UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20006

FORM 10-K

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

For the fiscal year ended December 31, 2002

Commission file number:  000-33063

SIERRA BANCORP
(Exact name of registrant as specified in its charter)
California	33-0937517
State of incorporation	I.R.S. Employer Identification Number
86 North Main Street Porterville, California	93257
Address of principal executive offices	Zip Code
(559) 782-4900
Registrant’s telephone number, including area code

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

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, No Par Value

          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   x No   o

          Check 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. x

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes   o No   x

          As of February 14, 2003, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $63.5 million, based on the closing price reported to the Registrant on that date of $12.70 per share.

          Shares of Common Stock held by each officer and director and each person owning more than five percent of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates.  This determination of the affiliate status is not necessarily a conclusive determination for other purposes.

          The number of shares of Common Stock of the registrant outstanding as of February 14, 2003 was 9,245,550.

          Documents Incorporated by Reference:   Portions of the definitive proxy statement for the 2003 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to SEC Regulation 14A are incorporated by reference in Part III, Items 10-13.

TABLE OF CONTENTS

	ITEM		PAGE
PART I			3
	Item 1.	Business	19
	Item 2.	Properties	19
	Item 3.	Legal Proceedings	19
	Item 4.	Submission of Matters to a Vote of Security Holders	19
PART II			19
	Item 5.	Market for Common Equity and Related Shareholder Matters	19
	Item 6.	Selected Financial Data	21
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	51
	Item 8.	Consolidated Financial Statements and Supplementary Data	51
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	88
PART III			88
	Item 10.	Directors and Executive Officers of the Registrant	88
	Item 11.	Executive Compensation	88
	Item 12.	Security Ownership of Certain Beneficial Owners and Management	88
	Item 13.	Certain Relationships and Related Transactions	88
	Item 14.	Controls and Procedures	88
PART IV			90
	Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	90
SIGNATURES			92
CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER			93

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PART I

ITEM 1. BUSINESS

General

The Company

Sierra Bancorp (the “Company”) is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is headquartered in Porterville, California.  The Company was incorporated in November 2000 and acquired all of the outstanding shares of Bank of the Sierra (the “Bank”) in August 2001.  The Company’s principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish.  At the present time, the Company’s only other direct subsidiary is Sierra Capital Trust I, which was formed in November 2001 solely to facilitate the issuance of capital trust pass-through securities. 

The Company’s principal source of income is dividends from the Bank, but the Company intends to explore supplemental sources of income in the future.  The expenditures of the Company, including (but not limited to) the payment of dividends to shareholders, if and when declared by the Board of Directors, and the cost of servicing debt, will generally be paid from dividends paid to the Company by the Bank.

At December 31, 2002, the Company had consolidated assets of $701.1 million, deposits of $605.7 million and shareholders’ equity of $53.3 million.  The Company’s liabilities include $15 million in capital trust pass-through securities issued by Sierra Capital Trust I in November 2001. 

References herein to the “Company” include the Company and its consolidated subsidiaries, unless the context indicates otherwise.

The Bank

The Bank is a California state-chartered bank that was incorporated in September 1977 and opened for business in January 1978.  The Bank’s Administrative Office is located at 86 North Main Street, Porterville, California.  At December 31, 2002 the Bank had approximately $698.8 million in assets, $511.6 million in loans and $609.5 million in deposits (including a deposit of $3.8 million from the Company).  It is currently the largest independent bank headquartered in Tulare County.  The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to maximum insurable amounts.  The Bank is not a member of the Federal Reserve System.

The Bank operates sixteen full service branch offices, nine of which are in seven Tulare County communities and five of which are located in three Kern County communities.  There is one branch each in Fresno and Kings Counties.  In addition, the Bank has received regulatory approval for a de novo branch in North Fresno in the vicinity of Herndon and Ingram, and expects to commence operations in that branch in the second quarter of 2003.  The Bank also has credit centers for agricultural lending and credit card loans, engages in construction and real estate lending at several of its branches, and offers a full range of banking services to individuals and various sized businesses in the communities it serves.  The locations of the Bank’s current offices are:

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Porterville:	Main Office	Bakersfield:	Bakersfield California Office
	90 North Main Street		5060 California Avenue
	Administrative Headquarters		Bakersfield Ming Office
	86 North Main Street		8500 Ming Avenue
	West Olive Branch
	1498 West Olive Avenue
Lindsay:	Lindsay Office	Tulare:	Tulare Office
	142 South Mirage Avenue		246 East Tulare Avenue
Exeter:	Exeter Office	Hanford:	Hanford Office
	1103 West Visalia Road		427 West Lacey Boulevard
Visalia:	Visalia Mooney Office	Tehachapi:	Tehachapi Downtown Office
	2515 South Mooney Boulevard		224 West “F” Street
	Visalia Downtown Office		Tehachapi Old Town Office
	128 East Main Street		21000 Mission Street
Three Rivers:	Three Rivers Office	Fresno:	Fresno Office
	40884 Sierra Drive		636 East Shaw Avenue
Dinuba:	Dinuba Office	California City:	California City Office
	401 East Tulare Street		8031 California City Blvd.

Prior to 1997, Bank of the Sierra had grown exclusively by establishing de novo full-service branch offices and credit centers in various locations in California’s South Central San Joaquin Valley.  In February 1997 we made our first branch purchase of the Dinuba Office of Wells Fargo Bank.  Between February 1997 and September 1999 we opened three additional de novo offices, in Tulare, Hanford, and Fresno.  In May 2000 we added four branches by the acquisition of Sierra National Bank (“SNB”).  One of the former SNB branches is in Bakersfield, two are in Tehachapi, and one is in California City.

With a predominant focus on personal service, Bank of the Sierra has positioned itself as a multi-community independent bank serving the financial needs of individuals and businesses within the Bank’s geographic footprint.  Our principal retail lending services include home equity and consumer loans.  In addition, we have three other significant dimensions that surround this core of retail community banking: agricultural lending, credit card loans, and real estate financing (both construction and long term). 

The Agricultural Credit Centers located in Fresno and Porterville provide a complete line of credit services in support of the agricultural activities which are key to the continued economic development of the communities we serve.  “Ag lending” clients include a full range of individual farming customers, small business farming organizations and major corporate farming units.

The Bank Card Center, headquartered in Porterville, provides credit, debit, and ATM card services to all qualified Bank customers.  In addition, we staff our Fresno, Visalia, Porterville, and Bakersfield offices with real estate lending specialists.  These officers are responsible for a complete line of land acquisition and development loans, construction loans for residential and commercial development, and multifamily credit facilities.  Secondary market services are provided though the Bank’s affiliations with Freddie Mac, Fannie Mae and various non-governmental programs.  Until recently, the Bank also had a group dedicated to originating residential mortgage loans.  However, in an effort to improve customer service and reduce overhead expense, the real estate lending area was restructured and this group’s focus was shifted to other products.  In early 2002 the Bank entered into an agreement with Moneyline Lending Services, Inc. (“Moneyline”), whereby Moneyline underwrites single family mortgage loans for qualifying Bank customers referred to them via Bank-branded delivery channels (i.e., Bank branches, the Bank’s internet site, and a dedicated telephone line).

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We also engage in Small Business Administration lending and have been designated as an SBA Preferred Lender since 1999.  For the SBA’s fiscal year ended September 30, 2002 the Bank produced 52 loans totaling $13.5 million.  This placed the Bank as the leader in the SBA’s Fresno California District for the dollar volume of SBA loans, and second for the number of SBA loans.  Additionally, according to the Fresno District Office, the Bank was the only financial institution to be among the top five SBA lenders for the last four years.

As of December 31, 2002, the principal areas in which we directed our lending activities, and the percentage of our total loan portfolio for which each of these areas was responsible, were as follows: (i) loans secured by real estate (67.77%); (ii) commercial and industrial (including SBA) loans (18.22%); (iii) consumer loans (9.68%); (iv) agricultural loans (2.15%); and (v) credit cards (2.18%).

Real-estate secured loans, loan sales, and loan servicing activities generated approximately 52.10% of our total interest and other income for 2002, and 50.11% during 2001.  Real estate loans and related activities generated total revenue of $26.3 million and $26.6 million in 2002 and 2001, respectively.

In addition to the lending activities noted above, we offer a wide range of deposit products for the retail banking market including checking, interest bearing transaction, savings, time deposit and retirement accounts, as well as telephone banking and internet banking with bill-pay options.  As of December 31, 2002, the Bank had 47,772 deposit accounts with balances totaling approximately $609.5 million, compared to 47,661 deposit accounts with balances totaling approximately $525.3 million at December 31, 2001.  We attract deposits through our customer-oriented product mix, competitive pricing, convenient locations, extended hours and drive-up banking, all provided with the highest level of customer service. 

Most of our deposits are attracted from individuals, business-related sources and smaller municipal entities.  This resulted in a relatively modest average deposit balance of approximately $13,000 at December 31, 2002, but makes us less vulnerable to adverse effects from the loss of depositors who may be seeking higher yields in other markets or who may otherwise draw down balances for cash needs.

We also offer a multitude of other products and services to our customers to complement the lending and deposit services previously reviewed.  These include installment note collection, cashier’s checks, traveler’s checks, bank-by-mail, ATM, night depository, safe deposit boxes, direct deposit, automated payroll services, electronic funds transfers, on-line banking, and other customary banking services.  During the past few years we have substantially enhanced our ATM locations to include off-site areas not previously served by cash or deposit facilities.  We now have a total of seven such ATM’s at six different locations that include a hospital, county offices, and a college campus.  These locations facilitate cash advances and deposit capabilities that would not otherwise be available to consumers at non-branch locations, thereby increasing consumer convenience.  Moreover, we utilize a mobile ATM unit at fairs, exhibitions, and various other community functions within our market area.  We have a Spanish language option on our own network of ATMs, and shared ATM and Point of Sale (POS) networks allow our customers access to national and international funds transfer networks.  In addition to these customer-oriented products and services, we have established a convenient customer service group accessible by toll-free telephone to answer questions and assure a high level of customer satisfaction.

In order to provide non-deposit investment options we have developed a strategic alliance with Investment Centers of America, Inc. of Bismarck, North Dakota (“ICA”).  Through this arrangement, registered and licensed representatives of ICA provide our customers with convenient access to annuities, insurance products, mutual funds, and a full range of investment products.  They conduct business from offices located in our Porterville, Visalia, Tulare and Tehachapi branches.

We have not engaged in any material research activities relating to the development of new products or services during the last two fiscal years; however, a substantial investment of time and capital has been devoted to the improvement of existing Bank services during the last twelve months.  Specifically, mortgage lending was outsourced as previously discussed, the item processing function was brought in-house to reduce recurring

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expenses and enable the Bank to produce imaged statements for its customers, the customer service function was reorganized to increase training, ensure consistency and improve our customers’ overall in-branch experience, and marketing resources have been added.  The officers and employees of the Bank are continually engaged in marketing activities, including the evaluation and development of new products and services to enable the Bank to retain and improve its competitive position in its service area.  Our decision in October 1999 to introduce “Sierra Access” internet banking, which includes electronic bill paying capabilities, was the result of such evaluation.  Another example is “Sierra Loan Access”, a consumer loan application process made available through the Bank’s internet site during 2001.  This function allows a consumer to gain an answer within fifteen to thirty minutes on a request for any number of consumer loans, including auto, personal revolving lines, credit card, or home equity/home improvement loans.  The initiation of our partnership with Moneyline in 2002 has enabled similar improvements in the consumer mortgage lending process.  We also rolled out “Sierra Web Cash Manager” in 2001, a commercial checking account cash management system which functions through the Bank’s internet web site.  Alternatives for future electronic banking delivery are currently being examined in an effort to keep pace with evolving technology and continue to provide superior customer service.

All of these developments are meant to increase public convenience in the Bank’s service area and enhance public access to the electronic payments system.  The cost to the Bank for these development, implementation, and marketing activities cannot expressly be calculated with any degree of certainty. 

We hold no patents or licenses (other than licenses required by appropriate bank regulatory agencies), franchises, or concessions.  Our business has a modest seasonal component due to the heavy agricultural orientation of the Central Valley.  As our branches in more metropolitan areas such as Fresno and Bakersfield have expanded, however, the agriculture-related base has become less important.  We are not dependent on a single customer or group of related customers for a material portion of its deposits, nor is a material portion of our loans concentrated within a single industry or group of related industries.  There has been no material effect upon our capital expenditures, earnings, or competitive position as a result of Federal, state, or local environmental regulation.

Recent Developments

In the first quarter of 2002 the Bank distributed all of the stock of its subsidiary, Sierra Phoenix, Inc., to the Company as a dividend. The sole function of Sierra Phoenix was to hold certain investments that the Bank is not permitted to hold directly but which can now be held directly by the Company.  One of those investments was stock in Sphinx International, Inc. (“Sphinx”), of which the remaining $90,000 book value was written off by the Bank prior to the transfer of Sierra Phoenix to the Company.  Sphinx was formerly known as Phoenix International Ltd., Inc., a computer software company which specialized in the production and marketing of client user software for financial institutions.  In 2001, Sphinx sold substantially all of its assets (including all of its operating business) and certain of its liabilities to London Bridge Phoenix Software, Inc.  A partial cash distribution was made to shareholders at that time, with the promise of potential additional distributions as the remaining contingent liabilities were resolved.  The investment was written off subsequent to the receipt a letter from Sphinx that raised doubts about the ultimate resolution of those contingent liabilities, although approximately $359,000 was received by the Company from Sphinx in the form of liquidating dividends in 2002 after that letter.  The other investment held by Sierra Phoenix was an equity position in California Banker’s Insurance Agency (“CBIA”), an entity which was formed to facilitate insurance product sales after enabling legislation under the Gramm-Leach-Bliley Financial Services Modernization Act was passed.  After the Bank transferred its investment in Sierra Phoenix transferred to Sierra Bancorp, Sierra Phoenix was dissolved and the Company became a direct investor in CBIA.  This did not have a material impact on the operations of the Bank or the Company.

Sierra Real Estate Investment Trust, a Maryland real estate investment trust (“REIT”), was formed in June 2002 with the primary business purpose of investing in the Bank’s real-estate related assets, and to enhance and strengthen the Bank’s capital position and increase its earnings.  Sierra Real Estate Investment Trust was capitalized in August 2002, when the Bank exchanged real-estate related assets for 100% of the common and

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preferred stock of the REIT, and it is currently the Bank’s only subsidiary.  The Bank distributed a portion of its shares of the REIT’s preferred stock to more than 100 other individual investors in January 2003.  The formation and capitalization of Sierra REIT had a substantial impact on the Bank’s estimated 2002 tax liability and tax accruals were reduced accordingly.  No assurance can be given, however, that the tax benefits available from the REIT will continue to be available in the future.  Furthermore, there is a possibility that a future modification of existing tax laws by the California legislature could require that the tax benefits already realized from the REIT be reversed, although that is not likely in the opinion of management.  Also having a positive impact on taxes was an additional $3 million investment in low-income housing tax credit funds in 2002.  That investment was made in WNC Institutional Tax Credit Fund X, California 2 L.P. in May 2002 and increased the Bank’s total tax credit fund investments to $5.5 million at December 31, 2002.

In September 2002 the Bank’s item processing function was converted to an in-house operation, although overlapping payments due under the Bank’s outsourcing contracts obscured any savings in that area during 2002.  The total capital investment to get the item processing operation functional was over $1.6 million, however even factoring in the additional personnel and occupancy costs, equipment depreciation, and software amortization, the annual savings commencing in 2003 are projected to be around $900,000 per year.  Additionally, the new item processing solution has enabled the Company to produce imaged statements for customers, and should ultimately provide customers with the ability to access imaged statements and checks through the online banking system.

The Company invested approximately $13 million in bank-owned life insurance (BOLI) in September and October of 2002.  The $13 million is a one-time premium that pays for insurance on the lives of certain directors and officers of the Company, with each insured individual initially allocated at least $100,000 in split-dollar death benefits.  Earnings on this investment, including increases in the net cash surrender value and estimated death benefits to the Company, are projected to provide an average annual tax-equivalent book rate of return of close to 8% on a tax-equivalent basis, even after accruing for expenses associated with certain employee benefit plans that were added in conjunction with the BOLI investment.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations.  SFAS 141 addresses the financial accounting and reporting for business combinations and requires the use of a single method to account for business combinations, the purchase method of accounting.  In addition, SFAS 141 requires that intangible assets be recognized as assets apart from goodwill if they meet one of two criteria, the contractual-legal criterion or the separability criterion.  SFAS 141 applies to all business combinations for which the date of acquisition is July 1, 2001 or later.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets.  The provisions of this statement apply to financial statements for fiscal years beginning after December 15, 2001, except for goodwill or other intangible assets acquired after June 30, 2001 for which SFAS No. 142 became immediately effective.

Goodwill generated from purchase business combinations consummated prior to the issuance of SFAS No. 142 was amortized on a straight-line basis.  SFAS No. 142 addresses the initial recognition and measurement of goodwill and other intangible assets acquired as a result of a business combination and the recognition of and measurement of those assets subsequent to acquisition.  Under the new standard, goodwill and other intangible assets deemed to have indefinite lives will no longer be amortized, but instead will be tested at least annually for impairment.  SFAS No. 142 also requires an analysis of impairment of goodwill at least annually or more frequently upon the occurrence of certain events.  The Company completed an initial assessment of goodwill impairment at June 30, 2002 and determined that no impairment existed.  Upon adoption of SFAS No. 142 on January 1, 2002, the Company had unamortized goodwill totaling $5.5 million that will no longer be subject to periodic amortization but will be evaluated for impairment.  Had goodwill not been amortized for the year ended December 31, 2001, net income would have increased by approximately $200,000.

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On October 1, 2002, the FASB issued FASB Statement No. 147, Acquisitions of Certain Financial Institutions.  This statement, which provides guidance on the accounting for the acquisition of a financial institution, applies to all acquisitions except those between two or more mutual enterprises (the Board has a separate project on its agenda that will provide guidance on the accounting for transactions between mutual enterprises).  The provisions of Statement 147 reflect the following conclusions:

• The excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination represents goodwill that should be accounted for under FASB Statement No. 142, Goodwill and Other Intangible Assets.  Thus, the specialized accounting guidance in paragraph 5 of FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, will not apply after September 30, 2002.  If certain criteria in Statement 147 are met, the amount of the unidentifiable intangible asset will be reclassified to goodwill upon adoption of that Statement.

• Financial institutions meeting conditions outlined in Statement 147 will be required to restate previously issued financial statements.  The objective of that restatement requirement is to present the balance sheet and income statement as if the amount accounted for under Statement 72 as an unidentifiable intangible asset had been reclassified to goodwill as of the date Statement 142 was initially applied (For example, a financial institution that adopted Statement 142 on January 1, 2002, would retroactively reclassify the unidentifiable intangible asset to goodwill as of that date and restate previously issued income statements to remove the amortization expense recognized in 2002).  Those transition provisions are effective on October 1, 2002; however, early application is permitted.

• The scope of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, is amended to include long-term customer-relationship intangible assets such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets.

The adoption of Statement No. 147 did not have a material effect on the Company’s consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.  This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002.  The interim disclosure provisions are effective for financial reporting containing financial statements for interim periods beginning after December 15, 2002.  Because the Company accounts for the compensation cost associated with its stock option plan under the intrinsic value method, the alternative methods of transition will not apply to the Company.  The additional disclosure requirements of the statement are included in these financial statements.  In management’s opinion, the adoption of this Statement did not have a material impact on the Company’s consolidated financial position or results of operations.

Competition

The banking business in California in general, and specifically in many of our market areas, is highly competitive with respect to virtually all products and services and has become increasingly more so in recent years.  The industry continues to consolidate, and unregulated competitors have entered banking markets with focused products targeted at highly profitable customer segments.  Many largely unregulated competitors are able to compete across geographic boundaries, and provide customers increasing access to meaningful alternatives to nearly all significant banking services and products.  These competitive trends are likely to continue.

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With respect to commercial bank competitors, the business is largely dominated by a relatively small number of major banks with many offices operating over a wide geographical area.  These banks have, among other advantages, the ability to finance wide-ranging and effective advertising campaigns and to allocate their resources to regions of highest yield and demand.  Many of the major banks operating in the area offer certain services that we do not offer directly but may offer indirectly through correspondent institutions.  By virtue of their greater total capitalization, such banks also have substantially higher lending limits than we do.  For customers whose loan demands exceed our legal lending limit, we attempt to arrange for such loans on a participation basis with correspondent banks.

In addition to other banks, our competitors include savings institutions, credit unions, and numerous non-banking institutions such as finance companies, leasing companies, insurance companies, brokerage firms, and investment banking firms.  In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal financial software.  Strong competition for deposit and loan products affects the rates of those products as well as the terms on which they are offered to customers.  Mergers between financial institutions have placed additional pressure on banks within the industry to streamline their operations, reduce expenses, and increase revenues to remain competitive.  Competition has also intensified due to federal and state interstate banking laws enacted in the mid-1990’s, which permit banking organizations to expand into other states, and the relatively large California market has been particularly attractive to out-of-state institutions.  The Financial Modernization Act, which became effective March 11, 2000, has made it possible for full affiliations to occur between banks and securities firms, insurance companies, and other financial companies, and has also intensified competitive conditions.

Our credit card business is subject to an even higher level of competitive pressure than our general banking business.  There are a number of major banks and credit card issuers that are able to finance often highly successful advertising campaigns with which community banks generally do not have the resources to compete.  As a result, our outstanding credit card balances are more likely to increase at a slower rate than for nationwide issuers.  Additional competition comes from many non-financial institutions, such various retailers that offer many types of credit cards.

Technological innovations have also resulted in increased competition in financial services markets.  Such innovation has, for example, made it possible for non-depository institutions to offer customers automated transfer payment services that previously were considered traditional banking products.  In addition, many customers now expect a choice of delivery systems and channels, including telephone, mail, home computer, ATMs, self-service branches, and/or in-store branches.  The sources of competition in such products include traditional banks as well as savings associations, credit unions, brokerage firms, money market and other mutual funds, asset management groups, finance and insurance companies, internet-only financial intermediaries, and mortgage banking firms.

For many years we have countered rising competition by providing our own style of community-oriented, personalized service.  We rely on local promotional activity, personal contacts by our officers, directors, employees, and shareholders, automated 24-hour banking, and the individualized service that we can provide through our flexible policies.  This appears to be well-received by the populace of the San Joaquin Valley, who appreciate a more personal and customer-oriented environment in which to conduct their financial transactions.  We also have “preferred lender” or “PLP” status with the Small Business Administration, which enables us to approve SBA loans faster than many of our competitors.  In addition, the Company has embraced the electronic age and installed telephone banking and personal computer and internet banking with bill payment capabilities to meet the needs of customers with electronic access requirements.  This high tech and high touch approach allows the individual to customize their access to the Company to their particular preference. 

Employees

As of December 31, 2002 the Company had 238 full-time and 92 part-time employees.  On a full time equivalent basis, the Company’s staff level was 311 at December 31, 2002, as compared to 287 at December 31,

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2001.  Staff was added during 2002 to facilitate in-house item processing, provide adequate resources for certain other technology initiatives, and to enhance business development activities in certain markets.  None of our employees is represented by a union or covered by a collective bargaining agreement.  Management of the Company believes its employee relations are satisfactory.

Regulation and Supervision

The Company and the Bank are subject to significant regulation by federal and state regulatory agencies.  The following discussion of statutes and regulations is only a brief summary and does not purport to be complete. This discussion is qualified in its entirety by reference to such statutes and regulations.  No assurance can be given that such statutes or regulations will not change in the future.

The Company

The Company is subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of 1934 (the “Exchange Act”) which requires the Company to file annual, quarterly and other current reports with the Securities and Exchange Commission (the “SEC”).  The Company is also subject to additional regulations including, but not limited to, the proxy and tender offer rules promulgated by the SEC under Sections 13 and 14 of the Exchange Act; the reporting requirements of directors, executive officers and principal shareholders regarding transactions in the Company’s Common Stock and short-swing profits rules promulgated by the SEC under Section 16 of the Exchange Act; and certain additional reporting requirements by principal shareholders of the Company promulgated by the SEC under Section 13 of the Exchange Act.

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 and is registered as such with the Federal Reserve Board.  A bank holding company is required to file with the Federal Reserve Board annual reports and other information regarding its business operations and those of its subsidiaries.  It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of any voting shares of any bank if, after such acquisition, it would directly or indirectly own or control more than 5% of the voting stock of that bank, unless it already owns a majority of the voting stock of that bank.

The Federal Reserve Board has by regulation determined certain activities in which a bank holding company may or may not conduct business.  A bank holding company must engage, with certain exceptions, in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks.  The permissible activities and affiliations of certain bank holding companies have recently been expanded.  (See “Financial Modernization Act” below.)

The Company and the Bank are deemed to be affiliates of each other within the meaning set forth in the Federal Reserve Act and are subject to Sections 23A and 23B of the Federal Reserve Act. This means, for example, that there are limitations on loans by the Bank to affiliates, and that all affiliate transactions must satisfy certain limitations and otherwise be on terms and conditions at least as favorable to the Bank as would be available for non-affiliates.

The Federal Reserve Board has a policy that bank holding companies must serve as a source of financial and managerial strength to their subsidiary banks.  It is the Federal Reserve Bank’s position that bank holding companies should stand ready to use their available resources to provide adequate capital to their subsidiary banks during periods of financial stress or adversity.  Bank holding companies should also maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting their subsidiary banks.

The Federal Reserve Board also has the authority to regulate bank holding company debt, including the authority to impose interest rate ceilings and reserve requirements on such debt. Under certain circumstances, the Federal Reserve Board may require The Company to file written notice and obtain its approval prior to purchasing or redeeming The Company’s equity securities.

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The Bank

As a California state-chartered bank whose accounts are insured by the FDIC up to a maximum of $100,000 per depositor, the Bank is subject to regulation, supervision and regular examination by the Department of Financial Institutions (the “DFI”) and the FDIC.  In addition, while the Bank is not a member of the Federal Reserve System, it is subject to certain regulations of the Federal Reserve Board.  The regulations of these agencies govern most aspects of the Bank’s business, including the making of periodic reports by the Bank, and the Bank’s activities relating to dividends, investments, loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and acquisitions, reserves against deposits and numerous other areas.  Supervision, legal action and examination of the Bank by the FDIC is generally intended to protect depositors and is not intended for the protection of shareholders. 

The earnings and growth of the Bank are largely dependent on its ability to maintain a favorable differential or “spread” between the yield on its interest-earning assets and the rate paid on its deposits and other interest-bearing liabilities.  As a result, the Bank’s performance is influenced by general economic conditions, both domestic and foreign, the monetary and fiscal policies of the federal government, and the policies of the regulatory agencies, particularly the Federal Reserve Board.  The Federal Reserve Board implements national monetary policies (such as seeking to curb inflation and combat recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rate applicable to borrowings by banks that are members of the Federal Reserve System.  The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and deposits.  The nature and impact of any future changes in monetary policies cannot be predicted.

Capital Adequacy Requirements

The Company and the Bank are subject to the regulations of the Federal Reserve Board and the FDIC, respectively, governing capital adequacy.  Those regulations incorporate both risk-based and leverage capital requirements.  Each of the federal regulators has established risk-based and leverage capital guidelines for the banks or bank holding companies it regulates, which set total capital requirements and define capital in terms of “core capital elements,” or Tier 1 capital; and “supplemental capital elements,” or Tier 2 capital.  Tier 1 capital is generally defined as the sum of the core capital elements less goodwill and certain other deductions, notably the unrealized net gains or losses (after tax adjustments) on available for sale investment securities carried at fair market value. The following items are defined as core capital elements: (i) common shareholders’ equity; (ii) qualifying non-cumulative perpetual preferred stock and related surplus (not to exceed 25% of tier 1 capital); and (iii) minority interests in the equity accounts of consolidated subsidiaries.  Of the Company’s Tier 1 capital at December 31, 2002, $15 million, or approximately 25%, consisted of Trust Preferred Securities.  Supplementary capital elements include:  (i) allowance for loan and lease losses (but not more than 1.25% of an institution’s risk-weighted assets); (ii) perpetual preferred stock and related surplus not qualifying as core capital; (iii) hybrid capital instruments, perpetual debt and mandatory convertible debt instruments; and (iv) term subordinated debt and intermediate-term preferred stock and related surplus.  The maximum amount of supplemental capital elements which qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill.

The minimum required ratio of qualifying total capital to total risk-weighted assets is 8.0% (“Total Risk-Based Capital Ratio”), at least one-half of which must be in the form of Tier 1 capital, and the minimum required ratio of Tier 1 capital to total risk-weighted assets is 4.0% (“Tier 1 Risk-Based Capital Ratio”).  Risk-based capital ratios are calculated to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are recorded as off-balance sheet items. Under the risk-based capital guidelines, the nominal dollar amounts of assets and credit-equivalent amounts of off-balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U. S. Treasury securities, to 100% for assets with relatively high

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credit risk, such as business loans.  As of December 31, 2002 and 2001, the Bank’s Total Risk-Based Capital Ratios were 10.99% and 11.17%, respectively, and its Tier 1 Risk-Based Capital Ratios were 9.92% and 10.01%.  As of December 31, 2002 and 2001, the Company’s Total Risk-Based Capital Ratios were 11.98% and 12.18%, respectively, and its Tier 1 Risk-Based Capital Ratios were 10.91% and 11.03%.

The risk-based capital requirements also take into account concentrations of credit (i.e., relatively large proportions of loans involving one borrower, industry, location, collateral or loan type) and the risks of “non-traditional” activities (those that have not customarily been part of the banking business).  The regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards, and authorize the regulators to review an institution’s management of such risks in assessing an institution’s capital adequacy.

Additionally, the risk-based capital regulations also include exposure to interest rate risk as a factor that the regulators will consider in evaluating a bank’s capital adequacy.  Interest rate risk is the exposure of a bank’s current and future earnings and equity capital arising from adverse movements in interest rates.  While interest risk is inherent in a bank’s role as financial intermediary, it introduces volatility to earnings and to the economic value of the bank.

The FDIC and the Federal Reserve Board also require the maintenance of a leverage capital ratio designed to supplement risk-based capital guidelines.  Banks and bank holding companies that have received the highest rating of the five categories used by regulators to rate banks and are not anticipating or experiencing any significant growth must maintain a ratio of Tier 1 capital (net of all intangibles) to adjusted total assets (“Leverage Capital Ratio”) of at least 3%.  All other institutions are required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%.  Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the volume and severity of problem loans, and federal regulators may, however, set higher capital requirements when a bank’s particular circumstances warrant.  The Bank’s Leverage Capital Ratio was 8.17% on both December 31, 2002 and 2001.  As of December 31, 2002 and 2001, the Company’s leverage capital ratios were 8.99% and 9.02%, exceeding regulatory minimums. 

For more information on the Company’s capital, see Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation – Capital Resources.  Risk-based capital ratio requirements are discussed in greater detail in the following section.

Prompt Corrective Action Provisions

Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured financial institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios.  The federal banking agencies have by regulation defined the following five capital categories: “well capitalized” (Total Risk-Based Capital Ratio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%); “adequately capitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1 Risk-Based Capital Ratio of 4%; and Leverage Ratio of 4%) (or 3% if the institution receives the highest rating from its primary regulator); “undercapitalized” (Total Risk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based Capital Ratio of less than 4%; or Leverage Ratio of less than 4%) (or 3% if the institution receives the highest rating from its primary regulator); “significantly undercapitalized” (Total Risk-Based Capital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio of less than 3%; or Leverage Ratio less than 3%); and “critically undercapitalized” (tangible equity to total assets less than 2%).  A bank may be treated as though it were in the next lower capital category if after notice and the opportunity for a hearing, the appropriate federal agency finds an unsafe or unsound condition or practice so warrants, but no bank may be treated as “critically undercapitalized” unless its actual capital ratio warrants such treatment.

At each successively lower capital category, an insured bank is subject to increased restrictions on its operations.  For example, a bank is generally prohibited from paying management fees to any controlling persons or from making capital distributions if to do so would make the bank “undercapitalized.”  Asset

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growth and branching restrictions apply to undercapitalized banks, which are required to submit written capital restoration plans meeting specified requirements (including a guarantee by the parent holding company, if any).  “Significantly undercapitalized” banks are subject to broad regulatory authority, including among other things, capital directives, forced mergers, restrictions on the rates of interest they may pay on deposits, restrictions on asset growth and activities, and prohibitions on paying certain bonuses without FDIC approval.  Even more severe restrictions apply to critically undercapitalized banks.  Most importantly, except under limited circumstances, not later than 90 days after an insured bank becomes critically undercapitalized, the appropriate federal banking agency is required to appoint a conservator or receiver for the bank. 

In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency.  Enforcement actions may include the issuance of cease and desist orders, termination of insurance of deposits (in the case of a bank), the imposition of civil money penalties, the issuance of directives to increase capital, formal and informal agreements, or removal and prohibition orders against “institution-affiliated” parties.

Safety and Soundness Standards

The federal banking agencies have also adopted guidelines establishing safety and soundness standards for all insured depository institutions.  Those guidelines relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure.  In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired.  If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan and institute enforcement proceedings if an acceptable compliance plan is not submitted.

Premiums for Deposit Insurance

The FDIC regulations also implement a risk-based premium system, whereby insured depository institutions are required to pay insurance premiums depending on their risk classification.  Under this system, insured banks are categorized into one of three capital categories (well capitalized, adequately capitalized, and undercapitalized) and one of three supervisory categories based on federal regulatory evaluations.  The three supervisory categories are: financially sound with only a few minor weaknesses (Group A), demonstrates weaknesses that could result in significant deterioration (Group B), and poses a substantial probability of loss (Group C).  The capital ratios used by the FDIC to define well capitalized, adequately capitalized and undercapitalized are the same in the FDIC’s prompt corrective action regulations.  The current base assessment rates (expressed as cents per $100 of deposits) are summarized as follows: 

	Group A		Group B		Group C
Well Capitalized		0		3		17
Adequately Capitalized		3		10		24
Undercapitalized		10		24		27

In addition, banks must pay an amount toward the retirement of the Financing Corporation bonds issued in the 1980’s to assist in the recovery of the savings and loan industry.  This amount fluctuates but for the first quarter of 2003 is 1.68 cents per $100 of insured deposits.

Community Reinvestment Act

The Bank is subject to certain requirements and reporting obligations involving Community Reinvestment Act (“CRA”) activities.  The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods. The CRA further requires the agencies to take a financial institution’s record of meeting its

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community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations.  In measuring a bank’s compliance with its CRA obligations, the regulators utilize a performance-based evaluation system which bases CRA ratings on the bank’s actual lending service and investment performance, rather than on the extent to which the institution conducts needs assessments, documents community outreach activities or complies with other procedural requirements.  In connection with its assessment of CRA performance, the FDIC assigns a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.”  The Bank was last examined for CRA compliance in June 2001 when it received a “satisfactory” CRA Assessment Rating.

Other Consumer Protection Laws and Regulations

The bank regulatory agencies are increasingly focusing attention on compliance with consumer protection laws and regulations.  Examination and enforcement has become intense, and banks have been advised to carefully monitor compliance with various consumer protection laws and regulations. The federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in home mortgage lending describing three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact.  In addition to CRA and fair lending requirements, the Bank is subject to numerous other federal consumer protection statutes and regulations.  Due to heightened regulatory concern related to compliance with consumer protection laws and regulations generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in the local communities it serves.

Interstate Banking and Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Act”) regulates the interstate activities of banks and bank holding companies and establishes a framework for nationwide interstate banking and branching.  Since June 1, 1997, a bank in one state has generally been permitted to merge with a bank in another state without the need for explicit state law authorization.  However, states were given the ability to prohibit interstate mergers with banks in their own state by “opting-out” (enacting state legislation applying equality to all out-of-state banks prohibiting such mergers ) prior to June 1, 1997.

Since 1995, adequately capitalized and managed bank holding companies have been permitted to acquire banks located in any state, subject to two exceptions: first, any state may still prohibit bank holding companies from acquiring a bank which is less than five years old; and second, no interstate acquisition can be consummated by a bank holding company if the acquirer would control more than 10% of the deposits held by insured depository institutions nationwide or 30% percent or more of the deposits held by insured depository institutions in any state in which the target bank has branches.

A bank may establish and operate de novo branches in any state in which the bank does not maintain a branch if that state has enacted legislation to expressly permit all out-of-state banks to establish branches in that state.

In 1995 California enacted legislation to implement important provisions of the Interstate Banking Act discussed above and to repeal California’s previous interstate banking laws, which were largely preempted by the Interstate Banking Act.

The changes effected by Interstate Banking Act and California laws have increased competition in the environment in which the Bank operates to the extent that out-of-state financial institutions directly or indirectly enter the Bank’s market areas.  It appears that the Interstate Banking Act has contributed to the accelerated consolidation of the banking industry. While many large out-of-state banks have already entered the California market as a result of this legislation, it is not possible to predict the precise impact of this legislation on the Bank and the Company and the competitive environment in which they operate.

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Financial Modernization Act

Effective March 11, 2000 the Gramm-Leach-Bliley Act eliminated most barriers to affiliations among banks and securities firms, insurance companies, and other financial service providers, and enabled full affiliations to occur between such entities.  This legislation permits bank holding companies to become “financial holding companies” and thereby acquire securities firms and insurance companies and engage in other activities that are financial in nature.  A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the FDICIA prompt corrective action provisions, is well managed, and has at least a satisfactory rating under the CRA by filing a declaration that the bank holding company wishes to become a financial holding company.   No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board.  The Company has no current intention of becoming a financial holding company, but may do at some point in the future if deemed appropriate in view of opportunities or circumstances at the time.

The Gramm-Leach-Bliley Act defines “financial in nature” to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Board has determined to be closely related to banking.  A national bank (and therefore, a state bank as well) may also engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development and real estate investment, through a financial subsidiary of the bank, if the bank is well capitalized, well managed and has at least a satisfactory CRA rating.  Subsidiary banks of a financial holding company or national banks with financial subsidiaries must continue to be well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial in nature subsidiary or subsidiaries.  In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has a CRA rating of satisfactory or better.

The Gramm-Leach-Bliley Act also imposes significant new requirements on financial institutions with respect to the privacy of customer information, and modifies other existing laws, including those related to community reinvestment.

USA Patriot Act of 2001

On October 26, 2001, President Bush signed the USA Patriot Act of 2001 (the “Patriot Act”).  Enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. on September 11, 2001, the Patriot Act is intended to strengthen the ability of U.S. law enforcement agencies and intelligence communities to work cohesively to combat terrorism on a variety of fronts. The impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations applicable to financial institutions, including:

• due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons;

• standards for verifying customer identification at account opening; and

• rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

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Other Pending and Proposed Legislation

Other legislative and regulatory initiatives which could affect the Company, the Bank and the banking industry in general are pending, and additional initiatives may be proposed or introduced before the United States Congress, the California legislature and other governmental bodies in the future.  Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among financial institutions, and may subject the Bank to increased regulation, disclosure and reporting requirements.  In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation.  It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the extent to which the business of the Company or the Bank would be affected thereby.

RISK FACTORS

Statements and financial discussion and analysis by management contained throughout this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements involve a number of risks and uncertainties.  Factors that could cause actual results to differ materially from the forward-looking statements herein include, without limitation, the factors set forth below.

Poor Economic Conditions in Our Market Areas May Cause Us to Suffer Higher Default Rates on Our Loans.  A substantial majority of our assets and deposits are generated in the San Joaquin Valley in central California.  As a result, poor economic conditions in the San Joaquin Valley could cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio.  The San Joaquin Valley has not experienced the same type of growth that has occurred in other areas of California, especially those where high-tech industries have taken hold.  Unemployment levels have historically been and remain relatively high, especially in Tulare County, which is our geographic center and the base of our agriculturally oriented communities.  The United States entered into an economic recession in 2001, and California’s Silicon Valley and other high-tech areas were particularly impacted.  In addition, the war with Iraq could have a significant negative effect on the national economy.  While the national recession has not necessarily worsened economic conditions in the San Joaquin Valley, the Company’s balance of non-performing assets, while showing a decrease relative to year-end 2001, remains relatively high due in large part to lingering agricultural difficulties.  Because of increased global competition and other factors, excess supply and low prices characterize the markets for many agricultural products.  If current recessionary conditions continue or deteriorate, we expect that our level of non-performing assets could increase further.

Concentrations of Real Estate Loans Could Subject Us to Increased Risks in the Event of a Real Esate Recession or Natural Disaster.  Our loan portfolio is heavily concentrated in real estate loans, particularly commercial real estate.  At December 31, 2002, 67.8% of our loan portfolio consisted of loans secured by real estate.  Between the end of 1998 and the end of 2002, our loans secured by commercial/professional office properties (including construction and development loans) increased from 28.9% to 46.5% of total loans, while loans secured by residential properties have decreased form 27.0% to 17.8%.  In the early 1990’s, the entire state of California experienced an economic recession that particularly impacted real estate values and resulted in increases in the level of delinquencies and losses for many financial institutions.  Much of our market area seems to have been insulated from the significant fluctuations in real estate prices experienced by other parts of California over the past few decades.  However, if a similar real estate recession affects our market areas in the future, the security for many of our loans could be reduced in value and the ability of some of our borrowers to pay could decline.  Similarly, the occurrence of a natural disaster like those California has experienced in the past, including earthquakes, brush fires, and flooding could impair the value of the collateral we hold for real estate secured loans and negatively impact our results of operations.

Poor Economic Conditions Affecting the Agricultural Industry Could Have an Adverse Effect on Our Customers and Their Ability to Make Payments to Us.  A sizable portion of our total loan portfolio is to borrowers either directly or indirectly involved in the agricultural industry.  While a great number of our

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borrowers may not be individually involved in agriculture, many of the jobs in the San Joaquin Valley are ancillary to the regular production, processing, marketing and sales of agricultural commodities.  The ripple effect of lower commodity prices for milk, olives, grapes, tree fruit and oranges has a tendency to spread to lower land prices, lower borrower income, and lower collateral values.  In addition, weather patterns are of critical importance to row crop, tree fruit, and orange production.  A degenerative cycle of weather and commodity prices can impact consumer purchasing power, which has the potential to create further unemployment throughout the San Joaquin Valley.  Such conditions have affected and may continue to adversely affect our borrower base and negatively impact our business.

We May Have Difficulty Managing Our Growth.  Management intends to leverage the Company’s current infrastructure to grow assets, and one to two new branches per year are also tentatively planned, although no assurance can be provided that this strategy will result in significant growth.  Our ability to manage growth will depend primarily on our ability to:

• monitor operations;

• control funding costs and operating expenses;

• maintain positive customer relations; and

• attract, assimilate and retain qualified personnel.

If we fail to achieve those objectives in an efficient and timely manner we may experience disruptions in our business plans, and our financial condition and results of operations could be adversely affected.

Our Earnings are Subject to Interest Rate Risk, Especially if Rates Fall.  The earnings of most financial institutions depend largely on the relationship between the cost of funds, primarily deposits and borrowings, and the yield on earning assets such as loans and investment securities.  This relationship, known as the interest rate spread, is subject to fluctuation and is affected by economic, regulatory and competitive factors that influence interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets.  Many of these factors are beyond our control.  Fluctuations in interest rates affect the demand of customers for our products and services, and the Company is subject to interest rate risk to the degree that our interest-bearing liabilities re-price or mature more slowly or more rapidly or on a different basis than our interest-earning assets.  Given the current volume, mix, and re-pricing characteristics of interest-bearing liabilities and interest-earning assets, our interest rate spread could be expected to decline slightly during times of falling interest rates, but could also be adversely impacted if interest rates increase.  Therefore, significant fluctuations in interest rates may have a negative effect on our results of operations.

We Operate in a Competitive Market Dominated by Banks and Other Financial Services Providers that Offer a Broder Range of Services than We Provide, Many of Which Have Lower Cost Structures.  In California generally, and in our primary service area specifically, branches of major banks dominate the commercial banking industry.  By virtue of their larger capital, such institutions have substantially greater lending limits than we have, and perform certain functions for their customers, including trust services and international banking, which we are not equipped to offer directly (but some of which we offer indirectly through correspondent relationships).  Many of these banks also operate with “economies of scale” that result in lower operating costs than ours on a per loan or per asset basis.

We also compete with other financial institutions such as savings and loan associations, credit unions, thrift and loan companies, mortgage companies, securities brokerage companies and insurance companies located within and without our service area, and with quasi-financial institutions such as money market funds for deposits and loans.  Financial services like ours are increasingly offered over the Internet on a national and international basis, and we compete with providers of these services as well.  Ultimately, competition can drive down our interest margins and reduce our profitability.  It can also make it more difficult for us to continue to increase the size of our loan portfolio and deposit base.

You May Have Difficulty Selling Your Shares in the Future If a More Active Trading Market for Our Stock Does Not Develop.  Although Sierra Bancorp’s Common Stock has been listed on the Nasdaq National Market since August 10, 2001 (the effective date of the holding company reorganization) and Bank of the

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Sierra’s Common Stock was previously listed on the Nasdaq National Market since June 10, 1999, trading in our stock has not been extensive and cannot be characterized as amounting to an active trading market.

We May Experience Loan Losses in Excess of Our Allowance for Loan Losses.  We try to limit the risk that borrowers will fail to repay loans by carefully underwriting the loans, nevertheless losses can and do occur.  We create an allowance for estimated loan losses in our accounting records, based on estimates of the following:

• industry standards;

• historical experience with our loans;

• evaluation of economic conditions;

• regular reviews of the quality mix and size of the overall loan portfolio;

• regular reviews of delinquencies; and

• the quality of the collateral underlying our loans.

We maintain an allowance for loan losses at a level that we believe is adequate to absorb any specifically identified losses as well as any other losses inherent in our loan portfolio.  However, changes in economic, operating and other conditions, including changes in interest rates, that are beyond our control, may cause our actual loan losses to exceed our current allowance estimates.  If the actual loan losses exceed the amount reserved, it will hurt our business.  In addition, the FDIC and the Department of Financial Institutions, as part of their supervisory functions, periodically review our allowance for loan losses.  Such agencies may require us to increase our provision for loan losses or to recognize further loan losses, based on their judgments, which may be different from those of our management.  Any increase in the allowance required by the FDIC or the Department of Financial Institutions could also hurt our business.

Our Directors and Executive Officers Control Almost a Majority of Our Stock, and Your Interests May Not Always be the Same as Those of the Board and Management.  As of February 14, 2003, our directors and executive officers together with their affiliates, beneficially owned approximately 45.9% of the Bank’s outstanding voting stock (not including vested option shares).  As a result, if all of these shareholders were to take a common position, they could most likely control the outcome of most corporate actions, such as:

• approval of mergers or other business combinations;

• sales of all or substantially all of our assets;

• any matters submitted to a vote of our shareholders;

• issuance of any additional common stock or other equity securities;

• incurrence of debt other than in the ordinary course of business;

• the selection and tenure of our Chief Executive Officer; and

• payment of dividends on common stock or other equity securities.

In some situations, the interests of our directors and executive officers may be different from yours.  However, our Board of Directors and executive officers have a fiduciary duty to act in the best interests of the shareholders, rather than in their own best interests, when considering a proposed business combination or any of these types of matters.

Provisions in Our Articles of Incorporation Will Delay or Prevent Changes in Control of Our Corporation or Our Management.  These provisions make it more difficult for another company to acquire us, which could reduce the market price of our common stock and the price that you receive if you sell your shares in the future. These provisions include the following:

• a requirement that certain business combinations not approved by our Board of Directors receive the approval of two-thirds of the outstanding shares;

• staggered terms of office for members of the board of directors;

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• the elimination of cumulative voting in the election of directors; and

• a requirement that our Board of Directors consider the potential social and economic effects on the our employees, depositors, customers and the communities we serve as well as certain other factors, when evaluating a possible tender offer, merger or other acquisition of the Company.

ITEM 2. PROPERTIES

The Company’s administrative headquarters is located at 86 North Main Street, Porterville, California, and is leased through April 2014 from parties unrelated to the Company.  It consists of approximately 37,000 square feet in a three-story building of which the Company is sole occupant, and the rent as of December 31, 2002 was $10,497 per month.  The Company also owns unencumbered property on which 13 of the its 16 current branches are located, including the branches in Porterville, Lindsay, Exeter, Three Rivers, Dinuba, Tulare, Hanford, Fresno, Tehachapi, and California City.  One of the Bakersfield branches is owned while the other is leased from unrelated parties, and the branches in Visalia are also leased from unrelated parties.  In addition, the Company operates a technology center in Porterville which consists of approximately 12,000 square feet in a freestanding single-story building that is leased from unrelated parties.  The Bank also has six remote ATM locations leased from unrelated parties, although the amount of monthly rent at these locations is minimal.

Management believes that the Company’s existing facilities are adequate to accommodate the Company’s operations for the immediately foreseeable future, although limited branch expansion is planned.

ITEM 3. LEGAL PROCEEDINGS

From time to time, the Company is a party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel to the Company as to the current status of these claims or proceedings to which the Company is a party, management is of the opinion that the ultimate aggregate liability represented thereby, if any, will not have a material adverse affect on the financial condition of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

               Not applicable.

PART II

ITEM 5.		MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
(a)	Market Information

Sierra Bancorp’s Common Stock has been listed on the Nasdaq National Market since August 10, 2001 (the effective date of the holding company reorganization), and Bank of the Sierra’s Common Stock was previously listed on the Nasdaq National Market since June 10, 1999.  Our Common Stock trades on the Nasdaq Stock Market® under the symbol BSRR and the CUSIP number for such common stock is #064860109. Trading in the Common Stock of the Company has not been extensive and such trades cannot be characterized as amounting to an active trading market.  Management is aware of the following securities dealers which make a market in the Company’s stock:  FTN Financial Securities Corp., Memphis; Goldman, Sachs & Co., New York; Hoefer & Arnett, San Francisco; J. Alexander Securities, Inc., Los Angeles; Knight Securities, L.P., Jersey City, New Jersey; The Seidler Companies, Inc., Big Bear, California; and Wedbush Morgan Securities, Portland (the “Securities Dealers”).

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The following table summarizes trades of the Company’s¹ Common Stock, setting forth the approximate high and low sales prices and volume of trading for the periods indicated, based upon information provided by public sources.

	Sale Price of the Company’s1 Common Stock (per share)				Approximate Trading Volume In Shares
Calendar Quarter Ended
	High		Low
March 31, 2001	$	8.13	$	6.25		96,100
June 30, 2001	$	7.30	$	6.00		126,400
September 30, 2001	$	7.25	$	6.00		122,000
December 31, 2001	$	7.30	$	6.00		167,300
March 31, 2002	$	10.94	$	6.96		139,900
June 30, 2002	$	12.99	$	9.53		150,500
September 30, 2002	$	11.25	$	9.71		380,400
December 31, 2002	$	11.15	$	8.66		403,500

(b) Holders

On February 14, 2003 there were approximately 1,850 shareholders of record of the Company’s Common Stock.

(c) Dividends

As a bank holding company that currently has no significant assets other than its equity interest in the Bank, the Company’s ability to declare dividends depends primarily upon dividends it receives from the Bank.  The Bank’s dividend practices in turn depend upon the Bank’s earnings, financial position, current and anticipated capital requirements and other factors deemed relevant by the Bank’s Board of Directors at that time.

The Company paid cash dividends totaling $2.59 million or $0.28 per share in 2002 and $1.66 million or $0.18 per share in 2001, representing 38% and 24%, respectively of the prior year’s earnings.  (As the holding company reorganization became effective on August 10, 2001, all of the dividends paid prior to that date were paid by the Bank, rather than the Company.)  Since 1999, the Bank (or the Company, as applicable) has generally adhered to a policy of paying quarterly cash dividends totaling about 35% of the prior year’s net earnings to the extent consistent with general considerations of safety and soundness, provided that such payments do not adversely affect the Bank’s or the Company’s financial condition and are not overly restrictive to its growth capacity.  However, the Bank experienced significant growth in 2000, due mainly to its acquisition of Sierra National Bank in May of that year, and also had a slight contraction in earnings in the 2000 calendar year.  In light of these events, the Board of Directors declared dividends in 2001 totaling only approximately 24% of the prior year earnings.

The Company anticipates paying dividends in the future consistent with the general dividend policy as described above.  However, no assurance can be given that the Bank’s and the Company’s future earnings and/or growth expectations in any given year will justify the payment of such a dividend. 

The power of the Bank’s Board of Directors to declare cash dividends is also limited by statutory and regulatory restrictions which restrict the amount available for cash dividends depending upon the earnings, financial condition and cash needs of the Bank, as well as general business conditions.  Under California banking law, the Bank may declare dividends in an amount not exceeding the lesser of its retained earnings or its net income for the last three years (reduced by dividends paid during such period) or, with the prior approval of the

1 Inasmuch as the Company did not acquire the outstanding shares of the Bank until August, 2001, the information contained herein for part of 2001 is for the Bank's stock.  As of the effective date of the holding company reorganization (August 10, 2001), each outstanding share of common stock of the Bank was converted into one outstanding share of common stock of the Company.

20

California Commissioner of Financial Institutions, in an amount not exceeding the greatest of (i) the retained earnings of the Bank, (ii) the net income of the Bank for its last fiscal year, or (iii) the net income of the Bank for its current fiscal year.  The payment of any cash dividends by the Bank will depend not only upon the Bank’s earnings during a specified period, but also on the Bank meeting certain regulatory capital requirements.

The Company’s ability to pay dividends is also limited by state corporation law. The California General Corporation Law prohibits the Company from paying dividends on the Common Stock unless: (i) its retained earnings, immediately prior to the dividend payment, equals or exceeds the amount of the dividend or (ii) immediately after giving effect to the dividend the sum of the Company’s assets (exclusive of goodwill and deferred charges) would be at least equal to 125% of its liabilities (not including deferred taxes, deferred income and other deferred liabilities) and the current assets of the Company would be at least equal to its current liabilities, or, if the average of its earnings before taxes on income and before interest expense for the two preceding fiscal years was less than the average of its interest expense for the two preceding fiscal years, at least equal to 125% of its current liabilities.

(d) Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2002, with respect to options outstanding and available under our 1998 Stock Option Plan, which is our only equity compensation plan other than an employee benefit plan meeting the qualification requirements of Section 401(a) of the Internal Revenue Code:

Plan Category	Number of Securities to be Issued Upon Exercise of Outstanding Options		Weighted-Average Exercise Price of Outstanding Options	Number of Securities Remaining Available for Future Issuance
Equity compensation plans approved by security holders	1,947,536	$	7.82	746,064

ITEM 6. SELECTED FINANCIAL DATA

The “selected financial data” that follows is derived from the audited Consolidated Financial Statements of the Company and from our internal accounting system, although the audited Consolidated Financial Statements for earlier periods are not necessarily included in this Annual Report.  The selected financial data should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below.  Statistical information below is generally based on average daily amounts.

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Selected Financial Data

As of December 31,

(Dollars in thousands, except per share data)

									2002			2001			2000(1)			1999			1998
Income Statement Summary
Interest income									$	42,085		$	43,338		$	45,528		$	33,864		$	33,652
Interest expense									$	9,096		$	15,892		$	18,677		$	11,721		$	12,378
Net interest income before provision for loan losses									$	32,989		$	27,446		$	26,851		$	22,143		$	21,274
Provision for loan losses									$	3,350		$	1,300		$	2,760		$	2,118		$	2,800
Non interest income									$	8,522		$	9,663		$	6,436		$	5,346		$	6,076
Non-interest expense									$	26,242		$	25,309		$	22,304		$	16,984		$	16,383
Income before provision for income taxes									$	11,919		$	10,500		$	8,223		$	8,387		$	8,167
Provision for income taxes									$	3,080		$	3,622		$	2,742		$	2,775		$	2,943
Net Income									$	8,839		$	6,878		$	5,481		$	5,612		$	5,224
Balance Sheet Summary
Total loans, net									$	505,655		$	480,393		$	416,392		$	314,474		$	270,920
Allowance for loan losses									$	(5,939	)	$	(5,675	)	$	(5,362	)	$	(3,319	)	$	(4,394	)
Securities held to maturity									$	—		$	—		$	—		$	64,886		$	53,096
Securities available for sale									$	83,911		$	92,689		$	110,752		$	26,528		$	30,656
Cash and due from banks									$	55,819		$	39,835		$	43,433		$	31,413		$	24,545
Federal funds sold									$	—		$	—		$	246		$	—		$	9,800
Other real estate owned									$	1,421		$	769		$	1,530		$	2,553		$	1,273
Premises and equipment, net									$	17,578		$	14,304		$	14,477		$	11,597		$	9,491
Total Interest-Earning assets									$	596,529		$	579,480		$	535,689		$	408,924		$	369,216
Total Assets									$	701,114		$	650,410		$	606,726		$	458,384		$	404,064
Total Interest-Bearing liabilities									$	475,252		$	454,216		$	431,468		$	327,835		$	283,464
Total Deposits									$	605,705		$	521,317		$	527,776		$	385,818		$	355,881
Total Liabilities									$	647,827		$	604,269		$	565,944		$	421,685		$	369,046
Total Shareholders’ Equity									$	53,287		$	46,141		$	40,782		$	36,699		$	35,018
Per Share Data
Net Income Per Basic Share									$	0.96		$	0.75		$	0.60		$	0.61		$	0.57
Book Value									$	5.76		$	5.01		$	4.43		$	3.98		$	3.80
Cash Dividends									$	0.28		$	0.18		$	0.23		$	0.22		$	0.15
Weighted Average Common Shares Outstanding Basic										9,252,093			9,212,280			9,212,280			9,212,280			9,212,280
Weighted Average Common Shares Outstanding Diluted										9,665,839			9,221,480			9,212,280			9,252,193			9,212,280
Key Operating Ratios:
		Performance Ratios:
								Return on Average Equity(3)		17.59	%		15.94	%		14.30	%		16.24	%		15.81	%
								Return on Average Assets(2)		1.32	%		1.15	%		0.96	%		1.33	%		1.33	%
							Net Interest Spread(5)			5.05	%		4.25	%		4.60	%		5.10	%		4.97	%
							Net Interest Margin			5.47	%		5.07	%		5.19	%		5.80	%		5.92	%
						Dividend Payout Ratio(4)				29.31	%		24.11	%		38.33	%		36.07	%		26.32	%
						Equity to Assets Ratio(6)				7.50	%		7.21	%		6.69	%		8.22	%		8.42	%
					Net Loans to Total Deposits at Period End					83.48	%		92.15	%		78.90	%		81.51	%		76.13	%
	Asset Quality Ratios:
				Non Performing Loans to Total Loans						1.26	%		2.01	%		0.73	%		0.29	%		1.43	%
			Nonperforming Assets to Total Loans and Other Real Estate Owned							1.53	%		2.17	%		1.05	%		1.08	%		1.88	%
			Net Charge-offs (recoveries) to Average Loans							0.62	%		0.23	%		0.43	%		1.11	%		0.55	%
			Allowance for Loan Losses to Net Loans at Period End							1.17	%		1.18	%		1.29	%		1.06	%		1.62	%
			Allowance for Loan Losses to Non-Performing Loans							91.84	%		58.00	%		173.87	%		363.13	%		111.58	%
	Capital Ratios:
			Tier 1 Capital to Adjusted Total Assets							8.99	%		9.02	%		5.64	%		8.13	%		8.16	%
			Tier 1 Capital to Total Risk-weighted Assets							10.91	%		11.03	%		7.76	%		10.30	%		11.54	%
			Total Capital to Total Risk-weighted Assets							11.98	%		12.18	%		9.00	%		11.32	%		12.79	%

(1) On May 19, 2000, Bank of the Sierra acquired the net assets of Sierra National Bank. The transaction was accounted for using the purchase method of accounting. Bank of the Sierra paid $9,563,000 in cash (including acquisition-related costs of $463,000) for net assets of $3,694,000. The resulting purchase price in excess of net assets acquired (intangibles) is $5,869,000. The allocation of the purchase price is preliminary as not all estimations have been finalized.

(2) Net income divided by average total assets.

(3) Net income divided by average shareholders’ equity.

(4) Dividends declared per share divided by net income per share.

(5) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

(6) Average equity divided by average total assets.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion presents Management’s analysis of the financial condition and results of operations of the Company as of and for each of the years in the three-year period ended December 31, 2002.¹  The discussion should be read in conjunction with the Consolidated Financial Statements of the Company and the Notes related thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below).

Statements contained in this report that are not purely historical are forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended, including the Company’s expectations, intentions, beliefs, or strategies regarding the future.  All forward-looking statements concerning economic conditions, rates of growth, rates of income or values as may be included in this document are based on information available to the Company on the date noted, and the Company assumes no obligation to update any such forward-looking statements.  It is important to note that the Company’s actual results could materially differ from those in such forward-looking statements.  Factors that could cause actual results to differ materially from those in such forward-looking statements are fluctuations in interest rates, inflation, government regulations, economic conditions, customer disintermediation and competitive product and pricing pressures in the geographic and business areas in which the Company conducts its operations.

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the U.S.  The financial information contained within these statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred.  Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations.  In Management’s opinion, the Company’s critical accounting policies deal with the following areas:  The establishment of the Company’s allowance for loan losses, as explained in detail in the “Provision for Loan Losses” and “Allowance for Loan Losses” sections of this discussion and analysis; the annual evaluation of goodwill for impairment as more fully described in Part I, Item 1 under Recent Accounting Pronouncements; and the accrual of the Company’s tax liability, particularly as it relates to the inclusion of benefits from the REIT, as detailed in the section on “Income Taxes” in this discussion and analysis.

Summary of Performance

The strong improvement in earnings that was realized in 2001 provided momentum for another record year in 2002, with the Company again achieving its highest net income ever.  In fact, net income has increased in 18 of the last 19 years.  Net income in 2002 was $8.8 million, an increase of nearly $2.0 million, or 28.5%, over net earnings recognized in 2001.  Net income in 2001 was $6.9 million, an increase of $1.4 million, or 25.5%, over 2000 net earnings of $5.5 million.  Net income per basic share was $0.96 for 2002, as compared to $0.75 during 2001 and $0.60 in 2000.  The Company’s Return on Average Assets (“ROA”) was 1.32% and Return on Average Equity (“ROE”) was 17.59% in 2002, as compared to 1.15% and 15.94%, respectively in 2001, and .96% and 14.30%, respectively for 2000.

As is typical in many community banks, the Company’s interest-earning assets mature or reprice more quickly that its interest-bearing liabilities, in aggregate, and a record drop in interest rates during 2001 had a negative impact on the Company’s net interest margin that year.  Net income still increased in 2001, however, primarily due to gains on the sale of investment securities, gains on the sale of loan servicing, a lower loan loss provision, and the implementation of more stringent expense controls.  In 2002 the largest gain was in net

1 As the holding company reorganization pursuant to which the Company became the sole shareholder of the Bank was effective in August, 2001, all financial information as of and for the years ended December 31, 2000 and any earlier years or periods relates to the Bank rather than the Company.  Information as of and for the years ended December 31, 2001 and 2002 is provided for the Bank and the Company on a consolidated basis.

23

interest income, which increased not only because of $62 million growth in average earning assets but also as the result of a 40 basis point improvement in the Company’s net interest margin.  The net interest margin increased mainly because of a relatively stable interest rate environment during most of 2002 that allowed the Company to maintain its cost of funds at record low levels.

Other core income components also showed healthy improvement in 2002, although total non-interest income was lower due to the non-recurring gains realized in 2001.  Non-interest expenses were held to a 3.7% increase in 2002 despite the additional expenses associated with a conversion to in-house item processing and the relocation of the Company’s MIS group.  The provision for loan losses, however, increased by $2.1 million, largely as a result of growth in the Company’s loan portfolio but also due to a higher level of charge-offs, higher average non-accrual balances, and weakness in agricultural sectors of the local economy.

Additionally, despite a $1.4 million increase in pre-tax income from 2001 to 2002, the Company’s provision for income taxes was $542,000 lower in 2002 than in 2001.  Enterprise zone interest deductions and low-income housing investment tax credits have had an impact, but the substantial reduction in the tax provision in 2002 was mainly due to the tax benefit derived from the Company’s real estate investment trust (“REIT”) that was capitalized in August of 2002.  No assurance can be given that the tax benefits produced by the REIT in 2002 will continue to be available in the future, however, and it is conceivable but unlikely that a reinterpretation of existing tax laws by the California legislature could require that the tax benefits already realized from the REIT be reversed.

The Company’s total assets grew by $51 million, or 7.8%, from $650 million at the end of 2001 to $701 million at the end of 2002.  Loan balances showed a relatively modest increase of $25 million during 2002, although average loan balances for the year increased by $73 million due to significant growth in the last quarter of 2001.  Cash and due from banks was up by nearly $16 million at December 31, 2002 relative to December 31, 2001.  However, this was a temporary condition created by delayed credit in our Federal Reserve Bank account for cash items presented for collection, and the balance of cash and due from banks has subsequently dropped by over $23 million to close to its $33 million average balance for 2002.  Another important shift in the composition of the Company’s balance sheet was a $15 million increase in other assets, which jumped to 4.4% of total assets at December 31, 2002 from 2.6% at the end of 2001.  This increase was due to a $3 million investment in low-income housing tax credit funds in May 2002, and a $13 million investment in bank-owned life insurance (BOLI) in September 2002, both of which enhance profitability but neither of which is classified as an interest-earning asset.

The most notable change in deposits since December 31, 2001 was a $40 million increase in time deposits over $100,000.  This mainly represents the addition of brokered deposits to replace overnight borrowings from the Federal Home Loan Bank, which declined by $38 million. This is considered by management to be an interim measure to take advantage of relatively low rates in the wholesale deposit market and improve the Company’s shorter-term liquidity.  In the longer term, the Company anticipates replacing these brokered deposits with core deposits generated in its branches.  Although no assurance can be given that this will happen, core deposits did increase by $44 million, or 9.9%, from the end of 2001 to the end of 2002.  Furthermore, there was a significant shift among core deposit balances from time deposits under $100,000, which declined by $16 million, into money market accounts and non-interest bearing transaction accounts, which increased by $29 million and $22 million, respectively.  It is management’s sentiment that the increase in core deposits was due in large part to volatility in equity markets, and that continued uncertainty presents further opportunity to encourage migration into the Company’s relatively stable deposit products.  The Company’s current marketing campaigns are directed at taking advantage of this situation, although no assurance can be given that further increases in core deposits will indeed be realized. 

Another funding source is represented by securities sold under agreement to repurchase (Repo’s), which is the investment vehicle for customer “sweep account” arrangements.  Repo balances declined by almost $8 million from the end of 2001 to the end of 2002, due in part to certain Repo customers transferring balances to slightly higher yielding money market deposit accounts.  The Company also had $5 million in fed funds purchased at December 31, 2002; however, as the balance of items in process of collection has been reduced and core

24

deposit balances have increased, the need for these temporary short-term funds has subsequently been eliminated.

Due primarily to the retention of earnings, the Company’s total shareholders’ equity increased from $46 million at December 31, 2001 to $53 million at December 31, 2002.  This is an increase of $7 million, or about 15.5%.  The Company’s total risk-based capital ratio at December 31, 2002 was 11.98%.

Results of Operations

During 2002 the Company generated net income of $8.8 million as compared to $6.9 million in 2001 and $5.5 million in 2000.  The Company earns income from two primary sources.  The first is net interest income brought about by income from the successful deployment of earning assets less the costs of interest-bearing liabilities.  The second is non-interest income, which generally comes from customer service charges and fees, but can also result from non-customer sources such as gains on loan sales and gains on sales from the Company’s investment portfolio.  The majority of the Company’s non-interest expenses are operating costs that relate to providing a full range of banking services to our customers.

Net Interest Income and Net Interest Margin

Net interest income, which is simply total interest income (including fees) less total interest expense, was $33.0 million in 2002 compared to $27.4 million and $26.9 million in 2001 and 2000, respectively.  This represents an increase of 20.2% in 2002 over 2001 and an increase of 2.2% in 2001 over 2000.  The level of net interest income depends on several factors, including yields on earning assets, the cost of interest-bearing liabilities, the relative volume of total earning assets and total interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities.  Any change in the amount and mix of interest-earning assets and interest-bearing liabilities is referred to as “volume change.”  A change in interest rates earned on assets and rates paid on deposits and other borrowed funds is referred to as “rate change.”

The Volume and Rate Variances table which follows sets forth the dollar amount of changes in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to changes in average balances (volume) or changes in average interest rates.  The change due to an increase or decrease in volume is equal to the change in the average balance times the prior period rate, whereas the change due to an increase or decrease in the rate is equal to the change in the average rate times the current period balance. The variances attributable to both the volume and rate changes have been allocated to the change in rate.

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Volume & Rate Variances		Years Ended December 31,
		2002 over 2001									2001 over 2000
		Increase (decrease) due to									Increase (decrease due to)
(dollars in thousands)		Volume			Rate			Net			Volume			Rate			Net
Assets:
Investments:
Federal funds sold / Due from time		$	99		$	(294	)	$	(195	)	$	334		$	(180	)	$	154
Taxable		$	(1,021	)	$	(258	)	$	(1,279	)	$	(447	)	$	(207	)	$	(654	)
Non-taxable(1)		$	81		$	(232	)	$	(151	)	$	111		$	(133	)	$	(22	)
Equity		$	(11	)	$	116		$	105		$	(7	)	$	67		$	60
	Total Investments	$	(851	)	$	(669	)	$	(1,520	)	$	(9	)	$	(453	)	$	(462	)
Loans:
Agricultural		$	(168	)	$	(63	)	$	(231	)	$	(490	)	$	(331	)	$	(821	)
Commercial		$	1,224		$	(1,694	)	$	(470	)	$	1,456		$	(1,137	)	$	319
Real Estate		$	4,285		$	(3,446	)	$	839		$	101		$	(1,680	)	$	(1,579	)
Consumer		$	1,095		$	(855	)	$	240		$	694		$	(439	)	$	255
Credit Cards		$	(102	)	$	(9	)	$	(111	)	$	101		$	(3	)	$	98
	Total Loans	$	6,335		$	(6,068	)	$	267		$	1,862		$	(3,590	)	$	(1,728	)
	Total Earning Assets	$	5,483		$	(6,736	)	$	(1,253	)	$	1,853		$	(4,043	)	$	(2,190	)
Liabilities
Interest Bearing Deposits:
NOW		$	25		$	(191	)	$	(166	)	$	(16	)	$	(180	)	$	(196	)
Savings Accounts		$	57		$	(249	)	$	(192	)	$	51		$	(255	)	$	(204	)
Money Market		$	889		$	(1,906	)	$	(1,017	)	$	862		$	510		$	1,372
TDOA’s & IRA’s		$	(68	)	$	(394	)	$	(462	)	$	27		$	4		$	31
Certificates of Deposit < $100,000		$	(1,161	)	$	(2,410	)	$	(3,571	)	$	(767	)	$	(884	)	$	(1,651	)
Certificates of Deposit > $100,000		$	648		$	(2,681	)	$	(2,033	)	$	(240	)	$	(1,062	)	$	(1,302	)
	Total Interest Bearing Deposits	$	390		$	(7,831	)	$	(7,441	)	$	(83	)	$	(1,867	)	$	(1,950	)
Borrowed Funds:
Federal Funds Purchased		$	53		$	(100	)	$	(47	)	$	189		$	(103	)	$	86
Repurchase Agreements		$	286		$	(393	)	$	(107	)	$	95		$	(264	)	$	(169	)
Other Borrowings		$	(2	)	$	(5	)	$	(7	)	$	(840	)	$	3		$	(837	)
TRUPS		$	827		$	(21	)	$	806		$	—		$	—		$	85
	Total Borrowed Funds	$	1,163		$	(518	)	$	645		$	(556	)	$	(364	)	$	(835	)
	Total Interest Bearing Liabilities	$	1,554		$	(8,350	)	$	(6,796	)	$	(639	)	$	(2,231	)	$	(2,785	)
	Net Interest Margin/Income	$	3,930		$	1,613		$	5,543		$	2,492		$	(1,812	)	$	595

(1) Yields on tax exempt income have not been computed on a tax equivalent basis.

The Company’s net interest margin is its net interest income expressed as a percentage of average earning assets.  The Company’s net interest margin for 2002 was 5.47%, an increase of 40 basis points from the 5.07% margin reported for 2001.  In 2000 the net interest margin was 5.19%.  The following Distribution, Rate and Yield table shows, for each of the past three years, the rates earned on each component of the Company’s investment and loan portfolio, the rates paid on each segment of the Company’s interest bearing liabilities, and the Company’s net interest margin.  The same table also shows the annual average balance for each principal balance sheet category, and the amount of interest income or interest expense associated with that category.

26

Distribution, Rate & Yield
(dollars in thousands)

		Year Ended December 31,
		2002(a)							2001(a)							2000(a)
		Average Balance		Income/ Expense		Average Rate			Average Balance		Income/ Expense		Average Rate			Average Balance		Income/ Expense		Average Rate
Assets
Investments:
Federal Funds Sold/Due from Time		$	11,734	$	203		1.73	%	$	9,395	$	398		4.24	%	$	3,959	$	243		6.14	%
Taxable		$	43,314	$	2,382		5.50	%	$	60,057	$	3,661		6.10	%	$	66,993	$	4,316		6.44	%
Non-taxable (b)		$	44,145	$	1,849		4.19	%	$	42,427	$	2,000		4.71	%	$	40,211	$	2,022		5.03	%
Equity		$	2,113	$	199		9.42	%	$	2,391	$	94		3.93	%	$	2,680	$	34		1.27	%
	Total Investments	$	101,306	$	4,633		4.57	%	$	114,270	$	6,153		5.38	%	$	113,843	$	6,615		5.81	%
Loans:(c)
Agricultural		$	9,191	$	654		7.12	%	$	11,344	$	885		7.80	%	$	15,921	$	1,706		10.72	%
Commercial		$	90,662	$	6,055		6.68	%	$	76,341	$	6,525		8.55	%	$	61,830	$	6,206		10.04	%
Real Estate		$	333,517	$	25,554		7.66	%	$	284,239	$	24,715		8.70	%	$	283,147	$	26,294		9.29	%
Consumer		$	48,727	$	3,801		7.80	%	$	37,264	$	3,561		9.56	%	$	30,795	$	3,306		10.74	%
Credit Cards		$	10,983	$	1,388		12.64	%	$	11,781	$	1,499		12.72	%	$	10,987	$	1,401		12.75	%
Other		$	7,381	$	—		0.00	%	$	5,999	$	—		0.00	%	$	610	$	—		0.00	%
	Total Loans	$	500,461	$	37,452		7.48	%	$	426,968	$	37,185		8.71	%	$	403,290	$	38,913		9.65	%
Other Earnings Assets		$	1,033
Total Earning Assets(e)		$	602,800	$	42,085		6.98	%	$	541,238	$	43,338		8.01	%	$	517,133	$	45,528		8.80	%
Non-Earning Assets		$	67,608						$	57,318						$	56,093
	Total Assets	$	670,408						$	598,556						$	573,226
Liabilities and Shareholders’ Equity
Interest-Bearing Deposits:
NOW		$	51,058	$	50		0.10	%	$	45,668	$	216		0.47	%	$	47,498	$	412		0.87	%
Savings		$	34,785	$	178		0.51	%	$	30,170	$	370		1.23	%	$	27,698	$	574		2.07	%
Money Market		$	109,561	$	1,894		1.73	%	$	83,925	$	2,911		3.47	%	$	53,784	$	1,539		2.86	%
TDOA’s, and IRA’s		$	19,005	$	456		2.40	%	$	20,526	$	918		4.47	%	$	19,924	$	887		4.45	%
Certificates of Deposit < $100,000		$	96,448	$	2,258		2.34	%	$	120,434	$	5,829		4.84	%	$	134,199	$	7,480		5.57	%
Certificates of Deposit > $100,000		$	115,133	$	2,975		2.58	%	$	101,944	$	5,008		4.91	%	$	105,970	$	6,310		5.95	%
	Total Interest-Bearing Deposits	$	425,990	$	7,811		1.83	%	$	402,667	$	15,252		3.79	%	$	389,073	$	17,202		4.42	%
Borrowed Funds:
Federal Funds Purchased		$	3,791	$	69		1.82	%	$	2,608	$	116		4.45	%	$	439	$	30		6.83	%
Repurchase Agreements		$	26,148	$	325		1.24	%	$	15,728	$	432		2.75	%	$	13,573	$	601		4.43	%
Other Borrowings		$	41	$	—		0.00	%	$	63	$	7		11.11	%	$	13,017	$	844		6.48	%
TRUPS		$	15,000	$	891		5.94	%	$	1,397	$	85		6.08	%	$	—	$	—		0.00	%
	Total Borrowed Funds	$	44,980	$	1,285		2.86	%	$	19,796	$	640		3.23	%	$	27,029	$	1,475		5.46	%
	Total Interest Bearing Liabilities	$	470,970	$	9,096		1.93	%	$	422,463	$	15,892		3.76	%	$	416,102	$	18,677		4.49	%
Demand Deposits		$	141,120						$	125,833						$	113,757
Other Liabilities		$	8,056						$	7,118						$	5,029
Shareholders’ Equity		$	50,262						$	43,142						$	38,338
Total Liabilities and Shareholders’ Equity		$	670,408						$	598,556						$	573,226
Interest Income/Earning Assets							6.98	%						8.01	%						8.80	%
Interest Expense/Earning Assets							1.51	%						2.94	%						3.61	%
Net Interest Margin(d)				$	32,989		5.47	%			$	27,446		5.07	%			$	26,851		5.19	%

(a) Average balances are obtained from the best available daily or monthly data.

(b) Yields on tax exempt income have not been computed on a tax equivalent basis.

(c) Loan fees have been included in the calcualtion of interest income. Loan Fees were approximately $779,000, $(85,500), and $667,000 for the years ended. December 31, 2002, 2001, and 2000 respectively. Loans are gross of the allowance for possible loan losses, deferred fees and related direct cost.

(d) Represents net interest income as a percentage of average interest-earning assets.

(e) Non-accrual loans have been included in total loans for purposes of total earning assets.

During most of 2001 the drop in interest rates had a negative impact on the Company’s net interest margin, although toward the end of 2001 and throughout 2002 the net interest margin rebounded.  A substantial portion of the Company’s earning assets are variable-rate loans that re-price immediately when interest rates fluctuate, versus a large base of core deposits which are generally slower to re-price.  This created timing differences for most of 2001 as interest income fell more rapidly than interest expense.  Exacerbating the timing effect was the narrowing of the relative spread between loan and deposit rates as market rates moved significantly lower.

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The Company’s net interest margin improved toward year-end 2001, however, due to floors on loan rates and aggressive reductions in the pricing of deposit products.  Demand for deposits has proven to be relatively inelastic, possibly because insured bank deposits are currently viewed as a safe haven relative to alternative investment products.  However, as depositors feel more secure with alternative investments the Company could be forced to pay increasingly more for deposits to avoid potential run-off, even if other interest rates remain static.  The improvement in the Company’s net interest margin was sustained in 2002, as market interest rates remained relatively stable for most of the year.

A positive factor impacting the Company’s net interest margin in both 2001 and 2002 was a favorable shift in the mix of the Company’s deposits and other interest-bearing liabilities.  The Company ran an advertising campaign targeting variable-rate money market deposits early in 2001, which attracted new depositors and enticed some existing customers with maturing time deposits to roll their money into money market accounts.  Money market account annual average balances increased by $30 million in 2001, and by another $26 million in 2002.  The initial increases were stimulated by relatively high promotional rates, however balances continued to increase even after rates paid on the Company’s money market accounts were reduced to levels at or below competitor rates.  Substantial increases have also been seen in average NOW and savings account balances, which increased by $5.4 million and $4.6 million, respectively, from 2001 to 2002.  Additionally, average demand deposit balances increased by $12 million from 2000 to 2001, and by $15 million from 2001 to 2002.  Average time deposit balances fell by $17 million from 2000 to 2001, and again by $12 million from 2001 to 2002.  Time deposit balances would have fallen by substantially more if the Company had not added $45 million in broker deposits in early 2002 that were reflected on the balance sheet for most of the year.  The changes in customer deposit balances are presumably due in large part to uncertainty in equity markets, and the desire of our customers to minimize their risk of principal loss and keep their money in liquid investments.  The net result of the changes in the mix of average deposits was that relatively more costly time deposits declined from 46.0% of average total deposits in 2001 to 40.6% in 2002, while other lower-cost interest-bearing deposits increased from 30.2% to 34.5% of average total deposits.  In 2002, time certificates of deposit had a weighted average cost of 2.47%, while money market, savings, and NOW accounts had a weighted average cost of 1.09%.  Non-interest bearing demand deposits also increased from 23.8% to 24.9% of average total deposits from 2001 to 2002.  Also impacting the net interest margin was the addition of $15 million in Trust-Preferred Securities in late November 2001.  The impact on the Company’s net interest margin in 2001 was negligible, however the 2002 results of operation reflect a full year of interest on the TRUPS at a cost of 5.94%.  If the $15 million in TRUPS had, instead, been fed funds purchased, the Company’s net interest margin would likely have been about 10 basis points higher than it actually was in 2002.

From 2001 to 2002, the Company’s average loan portfolio grew by approximately $73 million, or 17.2%, with earnings on that growth, net of associated funding costs, contributing to net interest income.  The increase in annual average balances is significantly higher than the $25 million increase in actual balances from the end of 2001 to the end of 2002, since most of the growth in 2001 occurred in the last two months of the year.  Additionally, loan balances, which are the highest yielding component of the Company’s earning assets, have become a larger portion of the Company’s average asset base, increasing from 71.3% of average assets in 2001 to 74.7% in 2002.  The reverse of this trend is that average investment balances have declined relative to total assets, from 19.9% in 2000, to 19.1% in 2001 and 15.1% in 2002.  Despite their decline relative to total assets, a shifting of investment balances into higher-yielding mortgage-backed securities and municipal bonds from treasury and agency bonds has also helped support the Company’s net interest margin.

Another factor that had a slight negative effect on the Company’s net interest margin in the fourth quarter of 2002 and will continue to have a similar impact going forward is the increase in other non-earning assets.  The Company’s BOLI and low-income housing tax credit funds now total more than $20 million.  These assets, while having a positive impact on the Company’s profitability with expected tax-equivalent returns in the 8% to 11% range, are technically not interest-earning assets.  Their returns are not included as interest income, yet they are “funded” for the most part with interest-bearing liabilities and thus these balances ultimately have a negative impact on the Company’s net interest margin.  Management estimates that this impact in 2003 should not be more than a few basis points, although it would become more significant in a rising rate environment.

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This will be more than offset by increases in other income from gains in the net cash surrender value of BOLI and tax credits generated by the low-income housing tax credit funds, however.

Based on current economic conditions, the Company expects only moderate changes in the rates paid on interest-bearing liabilities and rates earned on both the investment and loan portfolios during 2003.  The Company’s net interest margin is anticipated to stay approximately the same as in 2002, and net interest income should increase if loans grow as planned and the loan growth is funded by reasonably priced deposits.  However, no assurance can be given that this will, in fact, occur.

Non-interest Income and Non-interest Expense

The following table sets forth the various components of the Company’s non-interest income and non-interest expense for the years indicated:

Non Interest Income/Expense
(dollars in thousands, unaudited)

			2002		% of Total			2001		% of Total			2000		% of Total
OTHER OPERATING INCOME:
Service charges on deposit accounts			$	5,276		61.91	%	$	4,754		49.20	%	$	4,085		63.47	%
Credit Card Fees			$	603		7.08	%	$	482		4.99	%	$	472		7.33	%
Other service charges, commissions & fees			$	1,307		15.34	%	$	926		9.58	%	$	391		6.08	%
Gains on sales of loans			$	658		7.72	%	$	899		9.30	%	$	505		7.85	%
Loan servicing income			$	217		2.55	%	$	1,168		12.09	%	$	520		8.08	%
Gains on sale of investment securities			$	280		3.29	%	$	1,108		11.47	%	$	119		1.85	%
Other			$	181		2.12	%	$	326		3.37	%	$	344		5.34	%
		Total non-interest income	$	8,522		100.00	%	$	9,663		100.00	%	$	6,436		100.00	%
		As a percentage of average earning assets				1.41	%				1.79	%				1.24	%
OTHER OPERATING EXPENSES:
Salaries and employee benefits			$	11,695		44.57	%	$	10,908		43.10	%	$	10,054		45.08	%
Occupancy costs
	Furniture & Equipment		$	2,219		8.46	%	$	1,987		7.85	%	$	1,964		8.81	%
	Premises		$	2,186		8.33	%	$	2,187		8.64	%	$	1,662		7.45	%
Advertising and Marketing Costs			$	995		3.79	%	$	829		3.28	%	$	925		4.15	%
Data Processing Costs
	Item processing costs		$	1,389		5.29	%	$	1,375		5.43	%	$	1,096		4.91	%
	Other data processing		$	787		3.00	%	$	506		2.00	%	$	441		1.98	%
Deposit Services Costs			$	1,101		4.20	%	$	1,418		5.60	%	$	1,304		5.85	%
Loan Services Costs
	Loan Processing		$	548		2.09	%	$	445		1.76	%	$	428		1.92	%
	ORE Owned		$	70		0.27	%	$	129		0.51	%	$	462		2.07	%
	Credit Card		$	583		2.22	%	$	566		2.24	%	$	532		2.39	%
	Other loan services		$	20		0.08	%	$	32		0.13	%	$	39		0.17	%
Other Operating Costs
	Telephone & data communications		$	784		2.99	%	$	1,041		4.11	%	$	797		3.57	%
	Postage & mail		$	518		1.97	%	$	426		1.68	%	$	309		1.39	%
	Other		$	786		3.00	%	$	415		1.64	%	$	371		1.66	%
Professional Services Costs
	Legal & Accounting		$	1,065		4.06	%	$	1,457		5.76	%	$	709		3.18	%
	Other professional service		$	743		2.83	%	$	853		3.37	%	$	428		1.92	%
Stationery & Supply Costs			$	593		2.26	%	$	615		2.43	%	$	605		2.71	%
Sundry & Tellers			$	160		0.61	%	$	120		0.47	%	$	178		0.80	%
		Total non-interest Expense	$	26,242		100.00	%	$	25,309		100.00	%	$	22,304		100.00	%
		As a % of average earning assets				4.35	%				4.68	%				4.31	%
Net non-interest income as a % of earning assets						-2.94	%				-2.89	%				-3.07	%

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The primary traditional sources of non-interest income for the Company include the following:  Service charges on deposit accounts; other service charges, commissions, and fees including ATM fees, check card interchange fees, BOLI income, and other miscellaneous income; gains on the sale of loans; loan servicing income; and credit card fees.  During 2001, the Company also realized substantial gains on the sale of investment securities, and from the sale of loan servicing rights it had retained on previously sold residential mortgage loans.  Loan sale and loan servicing income is becoming less significant to the Company, while service charges on deposits, other service charges and fees, and credit card fees are becoming increasingly important components of non-interest income.  Excluding non-recurring gains on loan servicing of approximately $789,000 in 2001 and taking investment gains out of the equation, combined loan sale and servicing income fell from 16.5% of recurring non-interest income in 2001 to 10.6% in 2002.  Using the same denominator, service charges on deposits increased from 61.2% in 2001 to 64.0% in 2002, other service charges, commissions and fees increased from 11.9% to 15.9%, and credit card fees increased from 6.2% to 7.3%.

The most significant source of non-interest income to the Company continues to be service charges on deposit accounts, which totaled $5.3 million in 2002, $4.8 million in 2001, and $4.1 million in 2000.  This income increased by $669,000, or 16.4%, from 2000 to 2001, and by $522,000, or 11.0%, from 2001 to 2002.  The Company’s ratio of service charge income to average transaction accounts (demand and interest-bearing NOW accounts) was 2.8% in 2002, as compared to 2.8% in 2001 and 2.5% for 2000.  The increase from 2000 to 2001 and 2002 is indicative of operational changes enacted in recent years to generate additional non-sufficient funds charges and a higher level of collected versus waived activity charges.

Other service charges, commissions, and fees also constitute a substantial portion of non-interest income, and totaled $1.3 million in 2002, $926,000 in 2001, and $391,000 in 2000.  The increase from 2000 to 2001 can largely be explained by increases in BOLI income and check card interchange fees, and likewise the bulk of the increase from 2001 to 2002 was the result of additional BOLI income and higher check card interchange fees.  BOLI income, which is not taxable, is generated by the increase in the cash surrender values of bank-owned life insurance policies net of the cost of the associated insurance benefits and certain consulting expenses.  BOLI income is expected to increase again by approximately $600,000 in 2003, which will reflect a full year of income from the $13 million BOLI purchase made in September and October of 2002.  Moneyline referral fees, which are discussed in greater detail in the next paragraph, supplemented the increase in other service charges, commissions, and fees in 2002.

Income from loan sales was $658,000 in 2002, $899,000 in 2001, and $505,000 in 2000.  Loan sale income increased by $394,000, or 78.0%, from 2000 to 2001 as a larger volume of mortgage loans were booked and sold.  The relatively high level of mortgage loan activity in 2001 was prompted by a significant drop in mortgage rates, and this momentum carried over into the first quarter of 2002 as well.  In March 2002, however, the Company restructured its mortgage lending group to reduce expenses and began outsourcing residential mortgage loan origination services to Moneyline.  Since that time loan sale income has fallen to an annualized level of slightly over $300,000 per year.  Referral fees from Moneyline are reflected in other service charges, commissions and fees and totaled approximately $65,000 in 2002, but are expected to increase to approximately $100,000 in 2003.  Moneyline fees are dependent on the volume of closed residential mortgage loans, though, and no assurance can be given that this level of income will be realized.

Loan servicing income reached unusual levels in 2001, when non-recurring gains of approximately $789,000 were realized on the sale of the loan servicing rights the Company had retained on previously sold residential mortgage loans.  Pursuant to a detailed analysis of the loan servicing area, management determined that loan servicing revenue was not sufficient to cover associated costs and maintain a reasonable profit margin, and decided to sell the servicing rights on its residential loan servicing portfolio.  With the sale of most of the Company’s loan servicing portfolio, recurring loan servicing income (excluding one-time gains) dropped off substantially in 2002 and was only $217,000, compared to approximately $379,000 in 2001 and $520,000 in 2000, although associated expenses also declined.

Credit card fees increased by $10,000, or 2.1%, from 2000 to 2001, but expanded more significantly in 2002 with the addition of an annual fee for participation in the Company’s “Score Card” program.  From 2001 to

30

2002 credit card fees increased by $121,000, or 25.1%, growing from $482,000 to $603,000.  With no plans for significant growth in credit card receivables, it is expected that credit card fees will stay at about the same level in 2003.

The $280,000 gain on investment securities in 2002 is primarily comprised of liquidating dividends resulting from the Company’s investment in Sphinx, as that company is winding down operations.  The gain is net of the write-off of the remaining $90,000 book value of that equity investment.  Gains on investments were significantly higher in 2001 than in either 2002 or 2000.  The decline in market interest rates in 2001 had the effect of increasing the market value of the Company’s investment portfolio, which is substantially comprised of fixed-rate bonds, and the Company was able to realize some of those gains as bonds were sold during the year.  Management determined at the beginning of 2001 that the portfolio should be repositioned to improve its total return, by reducing the overall size of the portfolio and moving balances from lower-yielding treasuries and agencies into municipal bonds and mortgage-backed securities.  As bonds were sold during the course of 2001 in pursuit of that strategy, the Company realized gains totaling approximately $1.1 million, compared to $119,000 in 2000.

The Company’s total non-interest expense (excluding the provision for loan losses) increased to $26.2 million in 2002, compared to $25.3 million in 2001 and $22.3 million in 2000.  The $933,000, or 3.7%, increase in non-interest expenses in 2002 is mainly the result of the conversion to in-house item processing and other technology enhancements.  The $3.0 million, or 13.5%, overall increase in non-interest expenses in 2001 was due in large part to the Company’s acquisition of SNB in May of 2000.  In 2001 a full year of the post-acquisition increase in operating expenses is reflected in the Company’s income statement, whereas in 2000 only those expenses subsequent to the acquisition date are included.  While non-interest expenses increased from 4.3% of average earning assets in 2000 to 4.7% in 2001, they subsequently declined to 4.4% of average earning assets in 2002.

The largest dollar increase in 2002 for any single non-interest expense category was in salaries and employee benefits, which increased by $787,000, or 7.21%, to $11.7 million.  These expenses increased only slightly relative to total non-interest expenses, however, going from 43.1% in 2001 to 44.6% in 2002, which is still below the 2000 ratio of 45.1%.  Salaries and benefits for item processing staff which came on board in July and August of 2002 totaled about $100,000 for the year.  Additionally, technology staff was added to provide support for item processing, ATM processing, information security, internal reporting, network operations, and desktop applications.  This additional staffing is estimated to have increased salaries and employee benefits by about $250,000 in 2002.  Also impacting expenses in 2002 was a decrease in the credit taken against salaries for FAS 91 loan origination costs.  Costs, primarily salaries, that are directly associated with originating loans are taken out of current period expenses and amortized over the life of the loan as a reduction of loan fee income.  Because origination activity slowed substantially in the latter part of 2002, due in part to the outsourcing of home mortgage loans, the credit to current period expenses dropped by $284,000.  The increase for 2002 also includes approximately $106,000 in accruals for a salary continuation plan for certain key employees that was adopted effective October 1^st in conjunction with the Company’s purchase of BOLI.  These accruals are expected to be approximately $450,000 in 2003.  The remainder of the 2002 increase can be explained by selective strategic staff additions in our branches to enhance business development activities, salary increases in the normal course of business, and rising benefits costs.  In 2001 salaries and benefits totaled $10.9 million, which represents an increase of $854,000, or 8.5%, relative to $10.1 million in 2000.  The main reason for the increase in salaries and benefits in 2001 is because it reflects a full year of the additional expense associated with staffing the four offices added through the SNB acquisition.  Based on market analysis and peer comparisons, it is management’s opinion that the Company can achieve future growth in loans and deposits with only minimal increases in staff.  Thus, it is expected that salaries and employee benefits will decline as a percentage of earning assets over the next few years, although there is no guaranty that this will actually occur.  The number of full-time equivalent employees was 311 at the end of 2002, 287 at the end of 2001, and 323 at the end of 2000. 

Total rent and occupancy costs, including furniture and equipment expenses, were $4.4 million in 2002, $4.2 million in 2001, and $3.6 million in 2000.  The increase in these expenses totaled $231,000, or 5.5%, in 2002,

31

and $548,000, or 15.1%, in 2001.  Approximately $125,000 of the increase in 2002 can be directly attributed to the in-house item processing operation, in the form of rent for the additional space and depreciation on the equipment and tenant improvements utilized by our new item processing group.  Our data processing operations also moved to the same building utilized by item processing, further increasing rent expense, and technology initiatives including comprehensive personal computer and server upgrades added to depreciation expenses.  And, despite cost-control efforts in this area, the Company’s overall utilities costs increased by $68,000 due to the electricity rate increases experienced by most companies operating in California.  The main reason for the increase in rent and occupancy costs in 2001 is, again, because that year reflects a full year of the depreciation and other occupancy expenses associated with the four offices added through the SNB acquisition.  There were also significant renovation and maintenance expenses incurred to bring the SNB offices up to Company standards. 

Data processing costs increased by $295,000, or 15.7%, to a total of $2.2 million in 2002.  Of this increase, $125,000 was in additional costs related to the Company’s core processing system and $120,000 was for other software costs.  Item processing outsourcing costs only increased by $14,000, but these costs totaled nearly $1.4 million for the year.  Outsourcing costs for item processing should be completely eliminated in 2003 due to the in-house conversion, and even after factoring in the additional costs associated with the in-house solution, management anticipates that the Company will reduce total item-processing related expenses by around $900,000 per year commencing in 2003.  No assurance can be given, however, that this level of savings will actually be realized.  Aggregate data processing costs also experienced a significant increase from 2000 to 2001, climbing from $1.5 million to $1.9 million.  This 22.4% increase was centered in item processing costs, which grew by $279,000 due to the additional number of items processed in 2001.

The cost of professional services was $1.8 million in 2002, $2.3 million in 2001, and $1.1 million in 2000.  While professional services expenses dropped by $502,000, or 21.7% in 2002, in 2001 these expenses were more that double their 2000 level.  Included in professional services costs in 2001 are about $200,000 in costs associated with forming the holding company.  This category also includes payments to consultants for compliance, loan, and operations reviews, which increased by $182,000 in 2001 relative to 2000 due to the increased size and complexity of the Company.  The Bank’s FDIC assessment also increased by $170,000 in 2001, due to the increase in the Bank’s assessable deposit base as well as the lower capital ratios that resulted from the SNB acquisition.  The Company’s regulatory assessments subsequently declined by $93,000 in 2002, since financial reports filed with regulators at the end of 2001 reflect improvement in the Company’s capital position.  Lending-related legal expenses were also approximately $81,000 lower in 2002 than in 2001.  In 2002 the Company also started accruing for the expected costs of a directors retirement plan adopted effective October 1^st in conjunction with the purchase of BOLI.  These accruals added approximately $65,000 to professional services expenses in 2002, and will be approximately $260,000 per year in 2003.

The “other operating costs” category, which includes telecommunications, postage, and other costs totaled $2.1 million in 2002, $1.9 million in 2001, and $1.5 million in 2000.  These expenses increased by $206,000, or 10.9% in 2002, and by $435,000, or 30.1% in 2001.  The increase in 2002 includes approximately $350,000 in accruals for anticipated operating losses on the Company’s investments in low-income housing tax credit funds.  The losses are an expected component of these investments, and are factored into the initial assessment of projected returns.  Postage expenses also increased by $92,000, mainly because of increased customer communications costs relative to in-house item processing and imaged statements.  These increases were partially offset by a $257,000 reduction in telecommunications expenses resulting from the restructuring of telephone and data line configurations and the renegotiation of certain contracts.  Most of the increase in 2001 was in telephone and data communications costs, which increased subsequent to the SNB acquisition but also increased as the Company upgraded its communications technology. 

We are increasingly focused on enhancing fee income and controlling overhead expenses to mitigate the potential effect of intensified competition on the Company’s net interest margin, and improvement is evident in the Company’s tax-equivalent overhead efficiency ratios of 61.5% for 2002 and 66.1% for 2001.  However, no assurance can be given that future reductions in the Company’s efficiency ratio can be achieved as planned.

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Provision for Loan Losses

Credit risk is inherent in the business of making loans.  The Company sets aside an allowance or reserve for loan losses through charges to earnings, which are shown in the income statement as the provision for loan losses.  Specifically identifiable and quantifiable losses are immediately charged off against the allowance.

The Company’s provision for loan losses was $3.4 million in 2002, $1.3 million in 2001, and $2.8 million in 2000.  The $2.1 million increase in the provision in 2002 was due in large part to the $74 million increase in average loan balances, but was also the result of a substantial increase in loan balances deemed likely to result in a loss and thus charged off.  Net charge-offs increased by $2.1 million in 2002 relative to 2001, as management was increasingly proactive in evaluating the Company’s loan portfolio and in aggressively identifying and resolving potential problem credits in light of continued recession-like economic circumstances.  In 2001 the provision was reduced by $1.5 million despite an increase in non-performing loans.  A lower amount was added to the Company’s allowance for loan losses in 2001 because net charge-offs fell by $748,000, and the allowance was maintained at a level determined to be appropriate subsequent to a thorough management review of the allowance relative to the Company’s current loan portfolio.  The loan loss provision is determined by conducting a monthly evaluation of the adequacy of the Company’s allowance for loan losses, and charging the shortfall, if any, to the current month’s expense.  This has the effect of creating variability in the amount and frequency of charges to the Company’s earnings.  The procedures for monitoring the adequacy of the allowance, as well as detailed information concerning the allowance itself, are included below under “Allowance for Loan Losses”. 

Income Taxes

In 2002, the Company’s provision for state and federal income taxes was $3.1 million, while the provision was $3.6 million and $2.7 million, respectively, for 2001 and 2000.  This represents 25.8% of income before taxes in 2002, 34.5% in 2001, and 33.3% in 2000.

The Company sets aside a provision for income taxes on a monthly basis.  As indicated in Note 9 in the Notes to the Consolidated Financial Statements, the amount of such provision is determined by applying the Company’s statutory income tax rates to pre-tax book income as adjusted for permanent differences between pre-tax book income and actual taxable income.  These permanent differences include but are not limited to tax-exempt income, increases in the cash surrender value of BOLI, California Enterprise Zone deductions, certain expenses that are not allowed as tax deductions, and tax credits.  An additional permanent difference arose as a result of the formation of a real estate investment trust (“REIT”) which began operations in August 2002.  The REIT was formed to provide the Company with greater flexibility in managing its capital, but had the added benefit of providing California income tax benefits.  Thus, the Company adjusted its tax accrual effective August 2002 to allow for the year-to-date impact of the REIT, and the tax accrual for 2002 was approximately $472,000 lower than it otherwise would have been.  No assurance can be given that the tax benefits available from the REIT will continue to be available in the future, however.  In addition, there is a possibility that a future modification of existing tax laws by the California legislature could require that the tax benefits already realized from the REIT be reversed, although in the opinion of management that is remote.

Some items of income and expense are recognized in different years for tax purposes than when applying generally accepted accounting principles, leading to timing differences between the Company’s actual tax liability and the amount accrued for this liability based on book income.  These temporary differences comprise the “deferred” portion of the Company’s tax expense, which is accumulated on the Company’s books as a deferred tax asset or deferred tax liability until such time as it reverses.  Most of the Company’s temporary differences involve recognizing more expenses in its financial statements than it has been allowed to deduct for taxes, and therefore the Company’s deferred tax asset typically exceeds its deferred tax liability.  At December 31, 2002 the Company’s $1,388 net deferred tax asset was primarily due to temporary differences in the reported allowance for loan losses, deferred compensation, and depreciation.

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The Company’s income tax expense is also affected by income earned on tax-exempt securities.  These securities are primarily the Company’s investments in state, county and municipal bonds, which averaged 43.6% of the total investment portfolio in 2002 and 37.1% in 2001, and provided $1.8 million in federal tax-exempt income in 2002 and $2.0 million in 2001. 

Although not reflected in the investment portfolio, in 2002 the Company committed to approximately $3 million in WNC Institutional Tax Credit Fund X, a low-income housing partnership, which should result in about $3.2 million in net total tax credits over its 15 year life.  In 2001 the Company also committed to an approximate $2.9 million investment in a similar tax credit fund, which should result in approximately $3.0 million in net total tax credits.  About $336,000 of those credits should be available for the 2002 tax year, and about $77,000 of the tax credits were realized in 2001.  In 2003, it is expected that approximately $345,000 of these tax credits will be utilized.  All of the credits, however, are dependent upon the occupancy level of the housing projects and income of the tenants and cannot be projected with complete certainty. 

In addition, in early 2002 the Company reevaluated the interest income earned on its loans to companies whose operations are located in areas designated as “enterprise zones” by the State of California.  This interest income is partially exempt from California income taxes, and in 2002 the Company accrued for $307,000 in total refunds of prior year taxes based on amended returns filed with the California Franchise Tax Board.  These refunds are subject to audit by the California Franchise Tax Board, however, and there is also no guaranty that the exemption can or will be sustained going forward.

Financial Condition

A comparison between the summary year-end balance sheets for 1998 through 2002 was presented previously in the table of Selected Financial Data (see Item 6 above).  As indicated in that table, the Company’s total assets, loans, and shareholders’ equity have grown each year for the past four years, with asset growth most pronounced in 2000 as a result of the acquisition of SNB.  Growth in the Company’s total assets over the past year approximated $51 million, or 8%, as compared to growth in 2001 of $44 million, or 7.2%, and growth in 2000 of $148 million, or 32.4%.  Total assets were $701 million and $650 million at December 31, 2002 and 2001, respectively.  A positive trend is also seen in the increase in loans, which are typically higher-earning assets, relative to total earning assets every year since 1998.  On the liability side, an increase in non-interest bearing deposits relative to total deposits plus interest-bearing liabilities from the end of 2001 to the end of 2002 should also help lower overall interest expense going forward, although no assurance can be given that this impact will be sustained.

Loan Portfolio

The Company’s loan portfolio represents the single largest portion of invested assets, substantially greater than the investment portfolio or any other asset category, and the quality and diversification of the loan portfolio are important considerations when reviewing the Company’s results of operations.  At December 31, 2002, gross loans represented 73.0% of total assets.  At December 31, 2001 and 2000, gross loans were 74.7% and 69.5% of total assets, respectively.  Since loans to assets actually averaged 74.7% for 2002, Management does not feel that the drop from year-end 2001 to year-end 2002 is a reversal of the trend toward higher loans to assets.  Rather, it is simply a factor of specific balance sheet conditions that existed at year-end 2002, including the year-end inflation in assets caused by the temporary increase in cash and due from banks.  The ratio of loans to deposits also declined from 92.2% at the end of 2001 to 83.5% at the end of 2002, however this was due to the addition of brokered deposits during 2002 to replace FHLB borrowings.

The Selected Financial Data table in Item 6 above reflects the net amount of loans outstanding at December 31^st for each year from 1998 through 2002.  The Loan Distribution table that follows sets forth the amount of the Company’s total loans outstanding and the percentage distribution in each category at the dates indicated.  The amounts shown in the table are gross figures and do not include net deferred loan fees or net deferred loan origination costs.

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Loan Distribution

								As of December 31,
(dollars in thousands)								2002			2001			2000			1999			1998
Agricultural								$	11,030		$	14,471		$	16,306		$	15,096		$	19,249
Commercial and Industrial								$	71,462		$	71,857		$	59,554		$	41,817		$	38,459
Real Estate:
						Secured by Commercial/Professional Office Properties including construction and development		$	238,709		$	196,455		$	165,759		$	114,038		$	79,749
					Secured by Residential Properties			$	91,084		$	106,772		$	102,594		$	74,052		$	74,359
				Secured by Farmland				$	16,931		$	16,998		$	17,575		$	16,250		$	14,913
			Held for Sale					$	653		$	1,048		$	2,128		$	10,957		$	8,108
							Total Real Estate	$	347,377		$	321,273		$	288,056		$	215,297		$	177,129
Small Business Administration loans								$	21,918		$	16,942		$	10,883		$	7,185		$	4,618
Consumer Loans								$	49,606		$	50,714		$	35,416		$	27,449		$	24,564
Credit Cards								$	11,225		$	11,344		$	11,481		$	10,666		$	11,645
							Total Loans	$	512,618		$	486,601		$	421,696		$	317,510		$	275,664
Percentage of Total Loans
Agricultural									2.15	%		2.97	%		3.87	%		4.75	%		6.98	%
Commercial and Industrial									13.94	%		14.77	%		14.12	%		13.17	%		13.95	%
Real Estate:
			Secured by Commercial/Professional Office Properties including construction and development						46.57	%		40.37	%		39.31	%		35.93	%		28.93	%
		Secured by Residential Properties							17.77	%		21.94	%		24.33	%		23.32	%		26.97	%
		Secured by Farmland							3.30	%		3.49	%		4.17	%		5.12	%		5.41	%
	Held for Sale								0.13	%		0.22	%		0.50	%		3.45	%		2.94	%
							Total Real Estate		67.77	%		66.02	%		68.31	%		67.81	%		64.26	%
Small Business Administration loans									4.28	%		3.48	%		2.58	%		2.26	%		1.68	%
Consumer Loans									9.68	%		10.42	%		8.40	%		8.65	%		8.91	%
Credit Cards									2.18	%		2.34	%		2.72	%		3.36	%		4.22	%
									100.00	%		100.00	%		100.00	%		100.00	%		100.00	%

As reflected in the Loan Distribution table, aggregate loan balances have increased nearly $237 million, or 86.0%, over the last four years.  Existing business units generated all of the Company’s loan growth in 2002 and 2001, however about half of the Company’s total $104 million loan growth during 2000 was due to the acquisition of SNB.  The most significant shift in the loan portfolio mix over the past five years has been in real-estate loans secured by commercial properties, which increased from 28.9% of total loans at the end of 1998 to 45.9% of total loans at the end of 2002.  Commercial real estate lending is an increasingly important part of the Company’s focus, and is likely to remain so for the immediate future.

Demand for loans appears to be strong in some markets within the Company’s service area, despite apparent weak demand elsewhere in California and in the United States.  Competition, however, has intensified locally, especially in the Fresno and Bakersfield markets.  The Company’s relatively modest loan growth of $26 million, or 5.3%, in 2002 was partially the result of the competitive environment, but was also due in part to changes in the Company’s residential mortgage lending process.  The Company intends to address increased competition with a possible expansion of loan products and with an increase in loan-oriented marketing.  Overall, loan demand in the Company’s immediate market has been oriented toward loans secured by real estate, including commercial and professional buildings and single family dwellings, as well as commercial loans, including SBA loans.  As a result, these areas have comprised the major portion of the Company’s loan growth over the past few years.  Loans secured by real estate and commercial loans comprised 67.8% and 18.2%, respectively, of the Company’s total loan portfolio at the end of 2002.  The largest percentage and volume growth for any major category of loans during 2002 came in loans secured by real estate, which increased by $26 million, or 8.1%.  Real estate loans secured by commercial/professional office properties (including construction and development loans) actually increased by $39 million, or 19.8%, but this increase was partially offset by the $16 million decline in residential mortgage loans resulting from the aforementioned restructuring of our mortgage-lending group. 

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Commercial loans, including SBA loans, grew by $5 million, or 5.2%, during 2002.  Actually, all of this growth was in SBA loans, which increased by 29.4% when viewed separately.  The Company’s commercial loans are centered in locally oriented commercial activities in the markets where the Company has a presence.  Additionally, the Company has a business unit dedicated to its SBA product and is very active in specific SBA program lending, and sells a number of the SBA loans it originates.  Further, the Company is designated as an SBA Preferred Lender, which allows greater flexibility to meet small business loan requests with a more timely credit approval process.  The Company’s dedication to SBA lending was recently reaffirmed when Bank of the Sierra was named first in the SBA’s Fresno California District for the dollar volume of SBA loans produced, and second for the number of SBA loans.  Additionally, according to the Fresno District Office, the Bank was the only financial institution to be among the top five SBA lenders for the last four years.

Consumer loans represented 9.68% of total loans at December 31, 2002 and 10.4% of total loans outstanding at December 31, 2001.  These loans declined by $1.1 million, or 2.2%, during 2002.  However, during 2001 they grew by $15.3 million, or 43.2%.  The growth in 2001 came primarily from the purchase of $10 million in balances outstanding on unsecured lines of credit to high net-worth individuals.  The purchase, from a Los Angeles area financial institution, was consummated in December of 2001.  The remaining balances consist primarily of automobile and unsecured lines of credit, which have gained popularity due to their ease of use.  The Company has encountered a great deal of competition for consumer lending products, and has developed a program for lending to people rather than lending on property.  As a result, relationship lending has increased as a portion of overall consumer credit, and is exemplified by home equity lines, other revolving consumer credit facilities and credit card lines.  However, a great deal of consumer credit is now granted in the form of home equity lines, which allow a more favorable treatment of interest costs.  As a result, consumer credit separately reported is only for term debt and unsecured lines and does not include home equity lines, a more growth-oriented category.  Such consumer-oriented debt, secured by home equity, is captured within the total reported for real estate loans secured by residential property.

Agricultural loans dropped to 2.2% of the Company’s total loan balances at the end of 2002 from 7.0% at the end of 1998.  The decline in agricultural loans over the past few years has been due in part to the December 1998 freeze, along with reduced local plantings due to foreign competition.  However, the Company has also withdrawn from financing production lines, where year-to-year cash flow variations can impede the ability of borrowers to meet contractual repayment terms.  With uncertain commodity prices, our borrowers have faced declining equity in farming operations, and some are removing themselves from farming by selling land for housing and other development.

Credit card loans also represented just 2.2% of total loans outstanding at December 31, 2002, having declined from 4.2% of total loans at December 31, 1998.  Despite this decrease, the credit card segment of the Company’s loan product group remains an important part of the Company’s overall customer relationship lending strategy.

Another important aspect of the Company’s loan business has been that of residential real estate loans which, up until March of 2002, were generated internally by the real estate mortgage loan department and ultimately sold in the secondary market to government sponsored enterprises or other long-term lenders.  The Company originated and sold aggregate balances of approximately $41 million of such loans during 2001, an increase from the $38 million originated and sold in 2000.  This changed in March 2002, when the Company began to earn referral fees for directing most of its residential mortgage customers to Moneyline but ceased originating and selling those loans itself.  From March 2002 through December 2002, the Company referred a total of $17 million in successfully completed mortgage loans to Moneyline.  The Company also originates and sells agricultural mortgage loans to certain other investors, and the volume of these loans serviced totaled $54 million as of December 31, 2002.  Total loans serviced for others numbered 128 with an aggregate balance of $43 million at the end of 2002, as compared to 167 loans with an aggregate balance of $59 million at December 31 2001 and 1,480 loans with an aggregate balance of  $173 million at the end of 2000.

Because the Company is not involved with chemicals or toxins that might have an adverse effect on the environment, its primary exposure to environmental legislation is through its lending activities.  The

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Company’s lending procedures include steps to identify and monitor this exposure to avoid any significant loss or liability related to environmental regulations.

Loan Maturities

The following Loan Maturity table shows the amounts of total loans and leases outstanding as of December 31, 2002, which, based on remaining scheduled repayments of principal, are due within three months, after three months but less than one year, after one but within five years, and in more than five years.  The principal balance of loans due after one year is indicated by both fixed and floating rate categories.  (Non-accrual loans are intermixed within each category.)

Loan Maturity

(dollars in thousands)		As of December 31, 2002
		Three months or less		Three months thru twelve months		One to five years		Over five years		Total		Floating rate: due after one year		Fixed rate: due after one year
Agricultural		$	2,284	$	4,389	$	3,395	$	962	$	11,030	$	1,553	$	2,804
Commercial and Industrial (1)		$	11,390	$	30,503	$	20,296	$	31,191	$	93,380	$	32,398	$	19,089
Real Estate		$	29,619	$	26,802	$	49,731	$	241,225	$	347,377	$	163,700	$	127,256
Consumer Loans		$	1,284	$	4,173	$	19,479	$	24,670	$	49,606	$	28,847	$	15,302
Credit Cards		$	502	$	3,325	$	7,398	$	—	$	11,225	$	7,398	$	—
	TOTAL	$	45,079	$	69,192	$	100,299	$	298,048	$	512,618	$	233,896	$	164,451

(1) Includes Small Business Administration Loans

This schedule can be used in combination with the Investment Maturities table in the Investment Securities section and the Deposit Maturities table in the Deposits section to identify time periods with potential liquidity exposure.  The referenced maturity schedules do not convey a complete picture of the Company’s re-pricing exposure or interest rate risk, however.  For details on the re-pricing characteristics of the Company’s balance sheet and a more comprehensive discussion of the Company’s sensitivity to changes in interest rates, see the “Liquidity and Market Risk” section.

Off-Balance Sheet Arrangements

In the normal course of business, the Company makes commitments to extend credit to its customers as long as there are no violations of any conditions established in contractual arrangements.  These commitments are obligations that represent a potential credit risk to the Company, yet are not reflected in any form within the Company’s consolidated balance sheets. Total unused commitments to extend credit were $176 million at December 31, 2002 as compared to $148 million at December 31, 2001.  Net of credit card lines available which were $40 million and $43 million at December 31, 2002 and 2001, unused commitments represented 26.5% and 21.7% of outstanding gross loans at December 31, 2002 and 2001, respectively.  The Company’s stand-by letters of credit at December 31, 2002, and 2001 were $6.5 million and $4.4 million, respectively.

The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used.  For more information regarding the Company’s off-balance sheet arrangements, see Note 11 to the financial statements located elsewhere herein.

Non-performing Assets

Banks have generally suffered their most severe earnings declines as a result of customers’ inability to generate sufficient cash flow to service their debts, or as a result of the downturns in national and regional economies which have brought about declines in overall property values.  In addition, certain investments that the Company may purchase have the potential of becoming less valuable if the obligor’s financial capacity to repay deteriorates.  An institution has a certain level of exposure to asset quality risk and could obtain less than full repayment of an obligation because of the potential for these types of failures.  Since loans are the most

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significant assets of the Company and generate the largest portion of its revenues, the Company’s management of asset quality risk is focused primarily on loan quality.

The Company achieves a certain level of loan quality by establishing a sound credit plan, which includes well-defined goals and objectives and well-documented credit policies and procedures.  These policies and procedures identify market segments, set goals for portfolio growth or contraction, and establish limits on industry and geographic credit concentrations.  In addition, these policies establish the Company’s underwriting standards and the methods of monitoring ongoing credit quality.  The Company’s internal credit risk controls are centered in underwriting practices, credit granting procedures, training, risk management techniques, and familiarity with our loan customers as well as the relative diversity and geographic concentration of our loan portfolio. 

Unfortunately, the Company’s credit risk may also be affected by external factors such as the level of interest rates, employment, general economic conditions, real estate values, and trends in particular industries or geographic markets.  As a multi-community, independent bank headquartered in and serving Tulare County (with a smaller presence in each of Kern, Fresno and Kings counties), the Company must contend with the attendant vagaries of the California and San Joaquin Valley markets.  The Company’s asset quality has suffered during the last several years due to the impact of national and regional economic recessions, consumer bankruptcies, weather-related agricultural loan losses, and depressed prices for agricultural goods.  The San Joaquin Valley, however, may be experiencing a slow but sustained economic recovery, and appears poised for industrial and residential growth even as the agricultural industry remains weak.  The Company is optimistic that the local economy will improve over time, but no assurance can be given that such improvement will in fact occur.

Non-performing assets are comprised of the following:  Loans for which the Company is no longer accruing interest; loans 90 days or more past due and still accruing interest (although loans are generally placed on non-accrual when they become 90 days past due); loans restructured where the terms of repayment have been renegotiated resulting in a deferral of interest or principal; and other real estate owned (“OREO”).  Management’s classification of a loan as “non-accrual” is an indication that there is reasonable doubt as to the full collectibility of principal or interest on the loan.  At that point, the Company stops accruing income from the interest on the loan, reverses any uncollected interest that had been accrued but unpaid, and recognizes interest income only as cash interest payments are received and as long as the collection of all outstanding principal is not in doubt.  These loans may or may not be collateralized, but collection efforts are continuously pursued. Loans may be restructured by management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms and where the Company believes the borrower will eventually overcome those circumstances and repay the loan in full.  OREO consists of properties acquired by foreclosure or similar means that management intends to offer for sale.

The following table provides information with respect to components of the Company’s non-performing assets at the date indicated.

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Non-performing Assets
(dollars in thousands)

									As of December 31,
									2002			2001			2000			1999			1998
Nonaccrual Loans:(1)
Agricultural									$	15		$	185		$	652		$	—		$	635
Commercial and Industrial									$	1,070		$	1,022		$	47		$	—		$	175
Real Estate
					Secured by Commercial/Professional Office Properties including construction and development				$	350		$	503		$	—		$	—		$	—
				Secured by Residential Properties					$	31		$	—		$	—		$	130		$	125
				Secured by Farmland					$	2,343		$	4,945		$	1,267		$	—		$	—
			Held for Sale						$	—		$	—		$	—		$	—		$	—
								TOTAL REAL ESTATE	$	2,724		$	5,448		$	1,267		$	130		$	125
Small Business Administration loans									$	323		$	—		$	—		$	—		$	—
Consumer Loans									$	141		$	22		$	22		$	38		$	58
Credit Cards									$	56		$	39		$	132		$	220		$	125
							SUBTOTAL		$	4,329		$	6,716		$	2,120		$	388		$	1,118
Loans 90 days or more past due & still accruing:
(as to principal OR interest)
Agricultural									$	—		$	1,418		$	—		$	73		$	1,637
Commercial and Industrial									$	1,426		$	867		$	110		$	27		$	127
Real Estate
		Secured by Commercial/Professional Office Properties including construction and development							$	700		$	—		$	163		$	—		$	411
		Secured by Residential Properties							$	—		$	640		$	94		$	280		$	—
		Secured by Farmland							$	—		$	—		$	106		$	—		$	545
	Held for Sale								$	—		$	—		$	—		$	—		$	—
						TOTAL REAL ESTATE			$	700		$	640		$	363		$	280		$	956
Small Business Administration loans									$	—		$	—		$	438		$	102		$	—
Consumer Loans									$	—		$	126		$	31		$	4		$	7
Credit Cards									$	12		$	17		$	22		$	40		$	93
						SUBTOTAL			$	2,138		$	3,068		$	964		$	526		$	2,820
						TOTAL NON-PERFORMING LOANS			$	6,467		$	9,784		$	3,084		$	914		$	3,938
Other Real Estate Owned									$	1,421		$	769		$	1,530		$	2,553		$	1,273
Total nonperforming assets									$	7,888		$	10,553		$	4,614		$	3,467		$	5,211
Restructured Loans (2)										N/A			N/A			N/A			N/A			N/A
Nonperforming loans as% of total gross loans										1.26	%		2.01	%		0.73	%		0.29	%		1.43	%
Nonperforming assets as a% of total gross loans and other real estate owned										1.53	%		2.17	%		1.05	%		1.08	%		1.88	%

(1) Additional interest income of approximately $324,000 would have been recorded for the year ended December 31, 2002 if these loans had been paid in accordance with their original terms and had been outstanding throughout the applicable period then ended or, if not outstanding throughout the applicable period then ended, since origination.

(2) A “restructured loan” is one where the terms were renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower.

Total non-performing balances stood at $7.9 million at the end of 2002, with approximately 30% of those balances being agriculture-related.  This represents a decline of $2.7 million, or 25.3%, from year-end 2001 levels.  Non-performing assets to total gross loans plus OREO also declined for the same period, dropping to 1.53% at the end of 2002 from 2.17% at the end of 2001.  This was due in part to the favorable resolution of certain problem credits.  However, much of the decline was simply due to the level of net loan balances charged off, which increased by $2.1 million from 2001 to 2002 as the Company has taken a more proactive approach to identifying and aggressively charging off loans when losses appear imminent (see “Allowance for Loan Losses”).  Net Charge-offs increased to .62% of average loans in 2002 from .23% in 2001 and .43% in 2000.  The Company’s long-term average (1989 through 2002) for this ratio is approximately .49%, although no assurance can be given that the average will remain at this level in the future.  The Company’s non-performing assets increased by $5.9 million during 2001 primarily due to the placement on non-accrual status

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of $4.5 million in loans to a single borrower, although the Company’s exposure to that borrower has subsequently declined and only $1.7 million remained on non-accrual at December 31, 2002.  A mitigating factor when evaluating the Company’s non-performing loans is that $3.7 million, or 57.9%, of the total $6.5 million balance at year-end 2002 is secured by real estate, and an additional $1.9 million, or 28.7%, is comprised of the guaranteed portion of loans that are backed by the U.S. government. 

The Company anticipates influxes of non-accrual loans in the normal course of business as it further increases its lending activities and borrower performance issues periodically arise.  It also expects to acquire some level of “other real estate” as collection activities are undertaken to resolve problem and non-accrual credits.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of known and inherent risk in the Company’s loan portfolio.  The allowance is increased by provisions charged against current earnings, and reduced by net charge-offs.  Loans are charged off when they are deemed to be uncollectable; recoveries are generally recorded only when cash payments are received subsequent to the charge off.

We employ a systematic methodology for determining the allowance for loan losses that includes a monthly review process and monthly adjustment of the allowance.  Our process includes a periodic review of individual loans that have been specifically identified as problem loans or have characteristics that could lead to impairment, as well as detailed reviews of other loans (either individually or in pools).  While this methodology utilizes historical and other objective information, the establishment of the allowance for loan losses and the classification of loans is also to some extent based on management’s judgment and experience.

Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan losses that management believes is appropriate at each reporting date.  Quantitative factors include our historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans, and other factors.  Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements and borrowers’ sensitivity to quantifiable external factors including commodity prices as well as acts of nature (freezes, earthquakes, fires, etc.) that occur in a particular period.

Qualitative factors include the general economic environment in our markets and, in particular, the state of the agriculture industry and other key industries in the Central San Joaquin Valley.  The way a particular loan might be structured, the extent and nature of waivers of existing loan policies, the results of bank regulatory examination, model imprecision, and the rate of portfolio growth are additional qualitative factors that are considered.

The table which follows summarizes the activity in the allowance for loan losses for the years indicated:

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Allowance For Loan Losses
(dollars in thousands)

									As of December 31,
									2002			2001			2000			1999			1998
Balances:
Average gross loans outstanding during period									$	500,461		$	426,968		$	403,290		$	288,729		$	262,976
Gross loans outstanding at end of period									$	512,618		$	486,601		$	421,696		$	317,510		$	275,664
Allowance for Loan Losses:
Balance at beginning of period									$	5,675		$	5,362		$	3,319		$	4,394		$	3,034
Adjustments (1)									$	—		$	—		$	1,018		$	—		$	—
Provision Charged to Expense									$	3,350		$	1,300		$	2,760		$	2,118		$	2,800
Loan Charge-offs
						Agricultural			$	602		$	81		$	324		$	1,880		$	—
						Commercial & Industrial Loans (2)			$	1,161		$	295		$	705		$	290		$	236
						Real Estate loans			$	—		$	—		$	—			—			—
					Consumer Loans				$	1,031		$	376		$	253		$	374		$	398
				Credit Card Loans					$	580		$	587		$	657		$	729		$	907
								Total	$	3,374		$	1,339		$	1,939		$	3,273		$	1,541
Recoveries
				Agricultural					$	34		$	31		$	27		$	1		$	—
			Commercial & Industrial Loans (2)						$	156		$	187		$	44		$	28		$	42
		Real Estate loans							$	—		$	—		$	—			—		$	—
		Consumer Loans							$	37		$	39		$	66		$	12		$	18
	Credit Card Loans								$	61		$	95		$	67		$	39		$	41
							Total		$	288		$	352		$	204		$	80		$	101
Net Loan Charge-offs									$	3,086		$	987		$	1,735		$	3,193		$	1,440
Balance at end of period									$	5,939		$	5,675		$	5,362		$	3,319		$	4,394
Ratios:
Net Loan Charge-offs to Average Loans										0.62	%		0.23	%		0.43	%		1.11	%		0.55	%
Allowance for Loan Losses to Gross Loans at End of Period										1.16	%		1.17	%		1.27	%		1.05	%		1.59	%
Allowance for Loan Losses to Non-Performing Loans										91.84	%		58.00	%		173.87	%		363.13	%		111.58	%
Net Loan Charge-offs to Allowance for Loan Losses at End of Period										51.96	%		17.39	%		32.36	%		96.20	%		32.77	%
Net Loan Charge-offs to Provision for loan losses										92.12	%		75.92	%		62.86	%		150.76	%		51.43	%

(1) Allowance acquired from Sierra National Bank

(2) Includes Small Business Administration Loans.

At December 31, 2002, the Company’s allowance for loan losses was $5.9 million.  The loan loss provisions in 2002, 2001, and 2000 totaled $3.4 million, $1.3 million, and $2.8 million respectively.  Although the provision was significantly higher, net loans charged off in 2002 were also $2.1 million higher than in 2001, thus the allowance for loan losses increased by only $264,000 during 2002.  Net loan charge-offs in 2002 were $3.1 million, or 0.62% of average loans, compared to $987,000, or .23% of average loans in 2001.  The dollar amount of loans charged off in 2002 increased significantly for consumer, commercial and industrial (“C&I”), and agricultural loans.  The increase in consumer loan charge-offs consists mainly of certain of the unsecured lines of credit purchased by the Company in late 2001.  Specifically, some of the lines were to technology-sector executives who became unable to meet contractual repayment terms subsequent to the purchase.  The C&I loan charge-offs are primarily the result of Management’s proactive efforts to identify and aggressively pursue resolution of lingering problem loans.  About one-third of the C&I charge-offs were loans to companies

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in construction-related businesses that experienced difficulties due to competitive pressures and inefficient management.  The remainder of the C&I charge-offs are split fairly evenly among transportation, agriculture-related, healthcare, and retail/service businesses.  Many of the problems faced by the agriculture-related companies are linked to current market conditions.  The trucking companies’ difficulties are also economic in nature and can be traced back to September 11, 2001.  The increase in agricultural loans charged off can be explained by certain loans to a single borrower that were placed on non-accrual in 2001 and were ultimately deemed to be uncollectible. 

The allowance as a percentage of total loans at year-end 2002 versus 2001 declined only negligibly, from 1.17% to 1.16%, despite the increase in loan balances and the substantial decrease in the ratio of non-performing loans to total loans from 2.01% to 1.26% (see “Non-performing Assets” above).  The relatively large decline in non-performing loans also caused the allowance to increase from 58.0% of non-performing loans at the end of 2001 to 91.8% at the end of 2002. 

Our methodology for determining the adequacy of the Company’s allowance for loan losses is, and has been, consistently followed.  However, as we add new products, increase in complexity, and expand our geographic coverage, we expect to enhance our methodology to keep pace with the size and complexity of the loan portfolio.  On an ongoing basis we engage outside firms to independently assess our methodology, and to perform independent credit reviews of our loan portfolio.  The Company’s external auditors, the FDIC, and the California Department of Financial Institutions also review the allowance for loan losses as an integral part of the examination processes.  Management believes that the current methodology is appropriate given our size and level of complexity.  Further, management believes that the allowance for loan losses is adequate as of December 31, 2002 to cover known and inherent risks in the loan portfolio.  However, fluctuations in credit quality, or changes in economic conditions or other factors could cause management to increase or decrease the allowance for loan losses as necessary, and no assurance can be given that such factors may not result in increased losses in the loan portfolio in the future.

The following table provides a summary of the allocation of the allowance for loan losses for specific loan categories at the dates indicated. The allocation presented should not be interpreted as an indication that charges to the allowance for loan losses will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each loan category represents the total amounts available for charge-offs that may occur within these categories.

Allocation of Loan Loss Allowance
(dollars in thousands)

		As of December 31,
		2002					2001					2000					1999					1998
		Amount		% Total (1) Loans			Amount		% Total (1) Loans			Amount		% Total (1) Loans			Amount		% Total (1) Loans			Amount		% Total (1) Loans
Agricultural		$	419		2.15	%	$	997		2.97	%	$	574		3.87	%	$	478		4.75	%	$	982		6.98	%
Commercial and Industrial (2)		$	2,529		18.22	%	$	1,573		18.25	%	$	1,667		16.70	%	$	764		15.43	%	$	1,696		15.63	%
Real Estate		$	1,538		67.77	%	$	1,713		66.02	%	$	2,112		68.31	%	$	1,362		67.81	%	$	1,038		64.26	%
Consumer Loans		$	734		9.68	%	$	681		10.42	%	$	384		8.40	%	$	285		8.65	%	$	272		8.91	%
Credit Cards		$	719		2.19	%	$	711		2.33	%	$	625		2.72	%	$	430		3.36	%	$	406		4.22	%
	TOTAL	$	5,939		100.00	%	$	5,675		100.00	%	$	5,362		100.00	%	$	3,319		100.00	%	$	4,394		100.00	%

(1) Represents percentage of loans in category to total loans.

(2) Includes Small Business Administration loans.

Investment Portfolio

The investment securities portfolio had a book value of $84 million at December 31, 2002.  It is the second largest component of the Company’s earning assets, and the structure and composition of this portfolio is significant to any analysis of the financial condition of the Company.  The Company makes available two portfolios for the classification of its investments:  “Held-to-maturity”, and “Available-for-sale”.  While provision is also made for a trading portfolio classification, the Company has no investments that are classified as such.  The held-to-maturity portfolio can consist only of investments that the Company has both the intention and ability to hold until maturity, to be sold only in the event of concerns with an issuer’s credit worthiness, a

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change in tax law that eliminates their tax exempt status or other infrequent situations as permitted by generally accepted accounting principles. 

Prior to 2000, the Company’s long-term tax exempt obligations and certain pledged treasury and agency issues were classified as held-to-maturity.  During the fourth quarter of 2000, however, the Company adopted Financial Accounting Standards Board Statement 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), which afforded the opportunity to reclassify some or all of the Company’s investments.  Upon adoption of this statement, the Company reclassified substantially all of its investments from the held-to-maturity portfolio to the available-for-sale portfolio to allow more flexibility with regard to the active management of its investment securities.  As a result, the Company’s unrecorded potential increase in the market value of the reclassified bonds, net of the tax effect, was recorded on the balance sheet as an increase in accumulated other comprehensive income.

The investment portfolio serves the following purposes: 1) it provides liquidity to even out cash flows from the loan and deposit activities of customers; 2) it provides a source of pledged assets for securing public deposits and borrowed funds; 3) it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; 4) it is an alternative interest-earning use of funds when loan demand is weak; and 5) it can enhance the Company’s tax position by providing partially tax exempt income.

The Company’s investment portfolio is currently composed primarily of:  (1) U.S. Treasury and Agency issues for liquidity and pledging; (2) mortgage-backed securities to enhance the yield of the portfolio; (3) state, county and municipal obligations which provide limited tax free income and pledging potential; and (4) other equity investments.  The fourth category includes an equity investment in Farmer Mac stock, which is a required element to allow the Company to sell certain agricultural loans to this quasi-governmental agency.  In 2002 the relative distribution of these groups within the overall portfolio changed slightly, with U.S. Treasury and Agency bonds declining to 16.2% of the portfolio in 2002 from 22.2% in 2001, and mortgage-backed securities increasing to 28.6% in 2002 from 23.2% in 2001.  With the relatively low yield environment in 2002, maturing bonds were replaced when possible with short-duration higher-yielding mortgage-backed securities.  Still, as can be seen on the Distribution, Rate & Yield table presented in a previous section, the average yield earned on total investments declined from 5.38% to 4.57%.

The distribution of investments changed substantially in 2001, with a shift out of treasuries and agencies and into mortgage-backed securities and municipal obligations.  Municipal obligations remain the largest portion of the total portfolio at 48.9%, up from 37.8% at the end of 2000.  Treasuries and agencies together comprised 22.2% of total investments at the end of 2001, down from 48.7% at the end of 2000, while mortgage-backed securities increased proportionate to total investments in 2001, to 23.2% from 6.8%.  This movement away from pure liquidity instruments into higher-yielding bonds with a higher perceived risk and a longer duration helped the company minimize the impact of declining interest rates on the yield of the portfolio.  The portfolio yield fell to 5.38% in 2001 from 5.81% in 2000, a drop of only 43 basis points despite the Federal Reserve’s 475 basis point reduction in the fed funds rate during the year. 

The following Investment Portfolio table reflects the amortized cost and fair market values for the total portfolio for each of the categories of investments for the past three years.

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Investment Portfolio - Available For Sale
(dollars in thousands)

	As of December 31,
	2002									2001				2000
	Amortized Cost		Unrealized Gain		Unrealized Loss			Fair Market Value		Amortized Cost		Fair Market Value		Amortized Cost			Fair Market Value
US Treasury Securities	$	207	$	5				$	212	$	1,002	$	1,025	$	13,540		$	13,557
US Government Agencies & Corporations		12,876		481				$	13,357		18,824		19,548		40,705			41,204
Mortgage-backed securities (CMO)		23,341		665		(6	)	$	24,000		21,257		21,507		7,513			7,650
Corporate Bonds		4,503		94				$	4,597		4,996		5,210		4,985			5,039
State & political subdivisions		39,787		1,948				$	41,735		44,477		45,284		41,407			42,519
Equity securities		6		4				$	10		100		115		787			783
																&nb