Attached files

file filename
EX-31.1 - HERITAGE OAKS BANCORPv197395_ex31-1.htm
EX-32.1 - HERITAGE OAKS BANCORPv197395_ex32-1.htm


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


FORM 10-Q/A
Amendment No. 1
 

 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010.
 
or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______.

Commission File Number:  000-25020

HERITAGE OAKS BANCORP
 (Exact name of registrant as specified in its charter)

California
 
77-0388249
(State or other jurisdiction of
 incorporation or organization)
 
(I.R.S. Employer
Identification No.)
     
545 12th Street,
   
Paso Robles, California
 
93446
(Address of principal offices)
 
(Zip Code)

(805) 369-5200
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES x     NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES ¨     NO ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one.)

Large accelerated filer ¨     Accelerated filer ¨     Non-accelerated filer ¨    Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨      NO x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
As of August 6, 2010 there were 25,062,682 shares outstanding of the Registrant’s common stock.
 


 
 

 

Explanatory Note

Heritage Oaks Bancorp (the “Company”) is filing this Amendment No. 1 on Form 10-Q/A to amend its Quarterly Report on Form 10-Q as of and for the quarter ended June 30, 2010 that was originally filed with the Securities and Exchange Commission on August 9, 2010 (the “Original Filing”).  As disclosed in the Company’s Form 8-K filing dated ­­­­September 24, 2010, the Company is filing this Amendment No. 1 to reflect the change in its accounting treatment of the Series B Preferred Stock and to provide additional disclosure regarding the Series C Preferred Stock it issued in its March 2010 private placement.  Upon reevaluating the accounting for the transaction, the Company determined it did not account for the contingent beneficial conversion feature of the Series B Preferred Stock and as such has revised its consolidated financial statements and the notes thereto as of and for the period ended June 30, 2010.  The Company also revised the related Management’s Discussion and Analysis of Financial Condition and Results of Operations.  These revisions are included in this Amendment No. 1.

The revised accounting relates to the intrinsic value of the contingent beneficial conversion feature of the Series B Preferred Stock and the additional disclosure of the contingent beneficial conversion feature of the Series C Preferred Stock.  As more fully disclosed in Note 11. Preferred Stock, the Company issued a total of 56,160 shares of Series B Preferred Stock and 1,189,538 shares of its Series C Preferred Stock for total gross proceeds of approximately $60.0 million.  On March 10, 2010 (the “commitment date”), the date the Company made a firm commitment to issue the Series B and Series C Preferred Stock, the price of the Company’s common stock at the close of the market was $3.45 per share compared to the $3.25 per common share conversion price of the Series B and Series C Preferred Stock.  This $0.20 difference between the market value of the Company’s common stock and conversion price on the commitment date represented a contingent beneficial conversion feature of the Series B and Series C Preferred Stock of approximately $3.5 million, and $238 thousand, respectively.

The conversion of the Series B Preferred Stock as of the commitment date was contingent upon the approval of the Company’s common shareholders of additional authorized common shares sufficient to convert the Series B Preferred Stock to common stock and the approval of the issuance of common stock on conversion of the Series B Preferred Stock under NASDAQ rules.  Such approvals were received during the second quarter of 2010 at which time the Company should have recorded the beneficial conversion feature related to the Series B Preferred Stock.

The conversion of the Series C Preferred Stock as of the commitment date was contingent upon the approval of the Company’s common shareholders to approve the contingent conversion of Series C Preferred Stock to common stock, under NASDAQ rules, upon the transfer of the Series C Preferred Stock from the investor to an unaffiliated third party.  Approval of the contingent conversion of Series C Preferred Stock was received during the second quarter of 2010; however conversion of Series C Preferred Stock remains contingent upon the transfer from the investor to an unaffiliated third party.  Therefore, the contingent beneficial conversion feature related to the Series C Preferred Stock has not resulted in any accounting adjustment, rather it will represent a disclosure item in the Company’s financial statements until such time that the contingency is removed.

The Company’s revised financial statements filed on this Form 10-Q/A as of and for the three and six month periods ended June 30, 2010 reflect the impact of the recognition of the beneficial conversion feature on the Series B Preferred Stock.  The initial recognition of the beneficial conversion feature on the Series B Preferred Stock is accomplished through the establishment of a discount on Series B Preferred Stock and a corresponding increase in additional paid in capital.  These adjustments also reflect the recognition of the immediate accretion of the discount on Series B Preferred Stock through retained earnings which should have occurred on June 11, 2010, the date the Company converted the outstanding Series B Preferred Stock to common stock.

 
 

 

The calculation of net loss applicable to common shareholders and basic earnings per share for the three and six months ended June 30, 2010 to properly reflect the accretion of the Series B Preferred Stock discount is shown in the tables below:

   
For the three months ending,
 
         
Accretion of
       
         
beneficial conversion
       
   
June 30, 2010
   
discount on Series B
   
June 30, 2010
 
(dollar amounts in thousands except per share data)
 
As reported
   
Preferred Stock
   
Restated
 
Net loss
  $ (5,835 )         $ (5,835 )
Less: dividends and accretion on preferred stock
    (353 )     (3,456 )     (3,809 )
Net loss applicable to common shareholders
  $ (6,188 )           $ (9,644 )
Weighted average shares outstanding
    11,250,989               11,250,989  
Basic loss per share
  $ (0.55 )           $ (0.86 )

   
For the six months ending,
 
         
Accretion of
       
         
beneficial conversion
       
   
June 30, 2010
   
discount on Series B
   
June 30, 2010
 
(dollar amounts in thousands except per share data)
 
As reported
   
Preferred Stock
   
Restated
 
Net loss
  $ (7,174 )         $ (7,174 )
Less: dividends and accretion on preferred stock
    (704 )     (3,456 )     (4,160 )
Net loss applicable to common shareholders
  $ (7,878 )           $ (11,334 )
Weighted average shares outstanding
    9,492,421               9,492,421  
Basic loss per share
  $ (0.83 )           $ (1.19 )

As previously mentioned, the Company adjusted the balances of additional paid in capital and retained earnings to properly reflect the issuance of the Series B Preferred Stock as well as the immediate accretion of the Series B Preferred Stock discount as of the date the Company converted the Series B Preferred Stock to common stock. The table below reflects the impact of those adjustments at June 30, 2010:

   
June 30, 2010
 
   
Additional Paid
   
Retained
 
(dollar amounts in thousands)
 
in Capital
   
Earnings
 
Balance as of June 30, 2010, as previously reported
  $ 3,430     $ 5,529  
Increase in additional paid in capital / (accretion) of beneficial conversion discount on Series B Preferred Stock
  $ 3,456     $ (3,456 )
Balance as of June 30, 2010, as adjusted
  $ 6,886     $ 2,073  

This Amendment No. 1 on Form 10-Q/A amends:

Part I. Financial Information
Item 1. Consolidated Financial Statements (un-audited, except for Balance Sheet as of 12/31/2009)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 4. Controls and Procedures

This Amendment No. 1 includes the Original Filing in its entirety and the Company is only amending those portions affected by the revisions described above. The only exhibits included with this Amendment No. 1 are Exhibits 31.1 and 32.1 related to the certifications by the principal executive officer and the principal financial officer, as required by Rule 12b-15 of the Securities Exchange Act of 1934, as amended.

The Company also reassessed the effectiveness of the design and operation of its disclosure controls and procedures. Based on that evaluation and due to the restatement of the unaudited consolidated financial statements as of and for the quarter ended June 30, 2010, Management concluded that the Company’s disclosure controls and procedures were not effective as of June 30, 2010. However, Management believes that the consolidated financial statements included in this Amendment No. 1 on Form 10-Q/A were prepared in accordance with U.S. generally accepted accounting principles in all material respects.

 
 

 
 
   
Page
Part I.  Financial Information
 
  5
Item 1.  Consolidated Financial Statements (un-audited, except for Balance Sheet as of 12/31/2009)
 
  5
Consolidated Balance Sheets
 
  6
Consolidated Statements of Income
 
  7
Consolidated Statements of Stockholders' Equity
 
  8
Consolidated Statements of Cash Flows
 
  9
   
 
Notes to Consolidated Financial Statements
 
  10
Note 1.  Consolidated Financial Statements
 
  10
Note 2.  Investment Securities
 
  10
Note 3.  Loans and the Allowance for Loan Losses
 
  14
Note 4.  Other Real Estate Owned
 
  17
Note 5.  Deferred Tax Assets
 
  17
Note 6.  Earnings / (Loss) Per Share
 
  18
Note 7.  Recent Accounting Pronouncements
 
  19
Note 8.  Share-Based Compensation
 
  21
Note 9.  Fair Value Disclosures
 
  23
Note 10.  Fair Value of Financial Instruments
 
  25
Note 11.  Preferred Stock
 
  27
Note 12.  Regulatory Order and Written Agreement
 
  29
Note 13.  Junior Subordinated Debentures
 
  31
Note 14.  Reclassifications
 
  31
   
 
Forward Looking Statements
 
  32
   
 
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
  33
The Company
 
  33
Where You Can Find More Information
 
  33
Executive Summary
 
  34
Recent Developments
 
  36
Dividends and Stock Repurchases
 
  37
Selected Financial Data
 
  38
Local Economy
 
  38
Critical Accounting Policies
 
  39
Results of Operations
 
  42
Net Interest Income and Margin
 
  42
Non-Interest Income
 
  47
Non-Interest Expenses
 
  49
Provision for Income Taxes
 
  50
Provision for Loan Losses
 
  50
Financial Condition
 
  52
Loans
 
  52
Credit Quality
 
  57
Allowance for Loan Losses
 
  57
Non-Performing Assets
 
  60
Total Cash and Cash Equivalents
 
  65
Investment Securities and Other Earning Assets
 
  65
Deposits and Borrowed Funds
 
  67
Capital
 
  69
Liquidity
 
  72
Inflation
 
  73
Off-Balance Sheet Arrangements
 
  73
   
 
Item 3.  Quantative and Qualitative Disclosure About Market Risk
 
  74
Item 4.  Controls and Procedures
 
  75
   
 
Part II.  Other Information
 
  76
Item 1.  Legal Proceedings
 
  76
Item 1A.  Risk Factors
 
  77
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
  77
Item 3.  Defaults upon Senior Securities
 
  77
Item 4.  (Removed and Reserved)
 
  77
Item 5.  Other Information
 
  77
Item 6.  Exhibits
 
  78
   
 
Signatures
 
  79

 
Heritage Oaks Bancorp | - 4 -
 
 
 

 
 
Part I.  Financial Information

Item 1. Consolidated Financial Statements

The financial statements and the notes thereto begin on next page.
 
Heritage Oaks Bancorp | - 5 -
 
 
 

 
 
Heritage Oaks Bancorp
           
and Subsidiaries
           
Consolidated Balance Sheets
           
         
(audited)
 
   
June 30,
   
December 31,
 
(dollars in thousands except per share data)
 
2010
   
2009
 
             
Assets
           
Cash and due from banks
  $ 17,849     $ 19,342  
Interest bearing due from banks
    38,682       17,046  
Federal funds sold
    5,500       4,350  
Total cash and cash equivalents
    62,031       40,738  
                 
Interest bearing deposits with other banks
    119       119  
Securities available for sale
    192,904       121,180  
Federal Home Loan Bank stock, at cost
    5,611       5,828  
Loans held for sale
    9,429       9,487  
Loans, net of deferred fees of $1,698 and $1,825 and allowance for loan loss of $22,134 and $14,372 at June 30, 2010 and December 31, 2009, respectively.
    673,344       712,482  
Property, premises and equipment, net
    6,410       6,779  
Deferred tax assets
    19,174       10,553  
Bank owned life insurance
    12,811       12,549  
Goodwill
    11,049       11,049  
Core deposit intangible
    2,385       2,642  
Other real estate owned
    4,953       946  
Other assets
    10,302       10,825  
                 
Total assets
  $ 1,010,522     $ 945,177  
                 
Liabilities
               
Deposits
               
Demand, non-interest bearing
  $ 182,846     $ 174,635  
Savings, NOW, and money market deposits
    380,257       365,602  
Time deposits of $100 or more
    116,372       117,420  
Time deposits under $100
    116,358       117,808  
Total deposits
    795,833       775,465  
                 
Short term FHLB borrowing
    65,000       65,000  
Junior subordinated debentures
    8,248       13,403  
Other liabilities
    8,091       7,558  
                 
Total liabilities
    877,172       861,426  
                 
Commitments and contingencies
    -       -  
                 
Stockholders' Equity
               
Series A senior preferred stock, $1,000 per share stated value, 21,000 shares issued and outstanding
    19,610       19,431  
Series C preferred stock, $3.25 per share stated value, 1,189,538 shares issued and outstanding
    3,608       -  
Common stock, no par value; 100,000,000 shares authorized, issued and outstanding 25,062,682 and 7,771,952 as of June 30, 2010 and December 31, 2009, respectively.
    101,197       48,747  
Additional paid in capital
    6,886       3,242  
Retained earnings
    2,073       13,407  
Accumulated other comprehensive loss, net of tax benefit of $17 and $752 as of June 30, 2010 and December 31, 2009, respectively.
    (24 )     (1,076 )
                 
Total stockholders' equity
    133,350       83,751  
                 
Total liabilities and stockholders' equity
  $ 1,010,522     $ 945,177  

See notes to condensed consolidated financial statements.
 
Heritage Oaks Bancorp | - 6 -
 
 
 

 
 
Heritage Oaks Bancorp
                       
and Subsidiaries
                       
Consolidated Statements of Income
                       
   
For the three months
   
For the six months
 
   
ended June 30,
   
ended June 30,
 
(dollars in thousands except per share data)
 
2010
   
2009
   
2010
   
2009
 
                         
Interest Income
                       
Interest and fees on loans
  $ 11,429     $ 11,416     $ 22,570     $ 22,563  
Interest on investment securities
                               
Mortgage backed securities
    1,425       625       2,444       1,173  
Obligations of state and political subdivisions
    287       208       544       394  
Interest on time deposits with other banks
    1       1       1       2  
Interest on due from Federal Reserve Bank
    24       -       52       -  
Interest on federal funds sold
    1       10       2       17  
Interest on other securities
    9       9       13       16  
                                 
Total interest income
    13,176       12,269       25,626       24,165  
                                 
Interest Expense
                               
Interest on savings, NOW and money market deposits
    802       839       1,884       1,656  
Interest on time deposits in denominations of $100 or more
    519       631       1,095       1,175  
Interest on time deposits under $100
    577       664       1,190       1,228  
Other borrowings
    138       293       370       697  
                                 
Total interest expense
    2,036       2,427       4,539       4,756  
                                 
Net interest income before provision for possible loan losses
    11,140       9,842       21,087       19,409  
                                 
Provision for possible loan losses
    16,100       2,700       21,300       4,810  
                                 
Net interest (loss) / income after provision for possible loan losses
    (4,960 )     7,142       (213 )     14,599  
                                 
Non Interest Income
                               
Fees and service charges
    614       752       1,239       1,464  
(Loss) / gain on sale of investment securities
    (97 )     -       (97 )     122  
Gain / (loss) on sale of OREO
    62       (104 )     62       (131 )
Gain on sale of furniture fixtures and equipment
    58       -       58       -  
Gain on sale of SBA loans
    209       -       209       -  
Gain on extinguishment of debt
    1,700       -       1,700       -  
Other
    1,067       852       2,028       1,705  
                                 
Total non interest income
    3,613       1,500       5,199       3,160  
                                 
Non Interest Expenses
                               
Salaries and employee benefits
    4,351       3,745       8,729       7,548  
Equipment
    370       376       698       701  
Occupancy
    941       826       1,874       1,678  
Other
    3,166       3,067       6,393       5,512  
                                 
Total non interest expenses
    8,828       8,014       17,694       15,439  
                                 
(Loss) / income before provision for income taxes
    (10,175 )     628       (12,708 )     2,320  
                                 
(Benefit) / provision for income taxes
    (4,340 )     121       (5,534 )     711  
                                 
Net (loss) / income
    (5,835 )     507       (7,174 )     1,609  
                                 
Dividends and accretion on preferred stock
    3,809       250       4,160       261  
                                 
Net (loss) / income applicable to common shareholders
  $ (9,644 )   $ 257     $ (11,334 )   $ 1,348  
                                 
(Loss) / Earnings Per Common Share
                               
Basic
  $ (0.86 )   $ 0.03     $ (1.19 )   $ 0.17  
Diluted
  $ (0.86 )   $ 0.03     $ (1.19 )   $ 0.17  

See notes to condensed consolidated financial statements.
 
Heritage Oaks Bancorp | - 7 -
 
 
 

 
 
Heritage Oaks Bancorp
 
and Subsidiaries
 
Consolidated Statements of Stockholders' Equity
 
   
                                       
Accumulated
       
         
Common Stock
   
Additional
               
Other
   
Total
 
   
Preferred
   
Number of
         
Paid-In
   
Comprehensive
   
Retained
   
Comprehensive
   
Stockholders'
 
(dollars in thousands)
 
Stock
   
Shares
   
Amount
   
Capital
   
Income
   
Earnings
   
Income/(loss)
   
Equity
 
Balance, December 31, 2009
  $ 19,431       7,771,952     $ 48,747     $ 3,242           $ 13,407     $ (1,076 )   $ 83,751  
                                                               
Issuance of 56,160 shares of Series B preferred stock
    52,408                                                     52,408  
Discount on Series B preferred stock
    (3,456 )                     3,456                             -  
Conversion of Series B preferred stock to common stock
    (52,408 )     17,279,995       52,408                                     -  
Issuance of 1,189,538 shares of Series C preferred stock
    3,608                                                     3,608  
Accretion on Series A preferred stock
    179                                     (179 )             -  
Accretion on Series B preferred stock
    3,456                                     (3,456 )             -  
Dividends paid on preferred stock
                                          (262 )             (262 )
Accrued dividends on preferred stock
                                          (263 )             (263 )
Exercise of stock options
            11,260       42                                     42  
Share-based compensation expense
                            188                             188  
Retirement of restricted share awards
            (525 )                                              
Comprehensive income:
                                                             
Net loss
                                  $ (7,174 )     (7,174 )             (7,174 )
Unrealized security holding gains (net of $695 tax)
                                    995               995       995  
Realized loss on sale of securities (net of $40 tax benefit)
                                    57               57       57  
                                                                 
Total comprehensive loss
                                  $ (6,122 )                        
                                                                 
Balance, June 30, 2010
  $ 23,218       25,062,682     $ 101,197     $ 6,886             $ 2,073     $ (24 )   $ 133,350  
                                                                 
Balance, December 31, 2008
  $ -       7,753,078     $ 48,649     $ 1,055             $ 21,420     $ (1,092 )   $ 70,032  
                                                                 
Issuance of 21,000 shares of Series A Senior preferred stock and common stock warrant
    19,152                       1,848                               21,000  
Accretion on Series A preferred stock
    101                                       (101 )             -  
Dividends paid on preferred stock
                                            (160 )             (160 )
Exercise of stock options (including $9 excess tax benefit from exercise of stock options)
            10,050       46                                       46  
Share-based compensation expense
                            184                               184  
Retirement of restricted share awards
            (1,575 )                                                
Comprehensive income:
                                                               
Net income
                                  $ 1,609       1,609               1,609  
Unrealized security holding losses (net of $1,027 tax benefit)
                                    (1,469 )             (1,469 )     (1,469 )
Realized gains on sale of securities (net of $50 tax)
                                    72               72       72  
                                                                 
Total comprehensive income
                                  $ 212                          
                                                                 
Balance, June 30, 2009
  $ 19,253       7,761,553     $ 48,695     $ 3,087             $ 22,768     $ (2,489 )   $ 91,314  

 
See notes to condensed consolidated financial statements.
 
Heritage Oaks Bancorp | - 8 -
 
 
 

 
 
Heritage Oaks Bancorp
           
and Subsidiaries
           
Consolidated Statements of Cash Flows
           
   
For the six month periods
 
   
ended June 30,
 
(dollars in thousands)
 
2010
   
2009
 
             
Cash flows from operating activities:
           
Net (loss) / income
  $ (7,174 )   $ 1,609  
Adjustments to reconcile net income to net cash provided / (used) by operating activities:
               
Depreciation and amortization
    638       547  
Provision for possible loan losses
    21,300       4,810  
Amortization of premiums / discounts on investment securities, net
    591       29  
Amortization of intangible assets
    257       525  
Share-based compensation expense
    188       184  
Loss / (gain) on sale of available for sale securities
    97       (122 )
Gain on extinguishment of debt
    (1,700 )     -  
Decrease / (increase) in loans held for sale
    58       (3,753 )
Net increase in bank owned life insurance
    (262 )     (212 )
(Increase) / decrease in deferred tax asset
    (9,356 )     12  
(Gain) / loss on sale of other real estate owned
    (62 )     73  
Write-downs on other real estate owned
    205       131  
Increase in other assets
    (4,464 )     (7,799 )
Increase in other liabilities
    270       822  
Excess tax benefit related to share-based compensation expense
    -       (9 )
                 
NET CASH PROVIDED / (USED) IN OPERATING ACTIVITIES
    586       (3,153 )
                 
Cash flows from investing activities:
               
Purchase of securities, available for sale
    (83,443 )     (38,553 )
Sale of available for sale securities
    2,197       4,762  
Maturities and calls of available for sale securities
    338       1,136  
Proceeds from principal reductions and maturities of available for sale securities
    10,283       5,410  
Purchase of Federal Home Loan Bank stock
    -       (705 )
Redemption of Federal Home Loan Bank stock
    217       -  
Decrease / (increase) in loans, net
    16,198       (21,991 )
Allowance for loan and lease loss recoveries
    1,640       22  
Purchase of property, premises and equipment, net
    (269 )     (578 )
Proceeds from sale of other real estate owned
    837       2,863  
                 
NET CASH USED IN INVESTING ACTIVITIES
    (52,002 )     (47,634 )
                 
Cash flows from financing activities:
               
Increase in deposits, net
    20,368       100,468  
Proceeds from Federal Home Loan Bank borrowing
    -       75,000  
Repayments of Federal Home Loan Bank borrowing
    -       (119,000 )
Decrease in repurchase agreements
    -       (2,796 )
Decrease in junior subordinated debentures
    (3,455 )     -  
Excess tax benefit related to share-based compensation expense
    -       9  
Proceeds from exercise of stock options
    42       37  
Cash dividends paid
    (262 )     (160 )
Proceeds from issuance of preferred stock and common stock warrants, net
    56,016       21,000  
                 
NET CASH PROVIDED BY FINANCING ACTIVITIES
    72,709       74,558  
                 
Net increase in cash and cash equivalents
    21,293       23,771  
                 
Cash and cash equivalents, beginning of period
    40,738       24,571  
                 
Cash and cash equivalents, end of period
  $ 62,031     $ 48,342  
                 
Supplemental Cash Flow Disclosures:
               
                 
Cash Flow information
               
Interest paid
  $ 4,692     $ 4,836  
Income taxes paid
  $ 3,125     $ 220  
                 
Non-Cash Flow Information
               
Change in other valuation allowance for investment securities
  $ 1,787     $ (2,374 )
Loans transferred to OREO or foreclosed collateral
  $ 4,987     $ 8,403  
Preferred stock dividends declared not paid
  $ 263     $ -  
Accretion of preferred stock discount
  $ 3,635     $ -  
Conversion of preferred stock to common stock
  $ 52,408     $ -  

See notes to condensed consolidated financial statements.
 
Heritage Oaks Bancorp | - 9 -
 
 
 

 
 
Notes to Consolidated Financial Statements
 
Note 1.  Consolidated Financial Statements

The accompanying un-audited condensed consolidated financial statements of Heritage Oaks Bancorp and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and notes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for annual financial statements are not included herein. In the opinion of Management, all adjustments (which consist solely of normal recurring accruals) considered necessary for a fair presentation of results for the interim periods presented have been included. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2009 Annual Report filed on Form 10-K.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned financial subsidiary, Heritage Oaks Bank (“the Bank”).  All significant inter-company balances and transactions have been eliminated. Heritage Oaks Capital Trust II is an unconsolidated subsidiary formed solely for the purpose of issuing trust preferred securities. Operating results for the three and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. Certain amounts in the consolidated financial statements for the year ended December 31, 2009 and for the three and six months ended June 30, 2009 may have been reclassified to conform to the presentation of the consolidated financial statements in 2010.

The preparation of consolidated financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.
 
Events or transactions that provided evidence about conditions that did not exist at June 30, 2010, but arose before the financial statements were available to be issued have not been recognized in the financial statements as of and for the periods ended June 30, 2010.  Based on all currently available information, the Company is not aware of any such events.  Events or transactions that were deemed to be of a material nature and provide evidence about conditions that did exist at June 30, 2010 have been recognized in these consolidated financial statements.

Note 2.  Investment Securities

In accordance with U.S. GAAP, investment securities are classified in three categories and accounted for as follows: debt and mortgage-backed securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and are measured at amortized cost; debt and equity securities bought and held principally for the purpose of selling in the near term are classified as trading securities and are measured at fair value, with the unrealized gains and losses included in earnings; debt and equity securities not classified as either held-to-maturity or trading securities are deemed as available-for-sale and are measured at fair value, with the unrealized gains and losses, net of applicable taxes, reported in a separate component of stockholders’ equity. Any gains and losses on sales of investments are computed on a specific identification basis.  Premiums and discounts are amortized or accreted using the interest method over the lives of the related securities.
 
Heritage Oaks Bancorp | - 10 -
 
 
 

 

 
Notes to Consolidated Financial Statements
  
The following table sets forth the amortized cost and fair values of investment securities available for sale at June 30, 2010 and December 31, 2009:

(dollars in thousands)
       
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
As of June 30, 2010
 
Cost
   
Gains
   
Losses
   
Value
 
Obligations of U.S. government agencies and corporations
  $ 104     $ -     $ (4 )   $ 100  
Mortgage backed securities
                               
Agency
    146,080       1,330       (444 )     146,966  
Non-agency
    19,095       909       (2,271 )     17,733  
Obligations of state and political subdivisions
    27,557       576       (137 )     27,996  
Other securities
    109       -       -       109  
                                 
Total
  $ 192,945     $ 2,815     $ (2,856 )   $ 192,904  
                                 
As of December 31, 2009
                               
Obligations of U.S. government agencies
  $ 108     $ -     $ (4 )   $ 104  
Mortgage-backed securities
                               
Agency
    78,203       619       (872 )     77,950  
Non-agency
    21,935       1,184       (2,966 )     20,153  
Obligations of state and political subdivisions
    22,653       421       (210 )     22,864  
Other securities
    109       -       -       109  
                                 
Total
  $ 123,008     $ 2,224     $ (4,052 )   $ 121,180  

During the six months ended June 30, 2010 the Bank purchased approximately $83.4 million in investment securities.  Sales of investments totaled approximately $2.2 million.  In connection with these sales, the Bank recognized an aggregate pre-tax loss of $0.1 million.  Sales of investment securities during the first six months of 2009 totaled approximately $4.8 million.  Gains recognized in connection with those sales totaled approximately $0.1 million.  Principal pay-downs on mortgage related securities totaled approximately $10.3 million during the first six months of 2010.

Other than Temporary Impairment

Management periodically evaluates investments in the portfolio for other than temporary impairment and more specifically when conditions warrant such an evaluation.  When evaluating whether impairment is other than temporary, Management considers, among other things, the following: (1) the length of time the security has been in an unrealized loss position, (2) the extent to which the security’s fair value is less than its cost, (3) the financial condition of the issuer, (4) any adverse changes in ratings issued by various rating agencies, (5) the intent and ability of the Bank to hold such securities for a period of time sufficient to allow for any anticipated recovery in fair value and (6) in the case of mortgage related securities, credit enhancements, loan-to-values, credit scores, delinquency and default rates, cash flows and the extent to which those cash flows are within Management’s initial expectations based on pre-purchase analyses.

During the fourth quarter of 2009 the Company performed an analysis, with the assistance of an independent third party, on several non-agency whole loan collateralized mortgage obligations (“CMOs”) in the investment portfolio for other than temporary impairment (“OTTI”).  These securities were in a net unrealized loss position for more than 12 months, were downgraded to below investment grade status, and had been experiencing increases in delinquency and default rates for a period of at least 12 months.  The Company’s review of these securities was performed under FASB ASC 320, which includes new guidance the Company was required to adopt on January 1, 2009 in evaluating investments for other than temporary impairment.  OTTI is considered to have occurred: (1) if the Company intends to sell the related securities; (2) if it is “more likely than not” the Company will be required to sell the securities before recovery of its amortized cost basis; or (3) the present value of expected future cash flows is not sufficient to recover the entire amortized cost basis of the securities.

Under FASB ASC 320, an OTTI loss must be fully recognized in earnings if an investor has the intent to sell the security or if it is more likely than not the investor will be required to sell the security before the recovery of its amortized cost.  However, if an investor does not intend to sell the security, it must still evaluate the expected future cash flows to be received to determine if a credit loss has occurred.  In the event that a credit loss has occurred, only the amount of impairment related to the credit loss is recognized in earnings.  OTTI amounts related to all other factors, such as market conditions, are recorded as a component of accumulated other comprehensive income.

Although as of the date of evaluation the Company had the ability and intent to hold the related securities it evaluated for OTTI for the foreseeable future, the results of the analysis performed on these securities indicated that the present value of the expected future cash flows on each security was not sufficient to recover their entire amortized cost basis and thus indicating a credit loss had occurred.
 
Heritage Oaks Bancorp | - 11 -
 
 
 

 
 
Notes to Consolidated Financial Statements
  
The results of the Company’s Q4 2009 evaluation of several non-agency whole loan CMOs indicated there was OTTI on four holdings in the investment portfolio as of December 31, 2009.  The gross unrealized loss on these holdings at the time impairment was determined was approximately $2.0 million.  The Company’s analysis indicated that approximately $0.4 million of these losses were credit related, while approximately $1.6 million were related to all other factors, including general market conditions.  These amounts were recorded in the Company’s consolidated financial statements during the fourth quarter of 2009.  As of June 30, 2010 the remaining book balance of these securities was approximately $3.9 million, compared to the $5.4 million reported at December 31, 2009.  During the second quarter of 2010 the Bank sold one of the four securities mentioned above in an effort to take advantage of current, more favorable, market pricing during the second quarter.  The Bank recognized a loss of approximately $150 thousand on the sale of this security. The Company will continue to engage an independent third party to review these securities on a quarterly basis for the foreseeable future.

The Company’s evaluations of non-agency whole loan CMOs, with the assistance of an independent third party, compile relevant collateral details and performance statistics on a security-by-security basis.  These evaluations also include assumptions about prepayment rates, future delinquencies, and loss severities based on the underlying collateral characteristics, and vintage.  Additionally, evaluations include consideration of actual recent collateral performance, the structuring of the security, including the Company’s position within that structure, and expectations of relevant market and economic data as of the end of the reporting period.  Assumptions made concerning the items listed above allow the Company to then derive an estimate for the net present value of each security’s expected future cash flows.  This amount is then compared to the amortized cost of each security to determine the amount of any possible credit loss.

As of June 30, 2010, net unrealized losses on non-agency CMOs within the Bank’s investment portfolio totaled approximately $1.4 million compared to $1.8 million reported at December 31, 2009 and were primarily attributable to market interest rate volatility and a significant widening of interest rate spreads relating to the continued uncertainty in financial markets, rather than to credit risk.  Current characteristics of each security owned, such as delinquency rates, foreclosure levels, credit enhancements, and projected losses, are reviewed periodically by Management.   Accordingly, it is expected that these securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the Company does not have the intent to sell these investments and it is not more likely than not that the Company will be required to sell these investments before anticipated recovery of fair value, which may be at maturity, the Company did not consider these investments to be other than temporarily impaired as of June 30, 2010.  However, it is possible that the underlying loan collateral of these securities will perform worse than is currently expected, which could lead to adverse changes in cash flows on these securities and future OTTI losses.  Events that could trigger material unrecoverable declines in fair values, and therefore potential OTTI losses for these securities in the future, include, but are not limited to, further significantly weakened economic conditions, deterioration of credit metrics, significantly higher levels of default, loss in value on the underlying collateral, deteriorating credit enhancement, and further uncertainty and illiquidity in the financial markets.

As of June 30, 2010, the Company believes that unrealized losses on all other mortgage related securities such as agency securities, including those issued by the Federal Home Loan Mortgage Corporation (“FHLMC”), the Federal National Mortgage Association (“FNMA”) and the Government National Mortgage Association (“GNMA”) are not attributable to credit quality, but rather fluctuations in market prices for these types of investments.  Additionally, these securities have maturity dates that range from 1 to 30 years and have contractual cash flows guaranteed by agencies of the U.S. Government.  As of June 30, 2010, the Company does not believe unrealized losses related to these securities are other than temporary.

The following table provides a roll forward as of June 30, 2010 of investment securities credit losses recorded in earnings. The beginning balance represents the credit loss component for which OTTI occurred on debt securities in prior periods. Additions represent the first time a debt security was credit impaired or when subsequent credit impairments have occurred on securities for which OTTI credit losses have been previously recognized. The Company did not record any OTTI on investment securities during the three and six months ended June 30, 2010.

         
OTTI Related to
       
   
OTTI Related
   
All Other
   
Total
 
(dollar amounts in thousands)
 
to Credit Loss
   
Factors
   
OTTI
 
Balance, December 31, 2009
  $ 372     $ 1,584     $ 1,956  
Charges on securities for which OTTI was not previously recognized
    -       -       -  
Realized losses for securities sold
    (45 )     (70 )     (115 )
                         
Balance, June 30, 2010
  $ 327     $ 1,514     $ 1,841  
 
Heritage Oaks Bancorp | - 12 -
 
 
 

 
 
Notes to Consolidated Financial Statements
  
The following table provides a summary of investment securities in an unrealized loss position as of June 30, 2010 and December 31, 2009:

   
Securities In A Loss Position
             
   
For Less Than 12 Months
   
For 12 Months or More
   
Total
 
(dollars in thousands)
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
As of June 30, 2010
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
Obligations of U.S. government agencies and corporations
  $ -     $ -     $ 100     $ (4 )   $ 100     $ (4 )
Mortgage-backed securities
                                               
Agency
    60,479       (444 )     76       -       60,555       (444 )
Non-agency
    -       -       10,054       (2,271 )     10,054       (2,271 )
Obligations of state and political subdivisions
    5,902       (124 )     139       (13 )     6,041       (137 )
                                                 
Total
  $ 66,381     $ (568 )   $ 10,369     $ (2,288 )   $ 76,750     $ (2,856 )
                                                 
As of December 31, 2009
                                               
Obligations of U.S. government agencies
  $ -     $ -     $ 104     $ (4 )   $ 104     $ (4 )
Mortgage backed securities
                                               
Agency
    38,625       (870 )     357       (2 )     38,982       (872 )
Non-agency
    -       -       11,618       (2,966 )     11,618       (2,966 )
Obligations of state and political subdivisions
    6,012       (210 )     -       -       6,012       (210 )