10QSB 1 a2029487z10qsb.txt FORM 10-QSB SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________________ TO _________________ COMMISSION FILE NO. 0-25020 ------- HERITAGE OAKS BANCORP -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER) STATE OF CALIFORNIA -------------------------------------------------------------------------------- (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) 77-0388249 -------------------------------------------------------------------------------- (I.R.S. EMPLOYER IDENTIFICATION CODE) 545 12TH STREET, PASO ROBLES, CA 93446 -------------------------------------------------------------------------------- (ADDRESS OF PRINCIPAL OFFICE) (805) 239-5200 -------------------------------------------------------------------------------- (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING TWELVE (12) MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST NINETY (90) DAYS. YES X NO ----- ----- AGGREGATE MARKET VALUE OF COMMON STOCK OF HERITAGE OAKS BANCORP AT OCTOBER 3, 2000: $21,396,673. INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE: NO PAR VALUE COMMON STOCK - 1,222,667 SHARES OUTSTANDING AT OCTOBER 3, 2000. PAGE 1 TABLE OF CONTENTS
PAGE Consolidated Balance Sheets as of December 31, 1999 and September 30, 2000 3. Consolidated Statements of Income for the THREE months ended September 30, 1999 and September 30, 2000 4. Consolidated Statements of Income for the NINE months ended September 30, 1999 and September 30, 2000 5. Consolidated Statements of Cash Flows for NINE months ended September 30, 1999 and September 30, 2000 6. Consolidated Statements of Stockholders' Equity for periods ended September 30, 1999 and September 30, 2000 7. Notes to Consolidated Condensed Financial Statements 8.-10. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11.-21. Part 2. Other Information Item 1. Legal Proceedings 22. Signatures 22.
PAGE 2 HERITAGE OAKS BANCORP CONSOLIDATED BALANCE SHEETS
12/31/99 09/30/00 (1) (UNAUDITED) ASSETS Cash and due from banks $17,159,073 $17,065,293 Federal funds sold 1,200,000 4,500,000 --------- --------- Total cash and cash equivalents 18,359,073 21,565,293 Interest bearing deposits other banks 375,255 198,000 Securities available for sale (see note 2) 18,663,504 16,068,861 Securities held to maturity 0 0 Federal Home Loan Bank, cost 395,300 375,400 Loans Held For Sale 120,382 1,636,850 Loans, net (see note 3) 102,426,192 127,288,386 Property, premises and equipment, net 3,427,289 3,167,687 Other real estate owned 0 0 Cash surrender value life insurance 1,305,787 1,353,232 Other assets 2,226,486 2,443,963 --------- --------- TOTAL ASSETS $147,299,268 $174,097,672 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand, non-interest bearing $39,901,884 $49,369,079 Savings, NOW, and money market deposits 55,251,328 62,073,465 Time deposits of $100,000 or more 10,596,650 5,047,817 Time deposits under $100,000 27,211,711 43,090,745 ---------- ---------- Total deposits 132,961,573 159,581,106 Other borrowed money 350,000 350,000 Securities Sold under an Agreement to Repurchase 2,211,000 0 Other liabilities 1,234,533 1,630,010 --------- --------- Total liabilities 136,757,106 161,561,116 Stockholders' equity Common stock, no par value; 20,000,000 shares authorized; issued and outstanding 1,144,282 and 1,222,667 for December 31, 1999, and September 30, 2000, respectively. 5,288,179 6,235,725 Accumulated other comprehensive income (658,840) (419,401) Retained earnings 5,912,823 6,720,232 --------- --------- Total stockholders' equity 10,542,162 12,536,556 ---------- ---------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $147,299,268 $174,097,672 ============ ============
(1) These numbers have been derived from the audited financial statements. See notes to consolidated financial statements PAGE 3 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED SEPTEMBER 30,
1999 2000 (UNAUDITED) (UNAUDITED) Interest Income: Interest and fees on loans $2,223,295 $3,330,366 Investment securities 276,835 231,582 Federal funds sold and commercial paper 46,030 77,228 Time certificates of deposit 3,986 2,743 ----- ----- Total interest income 2,550,146 3,641,919 Interest Expense: Now accounts 175,765 216,693 MMDA accounts 52,863 79,908 Savings accounts 73,999 76,010 Time deposits of $100,000 or more 84,266 76,020 Other time deposits 252,949 595,411 Other borrowed funds 8,161 32,812 ----- ------ Total interest expense 648,003 1,076,854 Net Interest Income Before Prov. for Possible Loan Losses 1,902,143 2,565,065 Provision for loan losses 42,000 105,000 ------ ------- Net interest income after provision for loan losses 1,860,143 2,460,065 Non-interest Income: Service charges on deposit accounts 198,090 295,422 Investment securities gains (losses), net 0 0 Other income 1,444,551 1,185,177 --------- --------- Total Non-interest Income 1,642,641 1,480,599 Non-interest Expense: Salaries and employee benefits 883,232 1,091,684 Occupancy and equipment 374,704 399,754 Other expenses 1,573,164 1,432,540 --------- --------- Total Noninterest Expenses 2,831,100 2,923,978 Income before provision for income taxes 671,684 1,016,686 Provision for applicable income taxes 236,589 383,148 ------- ------- Net Income $435,095 $633,538 ======== ======== Earnings per share: (See note #4) Basic $0.39 $0.52 Fully Diluted $0.35 $0.48 See notes to consolidated financial statements
PAGE 4 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1999 2000 (UNAUDITED) (UNAUDITED) Interest Income: Interest and fees on loans $5,957,706 $9,160,714 Investment securities 966,470 770,236 Federal funds sold and commercial paper 183,801 149,855 Time certificates of deposit 17,715 7,965 ------ ----- Total interest income 7,125,692 10,088,770 Interest Expense: Now accounts 496,257 567,398 MMDA accounts 150,573 168,603 Savings accounts 202,243 228,625 Time deposits of $100,000 or more 182,936 308,050 Other time deposits 775,049 1,476,234 Other borrowed funds 54,513 223,462 ------ ------- Total interest expense 1,861,571 2,972,372 Net Interest Income Before Prov. for Possible Loan Losses 5,264,121 7,116,398 Provision for loan losses 123,500 219,000 ------- ------- Net interest income after provision for loan losses 5,140,621 6,897,398 Non-interest Income: Service charges on deposit accounts 552,682 795,807 Investment securities gains (losses), net 0 -2,188 Other income 3,730,866 3,450,799 --------- --------- Total Non-interest Income 4,283,548 4,244,418 Non-interest Expense: Salaries and employee benefits 2,638,208 3,134,555 Occupancy and equipment 1,121,958 1,262,062 Other expenses 4,208,488 4,190,606 --------- --------- Total Noninterest Expenses 7,968,654 8,587,223 Income before provision for income taxes 1,455,515 2,554,593 Provision for applicable income taxes 499,487 881,481 ------- ------- Net Income $956,028 $1,673,112 ======== ========== Earnings per share: (See note #4) Basic $0.86 $1.37 Fully Diluted $0.76 $1.28 See notes to consolidated financial statements
PAGE 5 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000
1999 2000 (Unaudited) (Unaudited) Cash flows from operating activities: Net Income $956,028 $1,673,112 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 483,020 531,823 Provision for possible loan loss 123,500 219,000 Increase (decrease) in deferred loan fees 123,220 (21,940) Increase (decrease) in market value of investment securities 107,233 (429,649) Net loss on sales of investment securities - 2,188 Amortization of premiums (Discount accretion) on investment securities, net (118,659) (106,525) Loss on sale of other real estate owned - - Gain on sale of property, premises, and equipment - - Decrease (increase) in other assets 13,724 (264,922) Increase (decrease) in other liabilities (503,127) 395,477 Net cash used in operating activities 1,184,939 1,998,564 Cash flows from investing activities: Purchase of investment securities (17,433,000) - Proceeds from sales, principal reductions and maturities from investment securities 25,544,613 3,183,898 Increase in time deposits with other banks 194,321 177,255 Net additions to real estate acquired in settlement of loans - - Purchase of insurance policies (269,593) - Increase in loans, net (21,413,994) (26,378,662) Purchase of property, premises and equipment (1,325,616) (265,211) Net cash used in investing activities (14,703,269) (23,282,720) Cash flows from financing activities: Increase (decrease) in deposits, net 8,548,932 26,619,533 Net (decrease) increase in other borrowings (400,000) (2,211,000) Proceeds from exercise of stock options 111,453 85,766 Cash paid in lieu of fractional shares (2,890) (3,923) Net cash provided by (used in) financing activities 8,257,495 24,490,376 Net increase (decrease) in cash and cash equivalents (5,260,835) 3,206,220 Cash and cash equivalents at beginning of year 24,939,179 18,359,073 Cash and cash equivalents at end of period $19,678,344 $21,565,293 Supplemental Disclosures of Cash Flow Information Interest Paid $1,861,571 $2,972,372 Income taxes paid $579,609 $1,020,000 Supplemental Disclosures of Non-Cash Flow Information Change in other comprehensive income $891,688 $1,912,551 Transfer of loans to other estate owned through foreclosure $0 $0 Transfer of held-to-maturity securities to available-for-sale $0 $0
See notes to consolidated financial statements PAGE 6 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY SEPTEMBER 30, 1999 AND SEPTEMBER 30, 2000 (UNAUDITED)
ACCUMULATED OTHER TOTAL SHARES COMMON RETAINED COMPREHENSIVE STOCKHOLDERS' OUTSTANDING STOCK EARNINGS INCOME EQUITY ----------- ------ -------- ------------- ------------- Balance January 1, 1999 1,069,791 $4,470,170 5,154,666 (188,166) 9,436,670 Exercise of Stock Options 21,802 111,453 0 111,453 Cash dividends paid 0 0 0 0 Stock dividend - 4% 42,659 0 Cash paid to Shareholders' in Lieu of fractional shares on 4% Stock Dividend (2,890) (2,890) Comprehensive Income Net Income 956,028 956,028 Unrealized Security Holding Gains `(net of $65,4031 tax) (93,097) (93,097) Less Reclassification Adjustment for Losses (net of $23,125 tax) 28,757 28,757 ------- ------ Total Other Comprehensive Income Total comprehensive Income 891,688 BALANCE SEPTEMBER 30, 1999 1,134,252 $4,581,623 $6,107,804 (252,506) 10,436,921
ACCUMULATED OTHER TOTAL SHARES COMMON RETAINED COMPREHENSIVE STOCKHOLDERS' OUTSTANDING STOCK EARNINGS INCOME EQUITY ----------- ------ -------- ------------- ------------- Balance January 1, 2000 1,144,282 $5,288,179 $5,912,823 ($658,840) $10,542,162 Exercise of Stock Options 20,933 85,766 0 85,766 Cash dividends paid 0 0 0 0 Stock dividend - 5% 57,452 861,780 (861,780) 0 Cash paid to Shareholders' in Lieu of fractional shares on 4% Stock Dividend (3,923) (3,923) Comprehensive Income Net Income 1,673,112 1,673,112 Unrealized Security Holding Gains/(Losses) `(net of $44,167 tax) 240,752 240,752 Less Reclassification Adjustment for Losses (net of $875 tax) (1,313) (1,313) ------- ------- Total other comprehensive Income 1,912,551 BALANCE SEPTEMBER 30, 2000 1,222,667 $6,235,725 $6,720,232 ($419,401) $12,536,556
See notes to consolidated financial statements PAGE 7 Note 1: CONSOLIDATED FINANCIAL STATEMENTS In the opinion of Management, the unaudited consolidated financial statements contain all (consisting of only normal recurring adjustments) adjustments necessary to present fairly Heritage Oaks Bancorp's consolidated financial position at December 31, 1999 and September 30, 2000, and the results of cash flows for the nine months ended September 30, 1999 and 2000 and the results of operations for the three and nine months ended September 30, 1999 and 2000. Certain information and footnote disclosures normally presented in financial statements prepared in accordance with generally accepted accounting principles have been omitted. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1999 Annual Report to shareholders. The results for the three and nine months ended September 30, 1999 and 2000 may not necessarily be indicative of the operating results for the full year. Note 2: INVESTMENT SECURITIES The Company adopted Statement of Financial Accounting Standards (SFAS) No. 115 "Accounting for Certain Investments in Debt and Equity Securities" on January 1, 1994, which addresses the accounting for investments in equity securities that have readily determinable fair values and for investments in all debt securities. Securities are classified in three categories and accounted for as follows: debit and equity 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. Any gains and losses on sales of investments are computed on a specific identification basis. The amortized cost and fair values of investment securities available for sale at September 30, 2000 and December 31, 1999:
SEPTEMBER 30, 2000 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------------ ------------ ---------- ----------- Obligations of U.S. government agencies and corporations $2,425,509 $25,880 ($105,975) $2,345,414 Mortgage-backed securities 8,271,301 1,706 (427,324) 7,845,683 Obligations of State and Political Subdivisions 6,062,415 12,703 (205,991) 5,869,127 Other Securities 8,637 0 0 8,637 ----------- -------- ---------- ----------- TOTAL $16,767,862 $40,289 ($739,290) $16,068,861 ----------- -------- ---------- -----------
DECEMBER 30, 1999 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------------ ------------ ------------ ------------ Obligations of U.S. government agencies and corporations $3,642,261 $0 ($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 0 0 3,800 ----------- ------- ------------ ----------- TOTAL $19,792,155 $7,413 ($1,136,064) $18,663,504 ----------- ------- ------------ -----------
PAGE 8 Note 3: LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES Major classifications of loans were:
DECEMBER 31, SEPTEMBER 30, 1999 2000 ---- ---- Commercial, financial, and agricultural $38,419,611 $42,393,154 Real estate-construction 12,741,477 22,024,748 Real estate-mortgage 50,063,714 61,302,378 Installment loans to individuals 2,786,034 3,284,575 All other loans (including overdrafts) 141,846 143,407 ------- ------- 104,152,682 129,148,262 Less - deferred loan fees (485,474) (463,534) Less - reserve for possible loan losses (1,241,016) (1,396,342) ----------- ----------- Total loans $102,426,192 $127,288,386 ------------ ------------- Loans Held For Sale $120,382 $1,636,850
Concentration of Credit Risk At September 30, 2000, approximately $82,327,126 of the Heritage Oaks Bank's ("Bank") 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. Loans on nonaccrual status totaled $904,773 and $496,173 at December 31, 1999, and September 30, 2000, respectively. Interest income that would have been recognized on non-accrual loans if they had performed in accordance with the terms of the loans was approximately $91,207 and $66,917 for the period ended December 31, 1999 and September 30, 2000, respectively. PAGE 9 Note 3: LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES (CONTINUED) An analysis of the changes in the reserve for possible loan losses is as follows:
DECEMBER 31, SEPTEMBER 30, 1999 2000 ------------ ------------- Balance at beginning of year $1,069,535 $1,241,016 Additions charged to operating expense 165,500 219,000 Loans charged off (14,215) (81,392) Recoveries of loans previously charged off 20,196 17,718 ---------- ----------- Balance at end of period $1,241,016 $1,396,342 ========== ==========
At September 30, 1999, the Bank was contingently liable for letters of credit accommodations made to its customers totaling $780,227 and undisbursed loan commitments in the amount of $29,460,699. 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 conditional 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 loan facilities to customers. The Bank anticipates no losses as a result of such transactions. In accordance with Financial Accounting Standards Board Statement No. 114, "Accounting by Creditors for Impairment of a Loan", the allowance for credit losses related to loans that are identified for evaluation in accordance with Statement 114 is based on discounted cash flows using the loan's initial effect interest rate or the fair value of the collateral for certain collateral dependent loans. Management believes that the allowance for credit losses at September 30, 2000 is prudent and warranted, based on information currently available. However, no prediction of the ultimate level of loans charged-off in future years can be made with any certainty. Note 4: EARNINGS PER SHARE Basic earnings per share are based on the weighted average number of shares outstanding before any dilution from common stock equivalents. Diluted earnings per share includes common stock equivalents from the effect of the exercise of stock options. The total number of shares used for calculating basic and diluted for September 30, 1999 was 1,116,143 and 1,250,723, respectively. The total number of shares used for calculating basic and diluted for September 30, 2000 was 1,222,429 and 1,311,224, respectively. PAGE 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Heritage Oaks Bancorp (the "Company") commenced operations on November 15, 1994 with the acquisition of Heritage Oaks Bank (the "Bank"). Each shareholder of the Bank received one share of stock in the Company in exchange for each share of Heritage Oaks Bank stock owned. The Bank became a wholly owned subsidiary of the Company. The Bank is the only active subsidiary owned by the Company. SUMMARY OF FINANCIAL RESULTS As of September 30, 2000, total consolidated assets of Heritage Oaks Bancorp were $174,097,672 compared to $147,299,268 at December 31, 1999. This reflects an increase of 18.19%. This growth is attributable to continuing positive economic factors along with the opening of a de novo branch office in Arroyo Grande on January 13, 2000. Total cash at September 30, 2000 was $17,065,293. The large cash balance reflects the increased number of branch offices and cash needed to fund the Banks automatic teller machine ("ATM") network. As of September 30, 2000, the Bank was operating approximately 71 ATMs. Total net loans at September 30, 2000 were $127,288,386 compared to $102,426,192 at December 31, 1999. This increase from year-end is the result of branch expansion and the reputation our Bank has established in our new and existing market area. The level of loan growth has decreased on a month-to-month basis from the beginning of the year. No doubt, this is a direct result of the rising interest rate environment over the first nine months of 2000. Management intends to continue its moderate increase in the level of loans outstanding while not compromising underwriting standards. Securities available for sale, which are carried at market value, were $16,068,861 at September 30, 2000 compared to $18,663,504 at December 31, 1999. Securities have decreased through maturity and principal cash flow pay down to supply funds for loan demand. Federal funds sold were $4,500,000 at September 30, 2000 and $1,200,000 at December 31, 1999. Total deposits were $159,581,106 at September 30, 2000 compared to $132,961,573 at December 31, 1999, which represents an increase of PAGE 11 20.02%. The increase in total deposits is primarily attributable to the new branch office, deposits obtained in relationships as the result of new loans and the Bank's favorable reputation within its market areas. Core deposits (time deposits less than $100,000, demand, and savings) gathered in the local communities served by the Bank continue to be the Bank's primary source of funds for loans and investments. Core deposits of $154,533,289 represented 96.8% of total deposits at September 30, 2000. The Company does not purchase funds through deposit brokers. The Company has a $2 million revolving line of credit available with Pacific Coast Bankers Bank. At September 30, 2000, the balance of borrowed funds on this line was $350,000 compared to the same at December 31, 1999. RESULTS OF OPERATIONS The Company reported net income for the NINE MONTHS ended September 30, 2000 of $1,673,112 compared to $956,028 for the same period in 1999. Per share earnings on a diluted basis for September 30, 2000 and September 30, 1999 were $1.28 and $0.76, respectively. Basic per share earnings for September 30, 2000 and September 30, 1999 were $1.37 and $0.86, respectively. Net income for the THREE MONTHS ended September 30, 2000 was $633,538, compared to $435,095 for the same period in 1999. Increased year-to-date earnings are the result of numerous factors. Branch expansion into Santa Maria and Atascadero during the first quarter of 1999 continues to penetrate these relatively new market areas for the Bank. In addition, a full service branch office was opened in January 2000 in the city of Arroyo Grande. Deposits gathered from these new branch offices and growth in existing offices have supplied the necessary liquidity to fund the Banks loan growth. A continued favorable net interest margin along with controlled non-interest expense has fueled increased net income. The following discussion highlights changes in certain items in the consolidated statements of income. NET INTEREST INCOME Net interest income, the primary component of the net earnings of a financial institution, refers to the PAGE 12 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 non-accrual loans, and changes in market interest rates. Net interest income for the NINE MONTHS ended September 30, 2000 was $7,116,398 as compared to $5,264,121 for the same period in 1999. This represents an improvement of $1,852,277 or 35.19%. As a percentage of average earning assets, the net interest margin for the first nine months of 2000 increased to 6.72% from 6.31% from the same period one year earlier. The increase in the net interest margin is due to a combination of higher rates on earning assets as the result of increases to prime during 2000 and a $30,294,000 increase in average interest earning assets and an increase of only $22,179,000 in interest bearing liabilities. This improvement was the result of the banks marketing efforts to attract non-interest bearing demand deposit accounts. The average balance of demand deposits at September 30, 2000 was $45,334,000 compared to $36,413,000 at September 30, 1999. Net interest income for the THREE MONTHS ended September 30, 2000 was $2,565,065 compared to $1, 902,143 for the same period in 1999. This represents an increase of $662,922 or 34.85%. Interest expense for this three month period was $1,076,854 at September 30, 2000 compared to $648,003 at September 30, 1999. Average interest earning assets were $141,194,000 at September 30, 2000 compared to $110,900,000 at September 30, 1999. Average interest-bearing liabilities increased to $105,295,000 at September 30, 2000 from $83,116,000 at September 30, 1999. Average interest rates on interest-bearing liabilities increased from 3.00% for the first nine months of 1999 to 3.77% for the first nine months of 2000. PAGE 13 AVERAGE BALANCE SHEET INFORMATION FOR SEPTEMBER 30, (DOLLARS IN THOUSANDS)
-------------------------------------- ------------------------------------- 1999 2000 AVERAGE AVERAGE YIELD AMOUNT AVERAGE AVERAGE YIELD AMOUNT BALANCE RATE PAID INTEREST BALANCE RATE PAID INTEREST -------------------------------------- ------------------------------------- Interest Earning Assets: Time deposits with other banks $629 4.46% $21 $170 6.29% $8 Investment securities taxable 16,657 5.87% 731 11,438 6.29% 538 Investment securities non-taxable 6,544 4.74% 232 6,142 5.07% 233 Federal funds sold 4,952 4.97% 184 3,206 6.26% 150 Loans (1) (2) 82,118 9.70% 5,958 120,238 10.19% 9,160 -------- ----- -------- ------ Total interest earning assets 110,900 8.59% 7,126 141,194 9.55% 10,089 -------- ----- -------- ------ Allowance for possible loan losses (1,128) (1,293) Non-earning assets: Cash and due from banks 14,560 16,306 Property, premises and equipment 2,767 3,325 Other assets 3,723 4,120 -------- -------- TOTAL ASSETS $130,822 $163,652 ======== ======== Interest-bearing liabilities: Savings/NOW/money market 54,416 2.09% 849 56,596 2.28% 965 Time deposits 27,679 4.63% 958 44,273 5.39% 1,784 Other borrowings 1,021 7.20% 55 4,426 6.74% 223 -------- -- -------- ------ Total interest-bearing liabilities 83,116 3.00% 1,862 105,295 3.77% 2,972 -------- ----- -------- ------ Non-interest bearing liabilities: Demand deposits 36,413 45,334 Other liabilities 1,296 1,492 -------- -------- Total liabilities 120,825 152,121 -------- -------- Stockholders' equity Common stock 4,512 6,235 Retained earnings 5,744 5,933 Valuation Allowance Investments (259) (637) -------- ------- Total stockholders' equity 9,997 11,531 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $130,822 $163,652 ======== ======== Net Interest Income $5,264 $7,117 ------ ====== Net Interest Margin (3) 6.31% 6.72%
(1) NONACCRUAL LOANS HAVE BEEN INCLUDED IN TOTAL LOANS. (2) LOAN FEES OF $349,500 AND $432,073 FOR 1999 AND 2000, 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. PAGE 14 The preceding table sets forth the average balance sheet information, interest income and expense, average yields and rates and net interest income and margin for the nine months ended September 30, 1999 and 2000. NON-INTEREST INCOME Non-interest income consists of bankcard merchant fees, automatic teller machine transactions, and other fees, service charges, and gains on other real estate owned. Non-interest income for the NINE MONTHS ended September 30, 2000 was $4,244,418 compared to $4,283,548 for the same period in 1999. That represents a decrease of $39,130 or 0.91%. Service charge income increased from $552,682 during the first nine months of 1999 to $795,807 for the NINE MONTHS ended September 30, 2000. This increase in service charges is a result of the Bank's additional full service branch offices and subsequent growth in deposit accounts. ATM transaction fees and interchange income were $2,726,207 during the NINE MONTHS ended September 30, 2000 compared to $2,288,089 during the same period for 1999. The Bank receives income for each transaction. While there has been a 19.15% increase in this type of gross revenue, there has been an increase in associated gross expense of 27.02% relating to these transactions. Competition related to the installation of ATM machines has been increasing and while overall this continues to be a viable form of net revenue, profit margins related to the business have narrowed. Approximately 20% of the ATMs are located at gaming sites on Native American lands. In order for non-financial institutions to utilize the various regional, national and international networks, they need a financial institution to sponsor them on these networks. The Bank has entered an agreement with a few non-financial institutions to sponsor them on these networks. The Bank receives a nominal sponsorship fee for each transaction run through the networks. The sponsorship revenue for the nine months ended September 30, 2000 was $14,961 compared to $66,910 for the same period during 1999. For the NINE MONTHS ended September 30, 2000, income from bankcard merchant fees decreased to $86,818 compared to $587,963 for the same period during 1999. However, on September 1, 1999, the Bank divested itself of the liability in the Merchant Bankcard Program and receives a monthly check for a percentage of the NET sales volume of the portfolio. During the first nine months of 1999, gross revenue of $587,963 was offset by gross expense of $549,742 for a net gain of $38,221. Non-interest income for the THREE MONTHS ended September 30, PAGE 15 2000 was $1,480,599 compared to $1,642,641 for the same period in 1999. That represents a decrease of $162,042 or 9.86%. Service charge income was $295,422 for the THREE MONTHS ended September 30,2000 and $198,090 for the same period in 1999. ATM transaction fees and interchange income were $917,548 during the THREE MONTHS ended September 30, 2000 compared to $743,465 during the same period for 1999. The sponsorship revenue for the THREE MONTHS ended September 30, 2000 was $2,802 compared to $22,797 for the same period during 1999. Income from bankcard merchant fees was $31,978 for the three months ended September 30, 2000 compared to $229,822 for the same period during 1999. The accounting for income regarding bankard merchant fees changed as of September 1, 1999 as referred to in the above paragraph. OTHER EXPENSE The Bank opened a de novo branch in Arroyo Grande on January 13, 2000. Other expenses have grown as a result of the additional branch and overall growth of the Bank. Non-interest expense was $8,587,223 and $7,968,654 for the NINE MONTHS ended September 30, 2000 and the same period in 1999, respectively. Salaries and employee benefits expense were $3,134,555 and $2,638,208 for the NINE MONTHS ended September 30, 2000 and 1999, respectively. This represents an increase of $496,347 or 18.8%. Full time equivalent employees were 89 at September 30, 2000 compared to 86 at September 30, 1999. Full time equivalent employees increased by 3.5% while salary and related expense increased by 18.8% The difference in expense is partially attributable to the "Pay for Performance" program implemented by the Bank in 1999 and enhanced in 2000. This program provides for a meaningful sales culture that includes customer referrals, sales, community event attendance and teamwork building exercises. Occupancy and equipment costs grew to $1,262,062 for the NINE MONTHS ended September 30, 2000 from $1,121,958 for the same period of 1999. Expense associated with the ATM network was $1,908,809 and $1,501,790 for the NINE MONTHS ended September 30, 2000 and 1999, respectively. Expense associated with the Merchant Bancard program was $549,742 for the NINE MONTHS ended September 30, 1999 and $0.0 for the same period in 2000 due to the change in accounting effective September 1, 1999. Expense associated with all other non-interest expense categories was $2,281,797 and $2,155,956 for the NINE MONTHS ended September 30, 2000 and 1999, respectively. The increase in other expense reflects increases associated with the growth as a result of the new branch and the overall growth of the Bank. PAGE 16 Non-interest expense was $2,923,978 and $2,831,100 for the THREE MONTHS ended September 30, 2000 and the same period in 1999, respectively. Salaries and employee benefits expense were $1,091,684 and $883,232 for the THREE MONTHS ended September 30, 2000 and 1999, respectively. Occupancy and equipment costs grew to $399,754 for the THREE MONTHS ended September 30, 2000 from $374,704 for the same period of 1999. Expense associated with the ATM network was $632,051 and $537,639 for the THREE MONTHS ended September 30, 2000 and 1999, respectively. Expense associated with the Merchant Bancard program was $171,363 for the THREE MONTHS ended September 30, 1999 and $0.0 for the same period in 2000. Expense associated with all other non-interest expense categories was $800,489 and $864,795 for the THREE MONTHS ended September 30, 2000 and 1999, respectively. LOCAL ECONOMY The Company is located in the Central Coast region of California, primarily in San Luis Obispo County and to a lesser degree in Santa Barbara County. The Central Coast continues to outperform the state with a lower unemployment rate and higher job creation. Due to rising interest rates, there are some signs of weakness in real estate. New permits for both residential and commercial and industrial sites are down. This has translated to a decrease in loan demand in this sector, however, the Company continues to gain market share by virtue of its reputation and presence in six cities within the Central Coast region. The Central Coast has long been a destination point for tourists due to the many desirable sites of wineries, coastal attractions, Hearst Castle, quaintness of the communities and other diversified entertainment. It is expected that with the high cost of gas and oil, many residents in the Los Angeles area will forgo long vacations and visit the Central Coast, thereby increasing tourist revenue to the area. The Bank's branch locations have been strategically placed to ensure a presence to take advantage of the still healthy economy. In addition to the two new full service branches opened in Santa Maria and Atascadero during the first quarter of 1999, the Bank opened a full service branch Arroyo Grande in January 2000. PAGE 17 CAPITAL The Company's total stockholders equity was $12,536,556 at September 30, 2000 compared to $10,542,162 as of December 31, 1999. The increase in capital was from net income of $1,673,112, $85,766 from stock options exercised, ($3,923) for fractional shares from a 5% stock dividend during the first quarter and $239,439 net change in other comprehensive income related to unrealized security holding loss, net of tax. Capital ratios for commercial banks in the United States are generally calculated using nine different formulas. These calculations are referred to as the "Leverage Ratio" and two "risk based" calculations known as: "Tier One 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. Further, 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 average assets of the bank. In the Tier One Risk Based Capital Ratio, the numerator is the same as the leverage ratio, but the denominator is 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 weighing them by a percentage ranging from 0% (lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio again uses "risk-weighted assets" 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. PAGE 18 Summarized below are the bank and company's capital ratios at September 30, 2000:
ADEQUATELY CAPITALIZED HERITAGE HERITAGE REGULATORY OAKS BANK OAKS BANCORP STANDARD Leverage Ratio 4.00% 7.11% 7.57% Tier One Risk Based Capital Ratio 4.00% 8.59% 9.15% Total Risk Based Capital Ratio 8.00% 9.59% 10.14%
It is the intent of Management to maintain adequate capital ratios and achieve "well" capitalized standards for Heritage Oaks Bank by the first quarter of 2001. 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 $5,000,000 and additionally can borrow money through repurchase agreements with two brokerage firms. The Bank utilized the correspondent credit arrangements from time to time throughout 2000 for an average of $382,938 in Fed Funds Purchased. As of July 1999, the Bank became a member of the Federal Home Loan Bank of San Francisco. Certain securities and loans were pledged as collateral during the first quarter of 2000. The average funds borrowed through these facilities during the first nine months of 2000 was $3,273,650. These borrowings have allowed the bank to meet continued strong loan demand that has outpaced deposit growth. The Bank is able to borrow at a rate that does not significantly impact the net interest margin. As of September 30, 2000, the bank has no funds borrowed through these lines. PAGE 19 The Bank manages its liquidity by maintaining a majority of its investment portfolio in federal funds sold and other liquid investments. At September 30, 2000, the ratio of liquid assets to deposits and other liabilities was 13.56%. The ratio of gross loans to deposits, another key liquidity ratio, was 81.0% at September 30, 2000. 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, which 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. In addition, inflation affects the growth of total assets by increasing the level of loan demand, and may potentially adversely affect the Bank's capital adequacy because loan growth in inflationary periods may increase more rapidly than capital. The effect on inflation during the period ended September 30, 2000 has not been significant to the Bank's financial position or result of operations. YEAR 2000 RISKS AND PREPAREDNESS 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. 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. PAGE 20 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. 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. PART 2. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not aware of any legal proceeding against it that will have a material effect on the Company's financial statements. SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED. PAGE 21 HERITAGE OAKS BANCORP DATE: NOVEMBER 2, 2000 S/ LAWRENCE P. WARD -------------------------------------------- LAWRENCE P. WARD PRESIDENT CHIEF EXECUTIVE OFFICER S/ MARGARET A. TORRES -------------------------------------------- MARGARET A. TORRES CHIEF FINANCIAL OFFICER EXECUTIVE VICE PRESIDENT PAGE 22