Lease. 36. WAIVER The waiver of any breach of any of the provisions of this Lease by Landlord shall not constitute a continuing waiver or a waiver of any subsequent breach by Tenant either of the same or of another provision of this Lease. 37. JOINT OBLIGATION If there be more than one Tenant the obligations hereunder imposed shall be joint and several. 38. TIME Time is expressly declared to be the essence of this Lease and each and all of its provisions in which performance is a factor. 15 39. RECORDATION Neither Landlord nor Tenant shall record this Lease, but a short form memorandum hereof may be recorded at the request of Landlord. 40. QUIET POSSESSION Upon Tenant paying the rent reserved hereunder and observing and performing all of the covenants, conditions and provisions on the Tenant's part to be observed and performed hereunder, as far as Landlord is concerned, Tenant shall have quiet possession of the premises for the entire term hereof, subject to all provisions of this Lease. 41. INABILITY TO PERFORM This Lease and the obligations of the Tenant shall not be affected or impaired because the Landlord is unable to fulfill any of its obligations hereunder or is delayed in doing so, if such inability or delay is caused by reason of strike labor troubles, act of God, or any other cause beyond the reasonable control of the Landlord. 42. PARTIAL INVALIDITY Any provision of this Lease which shall prove to be invalid, void, or illegal shall in no way affect, impair or invalidate any other provision hereof and such other provision shall remain in full force and effect. 43. CUMULATIVE REMEDIES No remedy or election hereunder shall be deemed exclusive but shall, whenever possible, be cumulative with all other remedies at law or in equity. 44. SUBORDINATION This Lease is and shall be subordinate to any encumbrances not of record or effected or recorded after the date of this Lease affecting the building, premises, common areas, and land of which the Premises are a part, without limitations hereby. Such subordination is effective without any further act or consent of Tenant. Landlord shall from time to time request that Tenant execute and deliver documents or 16 instruments that may be required by a lender to effectuate any subordination. If Tenant fails to execute and deliver any such documents or instruments, Tenant irrevocably constitutes and appoints Landlord as Tenant's special attorney in fact to execute and deliver any such documents or instruments. 45. INCORPORATION OF PRIOR AGREEMENTS; AMENDMENTS This Lease contains all prior agreements of the parties with respect to any matter mentioned herein. No prior agreement or understanding pertaining to any such matter shall be effective. This Lease may be modified in writing only, signed by the parties in interest at the time of the modification. 46. EXTENSION OF LEASE AGREEMENT Subsequent to the initial term, tenant has the option to extend this lease for three (3) five (5) year extensions. Tenant must give notice to Landlord three (3) months prior to the termination date of this Lease,of Tenants wishes and intentions to extend and renegotiate this Lease for another term. EXECUTED ON MARCH 31, 1999, AT PASO ROBLES, SAN LUIS OBISPO COUNTY, CA. LANDLORD: TENANT: - ---------------------------------- ------------------------------ GWEN R. PELFREY, SECRETARY LAWRENCE P. WARD, PRES/CEO HERITAGE OAKS BANCORP HERITAGE OAKS BANK 17 EX-10.28 4 EXHIBIT 10.28 EXHIBIT (10.28) SERVICE BUREAU PROCESSING AGREEMENT BY AND BETWEEN ALLTEL INFORMATION SERVICES, INC. AND HERITAGE OAKS BANK AUGUST 1, 1999 1 This is a Service Bureau Agreement (the "Agreement"), dated as of the 1st day of August, 1999, (the "Effective Date"), by and between ALLTEL INFORMATION SERVICES, INC., an Arkansas corporation having its principal place of business at 4001 Rodney Parham Road, Little Rock, Arkansas 72212-2496 ("ALLTEL Information"), and HERITAGE OAKS BANK, a (State of California) corporation, having its principal place of business at 545 Twelfth Street, Paso Robles, CA 93446 ("Client"). WHEREAS, ALLTEL Information provides data processing services to multiple clients, and Client desires to obtain such data processing services from ALLTEL Information; NOW, THEREFORE, in consideration of the payments to be made and services to be performed hereunder, the parties agree as follows: 1. SERVICES. ALLTEL Information shall provide the data processing software and services ("Services") outlined throughout this Agreement, and such additional services as may be added by the parties from time to time pursuant to a written amendment to this Agreement. Services shall be provided in accordance with applicable ALLTEL Information user and operation manuals, bulletins, guidelines, procedures, policies and similar materials, as established and revised from time to time. ALLTEL will provide the software maintenance required to cause the HORIZON BANKING SYSTEM software to operate according to ALLTEL's most current documentation. ALLTEL Information shall process MICR Data, Statistical Data, records, and all other input furnished to ALLTEL Information (collectively, "Data") and shall prepare and make available for pick-up by Client, in accordance with such procedures and schedules established by ALLTEL Information documents, reports, customer statements and other output (collectively, "Output"). The method of delivery of reports is specified in Exhibit A, and a request from Client to change such method must be received by ALLTEL Information at least sixty (60) days prior to the requested change date. Any fees or charges resulting from such change shall be in accordance with ALLTEL Information's then prevailing fee schedule. For purposes of this Agreement, it is understood that any times that are listed are for Pacific Standard Time (PST). 2. DATA. 2.1 FORM. Data shall be delivered by messenger or electronic transmission to ALLTEL Information at its facility as designated by ALLTEL Information, or such other agreed delivery location, at the times and in the form prescribed by ALLTEL Information. ALLTEL Information shall not be liable for the accuracy, completeness and authenticity of Data furnished to ALLTEL Information by Client, a Federal Reserve Bank, an Automated Clearing House, or any other third party, and shall have no obligation or responsibility to audit, check or verify the 2 Data. Client shall be solely responsible for determining the correctness of magnetic ink encoding on items submitted for Client's payment, including but not limited to checks and drafts ("Items"); for verifying dates, signatures, amounts, endorsements, authorizations, payment notices, collection times, fees and charges to Client's customers and all other similar matters on Data submitted for processing, including Items; and for placing stop payments and holds on accounts. 2.2 MICR DATA. MICR Data as used in this Agreement refers to the magnetically encoded information on Items, or if Client captures its own MICR Data, to the Data submitted to ALLTEL Information from Client which is derived from magnetically encoded information on Items. If Client captures its own MICR Data, Client shall electronically transmit MICR Data to ALLTEL Information, and shall identify MICR Data as to description and amounts with verification as to the total of all amounts set forth. In the event of an emergency, ALLTEL Information may, in its sole discretion, accept MICR Data on magnetic tape. MICR Data shall be delivered to ALLTEL Information each ALLTEL Information business day. The method of delivery of MICR Data to ALLTEL Information is specified in Exhibit A. If the method of delivery is one of Electronic Data Transmission (EDT), then Exhibit D (Electronic Data Transmission Addendum) shall be applicable. MICR Data delivered by messenger must be received by ALLTEL Information at its facility, or other agreed delivery location, no later than 8:00 p.m. on Mondays through Thursdays and 10:00 p.m. on Fridays; MICR Data transmitted electronically must be received by ALLTEL Information at its facility no later than 10:00 p.m. on Mondays through Thursdays and 11:00 p.m. on Fridays. Client's request to change the method of delivery of MICR Data must be received by ALLTEL Information at least sixty (60) days prior to the requested change date. Any fees or charges due to such request shall be in accordance with ALLTEL Information's then prevailing fee schedule. 2.3 STATISTICAL DATA. All Statistical Data, including but not limited to changes to customer accounts, shall be transmitted electronically from Client's administrative terminal to ALLTEL Information's facility. All Statistical Data must be received by ALLTEL Information at its facility no later than 6:00 p.m. on Mondays through Thursdays and 7:00 p.m. on Fridays. 2.4 EFT DATA. EFT Data as used in this Agreement refers to any Data (input or output) that goes through the Automated Clearing House (ACH). All EFT Data must be received by ALLTEL Information at its facility no later than 6:00 p.m. on Mondays through Thursdays and 7:00 p.m. on Fridays. If EFT Data is one of the inputs/outputs used by the Client then Exhibit E (Electronic Funds Transfer Addendum) shall be applicable. 3. PROCESSING. ALLTEL Information shall follow such procedures and time schedules as it may deem appropriate in processing Data and posting entries on behalf of Client. ALLTEL Information is authorized to create and process such entries, including but not limited to adjusting or correcting entries, as it deems necessary or appropriate to process the Data. It shall be Client's sole responsibility to effect a timely return of any Item, or to pursue any claim or 3 right of action in a timely manner against any third party arising from such Item. If Data is received by ALLTEL Information prior to the time limits required by this Agreement, ALLTEL Information may process such Data immediately. If ALLTEL Information receives Data after the time limits required by this Agreement, or Data is delivered by any method other than that indicated in this Agreement or agreed to in writing by the parties, ALLTEL Information may delay the processing of such Data. However, if ALLTEL Information does process such Data, Client shall pay any additional fees and charges required by ALLTEL Information. 4. CONVERSION AND COMMENCEMENT. ALLTEL Information shall provide reasonable assistance to Client during its conversion to ALLTEL Information's electronic data processing system used in connection with the Services. Initial training of Client's Trainers as well as one set of Manuals for the Services will be provided to Client at no additional charge. Any additional training or Manuals requested by Client will be charged at ALLTEL Information's then prevailing rates. The Commencement Date for Services is the earliest date that conversion to ALLTEL Information's electronic data processing system is completed for any one of the Services. 4.1 TRAVEL AND EXPENSES. Client shall reimburse ALLTEL Information for all reasonable travel and expenses related to the performance of any conversion or special project requested by the Client. This would include the initial conversion to the ALLTEL Information's electronic data processing system as well as any other special project that would result in extra travel and expenses being incurred. 5. FEES 5.1 FEES TO ALLTEL Client shall pay to ALLTEL Information for the Services provided hereunder, and for any additional services which are added to this Agreement, the fees specified on the Schedules of Fees For Contracted Services which are designated in Attachment 1. Method of payment is specified in Exhibit A. Any amount not received within fifteen (15) days after the payment due date by ALLTEL Information shall bear interest at the rate of eighteen percent (18%) per annum until paid. However, if any amount is not paid when due, ALLTEL Information may, at its option, immediately suspend performance hereunder until payment is made, in addition to any other rights or remedies provided to ALLTEL Information by this Agreement or applicable law. 5.2 ADJUSTMENT OF FEES. The fees payable each year shall be adjusted annually during the month in which the anniversary of the Commencement Date for Services ("Adjustment Date") falls, as follows. Fees shall be increased, but not decreased, by the amount of the increase in the Consumer Price Index for All Urban Consumers Other Goods and Services (the "CPI-U") as published by the U.S. Department of Labor, Bureau of Labor Statistics for the month of December preceding the Adjustment Date over the Index for the month of December in the immediately preceding year. If additional Services are added to the Agreement, the fees shall be adjusted on such Adjustment Date in accordance with this Section. In no event shall the adjusted fee for any Service be less than the fee for that Service before 4 such adjustment. In the event the Index is unavailable in time to allow the adjustment to be made on the Adjustment Date, Client shall continue to pay the then current fees for the Services until the Index is made public, at which time the adjustment shall be calculated retroactively to the Adjustment Date, and Client shall immediately pay to ALLTEL Information any difference between the fees actually paid and adjusted fees. The adjustments shall be compounded and cumulative. In the event the CPI-U is discontinued or revised during the term of this Agreement and any extensions hereof, ALLTEL Information shall select another governmental index or computation as a substitute CPI-U in order to obtain substantially the same result as if the Index had not been discontinued or revised. 5.3 PAYMENT OF ONE-TIME FEES. Client shall pay to ALLTEL Information any one-time fees specified on the Schedules of Fees For Contracted Services which are designated in Attachment 1 of this Agreement, and for any additional services which are added to this Agreement. Method of payment is specified in Exhibit A. The one-time fees shall be due in the following manner. Fifty percent (50%) due upon signing of this Agreement. The remaining fifty percent (50%) will be due upon implementation of the initial conversion or the completion of the contracted service. 6. TAXES. Client shall pay to ALLTEL Information an amount equal to any applicable taxes or other governmental charges of any kind, however designated, levied or based upon or relating to the transactions contemplated by this Agreement, including any taxes that may be imposed on the use of any hardware, software, programs, supplies or operating systems utilized under this Agreement, except taxes based on ALLTEL Information's net income. 7. REPROCESSING. If any Data submitted to ALLTEL Information is incorrect, incomplete or not in the format required, ALLTEL Information, may require Client to resubmit the Data or ALLTEL Information may correct and complete the Data itself, and Client agrees to pay additional fees and charges for any additional work incurred by ALLTEL Information in connection therewith. In addition, any reprocessing required because of incorrect or incomplete Data shall be at Client's expense, in accordance with the fee for such Service then in effect. ALLTEL Information shall attempt to notify Client prior to incurring any expenses for which Client would be liable under this Article. 8. RISK OF LOSS DURING TRANSIT OR TRANSMISSION 8.1 ELECTRONIC TRANSMISSION. Client shall obtain, maintain and operate at its own expense, all necessary devices, software and services required for the electronic transmission of Data and, if applicable, the electronic reception of Output, including but not limited to hardware, software, installation, maintenance and telephone lines. Notwithstanding the foregoing, any communication devices (modems) must meet the requirements of ALLTEL Information. Exhibit D (Electronic Data Transmission Addendum) shall apply to all aspects of electronic transmissions. 5 8.2 MESSENGER. Client shall be solely responsible for and shall bear all costs associated with having a messenger service transport Data, Output or any other information relating to Client or the Services to or from ALLTEL Information's facility or other delivery location. The messenger of all such material shall be deemed to be the agent of Client. For purposes of this Agreement, unless noted otherwise, the delivery location will be ALLTEL Information Services, Inc., 5933 West Century Blvd. Suite 310, Los Angeles, California 90045. 8.3 LIMITATION. ALLTEL INFORMATION SHALL NOT BE LIABLE OR RESPONSIBLE FOR ANY LOSS OR DELAY OF DATA, OUTPUT OR ANY OTHER INFORMATION WHICH PERTAINS TO CLIENT OR THE SERVICES DURING ANY PERIOD OF TRANSIT OR ELECTRONIC TRANSMISSION TO OR FROM ALLTEL INFORMATION'S FACILITY OR OTHER AGREED DELIVERY LOCATION, REGARDLESS OF THE CAUSE OF SUCH DELAY OR LOSS. 9. PRINTING. Client shall be responsible to receive electronically all output for print. ALLTEL Information will provide such output in a hard copy, micro fiche, or optical form for the then current fees associated with such services. Client will furnish, at its own expense, all forms/paper for printing. 10. CLIENT REVIEW. It shall be Client's responsibility to review, verify and make a final audit of all Output. 11. TERM, TERMINATION AND RENEWAL. 11.1 TERM. This Agreement shall commence on the effective date hereof and shall expire four (4) years after the Commencement Date for Services ("Term"), unless terminated pursuant to Paragraph 11.2. The Commencement Date for Services for a renewal Term shall be the day immediately following the last day of the preceding Term. Not less than two hundred seventy (270) days prior to the expiration of the then current Term, ALLTEL Information may provide to Client a renewal agreement for the continuation of processing services hereunder and, if such renewal agreement is provided by ALLTEL Information, Client will promptly review such agreement and commence negotiations with ALLTEL Information, if necessary, and accept or reject the agreement within one hundred eighty (180) days prior to expiration of the then current Term. 11.2 TERMINATION. Either party may terminate this Agreement at any time during the Term or any renewal Term upon one hundred eighty (180) days prior written notice. If this Agreement is terminated by Client effective prior to the then current Term, Client shall pay to ALLTEL Information, in addition to any accrued fees and charges, a termination fee which is equal to fifty percent (50%) of the remaining contract value. Contract value being calculated as follows: Average monthly amount of last six (6) months of service multiplied by the number of months remaining in the Term of this Agreement. The parties acknowledge and agree that such fee is reasonable in light of the harm caused by such termination; that the loss suffered by ALLTEL Information would be difficult to prove; and that it would be inconvenient or 6 unfeasible for ALLTEL Information to obtain an adequate remedy otherwise. This termination fee is due and payable within sixty (60) days of notice of termination. The described termination fee is exclusive of any fees associated with deconversion activities. The deconversion fees are outlined in Exhibit C of this Agreement. 11.3 EXTENDED SERVICES. Any Services that are provided to Client after the expiration or termination of this Agreement, for which a written agreement has not been entered into by the parties, shall be provided on a month-to-month basis, and are subject to the terms and conditions of this Agreement, except that the fees for such Services shall be one hundred twenty five percent (125%) of the current prevailing ALLTEL Information fee schedule. 12. RETENTION OF DATA. With respect to any other Data, unless directed by Client to the contrary, ALLTEL Information may destroy the Data and other materials of Client at any time after the final use by ALLTEL Information of such Data and materials for processing. Pursuant to Client's written request, which must be received by ALLTEL Information within thirty (30) days after the termination or expiration of this Agreement, ALLTEL Information will furnish to Client, at ALLTEL's then current charges, copies of Client's data files and layouts as may be maintained by ALLTEL Information from time to time. In the absence of such notice by Client, ALLTEL Information may dispose of or destroy such material at ALLTEL Information's discretion. However, notwithstanding any other provision in this Agreement, ALLTEL Information may retain any materials of Client, including but not limited to Data, Reports and data files, until all fees, interest and other charges payable hereunder have been paid in full. 13. FORCE MAJEURE AND LIMITATION OF LIABILITY. 13.1 FORCE MAJEURE. ALLTEL Information shall not be liable for any loss, expense, error or delay, including but not limited to delays in processing of Data or delivery of Output or Items to Client, or any inability to provide Services hereunder, caused by accidents, strikes, fire, electrical or mechanical failures, non-ALLTEL software defects, acts or omissions of third parties (including but not limited to acts or omissions of any third party service provider or equipment vendor, messenger service or telephone carrier), acts of God or any other causes or conditions which are beyond ALLTEL Information's reasonable control. 13.2 LIMITATION OF LIABILITY. As a condition precedent to any liability of ALLTEL Information, Client must notify ALLTEL Information in writing of any alleged negligence or breach of this Agreement as promptly as reasonably possible, but in no event later than five (5) business days following the day on which such alleged negligence or breach was, or could reasonably have been, discovered by Client. ALLTEL INFORMATION'S LIABILITY, IF ANY, ARISING OUT OF OR IN ANY WAY RELATED TO ITS PERFORMANCE UNDER THIS AGREEMENT INCLUDING BUT NOT LIMITED TO LIABILITY FOR PROCESSING ERRORS OR NEGLIGENCE, SHALL NOT EXCEED ITS CHARGES DURING THE SIX-MONTH PERIOD PRECEDING THE DATE OF THE ALLEGED NEGLIGENCE OR BREACH FOR THE PARTICULAR SERVICE TO WHICH CLIENT'S CLAIM PERTAINS. SUCH MONEY DAMAGES SHALL BE CLIENT'S EXCLUSIVE REMEDY, AND IN NO 7 EVENT MAY SPECIAL, GENERAL, CONSEQUENTIAL, INCIDENTAL OR EXEMPLARY DAMAGES BE RECOVERED, EVEN IF ALLTEL INFORMATION HAS BEEN ADVISED OF THE POSSIBILITY THEREOF. This Paragraph also limits the liability of any agent, employee or affiliate of ALLTEL Information. 14. DISCLAIMER OF WARRANTIES. EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, ALLTEL INFORMATION MAKES NO WARRANTIES, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. 15. INDEMNIFICATION. Client agrees to indemnify ALLTEL Information and hold it harmless from and against any and all losses, liability, damages, claims, demands, expenses, and attorney's fees (including an allocable share of the cost of in-house counsel) which may be directly or indirectly caused by Client's determination to pay or return any Item; (ii) Client's failure to return any unpaid Items, or to provide notification thereof, to the Federal Reserve Bank and/or other sources, in the manner and within the time limits specified by applicable law; (iii) Client's failure to comply with any provision of this Agreement; (iv) any error or omission in any data, information or instruction furnished by Client; (v) ALLTEL Information's delay in providing, or failure to provide, any Services hereunder if due to causes or conditions beyond ALLTEL Information's reasonable control; or (vi) any unauthorized person gaining access to, or any improper use of, information pertaining to Client or its customers, including but not limited to account and loan data, which is made available to Client or its customers pursuant to the Services, except if such unauthorized access or improper use is caused solely by ALLTEL Information's negligence or breach of its obligations hereunder. 16. CONTINGENCY PLAN. ALLTEL Information shall maintain contingency plans to be used in the event ALLTEL Information's equipment or software used for the Services is partially or completely disabled. Such plans include recovery procedures and backup arrangements for equipment as determined solely by ALLTEL Information. In any necessary recovery efforts, the Services shall receive the same degree of priority as similar services performed for ALLTEL Information's own operations. Client, however, shall remain solely responsible for its contingency plan and maintaining adequate duplicate records of Data should file reconstruction become necessary. 17. CONFIDENTIAL INFORMATION 17.1 OWNERSHIP. Subject to Article 12 of this Agreement, all Data, Items, and Output are and shall remain the sole property of Client. All Specifications, manuals, tapes, programs, user documentation and other materials ("Materials") developed by ALLTEL Information and furnished to Client by ALLTEL Information in connection with this Agreement are and shall remain the sole property of ALLTEL Information, unless agreed to otherwise in writing by the parties. 17.2 CONFIDENTIALITY. ALLTEL Information acknowledges that the Data and Output are the confidential information of Client, and Client acknowledges that the Materials are the 8 confidential information of ALLTEL Information. Each party agrees to use the same standard of care for the other's confidential information that it would use for its own similar confidential information, and Client agrees to use the materials only for the functions and in the manner authorized by ALLTEL Information. Confidential information shall not include information that is in the public domain at the time of disclosure or is lawfully obtained from a third party. 17.3 NON-DISCLOSURE OF TERMS OF CONTRACT. Client agrees to treat all terms of this Agreement, including but not limited to all pricing terms, as strictly confidential and shall not disclose or describe the terms hereof to any other person or entity including but not limited to independent contractors and agents of Client. 17.4 REMEDIES. Client agrees that the remedy at law for the breach of any provision of this Article 17 may be inadequate and that ALLTEL Information shall be entitled to injunctive relief without bond, in addition to any rights or remedies which ALLTEL Information may have for such breach. The obligations of Client and the rights of ALLTEL Information under any provision of this Article 17 shall survive any termination of this Agreement. 18. AUDIT RECORDS Client shall be responsible for maintaining all necessary audit records required by law or any regulatory authority having jurisdiction over Client. 19. REGULATORY COMPLIANCE. To comply with the requests of applicable regulatory authorities, ALLTEL Information agrees that Client's processing will have priority over processing of ALLTEL Information's non-financial customers, if any. ALLTEL Information will provide, at the prescribed times, all required letters of assurance to the appropriate regulatory authorities. During the term of this Agreement, ALLTEL Information agrees that ALLTEL Information's programs will comply with the mandatory federal data processing output requirements specified by the federal authorities applicable to Client. Client will make ALLTEL aware of any applicable local or state regulatory requirements which have requirements different than those of federal regulatory authorities. Any changes required by such state or local requirements which ALLTEL Information agrees to make shall be paid for by Client, and to the extent possible, ALLTEL Information shall endeavor to obtain consents to share the costs of such charges required by such state and local requirements among the ALLTEL Information clients affected. 20. MODIFICATIONS TO SYSTEM. ALLTEL Information may, from time to time, modify any system utilized in providing the Services, with accompanying changes to the applicable Documentation, to the extent deemed necessary by ALLTEL Information. ALLTEL Information shall notify Client within a reasonable time (Not less than 30 days prior) of any such modification that affects Client's use of the Services. 21. INSURANCE. A schedule of ALLTEL Information's current insurance coverage has been furnished in Exhibit B. 22. AUDITOR'S REVIEW. A certified public accounting firm shall perform an annual 9 review of ALLTEL Information's computer facility. Client agrees that such firm shall have sole authority and responsibility for such review. ALLTEL Information will provide Client with a copy of the report for the fee set forth in Attachment 1. 23. SECURITY. Client shall implement all necessary security procedures, including but not limited to any security procedures required by ALLTEL Information, with regards to the Services. Client acknowledges that Client is fully responsible for security at its facilities, and that ALLTEL Information has NO control over the security of the terminals located at Client's facilities or those individuals accessing information through those terminals. Client assumes full responsibility for any unauthorized persons utilizing such terminals or for the unauthorized use of any information obtained therefrom. Client hereby expressly waives any claim against ALLTEL Information arising out of a breach of those terminals. 24. GOVERNMENTAL EXAMINATIONS. If required by a regulatory authority, agency or commission, ALLTEL Information is hereby authorized to furnish Data and/or Output thereto at Client's expense. Client authorizes ALLTEL Information to comply with all applicable provisions of any statute, law, regulation or ordinance of any governmental authority having jurisdiction, including but not limited to any laws pertaining to governmental regulation and examination of services. 25. SUBCONTRACTING. Client agrees that ALLTEL Information may, in its sole discretion, subcontract all or any part of its obligations hereunder to one or more subcontractors, but in no event shall Client be required, without prior written consent, to look to any such subcontractor directly for performance of any such obligation or to make any payment directly to any subcontractor. 26. GENERAL. 26.1 NOTICES. All notices required by this Agreement shall be in writing; shall be mailed or personally delivered to the other party at the address set forth below, or such other address as subsequently shall be given by either party to the other in writing; and shall be deemed effective upon personal delivery to the other party or three (3) days after mailing if mailed with sufficient postage and properly addressed. 26.2 HEADINGS AND CONSTRUCTION. The headings used in this Agreement are for convenience only and shall not be used in constructing the provisions hereof. All reference herein to ALLTEL Information shall be deemed to include ALLTEL Information. 26.3 SURVIVAL OF PARAGRAPHS. Articles 12, 14, 15, 17 and 25, and Paragraphs 13.1 and 13.2, herein shall survive the termination or expiration of this Agreement. 26.4 ENTIRE AGREEMENT AND AMENDMENTS. This Agreement contains the entire agreement of the parties hereto. No other agreement, statement or promise made by any party hereto or by any employee, officer, or agent of any party hereto that is not in writing and signed by the parties is binding; except that ALLTEL Information may amend from time to time the 10 terms and conditions of this Agreement, any Exhibits or any other Addenda upon written notice to Client. Notwithstanding the foregoing, ALLTEL Information shall not discontinue any Services hereunder without providing at least 180 days prior written notice to Client. Such notice will contain a reasonable alternative to the Services being discontinued. If this discontinuance of Services causes the Client any one-time financial impact ALLTEL Information agrees to reimburse Client for those one-time expenses on an actual costs basis. It will be assumed that the referenced notice will be considered delivered on the date the notice is post marked for delivery, faxed or couriered to the Client. 26.5 ASSIGNMENT. This Agreement shall inure to the benefit of and be binding upon the parties hereto, their successors and assigns. No assignment hereof may be made by Client without the prior written consent of ALLTEL Information. Nothing in this Agreement is to be construed to limit or restrict the right of ALLTEL Information to effect any assignment of this Agreement by merger, reorganization, sale of corporate assets or other corporate change as long as the Services outlined in this Agreement continue. 26.6 GOVERNING LAW. This Agreement is governed by the laws of the State of California. Both parties agree that any action brought as a result, directly or indirectly, of this Agreement shall be brought in a court of appropriate jurisdiction in Los Angeles, California. The successful party in any such action shall be entitled to recover from the unsuccessful party, in addition to any other relief to which it may be entitled, reasonable attorney's fees (including an allocable share of the cost of in house counsel) and costs incurred by it in prosecuting or defending such action. THIS AGREEMENT IS EFFECTIVE AUGUST 1, 1999 AND HAS BEEN EXECUTED BY THE DULY AUTHORIZED OFFICERS OF THE PARTIES HERETO. ALLTEL Information Client ALLTEL Information Services, Inc. Heritage Oaks Bank HORIZON Technology Center - West 545 Twelfth Street 5933 West Century Blvd, Suite 310 Paso Robles, CA 93446 Los Angeles, California 90045 Signature: _____________________________ Signature: ____________________ Date: _____________________________ Date: __________________ Print Name: GARY NORCROSS Print Name: ____________________________ ------------- Title: SVP AND GENERAL MANAGER Title: ________________ ----------------------- 11 EX-23 5 EXHIBIT 23 EXHIBIT 23 [VAVRINEK, TRINE, DAY & CO., LLP LETTERHEAD] CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To: Heritage Oaks Bancorp We consent to the incorporation of our report dated February 2, 2000 on the consolidated financial statements of Heritage Oaks Bancorp and Subsidiaries as of December 31, 1999 and 1998, and for each of three years in the period ended December 31, 1999, included in its Annual Report on Form 10-KSB for the year ended December 31, 1999. /s/ VAVRINEK, TRINE, DAY & CO., LLP Vavrinek, Trine, Day & Co., LLP Certified Public Accountants Rancho Cucamonga, California March 20, 2000 EX-27 6 EXHIBIT 27
9 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 17,159,073 375,255 1,200,000 0 19,058,804 0 0 103,667,208 1,241,016 147,299,268 132,961,573 2,561,000 1,234,533 0 0 0 5,288,179 5,253,983 147,299,268 8,424,833 1,488,660 0 9,913,493 2,514,138 2,600,935 7,312,558 165,500 0 10,406,243 2,185,056 1,430,928 0 0 1,430,928 1.27 1.15 6.42 904,773 0 0 0 1,069,535 14,215 20,196 1,241,016 1,241,016 0 0
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