HARRINGTON WEST FINANCIAL GROUP INC/CA - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004


o		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: 000-50066

HARRINGTON WEST FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)


Delaware		48-1175170
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

610 Alamo Pintado Road
Solvang, California
(Address of principal executive offices)

93463
(Zip Code)

(805) 688-6644
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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 þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes o No þ

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

5,278,934 shares of Common Stock, par value $0.01 per share, outstanding as of November 5, 2004.

PART 1-FINANCIAL INFORMATION

Item 1: Condensed Consolidated Financial Statements

HARRINGTON WEST FINANCIAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(Dollars in thousands, except share data)


	September 30, 2004			December 31, 2003
ASSETS
Cash and cash equivalents	$	15,873		$	22,856
Trading account assets (including assets pledged of $1,322 and $1,447, respectively)		1,904			2,111
Securities available for sale (including assets pledged of $218,024 and $160,599, respectively)		431,503			398,691
Securities held to maturity		121			222
Loans receivable, (net of allowance for loan losses of $5,128 and $4,587 at September 30, 2004 and December 31, 2003, respectively)		598,070			518,496
Accrued interest receivable		3,199			2,928
Premises and equipment, net		7,581			6,454
Prepaid expenses and other assets		2,339			1,867
Investment in FHLB stock, at cost		14,570			13,425
Deferred tax asset		2,337			2,651
Goodwill		3,981			3,981
Core deposit intangible, net		972			1,117

TOTAL ASSETS	$	1,082,450		$	974,799

LIABILITIES & STOCKHOLDERS’ EQUITY
Deposits:
Interest bearing	$	577,511		$	541,533
Non-interest bearing		35,411			29,164

Total Deposits		612,922			570,697
FHLB advances		298,000			262,500
Securities sold under repurchase agreements		80,090			65,728
Subordinated debt		25,774			15,464
Due to broker		5,696			—
Accounts payable and accrued expenses		8,677			11,623
Income taxes payable		967			711

TOTAL LIABILITIES		1,032,126			926,723

STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value: 1,000,000 shares authorized: none issued and outstanding
Common stock, $.01 par value; 9,000,000 shares authorized: 5,278,934 and 5,206,109 shares issued and outstanding as of September 30, 2004 and December 31, 2003, respectively		53			43
Additional paid-in capital		31,225			30,710
Retained earnings		21,979			20,082
Accumulated other comprehensive (loss), net of tax of $(119) and $(2,024) at September 30, 2004 and December 31, 2003, respectively		(2,933	)		(2,759	)

Total Stockholders’ Equity		50,324			48,076

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	1,082,450		$	974,799

The accompanying notes are an integral part of these condensed statements.

-2-

HARRINGTON WEST FINANCIAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

Dollars in thousands, except share data


	Three months ended						Nine months ended
	September 30,						September 30,
	2004			2003			2004			2003
INTEREST INCOME
Interest on loans	$	9,182		$	8,458		$	26,526		$	24,589
Interest and dividends on securities		4,089			3,393			11,720			9,926

Total interest income		13,271			11,851			38,246			34,515

INTEREST EXPENSE
Interest on deposits		2,705			2,555			7,761			7,866
Interest on FHLB advances and other borrowings		3,141			2,410			8,523			7,269

Total interest expense		5,846			4,965			16,284			15,135

NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES		7,425			6,886			21,962			19,380
PROVISION FOR LOAN LOSSES		230			100			550			710

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		7,195			6,786			21,412			18,670

OTHER INCOME (LOSS)
Income from trading assets		264			380			875			2,249
Loss on extinguishment of debt		(0	)		(187	)		(189	)		(1,610	)
Other income (loss) gain		(35	)		(2	)		(47	)		47
Banking fee income		734			1,036			2,342			3,260

Total other income		963			1,227			2,981			3,946

OTHER EXPENSES
Salaries & employee benefits		2,589			2,521			7,977			7,545
Premises & equipment		811			679			2,276			2,003
Insurance premiums		128			209			397			359
Marketing		83			103			312			315
Computer services		184			162			507			488
Consulting fees		274			234			854			716
Office expenses & supplies		215			172			641			533
Other		544			499			1,476			1,385

Total other expenses		4,828			4,579			14,440			13,344

INCOME BEFORE INCOME TAXES		3,330			3,434			9,953			9,272
INCOME TAXES		1,351			1,436			3,935			3,859

NET INCOME	$	1,979		$	1,998		$	6,018		$	5,413

BASIC EARNINGS PER SHARE	$	0.38		$	0.38		$	1.15		$	1.04

DILUTED EARNINGS PER SHARE	$	0.35		$	0.37		$	1.08		$	1.00

BASIC WEIGHTED AVERAGE SHARES OUTSTANDING		5,276,774			5,194,411			5,248,339			5,193,930

DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING		5,622,519			5,472,539			5,589,300			5,424,126

The accompanying notes are an integral part of these condensed statements.

-3-

HARRINGTON WEST FINANCIAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands, except share data)


													Accumulated
					Additional								Other			Total
	Common Stock				Paid-in		Retained			Comprehensive			Comprehensive			Stockholders'
	Stock		Amt		Capital		Earnings			Income			Income			Equity
Balance, January 1, 2003 (1)		4,327,951	$	43	$	30,641	$	13,795					$	(2,007	)	$	42,472
(Note 2)
Comprehensive income:
Net income								7,413		$	7,413						7,413
Other comprehensive income, net of tax Unrealized (losses) on securities											(1,245	)		(1,245	)		(1,245	)
Effective portion in change in fair value of cash flow hedges											493			493			493

Total comprehensive income										$	6,661

Stock options		10,500		—		69											69
Dividends on common stock								(1,126	)								(1,126	)

Balance, December 31, 2003		4,338,451		43		30,710		20,082						(2,759	)		48,076
Comprehensive income:
Net income								6,018		$	6,018						6,018
Other comprehensive income, net of tax Unrealized (losses) on securities											(164	)		(164	)		(164	)
Effective portion in change in fair value of cash flow hedges											(10	)		(10	)		(10	)

Total comprehensive income										$	5,844

Stock dividend — 6 for 5 stock split (Note 2)		867,658		9													9
Stock options exercised		72,825		1		515											516
Dividends on common stock								(4,121	)								(4,121	)

Balance, September 30, 2004		5,278,934	$	53	$	31,225	$	21,979						($2,933	)		50,324

(1) Previous year outstanding common stock has not been revised to reflect the 6 for 5 stock split (see Note 2)

The accompanying notes are an integral part of these condensed statements.

-4-

HARRINGTON WEST FINANCIAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (Unaudited)
(Dollars in thousands)


	Nine months ended
	September 30,
	2004			2003
DISCLOSURE OF RECLASSIFICATION AMOUNT:
Unrealized holding (loss) arising during period, net of tax (benefit) expense of $(391) and $(835) for the nine-months ending September 30, 2004 and 2003, respectively	$	(570	)	$	(1,333	)
Less: Reclassification adjustment for gains included in net income, net of tax (benefit) expense of $(279) and $595 for the nine months ending September 30, 2004 and 2003, respectively		(406	)		(839	)

Net unrealized (loss) on securities, net of tax (benefit) of $(112) and $(1,430) for the nine months ending, September 30, 2004 and 2003, respectively	$	(164	)	$	(494	)

Unrealized net (loss) on cash flow hedges, net of tax (benefit) of $(61) and $(320) for the nine months ending September 30, 2004 and 2003, respectively	$	(89	)	$	(448	)
Less: Reclassification adjustment for net gains on cash flow hedges included in net income, net of tax (benefit) of $(54) and $8 for the nine months ending September 30, 2004 and 2003, respectively.		(79	)		(12	)

Net unrealized loss on cash flow hedges, net of tax (benefit) of $(7) and $(312) for the nine months ending September 30, 2004 and 2003, respectively	$	(10	)	$	(460	)

The accompanying notes are an integral part of these condensed statements.

-5-

HARRINGTON WEST FINANCIAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)


	Nine months ended			Nine months ended
	September 30,			September 30,
	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	6,018		$	5,413
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of deferred loan fees and costs		211			(1,493	)
Depreciation and amortization		839			802
Amortization of premiums and discounts on loans receivable and securities		2,218			3,352
Provision for loan losses		550			710
(Gain) on sale of investment securities		(685	)		(1,455	)
Activity in securities held for trading		204			(14	)
FHLB stock dividend		(423	)		(434	)
(Increase) decrease in accrued interest receivable		(271	)		569
Increase (decrease) in income taxes payable		256			626
Increase (decrease) in deferred income taxes		314			(730	)
(Increase) in prepaid expenses and other assets		(472	)		(401	)
Increase in accounts payable		108			5,616

Net cash provided by operating activities		8,867			12,561

CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) in loans receivable		(80,619	)		(55,850	)
Proceeds from sales of securities available for sale		26,604			30,757
Principal paydowns on securities available for sale		71,380			119,494
Principal paydowns on securities held to maturity		102			55
Purchases of securities available for sale		(132,198	)		(172,588	)
Purchase of premises and equipment		(1,836	)		(2,070	)
(Purchase) of FHLB Stock		(722	)		(986	)

Net cash used in investing activities		(117,289	)		(81,188	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		42,240			14,906
Increase in securities sold under agreements to repurchase		14,362			65,376
Increase (decrease) in FHLB advances		35,500			(17,500	)
(Payments) on note payable					(11,300	)
Increase trust preferred securities		10,310			15,000
Exercise of stock options on common stock		515			69
Dividends paid on common stock		(1,488	)		(692	)

Net cash provided by financing activities		101,439			65,859

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(6,983	)		(2,768	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		22,856			19,212

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	15,873		$	16,444

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION -
Cash paid during the period for:
Interest	$	13,254		$	12,422
Income Taxes	$	3,502		$	3,301

The accompanying notes are an integral part of these condensed statements.

-6-

HARRINGTON WEST FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business of the Company — Harrington West Financial Group, Inc. (the “Company”) is a diversified, community-based financial institution holding company operating in multiple markets and incorporated on August 29, 1995 to acquire and hold all of the outstanding common stock of Los Padres Bank, FSB (the “Bank”), a federally chartered savings bank, which operates 13 banking facilities serving individuals and small to medium-sized businesses. Ten banking facilities are operated on the California Central Coast, one banking facility is located in Scottsdale Arizona, and two banking facilities in the Kansas City metropolitan area, which are operated as a division under the Harrington Bank brand name. On May 3, 2004, a thirteenth banking facility opened in Ventura, California. The Company has a definitive purchase agreement to acquire an existing 3,500 square-foot office building near the Scottsdale, Arizona airport to be converted into a full service banking operation. The Company also owns Harrington Wealth Management Company, a trust and investment management company with $126.6 million in assets under management or custody.

In June 2002, the Bank entered into a joint venture agreement with Market Resources, Inc., the owner of numerous RE/MAX brokerage agencies in the Phoenix and Scottsdale, Arizona, metropolitan areas. Under the agreement, the Bank established Los Padres Mortgage, LLC as a 51%-owned mortgage-banking subsidiary. Los Padres Mortgage, LLC brokers single-family residential and commercial real estate loans primarily to third party investors to generate fee income. In the September 2004 quarter, the Company terminated this joint venture and retained selected employees to continue the origination of mortgage loans in the Phoenix metro on the Bank’s platform.

Basis of Presentation — The unaudited consolidated financial statements are condensed and do not contain all information required by accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) to be included in a full set of financial statements. The condensed consolidated financial statements include the Company and the accounts of its wholly owned subsidiaries.

All intercompany balances and transactions have been eliminated. Certain reclassifications have been made to make information comparable between years. The information furnished reflects all adjustments, which in the opinion of management are necessary for a fair statement of the financial position and the results of the operations of the Company. All such adjustments are of a normal and recurring nature.

The preparation of financial statements that are 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.

The unaudited condensed consolidated interim financial statements of the Company and subsidiaries presented herein should be read in conjunction with the consolidated financial statements of the Company for the year ended December 31, 2003, included in the Annual Report on Form 10-K.

Allowance for Loan Losses - Allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries).

-7-

The allowance is maintained at a level believed by management to be sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the credit portfolio and other relevant factors. This evaluation is inherently subjective, as it requires material estimates, including, among others, the amounts and timing of expected future cash flows on impaired loans, estimated losses on consumer loans and residential mortgages, and general amounts for historical loss experience, economic conditions, uncertainties in estimating losses and inherent risks in the various credit portfolios, all of which may be susceptible to significant change.

In determining the adequacy of the allowance for loan losses, the Company makes specific allocations to impaired loans in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 114, Accounting by Creditors for Impairment of a Loan. Loans are identified as impaired when it is deemed probable that the borrower will be unable to meet the scheduled principal and interest payments under the terms of the loan agreement. Impairment is based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

Allocations to non-homogenous loan pools are developed by loan type and risk factor and are based on historical loss trends and management’s judgment concerning those trends and other relevant factors. These factors may include, among others, trends in criticized assets, regional and national economic conditions, changes in lending policies and procedures, trends in local real estate values and changes in volumes and terms of the loan portfolio.

Homogenous (consumer and residential mortgage) loan allocations are made at a total portfolio level based on historical loss experience adjusted for portfolio activity and economic conditions.

Management believes the level of the allowance as of September 30, 2004 is adequate to absorb losses inherent in the loan portfolio.

Fair Value of Options — The Company issues fixed stock options to certain employees, officers, and directors. SFAS No. 123, Accounting for Stock-based Compensation, encourages, but does not require, companies to account for stock options using the fair value method, which generally results in compensation expense recognition. As also permitted by SFAS No. 123, the Company accounts for its fixed stock options using the intrinsic-value method, prescribed in APB Opinion No. 25, Accounting for Stock Issued to Employees, which generally does not result in compensation expense recognition. Under the intrinsic value method, compensation cost for stock options is measured at the date of grant as the excess, if any, of the quoted market price of the Company’s stock over the exercise price of the options.

-8-

The fair values of options granted under the Company’s incentive stock option plan were estimated on the date of grant using the Black-Scholes option-pricing model. Had the Company recognized compensation expense over the expected life of the options based on the fair value method as discussed above, the Company’s pro forma net income and earnings per share for the three and nine-month periods ended September 30, 2004 and September 30, 2003 would have been as follows:

Pro Forma Results


	Three months ended
	September 30,		September 30,
	2004		2003
Net income:
As reported	$	1,979	$	1,998
Pro forma	$	1,943	$	1,979
Earnings per share — basic:
As reported	$	0.38	$	0.38
Pro forma	$	0.37	$	0.38
Earnings per share — diluted:
As reported	$	0.35	$	0.37
Pro forma	$	0.35	$	0.36

Pro Forma Results


	Nine months ended
	September 30,		September 30,
	2004		2003
Net income:
As reported	$	6,018	$	5,413
Pro forma	$	5,946	$	5,357
Earnings per share — basic:
As reported	$	1.15	$	1.04
Pro forma	$	1.13	$	1.03
Earnings per share — diluted:
As reported	$	1.08	$	1.00
Pro forma	$	1.06	$	0.99

For purposes of this computation, the significant assumptions used for the nine-month periods ending September 30, 2004 and September 30, 2003, computed on a weighted average basis, were:


	2004			2003
Risk free interest rate:		4.06	%		3.94	%
Expected life (years):		9			9
Expected volatility 9 years		32.67	%		29.03	%

-9-

Recent Accounting Pronouncements — In March 2004, the Emerging Issues Task Force (EITF) reached consensus on the guidance provided in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1) as applicable to debt and equity securities that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and equity securities that are accounted for using the cost method specified in Accounting Policy Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. An investment is impaired if the fair value of the investment is less than its cost. EITF 03-1 outlines that an impairment would be considered other-than-temporary unless: a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investor’s intent. In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary. This new guidance for determining whether impairment is other-than-temporary is effective for reporting periods beginning after June 15, 2004. Adoption of EITF 03-1 may cause the Company to recognize impairment losses in the Consolidated Statements of Income which would not have been recognized under the current guidance or to recognize such losses in earlier periods, especially those due to increases in interest rates. Since fluctuations in the fair value for available-for-sale securities are already recorded in accumulated other comprehensive income, adoption of this standard is not expected to have a significant impact on stockholders’ equity.

2. SIX - FOR - FIVE STOCK SPLIT

On February 11, 2004, the Company announced that its Board of Directors approved a six-for-five stock split in the form of a 20% stock dividend. The fractional shares distributed in connection with this stock dividend were paid in cash based on the closing market price on the record date. The additional shares were distributed to shareholders of record as of February 25, 2004 on March 11, 2004. The effect of the stock split has been recognized and reflected in all share and per share amounts for all periods presented.

-10-

3. EARNINGS PER SHARE

The following tables represent the calculation of earnings per share (“EPS”) for the periods presented.


	Three months ended September 30, 2004							Nine months ended September 30, 2004
	Income		Shares		Per-Share			Income		Shares		Per-Share
	(Numerator)		(Denominator)		Amount			(Numerator)		(Denominator)		Amount
Basic EPS	$	1,979		5,276,774	$	.38		$	6,018		5,248,339	$	1.15
Effect of dilutive stock options				345,745		(.03	)				340,961		(.07	)

Diluted EPS	$	1,979		5,622,519	$	.35		$	6,018		5,589,300	$	1.08


	Three months ended September 30, 2003							Nine months ended September 30, 2003
	Income		Shares		Per-Share			Income		Shares		Per-Share
	(Numerator)		(Denominator)		Amount			(Numerator)		(Denominator)		Amount
Basic EPS	$	1,998		5,194,411	$	.38		$	5,413		5,193,930	$	1.04
Effect of dilutive stock options				278,128		(.01	)				230,196		(.04	)

Diluted EPS	$	1,998		5,472,539	$	.37		$	5,413		5,424,126	$	1.00

4. COMMITMENTS AND CONTINGENCIES

In September 2004, the Company issued, through Harrington West Capital Trust II, $10.3 million of trust-preferred securities in a private placement. In September 2003, the Company issued, through Harrington West Capital Trust I, $15.5 million of trust-preferred securities in a private placement. Both Harrington West Capital Trust I and II are 100% owned unconsolidated subsidiaries of Harrington West Financial Group and were established for issuance of these trust preferred securities. In connection with the issuance of the preferred securities, the Company has committed to irrevocably and unconditionally guarantee the following payments or distributions with respect to the preferred securities to the holders thereof to the extent that Harrington West Trust I and II has not made such payments or distributions and has the funds therefore: (i) accrued and unpaid distributions, (ii) the redemption price, and (iii) upon a dissolution or termination of the trust, the lesser of the liquidation amount and all accrued and unpaid distributions and the amount of assets of the trust remaining available for distribution. The issuance of the trust preferred securities are reflected in the Consolidated Statement of Financial Condition as subordinated debt.

-11-

The following tables present our contractual obligations and commercial commitments as of September 30, 2004.


			Payment due period
			Less than		One to		Three to		More than
	Total		One Year		Three Years		Five Years		Five Years
	(In Thousands)
Contractual obligations:
Certificates of deposit	$	433,928	$	394,344	$	29,658	$	7,877	$	2,049
FHLB advances		298,000		279,000		—		—		19,000
Reverse Repurchase Agreements.		80,090		21,090		14,000		30,000		15,000
Leases		19,474		1,272		2,504		2,426		13,272
Subordinated debt.		25,774		—		—		—		25,774
Due to broker		5,696		5,696		—		—		—
Accrued interest payable		667		667

Total contractual obligations	$	863,629	$	702,069	$	46,162	$	40,303	$	75,095


			Amount of Commitment Expiration Per Period
	Unfunded		Less than		One to		Three to		After
	Commitments		One Year		Three Years		Five Years		Five Years
	(In Thousands)
Commitments:
Commercial lines of credit	$	23,748	$	9,106	$	1,813	$	11,834	$	995
Consumer lines of credit(1)		36,910		1,450		—		—		35,460
Undisbursed portion of loans in process		34,735		801		33,934		—		—
Approved but, unfuned mortgage loans		24,544		24,544		—		—		—
Approved but, unfunded commercial loans		7,661		7,661		—		—		—
Approved but unfunded consumer loans.		760		760		—		—		—
Letters of credit		791		226		105		—		460

Total commitments	$	129,149	$	44,548	$	35,852	$	11,834	$	36,915

(1)

Lines of credit with no stated maturity date are included in commitments for less than one year.

Item 2: Management’s Discussion and Analysis

General

We are a diversified, community-based, financial institution holding company operating in multiple markets and headquartered in Solvang, California with executive offices in Overland Park, Kansas.

Mission

Our mission is to develop diversified and highly profitable community-focused, banking operations in the markets of the Central Coast of California, the Kansas City metro, and the Phoenix/Scottsdale metro. Although these markets are geographically dispersed, we have considerable market knowledge of each of these areas, local management with extensive experience in banking and the particular market, relationship development potential due to our ties to the communities, and each market offers favorable demographic and economic characteristics. All of these banking operations are operated under the Los Padres Bank, FSB charter so that we can gain operating efficiencies from centralized

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administration and operating systems. However, each region’s banking operation is distinct to its market and its clientele, and lead by a local management team responsible for developing and expanding the banking operations on a profitable basis. The Kansas City banking offices operate under the Harrington Bank (dba) brand name, and the California and Arizona offices operate under the Los Padres Bank brand name.

We believe this multiple market banking strategy provides the following benefits to our shareholders:

1. Diversification of the loan portfolio and economic and credit risk.

2. Options to capitalize on the most favorable growth markets and harvest overvalued markets.

3. The capability to deploy the Company’s diversified product mix and emphasize those products that are best suited for the market

4. The ability to price products strategically among the markets in an attempt to maximize profitability.

We plan to grow the banking operations in these markets opportunistically and expect the opening of two to three banking offices every 18 months through new branching. We evaluate financial institution acquisition opportunities but are value oriented. Acquisitions are expected to be accretive to earnings per share within a 12 month period.

Since 1997, we have grown from 4 banking offices to 14 banking offices. We have 10 full service banking offices on the Central Coast of California from Ventura to Atascadero along Highway 101, 2 banking offices in Johnson County, Kansas in the fastest growing area of the Kansas City metro, and 2 offices in Scottsdale, Arizona, when the second office is completed and opened in the Scottsdale Airpark in early 2005. We are working on additional expansion opportunities in each market.

Product Line Diversification

We have broadened our product lines over the last 5 years to diversify our revenue sources and to become a full service community banking company. In 1999, we added Harrington Wealth Management Company, a federally registered trust and investment management company, to provide our customers a consultative and customized investment process for their trust and investment funds. In 2000, we added a full line of commercial banking and deposit products for small to medium sized businesses and expanded our consumer lending lines to provide Home Equity Lines of Credit. In 2001, we added internet banking and bill pay services to augment our in-branch services and consultation. In 2002, we further expanded our mortgage banking and brokerage activities in all of our markets.

Modern Financial Skills

We believe we have considerable expertise in investment and asset liability management from the CEO’s background in this field for 20 years, wherein he spent 13 years with Smith Breeden Associates, Inc. consulting on risk management practices with banking institutions and advising on billions of mortgage assets managed on a short duration basis. We attempt to control interest rate risk to a low level through the use of interest rate risk management tools, and we utilize excess capital in a low duration and high credit quality investment portfolio of largely mortgage related securities to enhance our earnings. Our goal is to produce a pre-tax return on these investments of 1.25% to 1.50% over the related funding sources. We believe our ability to price loans and investments on an option-adjusted spread basis and then manage the interest rate risk of longer term, fixed rate loans allows us to compete effectively against other institutions, who can not offer these products due to their inability to manage the interest rate risk.

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Control Banking Risks

We seek to control banking risks. We have established a disciplined credit evaluation and underwriting environment that emphasizes the assessment of collateral support, cash flows, guarantor support, and stress testing. We manage operational risk through stringent policies, procedures, and controls and interest rate risk through our modern financial and hedging skills.

Concentrate on Selected Performance Measures

We evaluate our performance based upon the primary measures of return on average equity, which we are trying to maintain in the mid teens, earnings per share growth, and additional franchise value creation through the growth of deposits, loans and wealth management assets.

Profitability Drivers

The factors that we expect to drive our profitability in the future are as follows:

1. Changing the mix of our loans to higher risk-adjusted spread earning categories such as business lending, commercial real estate lending, small tract construction and construction-to-permanent loan lending, and selected consumer lending activities such as HELOC loans.

2. Growing our non-costing consumer and commercial deposits and continuing to change the mix of deposits to less time based certificates of deposit.

3. Diversifying and growing our banking fee income through existing and new fee income sources such as our overdraft protection program and other deposit fees, loan fee income from mortgage banking, prepayment penalty fees and other loan fees, Harrington Wealth Management trust and investment fees, and other retail banking fees.

4. Achieving a high level of performance on our investment portfolio by earning a pre-tax total return over one month LIBOR of approximately 1.25% to 1.50% per annum.

5. Controlling interest rate risk of the institution and seeking high credit quality of the loan and investment portfolios.

Together, we believe these factors will contribute to more consistent and growing profitability. The effect of these factors on our financial results is discussed further in the following sections.

Results of Operations

The Company reported net income of $2.0 million for the three months ended September 30, 2004, as compared to $2.0 million for the three months ended September 30, 2003, a decrease of $19 thousand or 1.0%. The Company reported net income of $6.0 million for the nine months ended September 30, 2004, as compared to $5.4 million for the nine months ended September 30, 2003, an increase of $605 thousand or 11.2%. The increase in net income was primarily driven by an increase in net interest income and a decline in the provision for loan losses, which was partially offset by an increase in non-interest expense and a decrease in other income. The Company’s overall tax rate was reduced in the first quarter of 2004 due to the apportionment of taxable income to states with lower income tax rates. On a diluted earnings per share basis, the Company earned $.35 per share for the three months ended September 30, 2004, compared to $.37 per share for the three months ended September 30, 2003. On a diluted earnings per share basis, the Company earned $1.08 per share for the nine months ended

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September 30, 2004, compared to $1.00 per share for the nine months ended September 30, 2003. Return on average equity was 15.9% and 16.3% in the September 2004 quarter and year-to-date periods compared to 17.5% and 16.3% in the same periods in 2003, respectively.

The Company’s net interest income after provision for loan losses increased by $409 thousand or 6.0% to $7.2 million in the three months ended September 30, 2004 over the prior comparable period in 2003. The Company’s net interest income after provision for loan losses increased by $2.7 million or 14.7% to $21.4 million during the nine months ended September 30, 2004 over the prior comparable period in 2003. The increase in the Company’s net interest income during both periods reflected the continued growth in its interest-earning assets and its increased focus on higher spread-earning loans, primarily commercial and industrial, commercial real estate, and multi-family residential real estate loans. The net interest margin decreased by 34 basis points to 2.90% during the three months ended September 30, 2004, when compared to 3.24% in the same period of 2003. The net interest margin decreased by 16 basis points to 2.95% during the nine months ended September 30, 2004, when compared to the same period in 2003. The decline in the net interest margin is due to the $95.8 million in average growth in lower margin investment securities that exceeded the $67.1 million in average loan growth with higher margins. Also, the decline in the margin is also due to some temporary lags in the repricing of interest rates on loans relative to liabilities and hedge instruments.

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The following tables sets forth, for the periods presented, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rate; (iii) net interest income before provision for loan losses; (iv) interest rate spread; and (v) net interest margin. No tax equivalent adjustments were made during the periods presented. Information is based on average daily balances during the presented periods.


	Three months ended September 30,
	2004							2003
	Average				Average			Average				Average
	Balance		Interest		Yield/ Cost			Balance		Interest		Yield/ Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	581,250	$	9,182		6.36	%	$	503,728	$	8,458		6.72	%
FHLB stock		14,406		191		5.29	%		13,245		134		4.02	%
Securities and trading account assets (2)		425,735		3,880		3.65	%		325,143		3,209		3.95	%
Cash and cash equivalents (3)		12,271		18		.59	%		16,980		50		1.17	%

Total interest-earning assets		1,033,662		13,271		5.13	%		859,096		11,851		5.52	%

Noninterest-earning assets		24,749							20,645

Total assets	$	1,058,411						$	879,741

Interest-bearing liabilities:
Deposits:
NOW and money market accounts		121,312		298		.97	%		125,587		328		1.03	%
Passbook accounts and certificates of deposit		451,051		2,407		2.12	%		386,148		2,227		2.29	%

Total deposits		572,363		2,705		1.88	%		511,735		2,555		1.98	%

FHLB advances (4)		298,989		2,429		3.18	%		211,929		1,876		3.46	%
Reverse Repurchase Agreements		79,853		524		2.57	%		64,060		421		2.57	%
Other borrowings (5)		15,435		188		4.78	%		12,310		113		3.60	%

Total interest-bearing liabilities		966,640		5,846		2.39	%		800,034		4,965		2.45	%

Non-interest-bearing deposits		33,077							23,578
Non-interest-bearing liabilities		9,046							10,529

Total liabilities		1,008,763							834,141
Stockholders’ equity		49,648							45,600

Total liabilities and stockholders’ equity	$	1,058,411						$	879,741

Net interest-earning assets (liabilities)	$	67,022						$	59,062

Net interest income/interest rate spread			$	7,425		2.74	%			$	6,886		3.07	%

Net interest margin						2.90	%						3.24	%

Ratio of average interest-earnings assets to average interest-bearing liabilities						106.93	%						107.38	%

1) Includes non-accrual loans. Interest income includes fees earned on loans originated.

2) Consists of securities classified as available for sale, held to maturity and trading account assets.

3) Consists of cash and due from banks and federal funds sold.

4) Interest on FHLB advances is net of hedging costs. Hedging costs include interest income and expense and ineffectiveness adjustments for cash flow hedges. The Company uses pay-fixed, receive floating LIBOR swaps to hedge the short term repricing characteristics of the floating FHLB advances.

5) Consists of other debt and a note payable under a revolving line of credit.

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The following tables sets forth the effects of changing rates and volumes on net interest income. Information is provided with respect to (i) effects on interest income attributable to changes in rates (changes in rate multiplied by prior volume); (ii) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); (iii) changes in rate/volume (change in rate multiplied by change in volume).


	Three Months Ended
	September 30, 2004 vs. September 30,2003
	Increase (decrease) due to									Total Net
										Increase
	Rate			Volume			Rate/ Volume			(Decrease)
				(In Thousands)
Interest-earning assets:
Loans receivable (1)	$	(2,042	)	$	5,207		$	(2,441	)	$	724
FHLB stock		168			47			(158	)		57
Securities and trading account assets (2)		(985	)		3,972			(2,316	)		671
Cash and cash equivalents (3)		(99	)		(55	)		122			(32	)

Total Total net change in income on interest- earning assets		(2,958	)		9,171			(4,793	)		1,420

Interest-bearing liabilities:
Deposits
NOW and money market accounts		(78	)		(44	)		92			(30	)
Passbook accounts and certificates of deposit		(639	)		1,486			(667	)		180

Total deposits		(717	)		1,442			(575	)		150
FHLB advances (4)		(606	)		3,017			(1,858	)		553
Reverse Repurchase Agreements		(1	)		407			(303	)		103
Other borrowings (5)		145			112			(182	)		75

Total net change in expense on interest- bearing liabilities		(1,179	)		4,978			(2,918	)		881

Change in net interest income	$	(1,779	)	$	4,193		$	(1,875	)	$	539

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	Nine months ended September 30,
	2004							2003
	Average				Average			Average				Average
	Balance		Interest		Yield/ Cost			Balance		Interest		Yield/ Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	549,557	$	26,526		6.44	%	$	482,497	$	24,589		6.79	%
FHLB stock		14,001		456		4.34	%		12,946		452		4.66	%
Securities and trading account assets (2)		414,908		11,223		3.61	%		319,092		9,312		3.89	%
Cash and cash equivalents (3)		12,590		41		.43	%		16,881		162		1.28	%

Total interest-earning assets		991,056		38,246		5.15	%		831,416		34,515		5.54	%

Noninterest-earning assets		24,533							23,173
Total assets	$	1,015,589						$	853,589

Interest-bearing liabilities:
Deposits:
NOW and money market accounts		119,518		815		.91	%		128,464		1,068		1.11	%
Passbook accounts and certificates of deposit		439,617		6,946		2.11	%		380,603		6,798		2.38	%

Total deposits		559,135		7,761		1.85	%		509,067		7,866		2.06	%

FHLB advances (4)		276,971		6,549		3.15	%		231,529		6,439		3.71	%
Reverse Repurchase Agreements		74,074		1,455		2.62	%		25,246		497		2.62	%
Other borrowings (5)		15,146		519		4.57	%		12,134		333		3.66	%

Total interest-bearing liabilities		925,326		16,284		2.35	%		777,976		15,135		2.59	%

Non-interest-bearing deposits		29,946							20,492
Non-interest-bearing liabilities		11,117							10,731

Total liabilities		966,389							809,199
Stockholders’ equity		49,200							44,390

Total liabilities and stockholders’ equity	$	1,015,589						$	853,589

Net interest-earning assets (liabilities)	$	65,730						$	53,440

Net interest income/interest rate spread			$	21,962		2.81	%			$	19,380		2.95	%

Net interest margin						2.95	%						3.11	%

Ratio of average interest-earnings assets to average interest-bearing liabilities						107.10	%						106.87	%

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	Nine Months Ended
	September 30, 2004 vs. September 30, 2003
	Increase (decrease) due to									Total Net
										Increase
	Rate			Volume			Rate/ Volume			(Decrease)
				(In Thousands)
Interest-earning assets:
Loans receivable (1)	$	(1,732	)	$	4,556		$	(887	)	$	1,937
FHLB stock		(41	)		50			(5	)		4
Securities and trading account assets (2)		(909	)		3,729			(909	)		1,911
Cash and cash equivalents (3)		(143	)		(55	)		77			(121	)

Total net change in income on interest- earning assets		(2,825	)		8,280			(1,724	)		3,731

Interest-bearing liabilities:
Deposits
NOW and money market accounts		(256	)		(99	)		102			(253	)
Passbook accounts and certificates of deposit		(1,047	)		1,406			(211	)		148

Total deposits		(1,303	)		1,307			(109	)		(105	)
FHLB advances (4)		(1,284	)		1,684			(290	)		110
Reverse Repurchase Agreements		(1	)		1,281			(322	)		958
Other borrowings (5)		110			110			(34	)		186

Total net change in expense on interest- bearing liabilities		(2,478	)		4,382			(755	)		1,149

Change in net interest income	$	347		$	3,897		$	(970	)	$	2,582

The Company reported interest income of $13.3 million for the three months ended September 30, 2004, compared to $11.9 million for the three months ended September 30, 2003, an increase of $1.4 million or 12.0%. The Company reported total interest income of $38.2 million for the nine months ended September 30, 2004, compared to $34.5 million for the nine months ended September 30, 2003, an increase of $3.7 million or 10.8%. The primary reason for the increase during the periods was the increase in the volume of interest-earning assets in the periods, which was partially offset by a decrease in the average rate on interest-earning assets due to falling interest rates and the refinancing of higher rate loans and investments to lower rates.

The Company reported total interest expense of $5.8 million for the three months ended September 30, 2004, compared to $5.0 million for the three months ended September 30, 2003, an increase of $881 thousand or 17.7%. For the nine months ended September 30, 2004, the Company reported total interest expense of $16.3 million, compared to $15.1 million for the nine months ended

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September 30, 2003, an increase of $1.1 million or 7.6%. The increase in interest expense during both periods was attributable to an increase in the volume of interest-bearing liabilities net of a decrease in the average rate on interest-bearing liabilities as a result of the downward repricing of interest bearing-liabilities due to falling interest rates and the increase in non-costing deposits.

The Company recorded its provision for loan losses of $230 thousand during the three months ended September 30, 2004, compared to $100 thousand for the three months ended September 30, 2003, a increase of $130 thousand. Provision for loan losses of $550 thousand during the nine months ended September 30, 2004, compared to $710 thousand for the nine months ended September 30, 2003, a decrease of $160 thousand. The provision reflects the reserves required based upon, among other things, the Company’s analysis of the composition, credit quality and growth of its commercial real estate and commercial and industrial loan portfolios. At September 30, 2004, the Company had $380 thousand of non-performing assets, as compared to $12 thousand of total loans as of December 31, 2003.

The following table sets forth the activity in our allowance for loan losses for the periods indicated


	For the Quarter Ended						For the Year Ended
	September 30,						September 30,
	2004			2003			2004			2003
				(Dollars in thousands)
Balance at beginning of period	$	4,903		$	4,407		$	4,587		$	3,797
Charge-offs:
Real estate loans
Single-family residential					—						—
Multi-family residential					—						—
Commercial					—						—
Consumer and other loans		(5	)		—			(9	)		—

Total charge-offs		(5	)		—			(9	)		—

Net charge-offs		(5	)		—			(9	)		—

Provision (credit) for losses on loans		230			100			550			710

Balance at end of period	$	5,128		$	4,507		$	5,128		$	4,507

Allowance for loan losses as a percent of total loans outstanding		0.86	%		0.89	%		0.86	%		0.89	%

Ratio of net charge-offs to average loans outstanding		—	%		—	%		—	%		—	%

The Company’s total other income, which includes gain and losses on securities, other assets, and extinguishment of debt, loans, deposits, borrowings, and trading assets, plus banking fee income amounted to $963 thousand for the quarter ending September 30, 2004 compared to $1.2 million during the same quarter last year, a decrease of $264 thousand or 21.5%. The Company’s total other income

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amounted to $3.0 million for the nine month period ending September 30, 2004 compared to $3.9 million during the same period last year, a decrease of $965 thousand or 24.5%. The decrease in other income was primarily attributable to a decrease in mortgage brokerage and prepayment penalty fees as refinancings slowed markedly, as well as slightly lower net gains on assets and liabilities.

The Company attempts to manage its investment securities and the related borrowings and hedges thereof on a duration-matched basis and thus profit from its selection of undervalued investments. As such, net gains and losses on these investments are primarily the result of the changes in interest rate spreads between the securities and the hedged borrowings and the related effect on net market values. That is, as spreads tighten, net mark-to-market gains are generated, and as spreads widen, net mark-to-market losses occur on these instruments. During the September 2004 quarter, the Company had $229 thousand in net gains on trading assets, the sale of securities, other gains and losses and the extinguishment of related borrowings compared to net gain on these instruments of $191 thousand in the September 2003 quarter. For the nine-months ended September 30, 2004, the net gains on trading assets, the sale of securities, other gains and losses, and the extinguishment of related borrowings was $639 thousand compared to $686 thousand in the same period in 2003. The decrease in net gains in the first nine months of 2004 over 2003 of $47 thousand can be attributed largely to the greater degree of spread narrowing of investment grade, commercial mortgage backed securities to comparable duration LIBOR swap rates during the first nine-months of 2003 over 2004.

Management measures the performance of the investment portfolio on the spread between its total return (interest income plus net gains and losses on securities and hedges) and one month LIBOR with a goal spread of 1.25% and 1.50%. For the September 2004 quarter and year-to-date periods, the investment portfolio has generated annualized net returns on this basis of 3.9% and 2.4%, respectively. Management expects to manage the size of the investment portfolio opportunistically as equity capital levels warrant and based on the growth of core banking assets and liabilities.

Banking fee income amounted to $734 thousand for the quarter ending September 30, 2004 compared to $1.0 million during the same quarter last year, a decrease of $302 thousand or 29.2%. Banking fee income amounted to $2.3 million for the nine-month period ending September 30, 2004 compared to $3.3 million during the same period last year, a decrease of $918 thousand or 28.2%. Loan fees decreased in the comparable 2004 to 2003 periods due to the slowdown of mortgage loan refinancing activity, which decreased mortgage brokerage fees by $798 thousand or 48.4% and prepayment penalty and other loan fees decreased by $291 thousand or 48.3% when comparing the September 2004 nine-month period to the same period in 2003. Fees on deposits and trust fees from the Company’s subsidiary, Harrington Wealth Management Company, were the main source of the growth in banking fee income. Deposit and other retail banking fee income contributed $731 thousand for the nine months ending September 2004, an increase of $71 thousand or 10.8% as compared to the nine-months ending September 30 2003. Harrington Wealth Management’s trust fee income contributed $447 thousand for the nine-months ending September 2004, an increase of $100 thousand or 28.8%, compared to the same period in 2003.

In the September 2004 quarter, the Company did start to realize positive benefits from the implementation of its overdraft protection program in mid August. In the September 2004 quarter, overdraft related fees were $109 thousand, compared to $82 thousand and $63 thousand in the June 2004 and September 2003 quarters, respectively. The Company expects further growth in this fee income source over the next few quarters.

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The following chart shows the comparison of banking fee income sources for the September 2004 quarter and year-to-date periods over the same periods in 2003.


(Dollars in thousands)
	September		September					September		September
	2004		2003					2004		2003		%
Banking Fee Type	Quarter		Quarter		% Change			YTD		YTD		Change
Mortgage Brokerage Fees	$	234	$	490		(52.2	)%	$	852	$	1,650		(48.4	)%
Prepayment Penalties and other Loan Fees		81		206		(60.7	)%		312		603		(48.3	)%
Deposit & Other Retail Banking Fees		267		222		20.3	%		731		660		10.8	%
Harrington Wealth Management Fees		152		118		28.8	%		447		347		28.8	%

Total	$	734	$	1,036		(29.2	)%	$	2,342	$	3,260		(28.2	)%

The Company’s total other expenses were $4.8 million during the three months ended September 30, 2004, as compared to $4.6 million for the three months ended September 30, 2003, an increase of $249 thousand or 5.4%. The Company’s total other expenses were $14.4 million during the nine months ended September 30, 2004, as compared to $13.3 million for the nine months ended September 30, 2003, an increase of $1.1 million or 8.2%. The increase in expenses was largely due to the expenses associated with the initial start-up expenses for the Company’s new banking operations in Overland Park, Kansas and Ventura, California and higher costs for workers’ compensation insurance for the California operations and other insurance coverages, as well as an increase in general corporate expenses associated with the Company being a public company and the growth in banking operations.

Net income was favorably impacted in the September 2004 quarter and year-to-date periods by a reduction in the Company’s effective tax rate due to the taxable income being earned and apportioned to states with lower tax rates. The effective tax rate was 40.6% and 39.5% in the September 2004 quarter and year-to-date periods, respectively, compared to 41.8% and 41.6% for the September quarter and year-to-date in 2003.

Financial Condition

The Company’s total assets increased to $1.1 billion at September 30, 2004, as compared to $974.8 million at December 31, 2003, an increase of $107.7 million or 11.0%. The increase was partially attributable to growth in net loans of $79.6 million or 15.3% to $598.1 million as of September 30, 2004, compared to $518.5 million at December 31, 2003. . The Company’s primary focus with respect to its lending operations has historically been the direct origination of single-family and multi-family residential, commercial real estate, business, and consumer loans. Although the Company continues to emphasize single-family residential loan products that meet its customers’ needs, the Company now generally brokers such loans on behalf of third party investors in order to generate fee income. As part of its strategic plan to diversify its loan portfolio, the Company has been increasing its emphasis on loans secured by commercial real estate, multi-family residential, consumer and commercial and industrial loans. Single-family residential loan balances increased to $99.8 million at September 30, 2004, compared to $93.7 million at December 31, 2003, an increase of $6.1 million, while non-single-family loans as a group increased to $505.0 million at September 30, 2004, compared to $430.4 million at December 31, 2003, an increase of $74.6 million. The mix of non-single family loans increased from 82.1% to 83.5% over the December 31, 2003 to September 30, 2004 period.

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The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.


	September 30, 2004						December 31, 2003
													Change
	Amount			Percent			Amount			Percent			Amount
(Dollars in thousands)
Real Estate Loans:
Single-family	$	99,826			16.5	%	$	93,725			17.9	%	$	6,101
Multi-family		90,160			14.9			82,090			15.7			8,070
Commercial		272,269			45.0			234,607			44.8			37,662
Construction (1)		21,300			3.5			30,835			5.9			(9,535	)
Land acquisition and development		24,073			4.0			8,312			1.6			15,761
Commercial and industrial loans		73,104			12.1			56,942			10.8			16,162
Consumer loans		23,051			3.8			16,612			3.1			6,439
Other loans (2)		994			0.2			1,035			0.2			(41	)

Total loans receivable		604,777			100.0	%		524,158			100.0	%		80,619

Less:
Allowance for loan loss		(5,128	)					(4,587	)					(541	)
Net deferred loan fees		(1,640	)					(1,394	)					(246	)
Net premiums		61						319						(258	)

		(6,707	)					(5,662	)					(1,045	)

Loans receivable, net	$	598,070					$	518,496					$	79,574

(1) Includes loans secured by residential, land and commercial properties. At September 30, 2004, we had $14.3 million of construction loans secured by residential properties, $3.0 million for land development and $4.0 million secured by commercial properties

(2) Includes loans collateralized by deposits and consumer line of credit loans.

Securities classified as available for sale increased to $431.5 million at September 30, 2004, as compared to $398.7 million at December 31, 2003, an increase of $32.8 million or 8.2%. The Company manages the securities portfolio in order to enhance net interest income and net market value, as opportunities dictate, and deploys excess capital in investment assets until such time as the Company can reinvest into loans or other community banking assets that generate higher risk-adjusted returns.

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The amortized historical cost, market values and gross unrealized gains and losses of securities are as follows:


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
			(Dollars in thousands)
Securities Available for Sale:
September 30, 2004
Mortgage-backed securities — pass through	$	125,013	$	453	$	(907	)	$	124,559
Collateralized mortgage obligations		62,993		23		(441	)		62,575
Commercial mortgage-backed securities		49,637		791		(21	)		50,407
Asset-backed securities		191,613		1,257		(435	)		192,435
Corporate debt securities		1,530		—		(23	)		1,527

	$	430,806	$	2,524	$	(1,827	)	$	431,503


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
			(Dollars in thousands)
Securities Available for Sale:
December 31, 2003
Mortgage-backed securities — pass through	$	129,766	$	915	$	(307	)	$	130,374
Collateralized mortgage obligations		48,704		—		(123	)		48,581
Commercial mortgage-backed securities		59,927		1,022		(33	)		60,916
Asset-backed securities		157,821		404		(973	)		157,252
Corporate debt securities		1,489		79		—			1,568

	$	397,707	$	2,420	$	(1,436	)	$	398,691

The fair values of securities can change due to credit concerns, i.e. whether the issuer will in fact be able to pay the obligation when due, prepayment speeds, and due to changes in interest rates. All of the available for sale securities held by the Company are carried at their fair value. Adjustments to the carrying amount for changes in fair value for securities classified as available-for-sale are not recorded in the Company’s income statement. Instead, the after-tax effect of the change is shown in other comprehensive income. Consequently, as shown in the tables above, there are unrealized gains and losses related to the available for sale securities held by the Company.

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The following table discloses security balances by categories that are at an unrealized loss at September 30, 2004 with the corresponding duration of the loss. Included in the table are 53 securities that have been in an unrealized loss position for less than a year and 25 securities that have been in an unrealized loss position for more than one year. Although the securities have varying levels of credit risk, the Company has concluded that none of these securities is other than temporarily impaired and the full recovery of principal and interest is expected if held to maturity. The Company has the ability and intent to hold these securities until recovery.


	Less than 12 Months					12 Months or More					Total
	(Dollars in thousands)
	as of September 30, 2004
	Fair					Fair					Fair
	Value		Unrealized Losses			Value		Unrealized Losses			Value		Unrealized Losses
Mortgage-backed securities — pass through	$	65,087	$	(523	)	$	22,323	$	(384	)	$	87,410	$	(907	)
Collateralized mortgage obligations		25,860		(441	)		—		—			25,860		(441	)
Commercial mortgage-backed securities		61		—			816		(21	)		877		(21	)
Asset-backed securities		29,607		(75	)		5,775		(360	)		35,382		(435	)
Corporate debt securities		1,527		(23	)		—		—			1,527		(23	)

	$	122,142	$	(1,062	)	$	28,914	$	(765	)	$	151,056		($1,827	)


	Less than 12 Months					12 Months or More				Total
	(Dollars in thousands)
	as of December 31, 2003
	Fair					Fair				Fair
	Value		Unrealized Losses			Value		Unrealized Losses		Value		Unrealized Losses
Mortgage-backed securities — pass through	$	49,450	$	(307	)					$	49,450	$	(307	)
Collateralized mortgage obligations		48,581		(123	)						48,581		(123	)
Commercial mortgage-backed securities		2,766		(33	)						2,766		(33	)
Asset-backed securities		29,092		(973	)						29,092		(973	)
Corporate debt securities		—		—			—		—		—		—

	$	129,889	$	(1,436	)		—		—	$	129,889	$	(1,436	)

As of September 30, 2004, there were 25 securities in an unrealized loss position for greater than twelve months: 20 mortgage backed securities, 1 commercial mortgage-backed security, and 4 asset-backed securities. Of the four asset backed securities in an unrealized loss position for a period greater than twelve months, 1 was mortgage related and 3 were non-mortgage related. As to the one mortgage-related asset backed security, management believes that the unrealized loss associated with this investment is attributable to changes in interest rates and spreads, and accordingly, the unrealized losses are not “other-than-temporary impairments”. The 3 non-mortgage related asset-backed positions all relate to the same security, DVI 2002 A-3A, having a fair value and unrealized loss of $4.3 million and $358 thousand, respectively, at September 30, 2004. This security is collateralized by a pool of loans and leases on medical equipment and medical business loans, is of the senior tranches of the securities issued with priority cash flow rights, and is rated B1 by Moody’s and CCC by Fitch, as of September 30, 2004.

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Management believes that the $358 thousand of unrealized loss on this security is attributable to uncertainty surrounding the bankruptcy of the servicer, DVI, Inc. (“DVI”) and therefore the ability of the loans to be adequately monitored and serviced, as well as uncertainty about the future delinquency and default rates on the underlying loans. On February 24, 2004, an agreement was finalized to transfer the servicing of DVI securities to U.S. Bank, NA. Since December 2003, U.S. Bank personnel have been assisting DVI with the servicing of these securities and underlying loans. As of the nine-months ending September 30, 2004, and as a result of our senior tranche position, 21.5% of our outstanding principal has been returned, and the average life of the security is estimated to be approximately two years. Management performs a stress test of the delinquencies on the underlying loans and the recovery rates of defaulted loans, and under these assumptions that are more conservative than current experience, Management projects that all interest and principal can be recovered on this security if held to maturity. The value of the DVI securities increased by 9.5 points or $600 thousand from June 30, 2004 to September 30, 2004 due to the improvement in delinquencies, default rates and the repayment of underlying loans.

The following table presents available for sale securities in a loss position for greater than twelve months and summarizes by category of those securities, which securities are pledged as collateral versus securities that are not pledged as collateral as of September 30, 2004. Securities are pledged as collateral for FHLB advances, repurchase agreements and for our swap agreements.


	Pledged Securities					Unpledged Securities					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
						(Dollars in thousands)
Mortgage-backed securities — pass through	$	22,323	$	(384	)	$	—	$	—		$	22,323	$	(384	)
Collateralized mortgage obligations		—		—			—		—			—		—
Commercial mortgage-backed securities		816		(21	)							816		(21	)
Asset-backed securities		1,480		(1	)		4,295		(359	)		5,775		(360	)
Corporate debt securities		—		—			—		—			—		—

	$	24,619	$	(406	)	$	4,295	$	(359	)	$	28,914	$	(765	)

Total deposits increased to $612.9 million as of September 30, 2004, as compared to $570.7 million as of December 31, 2003, an increase of $42.2 million or 7.4%. The increase in deposits is primarily attributable to the opening of the Overland Park, Kansas office in December 2003 that contributed $20.5 million in deposits and the opening of the Ventura, California office in April 2004 that contributed $22.5 million of deposits through September 30, 2004. Deposits in other markets slightly decreased due to the Company’s emphasis on reducing the cost of higher rate sensitive deposits. Non-costing deposits reached $35.4 million at September 30, 2004 compared with $29.2 million at December 31, 2003. This increase in non-costing deposits has contributed to overall deposit costs remaining relatively stable despite rising interest rates in 2004. The cost of deposits was 1.80% in the September 2004 quarter versus 1.76% in December 2003.

Advances from the Federal Home Loan Bank (“FHLB”) of San Francisco increased to $298.0 million at September 30, 2004, compared to $262.5 million at December 31, 2003, a $35.5 million or 13.5% increase. During the quarter, the Company used FHLB advances and the growth of deposits in order to support the increase in new loan fundings. For additional information concerning limitations on FHLB advances, see “Liquidity and Capital Resources.”

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The “Due to broker” account increased to $5.7 million at September 30, 2004, as compared to $0 at December 31, 2003, as a result of the purchase of securities classified as available for sale, which were purchased in the quarter but not settled until after quarter-end. In accordance with trade date accounting, the securities were included in available for sale assets with a corresponding liability in the due to broker account.

As part of our hedging strategy and management of interest rate risk, the Company enters into repurchase agreements, cash flow hedges and other off-balance sheet arrangements. On April 20, 2004, the Company engaged in a $14.0 million, three year fixed rate term repurchase agreement at rate of 2.5% with Citigroup. Also, the Company engaged in a $10.0 million interest rate swap on May 11, 2004 with a fixed rate of 4.90% and another $10.0 million interest rate swap on October 4, 2004 with a fixed rate of 4.59%both with Citigroup.

On September 27, 2004, the Company announced that it completed a $10.0 million, thirty year 3.87% floating rate capital trust offering. The Capital Securities were issued through a newly formed subsidiary, Harrington West Capital Trust II, in a private transaction. The capital trust securities bear an interest rate of three-month LIBOR plus 1.90% and will mature on October 7, 2034. The proceeds from the offering will be used for funding further growth of its banking franchises in all of our markets.

On September 16, 2004, the Company renegotiated its Line of Credit with Harris Bank and U.S. Bank on more favorable terms to provide further capital for expansion.

Stockholders’ equity increased to $50.3 million at September 30, 2004, as compared to $48.1 million at December 31, 2003, an increase of $2.2 million or 4.7%. The $2.2 million increase in stockholders’ equity was positively influenced by $6.0 million of net income recognized during the nine-month period. and $516 thousand of incentive stock options exercised. A $174 thousand decrease in the unrealized gains on securities available for sale and hedge contracts and $4.1 million in special and regular dividends paid on the Company’s common stock offset these increases.

Liquidity and Capital Resources

Liquidity. The liquidity of Los Padres Bank, a consolidated subsidiary of the Company is monitored closely for regulatory purposes at the Bank level by calculating the ratio of cash, cash equivalents (not committed, pledged or required to liquidate specific liabilities), investments and qualifying mortgage-backed securities to the sum of total deposits plus borrowings payable within one year, was 24.8% at September 30, 2004. At September 30, 2004, Los Padres Bank’s “liquid” assets totaled approximately $148.1 million.

In general, the Bank’s liquidity is represented by cash and cash equivalents and is a product of its operating, investing and financing activities. The Company’s primary sources of internal liquidity consist of deposits, prepayments and maturities of outstanding loans and mortgage-backed and related securities, maturities of short-term investments, sales of mortgage-backed and related securities and funds provided from operations. The Company’s external sources of liquidity consist of borrowings, primarily advances from the FHLB of San Francisco, securities sold under agreements to repurchase and a revolving line of credit loan facility, which it maintains with two banks. At September 30, 2004, the Company had $298.0 million in FHLB advances and had $80.4 million of additional borrowing capacity with the FHLB of San Francisco based on a 35% of total Bank asset limitation. Borrowing capacity from the FHLB is further limited to $72.7 million based on excess collateral pledged at the FHLB as of September 30, 2004.

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Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally used to pay down short-term borrowings. On a longer-term basis, the Company maintains a strategy of investing in various mortgage-backed and related securities and loans. At September 30, 2004, the total approved loan commitments outstanding amounted to $129.1 million. Certificates of deposit scheduled to mature in one year or less at September 30, 2004 totaled $394.3 million, and FHLB borrowings and repurchase agreements scheduled to mature within the same period amounted to $300.1 million. Management believes the Company has adequate resources to fund all of its commitments and the Company could either adjust the rate of certificates of deposit in order to retain deposits in changing interest rate environments or replace such deposits with advances from the FHLB of San Francisco, or other borrowings, if it proved cost-effective to do so.

The Company has a revolving line of credit with a maximum borrowing capacity of $15.0 million with a maturity of September 30, 2007. We anticipate that we will utilize this line of credit as growth opportunities develop and to provide working capital. At September 30, 2004 and December 31, 2003, the Company was not indebted under its revolving line of credit.

A substantial source of the Company’s cash flow from which it services its debt and capital trust securities, pays its obligations, and pays dividends to its shareholders is the receipt of dividends from Los Padres Bank. The availability of dividends from Los Padres Bank is limited by various statutes and regulations. In order to make such dividend payment, Los Padres Bank is required to provide 30 days advance notice to the Office of Thrift Supervision (“OTS”), during which time the OTS may object to such dividend payment. It is possible, depending upon the financial condition of Los Padres Bank and other factors, the OTS could object to the payment of dividends by Los Padres Bank on the basis that the payment of such dividends is an unsafe or unsound practice. The OTS, on July, 7, 2004, approved the payment of $6 million in dividends from Los Padres Bank to the Company over the next four quarters.

Capital Resources. Federally insured savings institutions such as Los Padres Bank are required to maintain minimum levels of regulatory capital. Under applicable regulations, an institution is well capitalized if it has a total risk-based capital ratio of at least 10.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a leverage ratio of at least 5.0%, with no written agreement, order, capital directive, prompt corrective action directive or other individual requirement by the OTS to maintain a specific capital measure. An institution is adequately capitalized if it has a total risk-based capital ratio of at least 8.0% and a Tier 1 risk-based capital ratio of at least 4.0% and a leverage ratio of at least 4.0% (or 3.0% if it has a composite rating of “1”). The regulation also establishes three categories for institutions with lower ratios: undercapitalized, significantly undercapitalized and critically undercapitalized. At September 30, 2004, Los Padres Bank met the capital requirements of a “well capitalized” institution under applicable OTS regulations. At September 30, 2004, the Bank’s Tier 1 (Core) Capital Ratio was 6.34%, Total Risk-Based Capital Ratio was 10.65%, Tier 1 Risk-Based Capital Ratio was 9.91% and Tangible Equity Ratio was 6.34%.

Asset and Liability Management

The Company evaluates the change in its market value of portfolio equity (“MVPE”) to changes in interest rates and seeks to manage these changes to relatively low levels through various risk management techniques. MVPE is defined as the net present value of the cash flows from an institution’s existing assets, liabilities and off-balance sheet instruments. The MVPE is estimated by valuing our assets, liabilities and off-balance sheet instruments under various interest rate scenarios. The extent to which assets gain or lose value in relation to the gains or losses of liabilities determines the appreciation or depreciation in equity on a market value basis. MVPE analysis is intended to evaluate the impact of immediate and sustained interest rate shifts of the current yield curve upon the market value of the current

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balance sheet. In general, financial institutions are negatively affected by an increase in interest rates to the extent that interest-bearing liabilities mature or reprice more rapidly than interest-earning assets. This factor causes the income and MVPE of these institutions to increase as rates fall and decrease as interest rates rise.

The Company’s management believes that its asset and liability management strategy, as discussed below, provides it with a competitive advantage over other financial institutions. The Company believes that its ability to hedge its interest rate exposure through the use of various interest rate contracts provides it with the flexibility to acquire loans structured to meet its customer’s preferences and investments that provide attractive net risk-adjusted spreads, regardless of whether the customer’s loan or our investment is fixed-rate or adjustable-rate or short-term or long-term. Similarly, the Company can choose a cost-effective source of funds and subsequently engage in an interest rate swap or other hedging transaction so that the interest rate sensitivities of its interest-earning assets and interest-bearing liabilities are more closely matched.

The Company’s asset and liability management strategy is formulated and monitored by the board of directors of Los Padres Bank. The Board’s written policies and procedures are implemented by the Asset and Liability Committee of Los Padres Bank (“ALCO”), which is comprised of Los Padres Bank’s chief executive officer, president, chief financial officer, senior controller, director of financial reporting and four non-employee directors of Los Padres Bank. The ALCO meets at least eight times a year to review the sensitivity of Los Padres Bank’s assets and liabilities to interest rate changes, investment opportunities, the performance of the investment portfolios, and prior purchase and sale activity of securities. The ALCO also provides guidance to management on reducing interest rate risk and on investment strategy and retail pricing and funding decisions with respect to Los Padres Bank’s overall asset and liability composition. The ALCO reviews Los Padres Bank’s liquidity, cash flow needs, interest rate sensitivity of investments, deposits and borrowings, core deposit activity, current market conditions and interest rates on both a local and national level in connection with fulfilling its responsibilities.

The ALCO regularly reviews interest rate risk with respect to the impact of alternative interest rate scenarios on net interest income and on Los Padres Bank’s MVPE. The Asset and Liability Committee also reviews analyses concerning the impact of changing market volatility, prepayment forecast error, and changes in option-adjusted spreads and non-parallel yield curve shifts.

In the absence of hedging activities, the Company’s MVPE would decline as a result of a general increase in market rates of interest. This decline would be due to the market values of the Company’s assets being more sensitive to interest rate fluctuations than are the market values of its liabilities due to its investment in and origination of generally longer-term assets which are funded with shorter-term liabilities. Consequently, the elasticity (i.e., the change in the market value of an asset or liability as a result of a change in interest rates) of the Company’s assets is greater than the elasticity of its liabilities.

Accordingly, the primary goal of the Company’s asset and liability management policy is to effectively increase the elasticity of its liabilities and/or effectively contract the elasticity of its assets so that the respective elasticities are matched as closely as possible. This elasticity adjustment can be accomplished internally, by restructuring the balance sheet, or externally by adjusting the elasticities of assets and/or liabilities through the use of interest rate contracts. The Company’s strategy is to hedge, either internally through the use of longer-term certificates of deposit or less sensitive transaction deposits and FHLB advances, or externally through the use of various interest rate contracts.

External hedging generally involves the use of interest rate swaps, caps, floors, options and futures. The notional amount of interest rate contracts represents the underlying amount on which

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periodic cash flows are calculated and exchanged between counterparties. However, this notional amount does not necessarily represent the principal amount of securities that would effectively be hedged by that interest rate contract.

In selecting the type and amount of interest rate contract to utilize, the Company compares the elasticity of a particular contract to that of the securities to be hedged. An interest rate contract with the appropriate offsetting elasticity could have a notional amount much greater than the face amount of the securities being hedged.

The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, on January 1, 2001. SFAS No. 133 as amended requires that an entity recognize all interest rate contracts as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, an interest rate contract may be specifically designated as a fair value hedge, a cash flow hedge, or a hedge of foreign currency exposure. The accounting for changes in the fair value of an interest rate contract (that is, gains and losses) depends on the intended use of the interest rate contract and the resulting designation. To qualify for hedge accounting, the Company must show that, at the inception of the interest rate contracts, and on an ongoing basis, the changes in the fair value of the interest rate contracts are expected to be highly effective in offsetting related changes in the cash flows of the hedged liabilities. The Company has entered into various interest rate swaps for the purpose of hedging certain of its short-term liabilities. These interest rate swaps qualify for hedge accounting. Accordingly, the effective portion of the accumulated change in the fair value of the cash flow hedges is recorded in a separate component of stockholders’ equity, net of tax, while the ineffective portion is recognized in earnings immediately.

The Company has also entered into various total return swaps in an effort to enhance income, where cash flows are based on the level and changes in the yield spread on investment grade commercial mortgage and asset backed security indexes relative to similar duration LIBOR swap rates. These swaps do not qualify for hedge accounting treatment and are included in the trading account assets and are reported at fair value with realized and unrealized gains and losses on these instruments recognized in income (loss) from trading account assets. At September 30, 2004, the Company had $140.0 million of these swaps, and a 1 basis point spread change is expected to have a $64 thousand pre-tax mark-to-market value effect.

Critical Accounting Policies

General. The following discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, and the notes thereto, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable in the circumstances; however, actual results may differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods.

The financial information contained in our consolidated financial statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when recognizing income or expense, recovering an asset or relieving a liability. We use historical loss factors to determine the inherent loss that may be present in our loan portfolio. Actual losses could differ

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significantly from the historical factors that we use. We also calculate the fair value of our interest rate contracts and securities based on market prices and the expected useful lives of our depreciable assets. We enter into interest rate contracts that are classified as trading account assets or to accommodate our own risk management purposes. The interest rate contracts are generally interest swaps, although we could enter into other types of interest rate contracts. We value these contracts at fair value, using readily available, and market quoted prices. We have not historically entered into derivative contracts, which relate to credit, equity, commodity, energy or weather-related indices. Generally accepted accounting principles themselves may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. As of September 30, 2004, we have not created any special purpose entities to securitize assets or to obtain off-balance sheet funding. Although we have sold loans in past years, those loans have been sold to third parties without recourse, subject to customary representations and warranties.

Allowance for loan losses. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two principles of accounting: (i) Statement of Financial Accounting Standards, or SFAS, No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and estimable; and (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures,” which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has four components: (i) an allocated allowance for specifically identified problem loans, (ii) a formula allowance for non-homogenous loans, (iii) an allocated allowance for large groups of smaller balance homogenous loans and (iv) an unallocated allowance, which contains amounts that are based on management’s evaluation of conditions that are not directly measured in the determination of the specific allowances. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a model based on historical losses as an indicator of future losses and as a result could differ from the losses incurred in the future; however, since this history is updated with the most recent loss information, the differences that might otherwise occur may be mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, discounted cash flows, fair market value of collateral and secondary market information are all used to estimate those losses. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowances.

Trading and Investment Portfolio. Substantially all of our securities are classified as available for sale securities and, pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 115, are reported at fair value with unrealized gains and losses included in stockholders’ equity. We invest in a portfolio of mortgage-backed and related securities, interest rate contracts, U.S. Government agency securities and, to a much lesser extent, equity securities. The Company has also entered into various total return swaps in an effort to enhance income, where cash flows are based on the level and changes in the yield spread on investment grade commercial mortgage backed security indexes relative to similar duration LIBOR swap rates. These swaps do not qualify for hedge accounting treatment and are included in the trading account assets and are reported at fair value with realized and unrealized gains and losses on these instruments recognized in income (loss) from trading account assets, pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 115.

Hedging Activity. Accounting for Derivative Instruments and Hedging Activities was implemented on January 1, 2001. SFAS No. 133 requires that an entity recognize all interest rate

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contracts as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, an interest rate contract may be specifically designated as a fair value hedge, a cash flow hedge, or a hedge of foreign currency exposure. The accounting for changes in the fair value of an interest rate contract (that is, gains and losses) depends on the intended use of the interest rate contract and the resulting designation. To qualify for hedge accounting, the Company must show that, at the inception of the interest rate contracts, and on an ongoing basis, the changes in the fair value of the interest rate contracts are expected to be highly effective in offsetting related changes in the cash flows of the hedged liabilities. The Company has entered into various interest rate swaps for the purpose of hedging certain of its short-term liabilities. These interest rate swaps qualify for hedge accounting. Accordingly, the effective portion of the accumulated change in the fair value of the cash flow hedges is recorded in a separate component of stockholders’ equity, net of tax, while the ineffective portion is recognized in earnings immediately.

Cautionary Statement Regarding Forward-Looking Statements.

This Form 10-Q contains and incorporates by reference forward-looking statements about our financial condition, results of operations and business. These statements may include statements regarding projected performance for future periods. You can find many of these statements by looking for words such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “will,” “plans” or similar words or expressions. These forward-looking statements involve substantial risks and uncertainties. Some of the factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to, the following:

• we may experience higher defaults on our loan portfolio than we expect;

• changes in management’s estimate of the adequacy of the allowance for loan losses;

• changes in management’s valuation of our mortgage-backed and related securities portfolio and interest rate contracts;

• increases in competitive pressure among financial institutions;

• general economic conditions, either nationally or locally in areas in which we conduct or will conduct our operations, or conditions in financial markets may be less favorable than we currently anticipate;

• our net income from operations may be lower than we expect;

• we may lose more business or customers than we expect, or our operating costs may be higher than we expect;

• changes in the interest rate environment and yield spreads and their impact on customer behavior, our interest margins, and market values;

• the impact of repricing and competitors’ pricing initiatives on loan and deposit products;

• our ability to adapt successfully to technological changes to meet customers’ needs and developments in the market place;

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• our ability to access cost-effective funding; including non-costing consumer and commercial deposits, and thereby change the mix of our deposits;

• our ability to change the mix of our loan portfolio;

• our ability to diversify and grow our fee income;

• our ability to maintain low rate risk and high credit quality;

• our ability to successfully complete our strategy to continue to grow our business in California, Kansas and Arizona;

• our returns from our securities portfolio may be lower than we expect; or

• legislative or regulatory changes or changes in accounting principles, policies or guidelines may adversely affect our ability to conduct our business.

Because these forward-looking statements are subject to risks and uncertainties, our actual results may differ materially from those expressed or implied by these statements. You are cautioned not to place undue reliance on our forward-looking statements, which speak only as of the date of this Form 10-Q. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. The future results and stockholder values of our common stock may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond our ability to control or predict.

We do not undertake any obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events.

Item 3: Quantitative and Qualitative Disclosures about Market Risk

The OTS requires each thrift institution to calculate the estimated change in the institution’s MVPE assuming an instantaneous, parallel shift in the Treasury yield curve of 100 to 300 basis points either up or down in 100 basis point increments. The OTS permits institutions to perform this MVPE analysis using their own internal model based upon reasonable assumptions.

In estimating the market value of mortgage loans and mortgage-backed securities, the Company utilizes various prepayment assumptions, which vary, in accordance with historical experience, based upon the term, interest rate, prepayment penalties, if applicable, and other factors with respect to the underlying loans. At September 30, 2004, these prepayment assumptions varied from 7.5% to 53.2% for fixed-rate mortgages and mortgage-backed securities and varied from 4.7% to 49.0% for adjustable-rate mortgages and mortgage-backed securities.

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The following table sets forth at September 30, 2004 the estimated sensitivity of Los Padres Bank’s MVPE to parallel yield curve shifts using the Company’s internal market value calculation. The table demonstrates the sensitivity of the Company’s assets and liabilities both before and after the inclusion of its interest rate contracts.


	Change In Interest Rates (In Basis Points)(1)
	-300			-200			-100			-	+100			+200			+300
							(Dollars in Thousands)
Market value gain (loss) in assets	$	38,103		$	27,747		$	15,314			$	(18,576	)	$	(39,891	)	$	(62,865	)
Market value gain (loss) of liabilities		(24,056	)		(17,293	)		(8,820	)			9,137			18,406			27,634

Market value gain (loss) of net assets before interest rate contracts		14,047			10,454			6,494				(9,439	)		(21,485	)		(35,231	)
Market value gain (loss) of interest rate contracts before tax		(20,730	)		(13,247	)		(6,415	)			6,013			11,673			16,999

Total change in MVPE (2)	$	(6,683	)	$	2,793		$	79			$	(3,426	)	$	(9,812	)	$	(18,232	)

Change in MVPE as a percent of:
MVPE(2)		-7.36	%		3.07	%		0.09	%			-3.77	%		-10.80	%		-20.07	%
MVPE post shock ratio (3)		-0.87	%		0.44	%		0.12	%			-0.18	%		-0.63	%		-1.27	%

(1)		Assumes an instantaneous parallel change in interest rates at all maturities.

(2)		Based on the Company’s pre-tax tangible MVPE of $85.3 million at September 30, 2004.

(3)		Pre-tax tangible MVPE as a percentage of tangible assets.

The table set forth above does not purport to show the impact of interest rate changes on the Company’s equity under generally accepted accounting principles. Market value changes only impact the Company’s income statement or the balance sheet to the extent the affected instruments are marked to market, and over the life of the instruments as an impact on recorded yields.

Item 4: Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings. There have been no significant changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Disclosure controls and procedures are Company controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods

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specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

PART II — OTHER INFORMATION

Item 1: Legal Proceedings

The Company is involved in various legal proceedings occurring in the ordinary course of business, which, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Company.

Item 2: Changes in Securities and Use of Proceeds

We have the right to defer the payment of interest on both of the outstanding series of trust preferred securities. If we were to exercise such deferral right, we are restricted during such deferral period from paying any dividends on our common stock.

Item 3: Defaults Upon Senior Securities

Not applicable.

Item 4: Submission of Matters to a Vote of Security Holders.

None.

Item 5: Other Information

Not applicable.

Item 6: Exhibits and Reports on Form 8-K

a) Exhibits


EXHIBIT NO.		DESCRIPTION
31.1		Section 302 Certification by Chief Executive Officer filed herewith.
31.2		Section 302 Certification by Chief Financial Officer filed herewith.
32		Section 906 Certification by Chief Executive Officer and Chief Financial Officer furnished herewith.

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	Page
Part I — Financial Information
Item 1. Condensed Consolidated Financial Statements		2
Condensed Consolidated Statements of Financial Condition as of September 30, 2004 (Unaudited) and December 31, 2003		2
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2004 and 2003 (Unaudited)		3
Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Nine months ended September 30, 2004 (Unaudited) and Year Ended December 31, 2003		4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003 (Unaudited)		6
Notes to Unaudited Condensed Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 3. Quantitative and Qualitative Disclosures about Market Risk		33
Item 4. Controls and Procedures		34
Part II — Other Information
Item 1. Legal Proceedings		35
Item 2. Changes in Securities and Use of Proceeds		35
Item 3. Defaults upon Senior Securities		35
Item 4. Submission of Matters to a Vote of Security Holders		35
Item 5. Other Information		35
Item 6. Exhibits and Reports on Form 8-K		35
Signatures		37
Exhibit 31.1
Exhibit 31.2
Exhibit 32


	HARRINGTON WEST FINANCIAL GROUP, INC.
Date: November 12, 2004	By:	/S/ CRAIG J. CERNY
	Craig J. Cerny, Chief Executive Officer
	(Principal Executive Officer)


	By:	/S/ WILLIAM W. PHILLIPS
	William W. Phillips,
	President, Chief Operating Officer and Chief Financial Officer (Principal Financial and Accounting Officer)

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	1.		Changing the mix of our loans to higher risk-adjusted spread earning categories such as business lending, commercial real estate lending, small tract construction and construction-to-permanent loan lending, and selected consumer lending activities such as HELOC loans.

	2.		Growing our non-costing consumer and commercial deposits and continuing to change the mix of deposits to less time based certificates of deposit.

	3.		Diversifying and growing our banking fee income through existing and new fee income sources such as our overdraft protection program and other deposit fees, loan fee income from mortgage banking, prepayment penalty fees and other loan fees, Harrington Wealth Management trust and investment fees, and other retail banking fees.

	4.		Achieving a high level of performance on our investment portfolio by earning a pre-tax total return over one month LIBOR of approximately 1.25% to 1.50% per annum.

	5.		Controlling interest rate risk of the institution and seeking high credit quality of the loan and investment portfolios.

	1)		Includes non-accrual loans. Interest income includes fees earned on loans originated.

	2)		Consists of securities classified as available for sale, held to maturity and trading account assets.

	3)		Consists of cash and due from banks and federal funds sold.

	4)		Interest on FHLB advances is net of hedging costs. Hedging costs include interest income and expense and ineffectiveness adjustments for cash flow hedges. The Company uses pay-fixed, receive floating LIBOR swaps to hedge the short term repricing characteristics of the floating FHLB advances.

	5)		Consists of other debt and a note payable under a revolving line of credit.

	(1)		Includes loans secured by residential, land and commercial properties. At September 30, 2004, we had $14.3 million of construction loans secured by residential properties, $3.0 million for land development and $4.0 million secured by commercial properties

	(2)		Includes loans collateralized by deposits and consumer line of credit loans.

	•		we may experience higher defaults on our loan portfolio than we expect;

	•		changes in management’s estimate of the adequacy of the allowance for loan losses;

	•		changes in management’s valuation of our mortgage-backed and related securities portfolio and interest rate contracts;

	•		increases in competitive pressure among financial institutions;

	•		general economic conditions, either nationally or locally in areas in which we conduct or will conduct our operations, or conditions in financial markets may be less favorable than we currently anticipate;

	•		our net income from operations may be lower than we expect;

	•		we may lose more business or customers than we expect, or our operating costs may be higher than we expect;

	•		changes in the interest rate environment and yield spreads and their impact on customer behavior, our interest margins, and market values;

	•		the impact of repricing and competitors’ pricing initiatives on loan and deposit products;

	•		our ability to adapt successfully to technological changes to meet customers’ needs and developments in the market place;

	•		our ability to access cost-effective funding; including non-costing consumer and commercial deposits, and thereby change the mix of our deposits;

	•		our ability to change the mix of our loan portfolio;

	•		our ability to diversify and grow our fee income;

	•		our ability to maintain low rate risk and high credit quality;

	•		our ability to successfully complete our strategy to continue to grow our business in California, Kansas and Arizona;

	•		our returns from our securities portfolio may be lower than we expect; or

	•		legislative or regulatory changes or changes in accounting principles, policies or guidelines may adversely affect our ability to conduct our business.