Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

þ   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

o   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

HARRINGTON WEST FINANCIAL GROUP, INC.

Securities registered under Section 12(b) of the Exchange Act:

NOT APPLICABLE

Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK (PAR VALUE $0.01 PER SHARE)

(Title of Class)

Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

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

The aggregate value of the 3,573,106 shares of Common Stock of the Registrant issued and outstanding, which excludes 754,845 shares held by all directors and executive officers of the Registrant as a group, was approximately $40.2 million based on the last closing sale price of a share of Common Stock of $11.251 on December 31, 2002.

Number of shares of Common Stock outstanding as of March 10, 2003: 4,327,951

DOCUMENTS INCORPORATED BY REFERENCE

The registrant hereby incorporates its proxy statement for its 2003 annual meeting of stockholders in Part III, items 10-13.

Table of Contents

PART I

Cautionary Statement Regarding Forward-Looking Statements.

     This Form 10-K 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 their impact on customer behavior and our interest margins;
	•		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;
	•		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

1

Table of Contents

10-K. 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-K or to reflect the occurrence of unanticipated events.

Item 1. Business.

General

     We are Harrington West Financial Group, Inc., a Delaware corporation and a diversified, community-based, financial institution holding company headquartered in Solvang, California, with executive offices in Overland Park, Kansas. We conduct our operations primarily through our wholly-owned subsidiary, Los Padres Bank, FSB, a federally chartered savings bank, and its division in the Kansas City metropolitan area, Harrington Bank. Los Padres Bank provides an array of financial products and services for businesses and retail customers through its eleven full-service offices. At December 31, 2002, we had consolidated total assets of $824.3 million, total deposits of $525.3 million and stockholders’ equity of $42.5 million.

     We are focused on providing our diversified products and personalized service approach in three distinct markets: (i) the central coast of California, (ii) the Kansas City metropolitan area and (iii) the Phoenix/Scottsdale metropolitan area. Los Padres Bank has nine offices on the central coast of California, one office in Mission, Kansas and a new community banking office in the Phoenix/Scottsdale, Arizona metropolitan area which opened in November 2002. We also established in the September 2002 quarter, Los Padres Mortgage, LLC, a mortgage banking company, which is engaged in a joint venture with the largest RE/MAX franchise in Arizona, to originate single-family residential and commercial real estate loans in the Phoenix/Scottsdale metropolitan area. Los Padres Bank will open a second office in the Kansas City metropolitan area in the latter half of 2003. Each of our markets has its own local independent management team operating under the Los Padres or Harrington names. Our loan underwriting, corporate administration, and treasury functions are centralized in Solvang, California to create operating efficiencies. Our commercial lending operations are centralized in Mission, Kansas.

     Los Padres Bank is primarily engaged in attracting deposits from individuals and businesses and using these deposits, together with borrowed funds, to originate single-family and multi-family residential, commercial real estate, commercial business and consumer loans. We also generate fee income from the brokering of mortgage loans, deposit services, early prepayments of loans, and loan originations. We maintain a portfolio of highly liquid mortgage-backed and related securities as a means of managing our excess liquidity and enhancing our profitability. We utilize various interest rate contracts as a means of managing our interest rate risk. We also operate Harrington Wealth Management Company, which provides trust and investment management services to individuals and small institutional clients, by employing a customized asset allocation approach and investing predominantly in low fee, indexed mutual funds.

     On November 12, 2002, we completed our initial public offering. An aggregate of 1,120,000 shares of common stock were sold to the public at $12.00 per share, comprised of 973,615 shares sold by us and 146,385 shares sold by certain of our stockholders. In connection with the initial public offering, we raised approximately $10.2 million of net proceeds, which we initially used to reduce our secured line of credit.

2

Table of Contents

     Our goal is to continue to enhance our franchise value and earnings through controlled growth in our banking operations, while maintaining the combination of community-oriented customer service and sophisticated centralized financial management that have characterized our success to date. Our strategy for achieving this goal is:

	•		Hiring Experienced Employees With A Customer Service Focus. We provide personalized service and relationship banking to our customers. Our ability to continue to attract and retain banking professionals with significant experience in and knowledge of our markets who share our customer service philosophy is key to our success. By offering quick decision making in the delivery of banking products and services, offering customized products where appropriate, and providing customer access to our senior managers, we distinguish ourselves from larger, regional banks operating in our market areas, while our larger capital base and product mix enable us to compete effectively against smaller community banks.
	•		Expanding Our Product Offerings. We intend to diversify our loan portfolio by continuing to grow our commercial and industrial business lines, while still providing high quality loan products for single-family and multi-family residential borrowers. We also intend to selectively add additional products to provide diversification of revenue sources and to capture our customer’s full relationship. As part of this strategy, we are focused on increasing our deposit and loan fees and further developing our wholesale banking activities that provide single-family loan originations for other lenders. We intend to continue to expand the wealth management area of our business by cross selling our trust and investment products and services to our customers through Harrington Wealth Management Company (HWM). HWM offers a wide range of financial instruments and services, including low fee indexed mutual funds, personal trusts, investment management, custody, estates, guardianships, land trusts, and retirement plan services.
	•		Strategic Expansion. We intend to continue to expand our branch network through de novo office openings in all of our markets. We expect to open a second office in the Kansas City metropolitan area in the latter half of 2003. This opening is intended to capitalize on the opportunity this market presents to us with a view to continued growth in this market. We believe that our centralized underwriting, administration and treasury functions should enable us to increase operating efficiencies over time. Acquisitions have played an integral role in our past growth. We are committed to exploring opportunistic controlled expansion of our franchise through strategic acquisitions designed to increase our market share and branch office locations. We believe that continued development of the Los Padres and Harrington franchises will provide us with additional profits over time and enhance our market and franchise value.
	•		Using Financial Management Techniques to Manage Our Interest Rate Risk and Enhance our Profitability. We deploy our excess capital in a portfolio of highly liquid mortgage- backed and related securities until we are able to reinvest these assets into loans or other community banking assets. Our securities portfolio is funded primarily by deposits and borrowings and is managed to a short duration with the intention of creating additional income and improving our return on equity. The interest rate sensitivity of our investments, loans, and funding sources is reduced using various interest rate contracts, including interest rate swaps, caps and floors and exchange-traded futures and options. In selecting mortgage-backed and related securities for our portfolio and in pricing our loans, we employ option-adjusted spread pricing analysis to ascertain the net risk-adjusted spread expected to be earned on the various investments and loans. This analysis considers the interest rate, prepayment, credit and liquidity risks in an investment or loan, and we seek to select

3

Table of Contents

securities and loans with the highest spread over funding costs after covering the expected costs of the embedded risks. In this manner, our portfolio can enhance our profitability through interest earned on these securities over our funding costs and through possible gains as a result of price changes net of hedging activities.

Lending Activities

     General. At December 31, 2002, Los Padres Bank’s net loan portfolio totaled $448.1 million, representing approximately 54.4% of our $824.3 million of total assets at that date. Los Padres Bank’s primary focus with respect to its lending operations has historically been the direct origination of single-family residential, multi-family residential, consumer and commercial real estate loans. While we continue to emphasize single-family residential loans products that meet our customer’s needs, we now generally broker such loans on behalf of third party investors in order to generate fee income and have been increasing our emphasis on loans secured by commercial real estate, consumer loans, and commercial and industrial loans. We also offer multi-family residential loans, construction loans secured by both residential and commercial properties and consumer loans.

     The risks associated with mortgage lending are well-defined and controllable. Credit risk is controlled through the adherence, with few exceptions, to secondary market underwriting guidelines. We rely on our internal credit approval and administrative process to originate loans as well as our internal asset review process which oversees our loan quality in order to ensure that our underwriting standards are maintained. We believe that the low level of our non-performing assets is evidence of our adherence to our underwriting guidelines. Market risk is controlled by our approach to pricing and by regular monitoring and management of the institution’s overall sensitivity to interest rate changes.

     As a federally chartered savings bank, Los Padres Bank has general authority to originate and purchase loans secured by real estate located throughout the United States. Despite this nationwide lending authority, we estimate that at December 31, 2002, substantially all of the loans in Los Padres Bank’s portfolio are secured by properties located or made to customers residing in each of our primary market areas located in the California central coast, the Kansas City metropolitan area and the Phoenix/Scottsdale metropolitan area.

4

Table of Contents

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

[Additional columns below]

[Continued from above table, first column(s) repeated]

				December 31,
				1999								1998
				Amount				Percent				Amount				Percent
				(Dollars in Thousands)
Real estate loans:
	Single-family			$	206,572				53.4	%		$	199,161				59.1	%
	Multi-family				60,746				15.7				51,675				15.3
	Commercial				93,803				24.2				71,374				21.2
	Construction(1)				20,814				5.4				8,792				2.6
	Land acquisition and development				3,525				0.9				4,477				1.3
Commercial and industrial loans					—				—				—				—
Consumer loans					1,088				0.3				1,135				0.3
Other loans (2)					502				0.1				694				0.2
		Total loans receivable			387,050				100.0	%			337,308				100.0	%
Less:
	Allowance for loan losses				(3,112	)							(2,975	)
	Net deferred loan fees				(258	)							164
	Net premiums				543								772
					(2,827	)							(2,039	)
	Loans receivable, net			$	384,223							$	335,269

5

Table of Contents

     The following table sets forth certain information at December 31, 2002, regarding the dollar amount of loans maturing in our total loan portfolio based on the contractual terms to maturity or scheduled amortization, but does not include potential prepayments. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

     Scheduled contractual amortization of loans does not reflect the expected term of our loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sales clauses, which gives us the right to declare a conventional loan immediately due and payable in the event that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are lower than current mortgage loan rates. Under the latter circumstance, the weighted average yield on loans decreases as higher-yielding loans are repaid or refinanced at lower rates.

6

Table of Contents

     The following table sets forth the dollar amount of total loans due after one year from December 31, 2002, as shown in the preceding table, which have fixed interest rates or which have floating or adjustable interest rates.

     Origination, Purchase and Sale of Loans. The lending activities of Los Padres Bank are subject to the written, non-discriminatory underwriting standards and loan origination procedures established by Los Padres Bank’s board of directors and management. Loan originations are obtained by a variety of sources, including referrals from real estate brokers, builders, existing customers, walk-in customers and advertising. In its present marketing efforts, Los Padres Bank emphasizes its community ties, customized personal service, competitive rates and terms, and its efficient underwriting and approval process. Loan applications are taken by lending personnel, and the loan department supervises the obtainment of credit reports, appraisals and other documentation involved with a loan. Property valuations are performed by independent outside appraisers approved by Los Padres Bank’s board of directors. Los Padres Bank requires title, hazard and, to the extent applicable, flood insurance on all security property.

     Mortgage loan applications are initially processed by loan officers who do not have approval authority. All real estate loans which are either at or below the Federal Home Loan Mortgage Corporation’s (“Freddie Mac”), lending limit and which meet all of the current Freddie Mac underwriting guidelines can be approved by designated senior management of Los Padres Bank. All consumer loans up to $25,000 may be approved by designated senior management of Los Padres Bank. All loans in excess of these amounts up to $1.0 million require the approval of two members of Los Padres Bank’s Executive Loan Committee, which consists of designated senior management of Los Padres Bank. Loans in excess of $1.0 million, but not exceeding $3.0 million, require the approval of a majority of Los Padres Bank’s Loan Committee, consisting of designated senior management of Los Padres Bank. All loans in excess of $3.0 million, up to Los Padres Bank’s legal lending limit, must be approved by either Los Padres Bank’s Loan Oversight Committee, comprised of both designated senior management and certain members of the board of directors, or the board of directors of Los Padres Bank. In addition, the board of directors of Los Padres Bank ratifies all loans originated and purchased by Los Padres Bank.

     A savings institution generally may not make loans to any one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured

7

Table of Contents

by readily marketable securities. At December 31, 2002, Los Padres Bank’s regulatory limit on loans-to-one borrower was $8.0 million and its five largest loans or groups of loans-to-one borrower, including related entities, aggregated $5.9 million, $5.8 million, $5.7 million, $5.6 million and $5.5 million. These five largest loans or loan concentrations were secured by commercial real estate and business assets. All of these loans or loan concentrations were performing in accordance with their payment terms at December 31, 2002.

     Single-Family Residential Real Estate Loans. Los Padres Bank has historically concentrated its lending activities on the origination of loans secured by first mortgage liens on existing single-family residences. The single-family residential loans originated by Los Padres Bank are generally made on terms, conditions and documentation which permit the sale of such loans to Freddie Mac, the Federal National Mortgage Association (“Fannie Mae”), and other institutional investors in the secondary market. Since January 2001, as a means of generating additional fee income and in order to reflect management’s decision to emphasize holding higher yielding loans in its portfolio, Los Padres Bank has been brokering conforming permanent single-family residential loans on behalf of third parties in order to generate fee income. During the years ended December 31, 2002 and 2001, Los Padres Bank brokered $86.1 million and $39.8 million of such single-family residential loans on behalf of third parties.

     Los Padres Bank still holds a portfolio of single-family residential loans. Los Padres Bank will retain in its portfolio single-family residential loans that, due to the nature of the collateral, carry higher risk adjusted spreads. Examples of these types of loans include construction loans that have converted into permanent loans and non-conforming single-family loans, whether as a result of a non-owner occupied or rural property, balloon payment or other exception from agency guidelines. At December 31, 2002, Los Padres Bank had $116.7 million of single-family residential loans in its portfolio, which amounted to 25.8% of total loans receivable as of such date. At December 31, 2002, $67.6 million or 57.9% of Los Padres Bank’s single-family residential loans had fixed interest rates and $49.1 million or 42.1% had interest rates which adjust in accordance with a designated index. Single-family residential loans have terms of up to 30 years and generally have loan-to-value ratios of 80% or less, or 90% or less to the extent the borrower carries private mortgage insurance for the balance in excess of the 80% loan-to-value ratio.

     Multi-Family Residential and Commercial Real Estate Loans. At December 31, 2002, Los Padres Bank had an aggregate of $71.9 million and $183.3 million invested in multi-family residential and commercial real estate loans, respectively, or 15.9% and 40.5% of total loans receivable, respectively. Los Padres Bank has generally targeted smaller commercial real estate loans with principal balances of up to its legal lending limit.

     Los Padres Bank’s multi-family residential loans are secured by multi-family properties of five units or more, while Los Padres Bank’s commercial real estate loans are secured by industrial, warehouse and self-storage properties, office buildings, office and industrial condominiums, retail space and strip shopping centers, mixed-use commercial properties, mobile home parks, nursing homes, hotels and motels. Substantially all of these properties are located in Los Padres Bank’s primary market areas. Los Padres Bank typically originates commercial real estate loans for terms of up to 10 years based upon a 30-year loan amortization period and multi-family residential loans for terms of up to 15 years based upon up to a 30-year amortization schedule. Los Padres Bank will originate these loans on both a fixed-rate or adjustable-rate basis, with the latter adjusting on a periodic basis of up to one year based on the London Interbank Offered Rate (“LIBOR”), the one-year U.S. Treasury index of constant comparable maturities, a designated prime rate or the 11th District Cost of Funds Index. Adjustable-rate loans may have an established ceiling and floor, and the maximum loan-to-value for these loan products is generally 75%. As part of the criteria for underwriting commercial real estate loans, Los Padres Bank generally requires a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service)

8

Table of Contents

of 1.3:1 or more. It is also Los Padres Bank’s general policy to seek additional protection to mitigate any weaknesses identified in the underwriting process. Additional coverage may be provided through secondary collateral and personal guarantees from the principals of the borrowers.

     Commercial real estate lending entails different and significant risks when compared to single-family residential lending because such loans typically involve large loan balances to single borrowers and because the payment experience on such loans is typically dependent on the successful operation of the project or the borrower’s business. In addition, the balloon payment features of these loans may require the borrower to either sell or refinance the underlying property in order to make the payment. These risks can also be significantly affected by supply and demand conditions in the local market for apartments, offices, warehouses or other commercial space. Los Padres Bank attempts to minimize its risk exposure by requiring loan-to-value and debt coverage ratios, and by monitoring the operation and physical condition of the collateral.

     Construction Loans. Los Padres Bank also originates loans to finance the construction of single-family residences and commercial properties located in its primary market area. At December 31, 2002, Los Padres Bank’s construction loans amounted to $19.7 million or 4.4% of total loans receivable, $14.7 million of which were for the construction of residential properties and $5.0 million of which were for the construction of commercial properties. Los Padres Bank also originates land acquisition and development loans which are loans for the acquisition of land and the development of residential properties. At December 31, 2002, Los Padres Bank’s land acquisition and development loans amounted to $14.9 million of 3.3% of total loans receivable.

     Los Padres Bank primarily provides construction loans to individuals building their primary or secondary residence as well as to local developers with whom Los Padres Bank is familiar and who have a record of successfully completing projects. Residential construction loans to developers generally are made with terms not exceeding two years, have interest rates which are fixed or adjust, with the latter adjusting on a periodic basis of up to one year based upon a designated prime rate or LIBOR, and are generally made with loan-to-value ratios of 80% or less. Residential construction loans to individuals are interest only loans for the term of the construction and then generally convert to a permanent loan at market rates. Los Padres Bank’s construction/permanent loans have been successful due to its ability to offer borrowers a single closing and, consequently, reduced costs. Los Padres Bank also offers adjustable-rate loans based on a designated prime rate or other indices with terms of up to two years for the construction of commercial properties. Such loans are generally made at a loan-to-value ratio of 85% of discounted appraised value or less. Land acquisition and development loans are typically issued with one year terms, bearing adjustable-rates of interest based on a designated prime rate or LIBOR and are generally made with loan-to-value ratios of 75% or less.

     Construction lending and acquisition and development lending are generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate. Risk of loss on construction loans and acquisition and development loans is dependent largely upon the accuracy of the initial appraisal of the property’s projected value at completion of construction as well as the estimated cost, including interest, of construction. During the construction phase, a number of factors could result in delays and cost overruns. If either estimate proves to be inaccurate and the borrower is unable to provide additional funds, the lender may be required to advance funds beyond the amount originally committed to permit completion of the project and/or be confronted at the maturity of the construction loan with a project whose value is insufficient to assure full payment. Los Padres Bank attempts to minimize the foregoing risks primarily by limiting its construction lending to experienced developers and by limiting the total amount of loans to builders for speculative construction projects. It is also Los Padres Bank’s general policy to obtain regular financial statements and tax returns from builders so that it can monitor their financial strength and ability to repay.

9

Table of Contents

     Commercial and Industrial Loans. Los Padres Bank is placing increased emphasis on the origination of commercial business loans. During the year ended December 31, 2002, Los Padres Bank originated $41.0 million of commercial and industrial loans, as compared to $13.6 million and $9.5 million as of December 31, 2001 and 2000, respectively. At December 31, 2002, Los Padres Bank’s commercial and industrial loans amounted to $27.7 million or 6.1% of total loans receivable. Los Padres Bank’s commercial loan portfolio increased significantly in connection with the acquisition of the Kansas operations of Harrington Bank, FSB in November 2001.

     The commercial and industrial loans that Los Padres Bank is originating include lines of credit, term loans and letters of credit. These loans are typically secured by collateral and are used for general business purposes, including working capital financing, equipment financing, capital investment and general investment. Depending on the collateral pledged to secure the extension of credit, maximum loan-to-value ratios are 80% or less. Loan terms vary from one to seven years. The interest rates on such loans are generally variable and are indexed to the Wall Street Journal Prime Rate, plus a margin. Commercial and industrial loans typically have shorter maturity terms and higher interest spreads than mortgage loans, but generally involve more credit risk than mortgage loans because of the type and nature of the collateral. Los Padres Bank’s business customers are typically small to medium sized, privately-held companies with local or regional businesses that operate in Los Padres Bank’s primary markets.

     Consumer and Other Loans. Los Padres Bank is authorized to make loans for a wide variety of personal or consumer purposes. Los Padres Bank has been originating consumer loans in recent years in order to provide a wider range of financial services to its customers and because such loans generally carry higher interest rates than mortgage loans. The consumer and other loans offered by Los Padres Bank include home equity lines of credit, home improvement loans, automobile loans, secured and unsecured personal lines of credit and deposit account secured loans. At December 31, 2002, $18.1 million or 4.0% of Los Padres Bank’s total loans receivable consisted of consumer loans.

     Home equity lines of credit are originated by Los Padres Bank for up to 80% of the appraised value, less the amount of any existing prior liens on the property. Los Padres Bank also offers home improvement loans in amounts up to 80% of the appraised value, less the amount of any existing prior liens on the property. Home improvement loans have a maximum term of 15 years and carry fixed or adjustable interest rates. Home equity lines of credit have a maximum repayment term of 10 years and carry interest rates which adjust monthly in accordance with a designated prime rate or floating LIBOR rate. Los Padres Bank will secure each of these types of loans with a mortgage on the property, generally a second mortgage, and may originate the loan even if another institution holds the first mortgage. At December 31, 2002, home equity lines of credit and home improvement loans totaled $16.6 million or 91.6% of Los Padres Bank’s total consumer and other loan portfolio and an aggregate of $11.7 million was committed and undrawn under these loans and lines of credit.

     Los Padres Bank currently offers loans secured by deposit accounts, which amounted to $372,000 or 2.1% of Los Padres Bank’s total consumer and other loan portfolio at December 31, 2002. Such loans are originated for up to 90% of the deposit account balance, with a hold placed on the account restricting the withdrawal of the account balance.

     At December 31, 2002, automobile and secured and unsecured personal line of credit loans amounted to $1.1 million or 6.3% of Los Padres Bank’s total consumer and other loan portfolio.

     Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. Los

10

Table of Contents

Padres Bank believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and Los Padres Bank intends to continue to offer consumer loans in order to provide a full range of services to its customers.

Asset Quality

     General. Los Padres Bank’s Internal Asset Review Committee, consisting of Los Padres Bank’s senior executive officers, monitors the credit quality of Los Padres Bank’s assets, reviews classified and other identified loans and determines the proper level of reserves to allocate against Los Padres Bank’s loan portfolio, in each case subject to guidelines approved by Los Padres Bank’s board of directors.

     Loan Delinquencies. When a borrower fails to make a required payment on a loan, Los Padres Bank attempts to cure the deficiency by contacting the borrower and seeking payment. Contacts are generally made following the sixteenth day after a payment is due, at which time a late payment is assessed. In most cases, deficiencies are cured promptly. If a delinquency extends beyond 16 days, the loan and payment history is reviewed and efforts are made to collect the loan. While Los Padres Bank generally prefers to work with borrowers to resolve such problems, when the account becomes 90 days delinquent, Los Padres Bank will institute foreclosure or other proceedings, as necessary, to minimize any potential loss.

     Non-Performing Assets. Los Padres Bank will place loans on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When such a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. Los Padres Bank generally does not accrue interest on loans past due 60 days or more.

11

Table of Contents

     Non-performing loans are defined as non-accrual loans. Non-performing assets are defined as non-performing loans and real estate acquired by foreclosure or deed-in-lieu thereof. Troubled debt restructurings are defined as loans which Los Padres Bank has agreed to modify by accepting below market terms either by granting interest rate concessions or by deferring principal and/or interest payments. The following table sets forth the amounts and categories of our non-performing assets and troubled debt restructurings at the dates indicated.

     At December 31, 2002, we had $218,000 in non-performing loans, both 60-89 days delinquent, representing a decrease of $279,000 or 56.1% from December 31, 2001. At December 31, 2002, 2001 and 2000, we had two, three and two non-performing loans, respectively. At December 31, 2002, we had no real estate owned or troubled debt restructurings.

     The interest income that would have been recorded during the years ended December 31, 2002, 2001 and 2000 if Los Padres Bank’s non-accruing loans at the end of such periods had been current in accordance with their terms during such periods is $43,496, $41,195 and $39,256, respectively. The interest income that was recorded during the years ended December 31, 2002, 2001 and 2000 with respect to Los Padres Bank’s non-accruing loans was $33, $18 and $300, respectively.

     Classified Assets. Federal regulations require that each insured savings institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. Los Padres Bank has established three classifications for potential problem assets: “substandard,” “doubtful” and “loss.” Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable,

12

Table of Contents

and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Los Padres Bank has established another category, designated “special mention,” for assets which do not currently expose Los Padres Bank to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. Assets classified as substandard or doubtful require Los Padres Bank to establish allowances for loan losses based on the methodology described below. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. At December 31, 2002, in addition to the non-performing assets described above, Los Padres Bank had $1.8 million of classified loans, $1.8 million of which was classified as substandard and $50,000 of which was classified loss (as to which Los Padres Bank had established a specific reserve). As of December 31, 2002, Los Padres Bank had $10.4 million of loans that were designated special mention. Our classified and special mention loans, in addition to the non-performing loans discussed above, are the extent of the loans in our portfolio which give us some repayment concern.

     Allowance for Loan Losses. The allowance for loan losses reflects management’s judgment of the level of allowance adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date. On a quarterly basis, Los Padres Bank assesses the overall adequacy of the allowance for loan losses, utilizing a consistent and systematic approach which includes the application of an allocated allowance for specifically identified problem loans, a formula allowance for non-homogenous loans, a formula allowance for large groups of smaller balance homogenous loans and an unallocated allowance.

     Allocated allowance for specifically identified problem loans. A specific reserve is established for impaired loans in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The specific reserve is determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, we may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

     Formula allowance for non-homogenous loans. Los Padres Bank segments its non-homogenous loan portfolio into pools with similar characteristics based on loan type (collateral driven) and risk factor (loan grade). Currently, these loans are segmented into four categories by collateral, further stratified by loan grade (pass, special mention and substandard). The general pool categories are multi-family residential, commercial real estate, land acquisition and development, and commercial and industrial. These non-homogenous loans are reviewed individually.

     The formula allowance is calculated by applying adjusted loss rates to these pools. Pool loss rates are established by examining historical charge-off data for groups of loans and adjusting them for a variety of qualitative factors deemed appropriate by management. The analysis of historical loss data in determining the initial loss rates is based on average balances over a ten year period. Management believes this period is conservative since it includes the severe economic recession of the early 1990’s and the current recession, which started in the third quarter of 2001. Where Los Padres Bank has no or nominal actual charge-off data for certain loan types, industry data and management’s judgment is utilized as representative starting loss rates.

     Formula allowance for large groups of smaller balance homogenous loans. The allocated loan loss allowance for large groups of smaller balance homogenous loans is focused on loss experience for the pool rather than on an analysis of individual loans. Large groups of smaller balance homogenous

13

Table of Contents

loans consist of consumer loans and single-family residential loans. The allowance for groups of performing loans is based on historical losses over a ten year period.

     Unallocated Allowance. The unallocated allowance contains amounts that are based on management’s evaluation of conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following, which existed at the balance sheet date:

	•		trends in criticized and non-accrual assets;
	•		the levels and trends in charge-offs, recovery history and loan restructuring;
	•		changes in volumes and terms of the loan portfolio;
	•		changes in the effectiveness of the internal asset review process;
	•		changes in lending policies, procedures and practices;
	•		changes in the experience, ability and depth of lending management;
	•		changes in the national and local economic conditions; and
	•		the trend in local real estate values.

     Management and the Internal Asset Review Committee review these conditions quarterly in discussion with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance, applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the probable loss related to such condition is reflected in the unallocated allowance.

     The allowance for loan losses is based upon estimates of probable losses inherent in the loan portfolio. The actual losses can vary from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. The loss migration model that is used to establish the loan loss factors is designed to be self-correcting by taking into account our loss experience over prescribed periods. Similarly, by basing the loan loss factors over a period reflective of two business cycles, the methodology is designed to take our recent loss experience for consumer and commercial and industrial loans into account. Furthermore, based on management’s judgment, our methodology permits adjustments to any loss factor used in the computation of the formula allowance for significant factors, which affect the collectibility of the portfolio as of the evaluation date, but are not reflected in the loss factors. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon the most recent information that has become available.

     Although our management believes it uses the best information available to establish the level of the allowance, there can be no assurance that additions to such allowance will not be necessary in future periods. Furthermore, various regulatory agencies, as an integral part of their examination process,

14

Table of Contents

periodically review our valuation allowance. These agencies may require us to increase the allowance, based on their judgments of the information available to them at the time of the examination.

     The following table is an allocation of our allowance for loan losses as of the dates presented:

     At December 31, 2002, the formula allowance for non-homogeneous loans increased by $138,000 from December 31, 2001, primarily due to an increase in total non-homogeneous loans and, to a lesser extent, a decrease in criticized loans related to non-homogeneous loans.

     The formula allowance for homogeneous loans decreased by $33,000 and $214,000 for the years ending December 31, 2002 and 2001, respectively, as a result of decreasing single-family loan balances. Los Padres Bank shifted its strategic focus away from originating single-family loans for its portfolio and has opted to originate such loans on a brokered basis due to high competition and the resulting low risk-adjusted spreads. In addition, Los Padres Bank sold $27.6 million such loans in 2001, for the same reason.

     Specific reserves are established for impaired loans in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” From December 31, 2000 to December 31, 2002, the balance in specific reserves has remained constant at $50,000 and relates to one single-family loan.

15

Table of Contents

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

16

Table of Contents

     The following table sets forth information concerning the allocation of our allowance for loan losses by loan category at the dates indicated.

[Additional columns below]

[Continued from above table, first column(s) repeated]

			December 31,
			1999								1998
							Percent of								Percent of
							Loans in								Loans in
							Each								Each
							Category to								Category to
			Amount				Total Loans				Amount				Total Loans
			(Dollars in Thousands)
Real estate loans:
	Single-family residential		$	804				53.4	%		$	963				59.1	%
	Multi-family residential			424				15.7				399				15.3
	Commercial			994				24.2				783				21.2
	Construction			331				5.4				309				2.6
	Land acquisition and development			72				0.9				90				1.3
Commercial and industrial loans				—				—				—				—
Consumer and other loans				28				0.4				29				0.5
Unallocated reserve				459				—				402				—
Total			$	3,112				100.0	%		$	2,975				100.0	%