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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended June 30, 2002

OR

For the transition period from                              to                             

Commission file number 0-25979

WESTERN SIERRA BANCORP
(Exact name of Registrant as specified in its charter)

Registrant's telephone number, including area code: (530) 677-5600

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share

        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 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 ý    No o

        As of July 30, 2002 there were 3,984,941 shares outstanding of the Registrant's common stock.

WESTERN SIERRA BANCORP & SUBSIDIARIES
Index to Form 10-Q

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PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Western Sierra Bancorp and Subsidiaries
Consolidated Balance Sheet
(Unaudited)

See notes to consolidated financial statements.

3

Western Sierra Bancorp and Subsidiaries
Consolidated Statements of Income
(Unaudited)

See notes to consolidated financial statements.

4

Western Sierra Bancorp and Subsidiaries
Consolidated Statement of Cash Flows
(Unaudited)

See notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.    Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements of Western Sierra Bancorp and subsidiaries (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of Management, all adjustments (which consist solely of normal recurring accruals) considered necessary for a fair presentation of the results for the interim periods presented have been included. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company's 2001 Annual Report to Shareholders.

        The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Western Sierra National Bank (WSNB), Lake Community Bank (LCB), Central California Bank (CCB), Western Sierra Statutory Trust I and Western Sierra Statutory Trust II. All significant inter-company balances and transactions have been eliminated. Operating results for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. Certain amounts in the consolidated financial statements for the year ended December 31, 2001 may have been reclassified to conform to the presentation of the consolidated financial statements in 2002.

2.    Earnings per Share

        Basic earnings per share (EPS), which excludes dilution, is computed by dividing net income 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, such as stock options, result in the issuance of common stock which shares in the earnings of the Company. Earnings per share is retroactively adjusted for stock dividends for all periods presented. A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows (dollars in thousands, except for per share data).

3.    Stock Repurchase Plan

        On May 29, 2002, the Company announced that its' Board of Directors approved a plan to repurchase up to 5% (or approximately 200,000 shares) of the Company's common stock. The Company did not purchased any shares under the plan through June 30, 2002. From July 1, 2002

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through August 12, 2002, the Company purchase 5,000 shares at an average price of approximately $21.00.

4.    Acquisition of Central California Bank

        On April 1, 2002, pursuant to the Agreement and Plan of Reorganization dated November 15, 2001, Central California Bank ("Central") was acquired by the Company through a merger and tax-free reorganization whereby Central became a wholly-owned subsidiary of the Company. The Company believes that its shareholders will benefit from the merger because the business potential for the combined companies exceeds what each company could accomplish individually. Both the Company and Central provide similar and complementary financial products and services in the Northern California market. As of March 31, 2002, Central had $68.1 million in total assets, $46.7 million in net loans, and $62.9 million in deposits.

        The total consideration paid to Central's shareholders was approximately $8.6 million, which was comprised of $3.6 million in cash and approximately 252,271 shares of the Company's common stock valued at approximately $5.0 million based on the market value of the Company's stock. The funds required to pay the cash portion of the consideration were obtained by the Company through the issuance of $10 million of trust preferred securities in December 2001 (Western Sierra Statutory Trust II). The accompanying unaudited consolidated financial statements include the accounts of Central since April 1, 2002.

        The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. As of June 30, 2002, the allocation of the purchase price is preliminary as not all estimations have been finalized. The excess of the purchase price over the estimated fair value of the net assets acquired was $2.4 million, which was recorded as goodwill. Assets acquired included a core deposit intangible of $1.9 million that will be amortized using the straight-line method over a period of ten years. Prospectively, goodwill will be evaluated for possible impairment under the provisions of SFAS No. 142. Based upon an initial evaluation as of June 30, 2002, no impairment exists. In Management's opinion, the goodwill in this transaction arose from the synergies associated with the merger.

        The following supplemental pro forma information discloses selected financial information for the periods indicated as though the merger had been completed as of the beginning of each of the periods being reported. Pro forma net income for the six months ended June 30, 2002 includes a nonrecurring charge of approximately $425,000, on an after-tax basis, representing Central's merger-related expenses and the cost of retiring the outstanding stock options of Central at March 31, 2002. Dollars are in thousands except per share data.

5.    Recent Accounting Pronouncements

        In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS 141, Business Combinations. This Statement addresses financial accounting and reporting for business combinations, which are to be accounted for using a single method—the purchase method. In addition, this Statement requires that intangible assets be recognized as assets apart from goodwill if they meet one of two criteria—the contractual-legal criterion or the separability criterion. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all

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business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later.

        In June 2001, the FASB issued SFAS 142, Goodwill and Other Intangible Assets. This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets. Goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested annually for impairment. Intangible assets that have finite useful lives continue to be amortized over their useful lives, but without the constraint of an arbitrary ceiling. Because goodwill and other intangible assets will no longer be amortized, the reported amounts of goodwill and intangible assets will not decrease at the same time and in the same manner as under previous standards. The provisions of this Statement are required to be applied starting with the years beginning after December 15, 2001. However, goodwill and intangible assets acquired after June 30, 2001, will be subject immediately to the provisions of this Statement.

        The FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, in July 2002. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. Previous accounting guidance was provided by Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Statement 146 replaces Issue 94-3 and is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. In Management's opinion, the adoption of this statement will not have a material impact on the Company's financial position or results of its operations.

5.    COMPREHENSIVE INCOME

        Comprehensive income includes net income and other comprehensive income. The Company's only sources of other comprehensive income are derived from unrealized gains and losses on investment securities available-for-sale. Reclassification adjustments resulting from gains or losses on investment securities that were realized and included in net income of the current period that also had been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose are excluded from comprehensive income of the current period. The Company's total comprehensive income was as follows:

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

Private securities litigation reform act safe harbor statement

        This quarterly report on Form 10-Q includes forward-looking information, which is subject to the "safe harbor" created by the Securities Act of 1933, and Securities Act of 1934. These forward-looking statements (which involve the Company's plans, beliefs and goals) involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors:

1.

Competitive pressure in the banking industry and changes in the regulatory environment.



2.

Changes in the interest rate environment and volatility of rate sensitive deposits.



3.

Decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company's loans.



4.

Credit quality deterioration that could cause an increase in the provision for loan losses.



5.

Asset/Liability matching risks and liquidity risks.



6.

Volatility and devaluation in the securities markets.

        For additional information concerning risks and uncertainties related to the Company and its' operations please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 under the heading "Forward-Looking Information". Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

        The following sections discuss significant changes and trends in financial condition, capital resources and liquidity of the Company from December 31, 2001 to June 30, 2002. Also discussed are significant trends and changes in the Company's results of operations for the three months and six months ended June 30, 2002, compared to the same periods in 2001. The consolidated financial statements and related notes appearing elsewhere in this report are condensed and unaudited.

General

        Western Sierra Bancorp (the "Company") was incorporated under the laws of the State of California on July 11, 1996. The Company was organized pursuant to a plan of reorganization for the purpose of becoming the parent corporation of Western Sierra National Bank, and on December 31, 1996, the reorganization was effected and shares of the Company's common stock were issued to the shareholders of Western Sierra National Bank for the common shares held by Western Sierra National Bank's shareholders.

        In April 1999, the Company acquired Roseville 1st National Bank and Lake Community Bank in a stock for stock exchange. In May of 2000, the Company acquired Sentinel Community Bank in a stock for stock exchange. All of these mergers were accounted for as a pooling of interests and, accordingly, all prior period financial statements have been restated to reflect the combined operations of the Company, Roseville 1st National Bank, Lake Community Bank and Sentinel Community Bank. Sentinel Community Bank was immediately merged into Western Sierra National Bank. In May of 2000, Roseville 1st National Bank was also merged into Western Sierra National Bank.

        In April 2002, the Company acquired Central California Bank for $3.6 million in cash and 252,000 shares of the Company's stock. This transaction was accounted for under purchase accounting, which

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resulted in a preliminary purchase price allocation of $1.8 million in goodwill and $1.9 million in core deposit premium intangible assets. As required under purchase accounting, no prior period financial statements have been restated to reflect the combined operations of Central California Bank.

        The Company is a registered bank holding company under the Bank Holding Company Act. The Company conducts its operations at 4080 Plaza Goldorado Circle, Cameron Park, California 95682.

        Western Sierra National Bank was organized under national banking laws and commenced operations as a national bank on January 4, 1984. Western Sierra National Bank is a member of the Federal Reserve System and the FDIC insures its deposits to the maximum amount permitted by law. Western Sierra National Bank's head office is located at 4080 Plaza Goldorado Circle, Cameron Park, and its branch offices are located at 4011 Plaza Goldorado, Cameron Park, 2661 Sanders Drive, Pollock Pines, 3970 J Missouri Flat Road, Placerville, 1450 Broadway, Placerville, 3880 El Dorado Hills Blvd., El Dorado Hills, 571 5th Street, Lincoln, 1545 River Park Dr. #101 & #200, Sacramento, 229 South Washington Street, Sonora, 13753-A Mono Way, Sonora, 18711 Tiffeni Drive, Twain Harte, 1801 Douglas Blvd., Roseville, 6951 Douglas Blvd., Granite Bay, 22712 Main Street, Columbia,. Western Sierra National Bank does not have any other affiliates other than Sentinel Associates, Inc., an inactive entity formed by Sentinel Bank in 1983 to develop single-family residential real estate.

        Roseville 1st National Bank was founded in 1983 as Countryside Thrift and Loan (Countryside). Countryside operated as an industrial loan company until its conversion to a national bank on July 1, 1992. Roseville 1st National Bank was merged into Western Sierra National Bank in May of 2000, and operates as a DBA Roseville 1st National Bank—a branch of Western Sierra National Bank.

        Sentinel Community was incorporated under the laws of the State of California on December 24, 1980, and commenced operations on April 2, 1982. The corporation was formed as a State Chartered Savings and Loan Association. Sentinel Community converted its charter to a Federal Savings and Loan Association on June 9, 1989. In October of 1996, Sentinel Community changed its name to Sentinel Community Bank, while remaining chartered as a Federal Savings and Loan Association. Sentinel Community Bank was merged into Western Sierra National Bank in May 2000, and operates as a DBA Sentinel Community Bank—a branch of Western Sierra National Bank

        Lake Community Bank was incorporated as a banking corporation under the laws of the State of California on March 9, 1984 and commenced operations as a California state-chartered bank on November 15, 1984. Lake Community Bank is an insured bank under the Federal Deposit Insurance Act and is not a member of the Federal Reserve System. Lake Community Bank engages in the general commercial banking business in Lake County in the State of California from its headquarters banking office located at 805 Eleventh Street, Lakeport, California, and its branch located at 4280 Main Street, Kelseyville, California. Lake Community Bank does not have any affiliates or subsidiaries.

        Central California Bank was incorporated under the laws of the State of California on January 13, 1997, and commenced operations on April 24, 1998. Central California Bank is an insured bank under the Federal Deposit Insurance Act and is not a member of the Federal Reserve System. Central California Bank engages in the general commercial banking business in Tuolumne and Stanislaus Counties in the State of California from its headquarters banking office located at 14685 Mono Way, Sonora, California, and its branches located at 181 S. Washington St., Sonora, CA, 400 E. Olive Ave, Turlock, CA 3700 Lone Tree Way, Antioch, CA and a loan production office located at 3400 Tully Rd., #B, Modesto, CA. Central California does not have any affiliates or subsidiaries.

        Banking Services.    The Company is a locally owned and operated bank holding company, and its primary service area is the Northern California communities of Cameron Park, Pollock Pines, Placerville, El Dorado Hills, Lincoln, Sacramento, Roseville, Granite Bay, Sonora, Twain Harte, Columbia, Lakeport, Antioch and the surrounding communities. The Company's primary business is servicing the banking needs of these communities and its marketing strategy stresses its local ownership

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and commitment to serve the banking needs of individuals living and working in the Company's primary service areas and local businesses, including retail, professional and real estate-related activities, in those service areas.

        The Company offers a broad range of services to individuals and businesses in its primary service areas with an emphasis upon efficiency and personalized attention. The Company provides a full line of consumer services and also offers specialized services, such as courier services to small businesses, middle market companies and professional firms. Each of the Company's subsidiary banks offers personal and business checking and savings accounts (including individual interest-bearing negotiable orders of withdrawal ("NOW"), money market accounts and/or accounts combining checking and savings accounts with automatic transfer), IRA accounts, time certificates of deposit and direct deposit of social security, pension and payroll checks, computer cash management and internet banking including bill payment. The Company's subsidiary banks also make available commercial, construction, accounts receivable, inventory, automobile, home improvement, real estate, commercial real estate, single family mortgage, agricultural, Small Business Administration, office equipment, leasehold improvement, installment and credit card loans (as well as overdraft protection lines of credit), issue drafts and standby letters of credit, sell travelers' checks (issued by an independent entity), offer ATMs tied in with major statewide and national networks, extend special considerations to senior citizens and offer other customary commercial banking services.

        Most of the Company's deposits are obtained from commercial businesses, professionals and individuals. There is no concentration of deposits or any customer with 5% or more of any of the subsidiary banks' deposits. At June 30, 2002, the Company's largest customer was a title company that had $23.2 million on deposit with Western Sierra Bank or approximately 4.1% of the Company's total deposit balances.

        Other special services and products include both personal and business economy checking products, business cash management products and mortgage products and services.

        Employees.    At June 30, 2002, the Company and its subsidiaries employed 204 persons on a full-time equivalent basis. The Company believes its employee relations are excellent.

Financial Condition

        The Company increased total assets from $510.6 million at December 31, 2001 to $650.8 million at June 30, 2002, an increase of $140.1 million or 27%. The two primary components of asset growth were Loans, which grew $89.4 million, and Federal Funds, which increased $32.9 million. Asset growth was primarily funded by growth in deposits of $119.8 million and growth in other borrowings of $9.6 million.

        A portion of the growth the Company has experienced since December 31, 2001 was a result of the acquisition of Central California Bank in April 2002. Pursuant to purchase accounting, this acquisition contributed approximately $48 million in loans, $68 million in total assets and $62 million in deposits. These balances are not reflected in the Company's December 31, 2001 balance sheet—had they been included, the Company's "organic" asset growth would have been approximately $72 million or an increase of 14% during the six months ended June 30, 2002.

Results of Operations

        NOTE: The Central California Bank ("CCB") acquisition effective April 1, 2002 was accounted for under purchase accounting. Pursuant to purchase accounting rules, the operating results below include the effect of this acquisition for the three months ended June 30, 2002, but prior periods have not been restated to reflect CCB's operating results during those periods. Please refer to the proforma operating table in footnote 4 of the consolidated financial statements.

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        The Company reported net income of $1.96 million for the three months ended June 30, 2002 (or $0.47 per share, diluted) compared to $1.32 million (or $0.34 per share, diluted) for the same period in 2001. The quarterly earnings represent an increase of $644,000 or a 49% increase in net income and a 38% increase in diluted earnings per share.

        The Company reported net income of $3.77 million for the six months ended June 30, 2002 (or $0.95 per share, diluted) compared to $2.45 million (or $0.63 per share, diluted) for the same period in 2001. The six-month earnings represent an increase of $1.32 million or a 53% increase in net income and a 51% increase in diluted earnings per share. The primary factors contributing to the increase in operating results during the second quarter of 2002 and six months ended June 30, 2002 as compared to the second quarter of 2001 and six months ended June 30, 2001 include:

1.

An increase in net interest income of $2.05 million or 39% over the same quarter in the previous year and by $3.04 million or 29% year-to-date over the same period in the previous year. The net increase in both periods is due to an overall increase in average earning assets, including approximately $65 million in earning assets acquired in the CCB transaction, and a shift to higher yielding assets (primarily loans) from lower yielding assets (primarily Federal funds). Additionally, there was a transition from higher paying liabilities (primarily certificates of deposit) to lower paying or non-interest paying liabilities (primarily savings and demand deposit accounts).



2.

An increase in other income, primarily service fees on deposit accounts and gains on the sale and packaging of residential mortgage loans. Other income increased $238,000 or 16% and $640,000 or 25% over the second quarter and year-to-date totals in the previous years. These increases are primarily due to a program initiated in late 2001 which raised the banks' service fees to market level, more successful collection of these fees and a decreasing interest rate environment which has resulted in borrowers refinancing home mortgage loans. These long-term (greater than five years) first deeds of trust are generally not held on the subsidiary banks' books, but are sold off, generally at a gain, in the secondary mortgage market.



3.

The Company has decreased its effective tax rate by deploying a series of tax strategies including the purchase of tax-exempt municipal bonds, lending within enterprise zones and the establishment of a real estate investment trust ("REIT") in the first quarter of 2002. These strategies have lowered the Company's effective tax rate to 27.7% and 28.4% in the three and six-month periods ended June 30, 2002 as compared to 36.4% and 37.0% in 2001. This has resulted in tax savings of $235,000 and $453,000 in the three and six-month periods ended June 30, 2002 as compared to the same periods in 2001.

        The factors above were offset in part by:

1.

An increase in loss provisions of $280,000 and $590,000 in the quarter ended June 30, 2002 and the six months ended June 30, 2002, respectively, as compared to the same periods in 2001. Additional provisions were recorded as a result of growth in loans outstanding. The percentage of loan loss reserves to gross loans fell just .01% to 1.33% at June 30, 2002 as compared to 1.34% at June 30, 2001.



2.

Total operating expenses increased $1.36 million or 31% and $1.71 million or 20% in the quarter and six months ended June 30, 2002, respectively. The increase in operating expenses was a result of the Central California Bank costs absorbed as the entity was consolidated and costs associated with growth and general expansion in the Company's market place. Included in operating expenses was amortization of core deposit and other intangibles of $62,000 and $76,000 in the quarter and six months ended June 30, 2002 as compared to $14,000 and $29,000 in the same periods in 2001.

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Net Interest Income (Tax Equivalent Yield Basis)

        Net interest income is the primary source of income for the Company and represents the excess of interest and fees earned on interest-earning assets (loans, investments and Federal funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets.

        For the three months ended June 30, 2002, interest income on a tax equivalent basis increased by $1.03 million or 11.6% over the same period in 2001. Interest expense on deposit accounts and borrowings decreased $1.09 million or 30% over the same three-month period ended June 30, 2001. Average earning assets yielded (on a fully tax equivalent basis) 7.15% versus 8.18% a year ago, partly offset by a decrease in cost of funds where the average cost of funds decreased to 2.29% from 4.15% a year ago. Net interest margin increased 48 basis points to 5.36% from 4.88% for the same period a year ago.

        For the six months ended June 30, 2002, interest income on a tax equivalent basis increased by $189,000 or 1% over the same period in 2001. Interest expense on deposit accounts and borrowings decreased $2.98 million or 38% over the same six-month period ended June 30, 2001. Average earning assets yielded 7.19% versus 8.26% a year ago, partly offset by a decrease in cost of funds where the average cost of funds decreased to 2.35% from 4.41% a year ago. Net interest margin increased 58 basis points to 5.33% from 4.75% for the same period a year ago.

        Improvement in net interest margin was also driven by growth in non interest demand deposits ("DDA's"). Non-interest DDA's averaged $120 million in the quarter and $108 million for the six months ended June 30, 2002 as compared to $85 million and $84 million for the three and six month period in 2001. Central California Bank's contributed $20 million in average balances noninterst DDA balances during the second quarter of 2002.

        The following tables set forth the Company's daily average balance sheet, related interest income or expense and yield or rate paid for the periods indicated.

        Tax-exempt investment yields have been adjusted to a tax-equivalent yield basis, based on a 27.7% average tax rate in 2002 and a 36.4% average tax rate in 2001 (dollars in thousands).

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Average Balances, Interest Income/Expense and Yields/Rates Paid

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        Tax-exempt investment yields have been adjusted to a tax-equivalent yield basis, based on a 28.4% average tax rate in 2002 and a 37.0% tax rate in 2001 (dollars in thousands).

        The following tables set forth changes in interest income and expense for each major category of earning assets and interest-bearing liabilities, and the amount of change attributable to volume and rate

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changes for the periods indicated. Changes attributable to rate/volume have been allocated to volume changes (dollars in thousands).

Analysis of Changes in Net Interest Income

Non-interest Income

        The Company's non-interest income consists of service charges on deposit accounts, and other service fees, mortgage loan origination and processing fees and proceeds from the sale of investment securities.

        For the three months ended June 30, 2002, total non-interest income increased $238,000 (or 16%) over the same period in 2001. For the six months ended June 30, 2002, total non-interest income grew $640,000 or 25% over the same period in 2001. Included in the second quarter 2001 results was a gain of $135,000 from the sale of available-for-sale investment securities realized during the second quarter of 2001. No investment gains have been realized in 2002.

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        Service fee income rose $260,000 or 58% in the second quarter of 2002 versus the second quarter of 2001 and $469,000 or 53% over the six months ended June 30, 2002. These increases are primarily due to a program initiated in late 2001 that raised the subsidiary banks' service fees to market level and the more successful collection of these fees.

        In addition, income from mortgage loan origination and packaging fees increased $200,000 or 31% in the second quarter and $465,000 or 40% in the first six months of 2002 as compared to 2001. The increase was primarily a result of: 1) an increase in number of refinances (due to a decrease in interest rates), 2) an increase in first mortgages for home buyers as interest rates are at historic lows, 3) an increase in market share due to expansion of loan staff and marketing and 4) expansion of mortgage product line.

Non-interest Expense

        Non-interest expenses consist of salaries and related employee benefits, occupancy and equipment expenses, data processing fees, professional fees, directors' fees, merger and acquisition costs and other operating expenses. For the three months ended June 30, 2002, non-interest expense increased $1.36 million or 31% over the same period in 2001. For the six months ended June 30, 2002, non-interest expense increased $1.71 million or20% over the same period in 2001.

        Salary and benefits increased $698,000 or 31% over the same three-month period last year. This increase was due primarily to the integration of the Central California bank employees into the Company's operation, the increase in commissions related to the increased income on mortgage loan origination and packaging fees and the implementation of new company-wide incentive programs. These expenses for the six-month period ended June 30, 2002 increased $915,000 thousand or 20% over the same period in the prior year for similar reasons.

        The following table sets forth a summary of non-interest expense for the periods indicated (dollars in thousands):

Income Taxes

        The following table reflects the Company's tax provision and the related effective tax rate for the periods indicated (dollars in thousands):

        The Company's effective tax rate varies with changes in the relative amounts of its non-taxable income and non-deductible expenses. The Company's tax provision is attributable to increases in the

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Company's net income and the relative amount of tax-exempt income. The Company has decreased its effective tax rate in 2002 by deploying a series of tax strategies including the purchase of tax-exempt municipal bonds, the funding of enterprise zone loans and the establishment of a real estate investment trust ("REIT") in the first quarter of 2002. These strategies have lowered the Company's effective tax rate to 27.7% and 28.4% for the three and six-month periods ended June 30, 2002 as compared to 36.4% and 37.0% in 2001. This has resulted in tax savings of $235,000 and $453,000 in the three and six-month periods ended June 30, 2002 as compared to the same periods in 2001.

Asset Quality

        The Company concentrates its lending activities primarily within areas directly serviced by branches as previously discussed.

        The Company manages its credit risk through diversification of its loan portfolio and the application of underwriting policies and procedures and credit monitoring practices. Although the Company has a diversified loan portfolio, a significant portion of its borrowers' ability to repay their loans is dependent upon the professional services and residential real estate development industry sectors. Generally, the loans are secured by real estate or other assets and are expected to be repaid from the cash flows of the borrower or proceeds from the sale of collateral.

        The following table sets forth the amounts of loans outstanding by category as of the dates indicated (dollars in thousands):

        The following table sets forth a summary of the Company's nonperforming assets as of the dates indicated (dollars in thousands):

        The Company's non-accrual loans decreased from $2.7 million to $1.3 million in the first six months of 2002. The Company's "coverage ratio" or the ratio of allowance for loan and lease losses to non-accrual loans increased from 1.77 to 4.95 during the first six months of 2002. The Company carries

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real estate owned (acquired through foreclosure) at what Management currently believes to be market value. The Company expects to dispose of the properties held at June 30, 2002 by December 31, 2002.

Allowance for Loan and Lease Losses (ALLL)

        The Company makes provisions to the ALLL on a regular basis through charges to operations that are reflected in the Company's statements of income as a provision for loan and lease losses. When a loan or lease is deemed uncollectible, it is charged against the allowance. Any recoveries of previously charged-off loans are credited back to the allowance. There is no precise method of predicting specific losses or amounts that ultimately may be charged-off on particular categories of the loan portfolio.

        Accordingly, the adequacy of the ALLL and the level of the related provision for possible loan and lease losses is determined on a judgment basis by Management based on consideration of (i) economic conditions, (ii) borrowers' financial condition, (iii) loan impairment, (iv) evaluation of industry trends, (v) industry and other concentrations, (vi) loans which are contractually current as to payment terms but demonstrate a higher degree of risk as identified by Management, (vii) continuing evaluation of the performing loan portfolio, (viii) monthly review and evaluation of problem loans identified as having loss potential, (ix) quarterly review by the Board of Directors, (x) assessments by regulators and other third parties. Management and the Board of Directors evaluate the ALLL and determine its desired level considering objective and subjective measures, such as knowledge of the borrowers' business, valuation of collateral, the determination of impaired loans or leases and exposure to potential losses.

        The ALLL is a general reserve available against the total loan and lease portfolio. It is maintained without any inter-allocation to the categories of the loan portfolio, and the entire allowance is available to cover loan and lease losses. While Management uses available information to recognize possible losses on loans and leases, future additions to the allowance may be necessary, based on changes in economic conditions and other matters. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's ALLL. Such agencies may require the Company to provide additions to the allowance based on their judgment of information available to them at the time of their examination.

        The ALLL should not be interpreted as an indication that charge-offs in future periods will occur in the stated amounts or proportions.

        The adequacy of the ALLL calculation is based on three components. First is the dollar weighted risk rating of the loan portfolio, including all outstanding loans and leases. Every extension of credit has been assigned risk rating based upon a comprehensive definition intended to measure the inherent risk of lending money. Each rating has an assigned risk factor expressed as a reserve percentage. Secondly, established specific reserves are assigned to individual loans currently on the Company's Problem Loan Reports. These are estimated potential losses associated with specific borrowers based upon collateral value and event(s) causing the risk rating. Thirdly, the Company maintains an unallocated reserve for qualitative factors that may affect the portfolio as a whole, such as those factors described above, including model imprecisions.

        Management believes the assigned risk grades and methods for managing changes in assigned risk grades are satisfactory.

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        The following table summarizes the activity in the ALLL for the periods indicated (dollars in thousands):