Foothill Independent Bancorp (FOOT) 10-Q 2003 Q2 Quarterly report

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

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended:     June 30, 2003
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from _______________ to ________________
Commission file number 0-11337
Foothill Independent Bancorp
(Exact name of Registrant as specified in its charter)

Delaware	95-3815805
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
510 South Grand Avenue, Glendora, California	91741
(Address of principal executive offices)	(Zip Code)
(626) 963-8551 or (909) 599-9351
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed, since last year)

     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.

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

Yes  o No  x.

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

A total of 6,132,294 shares of Common Stock were outstanding as of August 7, 2003

FOOTHILL INDEPENDENT BANCORP

TABLE OF CONTENTS

		Page No.
Forward Looking Information		(i)
Part I.      Financial Information		1
Item 1.	Financial Statements
	Consolidated Balance Sheets June 30, 2003 and December 31, 2002 (unaudited)	1
	Condensed Consolidated Statements of Income for the six months and three months ended June 30, 2003 and 2002 (unaudited)	2
	Condensed Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2003 and 2002 (unaudited)	3
	Condensed Consolidated Statements of Cash Flows six months and three months ended June 30, 2003 and 2002 (unaudited)	4
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
	General	12
	Critical Accounting Policies	12
	Results of Operations	12
	Financial Condition	17
	Risks and Uncertainties Regarding Future Financial Performance	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	21
Part II.      Other Information
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 6.	Exhibits and Reports on Form 8-K	22
SIGNATURES		S-1
EXHIBITS
Exhibit 31.1  Certifications of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act
Exhibit 31.2  Certifications of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act
Exhibit 32.1  Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act
Exhibit 32.2  Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act

FORWARD LOOKING INFORMATION

          This Report contains “forward-looking” statements that set forth our current expectations or beliefs regarding our future financial performance.  Forward-looking statements are subject to a number of risks and uncertainties that could cause our actual financial performance in the future to differ, possibly significantly, from the expectations set forth in those statements.  A discussion of those risks and uncertainties is set forth at the end of Item 2 in Part I of this Report and readers of this Report are urged to review that discussion, which qualifies the forward looking statements contained in this Report.

i

PART I — FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
(Dollars in thousands)

	June 30, 2003			December 31, 2002
ASSETS
Cash and due from banks	$	34,745		$	32,665
Federal funds sold and Overnight Repurchase Agreements		29,500			26,300
Total Cash and Cash Equivalents		64,245			58,965
Interest-bearing deposits in other financial institutions		8,514			7,922
Investment Securities Held-to-Maturity (approximate market value of $9,844 in 2003 and $9,670 in 2002)
U.S. Treasury		551			349
U.S. Government Agencies		1,940			1,941
Municipal Agencies		4,678			4,678
Other Securities		2,311			2,311
Total Investment Securities Held-To-Maturity		9,480			9,279
Investment Securities Available-For-Sale		83,896			71,499
Federal Home Loan Bank stock, at cost		366			357
Federal Reserve Bank stock, at cost		229			229
Loans, net of unearned discount and prepaid points and fees		463,497			440,849
Direct lease financing		1,052			1,211
Less reserve for possible loan and lease losses		(4,665	)		(4,619	)
Total Loans & Leases, net		459,884			437,441
Bank premises and equipment		5,139			5,498
Accrued interest		2,321			2,243
Other real estate owned, net of allowance for possible losses of $0 in 2003 and in 2002		—			387
Cash surrender value of life insurance		11,103			6,778
Prepaid expenses		1,061			1,192
Deferred tax asset		2,243			2,317
Other assets		655			463
Total Assets	$	649,136		$	604,570
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand deposits	$	212,943		$	198,286
Savings and NOW deposits		144,744			138,430
Money market deposits		140,502			113,081
Time deposits in denominations of $100,000 or more		31,188			34,446
Other time deposits		49,283			50,319
Total deposits		578,660			534,562
Accrued employee benefits		2,869			2,792
Accrued interest and other liabilities		990			1,640
Floating rate trust preferred securities		8,000			8,000
Total liabilities		590,519			546,994
Stockholders’ Equity
Stock dividend to be distributed		—			9,328
Capital stock -- authorized: 25,000,000 shares $.001 par value; issued and outstanding: 6,040,272 shares at June 30, 2003 and 6,032,277 at December 31, 2002		6			6
Additional Paid-in Capital		53,203			43,110
Retained Earnings		5,014			4,868
Accumulated Other Comprehensive Income		394			264
Total Stockholders’ Equity		58,617			57,576
Total Liabilities and Stockholders’ Equity	$	649,136		$	604,570

See accompanying notes to financial statements

1

FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(Dollars in thousands)

	Six Months Ended June 30,				Three Months Ended June 30,
	2003		2002		2003		2002
INTEREST INCOME
Interest and fees on loans	$	15,529	$	15,513	$	7,700	$	7,901
Interest on investment securities
U.S. Treasury		9		8		4		4
Obligations of other U.S. government agencies		1,081		1,215		595		526
Municipal agencies		170		209		79		105
Other securities		88		96		36		60
Interest on deposits		62		100		29		42
Interest on Federal funds sold		191		259		96		156
Lease financing income		35		36		17		20
Total Interest Income		17,165		17,436		8,556		8,814
INTEREST EXPENSE
Interest on savings & NOW deposits		321		374		162		191
Interest on money market deposits		980		988		526		512
Interest on time deposits in denominations of $100,000 or more		322		479		148		209
Interest on other time deposits		433		772		209		342
Interest on borrowings		186		25		93		—
Total Interest Expense		2,242		2,638		1,138		1,254
Net Interest Income		14,923		14,798		7,418		7,560
Provision for Loan and Lease Losses		100		250		100		150
Net Interest Income After Provisions for Loan and Lease Losses		14,823		14,548		7,318		7,410
OTHER INCOME
Fees and service charges		2,515		2,690		1,283		1,444
Gain on sale SBA loans		1		1		—		—
Other		268		313		151		214
Total other income		2,784		3,004		1,434		1,658
OTHER EXPENSES
Salaries and benefits		5,729		5,652		2,838		2,880
Occupancy expenses, net of revenue of $99 in 2003 and $100 in 2002		1,240		1,239		632		621
Furniture and equipment expenses		761		807		388		416
Other expenses (Note 2)		3,606		3,777		1,806		2,031
Total Other Expenses		11,336		11,475		5,664		5,948
INCOME BEFORE INCOME TAXES		6,271		6,077		3,088		3,120
Provision for income taxes		2,267		2,202		1,115		1,127
NET INCOME	$	4,004	$	3,875	$	1,973	$	1,993
EARNINGS PER SHARE OF COMMON STOCK (Note 3)
Basic	$	0.67	$	0.64	$	0.33	$	0.33
Diluted	$	0.62	$	0.61	$	0.31	$	0.31

See accompanying notes to financial statements

2

FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)
(Dollars in thousands)

SIX MONTHS ENDED JUNE 30, 2003 AND 2002

	Number of Shares Outstanding			Capital Stock		Additional Paid-in Capital		Comprehensive Income		Retained Earnings			Accumulated Other Comprehensive Income		Total
BALANCE, January 1, 2002		5,514,363			6		42,892				8,877			77		51,852
Cash Dividend											(1,160	)				(1,160	)
Exercise of stock options		5,808			—		54									54
Common stock issued under employee benefit and dividend reinvestment plans		7,248			—		98									98
Common stock repurchased, cancelled and retired					—		—									—
COMPREHENSIVE INCOME
Net Income								$	3,875		3,875					3,875
Unrealized security holding losses (net of taxes $29)									17					17		17
Total Comprehensive Income								$	3,892
BALANCE, June 30, 2002		5,527,419		$	6	$	43,044			$	11,592		$	94	$	54,736
BALANCE, January 1, 2003		6,032,276			6		52,438				4,868			264		57,576
Cash Dividend											(1,396	)				(1,396	)
Exercise of stock options		141,001			—		765									765
Common stock repurchased, cancelled and retired		(133,005	)		—						(2,462	)				(2,462	)
COMPREHENSIVE INCOME
Net Income									4,004		4,004					4,004
Unrealized security holding gains (net of taxes $75)									130					130		130
Total Comprehensive Income								$	4,134
BALANCE, June 30, 2003		6,040,272		$	6	$	53,203			$	5,014		$	394	$	58,617

See accompanying notes to financial statements

3

FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)

SIX MONTHS ENDED JUNE 30, 2003 AND 2002

	2003			2002
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash Flows From Operating Activities:
Interest and fees received	$	17,106		$	18,065
Service fees and other income received		(1,535	)		2,800
Financing revenue received under leases		35			36
Interest paid		(2,290	)		(2,741	)
Cash paid to suppliers and employees		(11,097	)		(10,331	)
Income taxes paid		(2,288	)		(1,468	)
Net Cash Provided (Used) by Operating Activities		(69	)		6,361
Cash Flows From Investing Activities:
Proceeds from maturity of investment securities (AFS)		90,128			42,148
Purchase of investment securities (AFS)		(102,382	)		(21,191	)
Proceeds from maturity of investment securities (HTM)		—			3,600
Purchase of investment securities (HTM)		(202	)		(46	)
Net (increase) decrease in deposits at other financial institutions		(592	)		6,130
Net (increase) decrease in credit card and revolving credit receivables		(61	)		159
Recoveries on loans previously written off		(43	)		16
Net (increase) decrease in loans		(22,787	)		(19,393	)
Net decrease in leases		159			186
Proceeds from property, plant & equipment		63			—
Capital expenditures		(392	)		(259	)
Proceeds from sale of other real estate owned		387			1,687
Net Cash Provided by (Used in) Investing Activities		(35,722	)		13,037
Cash Flows From Financing Activities:
Net increase in demand deposits, NOW accounts, savings accounts, and money market deposits		48,458			44,798
Net decrease in certificates of deposit		(4,294	)		(8,644	)
Net decrease in short term borrowing		—			(19,000	)
Proceeds from exercise of stock options		765			54
Proceeds from stock issued under employee benefit and dividend reinvestment plans		—			98
Stock repurchased and retired		(2,462	)		—
Dividends paid		(1,396	)		(1,160	)
Net Cash Provided by Financing Activities		41,071			16,146
Net Increase in Cash and Cash Equivalents		5,280			35,544
Cash and Cash Equivalents at Beginning of Year		58,965			30,247
Cash and Cash Equivalents at June 30, 2002 & 2001	$	64,245		$	65,791

See accompanying notes to financial statements

4

FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)

SIX MONTHS ENDED JUNE 30, 2002 AND 2001

RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES

	2003			2002
Net Income	$	4,004		$	3,875
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities
Depreciation and amortization		682			708
Provision for possible credit losses		100			250
(Gain)/loss on sale of equipment		6			5
Benefit for deferred taxes		74			88
Increase (decrease) in taxes payable		(95	)		646
Increase in other assets		1			37
(Increase)/decrease in interest receivable		(78	)		643
Increase in discounts and premiums		54			22
Decrease in interest payable		(48	)		(103	)
Decrease in prepaid expenses		131			614
Decrease in accrued expenses and other liabilities		(575	)		(215	)
Gain on sale of other real estate owned		—			107
Increase in cash surrender value of life insurance		(4,325	)		(316	)
Total Adjustments		(4,073	)		2,486
Net Cash Provided (Used) by Operating Activities	$	(69	)	$	6,361

DISCLOSURE OF ACCOUNTING POLICY

          For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and Federal funds sold.  Generally, Federal funds are purchased and sold for one-day periods.

          See accompanying notes to financial statements

5

FOOTHILL INDEPENDENT BANCORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(Dollars in thousands)

JUNE 30, 2003 AND 2002

NOTE #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

          The accompanying financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, these interim condensed financial statements contain all adjustments (consisting only of normal recurring adjustments and accruals) necessary to present fairly the consolidated balance sheets, consolidated operating results, changes in stockholders’ equity and consolidated cash flows of the Company and its subsidiaries for the periods presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Operating results for the three and six month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected in subsequent quarters in or for the full year ending December 31, 2003.  These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.

NOTE #2 - OTHER EXPENSES

          The following is a breakdown of other expenses for the six and three month periods ended June 30, 2003 and 2002.

	Six Months Ended June 30,				Three Months Ended June 30,
	2003		2002		2003		2002
	(In thousands)
Data processing	$	782	$	712	$	402	$	361
Marketing expenses		491		488		245		247
Office supplies, postage and telephone		562		555		277		279
Bank Insurance		314		271		145		133
Supervisory Assessments		61		64		22		32
Professional Expenses		458		586		230		339
Other Expenses		938		1,101		485		640
Total Other Expenses	$	3,606	$	3,777	$	1,806	$	2,031

NOTE #3 - EARNINGS PER SHARE

          The following table is a reconciliation of net income and shares outstanding to the income and number of shares used to compute EPS (amounts in thousands):

	Six Months Ended June 30,										Three Months Ended June 30,
	2003					2002					2003					2002
	Income		Shares			Income		Shares			Income		Shares			Income		Shares
Net income as reported	$	4,004				$	3,875				$	1,973				$	1,993
Shares outstanding at period end (1)				6,040					6,025					6,040					6,025
Impact of weighting shares purchased during period				(30	)				(7	)				(41	)				(3	)
Used in Basic EPS		4,004		6,010			3,875		6,018			1,973		5,999			1,993		6,022
Dilutive effect of outstanding stock options				487					388					442					407
Used in Dilutive EPS	$	4,004		6,497		$	3,875		6,406		$	1,973		6,441		$	1,993		6,429

(1) The number of shares outstanding at June 30, 2002 has been retroactively adjusted for a 9% stock dividend issued after that date.

6

Notes to Condensed Consolidated Financial Statements (continued)

NOTE #3 - EARNINGS PER SHARE (Continued)

          The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provision of SFAS 123, Accounting for Stock Based Compensation, to stock based employee compensation.  All amounts are in thousands, except per share data.

	Six Months Ended June 30,						Three Months Ended June 30,
	2003			2002			2003			2002
	(In thousands, except per share data)
Net Income
As reported	$	4,004		$	3,875		$	1,973		$	1,993
Stock-based compensation using the intrinsic value method		—			—			—			—
Stock-based compensation that would have been reported using the fair value method of SFAS 123		(223	)		(2	)		(223	)		(2	)
Pro forma net income	$	3,781		$	3,873		$	1,750		$	1,991
Basic earnings per share (1)
As reported	$	0.67		$	0.64		$	0.33		$	0.33
Pro Forma	$	0.63		$	0.64		$	0.29		$	0.33
Earnings per share – Assuming dilution (1)
As reported	$	0.62		$	0.61		$	0.31		$	0.31
Pro forma	$	0.58		$	0.61		$	0.27		$	0.31

(1) Per share amounts at June 30, 2002 have been retroactively adjusted for a 9% stock dividend issued after that date.

NOTE #4 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

          The fair values of financial instruments for both assets and liabilities are estimated based on Accounting Standards Board Statement 107.  The following methods and assumptions were used to estimate the fair value of financial instruments.

          Investment Securities

          For U.S. Government and U.S. Agency securities, fair values are based on market prices.  For other investment securities, fair value equals quoted market price if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities as the basis for a pricing matrix.

          Loans

          The fair value for loans with variable interest rates is the carrying amount.  The fair value of fixed rate loans is derived by calculating the discounted value of the future cash flows expected to be received by the various homogeneous categories of loans.  All loans have been adjusted to reflect changes in credit risk.

          Deposits

          The fair value of demand deposits, savings deposits, savings accounts and NOW accounts is defined as the amounts payable on demand at June 30, 2003.  The fair value of fixed maturity certificates of deposit is estimated based on the discounted value of the future cash flows expected to be paid on the deposits.

          Notes Payable

          Rates currently available to the Bank for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.

          Commitments to Extend Credit and Standby Letters of Credit

          The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the parties involved.  For fixed-rate loan commitments, fair value also takes into account the difference between current levels of interest rates and committed rates.

7

Notes to Condensed Consolidated Financial Statements (continued)

NOTE #4 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

          Commitments to Extend Credit and Standby Letters of Credit (continued)

          The fair values of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with parties involved at June 30, 2003.

          The respective estimated fair values of the Company’s financial instruments at June 30, 2003 are as follows:

	June 30, 2003
	Carrying Amount		Fair Value
	(In thousands)
Financial Assets
Cash and cash equivalents	$	64,245	$	64,245
Investment securities and deposits		102,485		100,515
Loans		463,556		477,337
Direct lease financing		1,052		1,043
Cash surrender value of life insurance		11,103		11,103
Financial Liabilities
Deposits		578,660		579,891
Long-term debt		8,000		8,000
Unrecognized Financial Instruments
Commitments to extend credit		45,410		454
Standby letters of credit		1,290		13

NOTE #5 - NON-PERFORMING LOANS

          The following table sets forth information regarding the Bank’s non-performing loans at June 30, 2003 and December 31, 2002.

	June 30, 2003		December 31, 2002
	(In thousands)
Accruing Loans More Than 90 Days Past Due (1)
Commercial, financial and agricultural	$	—	$	—
Real estate		—		—
Installment loans to individuals		3		5
Aggregate leases		—		—
Total loans past due more than 90 days	$	3	$	5
Troubled debt restructurings (2)		22		1,096
Non-accrual loans (3)		1,723		1,455
Total non-performing loans	$	1,748	$	2,556

(1)	Reflects loans for which there has been no payment of interest and/or principal for 90 days or more.  Ordinarily, loans are placed on non-accrual status (accrual of interest is discontinued) when we have reason to believe that continued payment of interest and principal is unlikely.
(2)	Renegotiated loans are those which have been renegotiated to provide a deferral of interest or principal.
(3)	There were 4 loans on non-accrual status, totaling approximately $1,723,000, at June 30, 2003 and 4 loans totaling approximately $1,455,000 at December 31, 2002.

8

Notes to Condensed Consolidated Financial Statements (continued)

NOTE #5 - NON-PERFORMING LOANS (continued)

          Management regularly reviews the loan portfolio to identify problem loans.  The Federal Reserve Board (the “FRB” or “Federal Reserve”) and the California Department of Financial Institutions (the “DFI”), which are the Bank’s principal federal and state regulatory agencies, respectively, also identify and classify problem credits during their periodic regulatory examinations of the Bank.  There are three classifications for problem loans:  “substandard”, “doubtful”, and “loss”.  Substandard loans have one defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  Doubtful loans have the weaknesses of substandard loans with the additional characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, questionable.  A loan classified as “loss” is considered uncollectible and of such little value that the continuance as an asset of the institution is not warranted. Another category designated “special mention” is maintained for loans which do not currently expose the Bank to a significant degree of risk to warrant classification as substandard, doubtful or loss, but which do possess credit deficiencies or potential weaknesses deserving management’s close attention.

          Another classification, “special mention,” is assigned to loans which do not currently expose the Bank to a significant degree of risk to warrant classification as substandard, doubtful or loss, but do possess credit deficiencies or potential weaknesses deserving management’s close attention.

          The following table sets forth information regarding the Bank’s classified loans at June 30, 2003:

Loan Classification	Amounts at June 30, 2003 (in thousands)
Substandard	$	4,283
Doubtful		0
Loss		0

          Of the loans classified substandard at June 30, 2003, a total of $2,560,000 were performing and accruing loans and the remaining $1,723,000 were non-accrual loans, on which we had ceased accruing interest. 

NOTE #6 - RESERVE FOR LOAN AND LEASE LOSSES

          The reserve for loan and lease losses is a general reserve established to absorb potential losses inherent in the entire loan and lease portfolio.  The level of and ratio of additions to the reserve are based on analyses conducted of the loan and lease portfolio and, at June 30, 2003, the reserve reflected an amount which, in management’s judgment, was adequate to provide for potential loan losses.  In evaluating the adequacy of the reserve, management considers a number of factors, including the composition of the loan portfolio, the performance of loans in the portfolio, evaluations of loan collateral, prior loss experience, current economic conditions and the prospects or worth of respective borrowers or guarantors.  In addition, the FRB and the DFI, as part of their periodic examinations of the Bank, review the adequacy of the Bank’s reserve for possible loan and lease losses.  On the basis of those examinations, those agencies may require the Bank to recognize additions to the reserve.  The Bank was most recently examined by the FRB as of December 31, 2002.

    ��     The reserve for loan and lease losses at June 30 2003, was $4,665,000, or 1.00% of total loans and leases.  Additions to the reserve are made through the provision for loan losses which is an operating expense of the Company.

9

Notes to Condensed Consolidated Financial Statements (continued)

NOTE #6 - RESERVE FOR LOAN AND LEASE LOSSES (continued)

          The following table provides certain information with respect to the reserve for loan losses as of the end of, and loan charge-off and recovery activity for, the periods presented below.

	June 30, 2003			December 31, 2002
	(Dollars in thousands)
Reserve for Loan Losses
Balance, Beginning of period	$	4,619		$	4,206
Charge-Offs
Commercial, financial and agricultural		—			(77	)
Real estate – construction		—			—
Real estate – mortgage		—			—
Consumer loans		(7	)		(18	)
Lease Financing		—			—
Other		—			—
Total Charge-Offs		(7	)		(95	)
Recoveries
Commercial, financial and agricultural		14			46
Real estate – construction		—			—
Real estate – mortgage		—			—
Consumer loans		—			2
Lease Financing		—			—
Other		—			—
Total recoveries		14			48
Net recoveries (charge-offs) during period		7			(47	)
Provision charged to operations during period		100			460
Provision for off-balance loan commitments (1)		(61	)		—
Balance at end of period	$	4,665		$	4,619
Ratios:
Net charge-offs to average loans outstanding during period		0.002	%		0.011	%
Reserve for loan losses to total Loans		1.000	%		1.040	%

(1) During the six months ended June, 2003, $61,000 was moved from the loan loss reserve to create a separate reserve for possible losses on off-balance sheet loan commitments.  Prior to that time, the reserve allocable to loan commitments was included as part of the overall loan losses reserve.

NOTE #7 - MARKET RISK

          We utilize the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes.  The simulation model estimates the impact of changing interest rates on the interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company’s balance sheet.  This sensitivity analysis is compared to policy limits which specify maximum tolerance level for net interest income exposure over a one year horizon assuming no balance sheet growth, given both a 100 and 300 basis point upward and downward shift in interest rates.  A parallel and pro rata shift in rates over a 12-month period is assumed.

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Notes to Condensed Consolidated Financial Statements (continued)

NOTE #7 - MARKET RISK (continued)

          The following reflects the Company’s net interest income sensitivity analysis as of June 30, 2003 (with dollars stated in thousands):

SIMULATED RATE CHANGES	INTEREST INCOME SENSITIVITY
			MARKET VALUE
			ASSETS		LIABILITIES
			(Dollars in thousands)
+100 basis points		-2.26%	$	656,568	$	588,692
+300 basis points		-5.82%	$	639,524	$	587,702
-100 basis points		4.27%	$	675,712	$	589,709
-300 basis points		-3.08%	$	696,796	$	588,883

          The Company does not engage in any hedging activities and does not have any derivative securities in its portfolio.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

          Our principal operating subsidiary is Foothill Independent Bank (the “Bank”), which is a California state chartered bank and member of the Federal Reserve System. The Bank accounts for substantially all of our consolidated revenues and income. Accordingly, the following discussion focuses primarily on the Bank’s operations and financial condition.

Critical Accounting Policies

          Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and general practices in the banking industry.  The information contained within our financial statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred.  However, the carrying value of some of our assets can be affected by estimates and the judgments we make about future or anticipated events, the outcome of which, in some cases, is outside of our control. 

          Judgments Regarding Reserves for Potential Loan Losses.  In particular, the accounting policies we follow in determining the sufficiency of the reserves we establish for possible loan losses involve judgments and assumptions by management about future economic and market conditions which can have a material impact on the carrying value of our loans and our results of operations.  In determining the adequacy of the reserve for loan losses, we use historical loss factors, adjusted not only for current conditions, but also for anticipated future conditions, to determine the inherent loss that may be present in our loan portfolio.   Actual loan losses could differ significantly from the loss factors that we use and, if loan losses were to exceed those we had anticipated, due to changes in events or circumstances, it could become necessary for us to increase our loan loss reserve by a charge to income which would reduce both the carrying value of our loans that is reflected on our balance sheet and our earnings.  See “Provision for Loan Losses” below in this Section of this Report.

          Utilization of Deferred Income Tax Benefits.  In addition, the provision that we make for income taxes is based on, among other things, our ability to use certain income tax benefits available under state and federal income tax laws to reduce our income tax liability.  As of June 30, 2003, the total of the unused income tax benefits (referred to in our consolidated financial statements as a “deferred tax asset”), available to reduce our income taxes in future periods was $2,243,000.  Such tax benefits expire over time unless used and the realization of those benefits is dependent on our generating taxable income in the future in amounts sufficient to utilize those tax benefits prior to their expiration.  We have made a judgment, based on historical experience and current and anticipated market and economic conditions and trends, that it is more likely than not that we will generate taxable income in future years sufficient to fully utilize those benefits.  In the event that our income were to decline in future periods making it less likely that those benefits could be fully utilized, we would be required to establish a valuation reserve to cover the potential loss of those tax benefits, by increasing the provision we make for income taxes, which would have the effect of reducing our net income.

Results of Operations

          Overview.  The principal determinant of a bank’s income is net interest income, which is the difference between the interest that a bank earns on loans, investments and other interest earning assets, and its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest that it pays on other interest bearing liabilities.  A bank’s interest income and interest expense are, in turn, affected by a number of factors, some of which are outside of its control, including the monetary policies of the Federal Reserve Board, national and local economic conditions, and competition from other depository institutions and financial services companies, which affect interest rates and also the demand for loans and the ability of borrowers to meet their loan payment obligations.

          During 2001 the Federal Reserve Board adopted and implemented a monetary policy that was designed to reduce market rates of interest in an effort to stimulate the U.S. economy, which was heading into recession.  That

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policy continued through 2002 and into 2003, as the hoped for economic recovery has been slow to develop.  Pursuant to that policy the Federal Reserve Board reduced interest rates throughout 2001 and, as a result, the prime rate of interest charged by most banks declined from 9.50% to 4.75% during 2001.  It remained at 4.75% through most of 2002, declining to 4.25% in November 2002.  It remained at 4.25% until late June of 2003 when it declined further to 4.00% as a result of a further reduction in interest rates by the Federal Reserve Board.  Those monetary policies, combined with the continued softness in the United States economy, caused the average rate of interest earned on our interest earning assets for the quarter and six months periods ended June 30, 2003  to decline to 5.86% and 6.03%, respectively, from 6.83% and 6.86%, respectively, during the same periods of 2002.

          Despite the decline in yields on our interest earning assets, we were able to generate net earnings of $1,973,000 and $4,004,000, respectively, during the quarter and six month periods ended June 30, 2003.  Second quarter earnings for 2003 were relatively unchanged from the same quarter of 2002; while net earnings for the six months ended June 30, 2003 increased modestly, by $129,000, or 3.3%, over net earnings generated in the six months ended June 30, 2002.  On a fully diluted per share basis, net earnings for the second quarter of 2003 were the same as in the second quarter of 2002, at $0.31 per diluted shares.  For the six months ended June 30 2003, net earnings increased to $0.62 per diluted share from $0.61 per diluted share in the same six months of 2002.  The increase in earnings in the six months ended June 30, 2003 was due primarily to an increase in net interest income that resulted from a decrease in interest expense in that six month period. See “Net Interest Income” below.

          The following table sets forth the Company’s annualized returns on average assets and average equity in the three and six month periods ended June 30, 2003 as compared to the corresponding periods of 2002.

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Annualized Returns on Average Assets		1.23	%		1.41	%		1.29	%		1.39	%
Annualized Returns on Average Equity		13.59	%		14.76	%		13.82	%		14.55	%

          Net Interest Income.  Net interest income declined by $142,000, or 1.9%, in the three month period ended June 30, 2003 as compared to the same period of 2002, as a result of a $258,000 or 2.9% decrease in interest income.  The decline in interest income was attributable primarily to declining market rates of interest which reduced the amounts we were able to earn on our interest earning assets.  That decline was partially offset by a $116,000, or 9.2%, reduction in interest expense in the quarter ended June 30, 2003.  For the six months ended June 30, 2003, net interest income increased by $125,000, or 0.8%, as compared to the same six months of 2002.  That increase was primarily due to a $396,000, or 15.0%, reduction in interest expense which more than offset a decrease of $271,000, or 1.6%, in interest income.  The decreases in interest expense in the quarter and six months ended June 30, 2003 were attributable to lower market rates of interest on deposits and, to a lesser extent, reductions in the average volume of outstanding time deposits, including those in denominations of $100,000 or more (“TCDs”), on which we pay higher rates of interest than on savings and money market deposits.  The lowering of interest rates on deposits was primarily the result of actions taken by the Federal Reserve Board to lower market rates of interest in order to stimulate the economy.  The reduction in the volume of our time deposits was primarily attributable to a decision made by management to lower rates of interests on those deposits in order to discourage their renewal and thereby reduce the volume outstanding at the Bank.    During the three and six month periods ended June 30, 2003, we also were able to mitigate, partially, the impact of declining market rates of interest on our net interest income by implementing marketing programs that increased the volume of our outstanding loans which generate higher yields than other interest earning assets.

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          Rate Sensitivity, Net Interest Margins and Market Risk.

                    Rate Sensitivity.  Like other banks and bank holding companies, our net interest margin (that is, the difference between yields we are able to realize on loans and on other interest earning assets and the interest we pay on deposits) is affected by a number of factors, including the relative percentages or the “mix” of:

• our assets, between loans, on the one hand, on which we are able to charge higher rates of interest, and investment securities, federal funds sold and funds held in interest-bearing deposits with other financial institutions, on the other hand, on which yields are lower;

• variable and fixed rate loans in our loan portfolio; and

• demand, savings and money market deposits, on the one hand, and higher priced time deposits, on the other hand.

                    Impact on Net Interest Margins of the Mix of Fixed and Variable Rate Loans.  As a general rule, in an interest rate environment like the one we have experienced during the past two years, a bank with a relatively high percentage of variable rate loans will experience a decline in net interest margins because those loans will “reprice” automatically when market rates of interest decline.  By contrast, a bank with a large proportion of fixed rates loans generally will experience an increase in net interest margins, because the interest rates on those fixed rate loans will not decline in response to declines in market rates of interest.  In a period of increasing interest rates, however, the interest margin of banks with a high proportion of fixed rate loans generally will suffer because they will be unable to “reprice” those loans to fully offset the increase in the rates of interest they must offer to retain maturing time deposits and attract new deposits.  A bank with a higher proportion of variable loans in an environment of increasing market rates of interest will, on the other hand, be able to offset more fully the impact of rising rates of interest on the amounts they must pay to retain existing and attract new deposits. 

                    However, the impact of changes in interest rates on net interest income also can be affected by changes in the volume of loans or volume of interest bearing deposits.  In six month period ended June 30, 2003, we were able to achieve an increase of $125,000 in our net interest income, as compared to the same period of 2002, due not only to the decline in interest rates paid on interest bearing deposits (which would not have been sufficient, alone, to fully offset the effects of declining market rates of interest on our interest income), but also to a reduction in the volume of our higher priced time deposits that resulted from a decision we made to allow those deposits to “run off” rather than to seek their renewal.  Additionally, we were able to mitigate somewhat the effect of declining market rates of interest on interest income by increasing the volume of our outstanding loans by means of loan marketing programs.

                    Net Interest Margin.  Our net interest margin (i.e., tax-adjusted net interest income stated as a percentage of average interest-earning assets) declined in the quarter and six months ended June 30, 2003 to 5.08% and 5.25%, respectively, from 5.87% and 5.83%, respectively, for the same periods of 2002.  Those declines were due primarily to the decrease in interest rates mentioned above.  However, notwithstanding those declines, we believe that our net interest margin continues to exceed the average net interest margin for California-based, publicly traded banks and bank holding companies with assets ranging from $250-to-$750 million (the “Peer Group Banks”), because we have been able to maintain the ratio of demand and savings deposits to total deposits at a higher level than that of our Peer Group Banks.

                    We attempt to reduce our exposure to market risks associated with interest rate fluctuations by seeking (i) to attract and maintain a significant volume of demand and savings deposits that are not as sensitive to interest rate fluctuations as are TCDs and other time deposits, (ii) to match opportunities to “reprice” interest earning assets and interest bearing liabilities in response to changes in market rates of interest, and (iii) to change the mix of interest earning assets and interest bearing liabilities in a manner that is designed to achieve increases in net interest income.  In the current interest rate environment, however, it is no longer possible to reduce the rates we pay on deposits much further in response to declining yields on interest earning assets, which has continued to put downward pressure on net interest margin of the Bank, as well as banks generally. 

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                    As a result, during the past six months we have taken the following actions in an effort to counteract this downward pressure on net interest margin: 

• We have continued sales and marketing programs that are designed to increase our volume of loans, on which yields are higher than other earning assets, and to change the mix of deposits to a greater proportion of lower cost demand and savings deposits;

• We have allowed time deposits to “run-off,” rather than to seek their renewal as a means of reducing our interest expense; and

• We adopted a new loan repricing policy which places an interest rate “floor,” currently at 4.59%, that is applicable to all new variable rate loans that we make.

                    As a result of these measures, during the six months ended June 30, 2003 the average volume of outstanding loans increased by $37,896,000, or 9%, and the average volume of demand, savings and money market deposits increased to 85% of average total deposits, as compared to 82% for the corresponding six month period of 2002.  At the same, TCDs and other time deposits declined, as a percentage of average total deposits, to 15% from 18% in the same six month period of 2002.

                    Assuming modest economic growth, we currently expect that we will be able to achieve additional loan growth, without increasing time deposits, as a percentage of total deposits, during the balance of the current fiscal year.  However, depending on loan demand and interest rates, we may find it necessary or prudent to increase time deposits to fund increases in loan volume.

                    Despite these actions, we currently expect our net interest margin in 2003 to decline somewhat, approximating the decline experienced in 2002, because we expect that any resulting increases in interest income we are able to generate from increased loan volume will be largely offset by a combination of (i) the increase in interest expense that will result from the increase in the volume of our deposits needed to fund the increase in loan volume, and (ii) continuing downward pressure on rates of interest that we are able to charge on loans, which are largely determined by the Federal Reserve Board’s monetary policies and economic conditions in the United States.  However, there are a number of uncertainties and risks that could adversely affect our net interest margin in 2003, including (i) increased competition in our market areas, both from banks and other types of financial institutions as well as from securities brokerage firms and mutual funds that offer competing investment products, and (ii) the possibility that the economic slowdown will continue longer than is currently anticipated, which could result in reduced loan activity and lead to further rate reductions by the Federal Reserve Board.

                    The ability to maintain our net interest margin is not entirely within our control because the interest rates we are able to charge on loans and the interest rates we must offer to maintain and attract deposits are affected by national monetary policies established and implemented by the Federal Reserve Board and by competitive conditions in our service areas.

                    In addition, the effect on a bank’s net interest margin of changes in market rates of interest is affected by the types and maturities of its deposits and earning assets.  For example, a change in interest rates paid on deposits in response to changes in market rates of interest can be implemented more quickly in the case of savings deposits and money market accounts than with respect to time deposits as to which a change in interest rates generally cannot be implemented until such deposits mature.  In addition, a change in rates of interest paid on deposits can and often does lead consumers to move their deposits from one type of deposit to another or to shift funds from deposits to non-bank investments or from such investments to bank deposit accounts or instruments, which also will affect a bank’s net interest margin.

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          Provision for Loan Losses.  Like virtually all banks and other financial institutions, we follow the practice of maintaining a reserve (the “Loan Loss Reserve”) for possible losses on loans and leases that occur from time to time as an incidental part of the banking business.  When it is determined that the payment in full of a loan has become unlikely, the carrying value of the loan is reduced to what management estimates is its realizable value.  This reduction, which is referred to as a loan “charge-off,” is charged against the Loan Loss Reserve.  The amount of the Loan Loss Reserve is increased periodically (i) to replenish the Reserve after it has been reduced due to loan charge-offs, (ii) to reflect changes in the volume of outstanding loans, and (iii) to take account of increases in the risk of potential losses due to a deterioration in the condition of borrowers or in the value of property securing non-performing loans, or due to adverse changes in national or local economic conditions. Those increases and additions are made through a charge against income referred to as the “provision for loan and lease losses.” Recoveries of loans previously charged-off are added back to and, therefore, also have the effect of increasing, the Loan Loss Reserve.

          Although we employ economic models that are based on bank regulatory guidelines and industry standards to evaluate and determine the sufficiency of the Loan Loss Reserve and, thereby, also the amount of the provisions that we make for potential loan losses, those determinations involve judgments or forecasts about future economic conditions and other events that are subject to a number of uncertainties, some of which are outside of our ability to control.  See the discussion below under the Forward Looking Information and Uncertainties Regarding Future Performance.”  Since loans represent the largest portion of our total assets, these judgments and forecasts can have a significant effect on the amount of our reported assets as set forth on our balance sheet.  Those judgments also determine the amount of the provisions we make for loan possible loan losses and therefore can have a significant effect on our operating results.  If conditions or circumstances change from those that were expected at the time those judgments or forecasts were made, it could become necessary to increase the Loan Loss Reserve by making additional provisions for loan losses that would adversely affect our operating results.  Additionally, to the extent those conditions or events were to result in loan charge-offs, the total amount of our reported loans would decline as well.

          We made provisions for potential loan losses of $100,000, in the three and six month periods ended June 30, 2003, as compared to $150,000 and $250,000, respectively, for the corresponding periods of  2002.  At June 30, 2003, the Loan Loss Reserve was approximately $4,665,000 or 1.00% of total loans outstanding, compared to $4,619,0000, or 1.04% of total loans outstanding, at December 31, 2002 and $4,436,000 or 1.04% of total loans outstanding at June 30, 2002.  During the six month period ending June 30, 2003, recoveries of previously “charged-off” loans exceeded loan charge-offs by $7,000.  See Note 6 to our Condensed Consolidated Financial Statements contained in this Report for additional information with respect to our loan and lease loss experience in the six months ended June 30, 2003 and the fiscal year ended December 31, 2002.

          Non-Interest Income. Non-interest income (also sometimes referred to as “other income”) decreased by $224,000, or 13.5%, and $220,000, or 7.3%, in the three and six month periods ending June 30, 2003 as compared to the same periods of 2002, due primarily to decreases in transaction fees and services charges collected on deposits and other banking transactions.  Additionally, non-interest income in the second quarter of 2002 included a $107,000 gain on the sale of a parcel of real estate on which the Bank foreclosed several years ago.  No similar sales occurred in the second quarter of the current year.

          Non-Interest Expense.  Non-interest expense (also sometimes referred to as “other expense”) consists primarily of (i) salaries and other employee expenses, (ii) occupancy and furniture and equipment expenses, and (iii) other operating and miscellaneous expenses that include insurance premiums, marketing expenses, data processing costs, and professional expenses.  See Note 2 to our Condensed Consolidated Financial Statements contained above in this Report.

          In order to attract a higher volume of non-interest bearing demand and lower cost savings and money market deposits as a means of maintaining the Bank’s net interest margin, it has been our policy to provide a higher level of personal service to our customers than the level of services that is typically provided by many of our competitors.  As a result, we have more banking personnel than many of our competitors of comparable size, which is reflected in our non-interest expense.  However, we believe that this higher level of service has helped us to retain our customers and enabled us to achieve an average net interest margin that exceeds the average net margin of the banks in our Peer Group.

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          Non-interest expense decreased approximately by $284,000, or 4.8%, and by $139,000, or 1.2%, in the quarter and six-month periods ended June 30, 2003, respectively, compared to same periods of 2002, primarily due to decreases professional and other expenses.  However, notwithstanding that decrease, our efficiency ratio increased to 64.6% and 64.7%, respectively,  for the quarter and six month periods ended June 30, 2003, compared to 63.9% and 64.2%, respectively,  in the same periods of  2002, primarily due to the decrease in non-interest income.  The efficiency ratio is, basically, the ratio of non-interest expense to the sum of net interest income and non-interest income, adjusted to eliminate nonrecurring expense and income items.  

          Income Taxes.  The decrease in the provision for income taxes in the second quarter of 2003 and the increase in that provision for the six months ended June 30, 2003 were attributable to the changes in pre-tax income in those periods, as the Company’s effective income tax rate remained unchanged at approximately 36%.  As discussed above, under the caption “Critical Accounting Policies,” that income tax rate reflects the beneficial impact of our ability to make use of certain income tax benefits available under state and federal income tax laws.

          The realization of those income tax benefits is dependent on our generating taxable income in the future in amounts sufficient to utilize those tax benefits prior to their expiration.  We have made a judgment that it is more likely than not that we will generate taxable income in future years sufficient to fully utilize those benefits.  In the event that our taxable income were to decline in future periods, making it less likely that those benefits could be fully utilized, we would be required to establish a valuation reserve to cover the potential loss of those tax benefits, by increasing the provision we make for income taxes, which would have the effect of reducing our net income.  See “Critical Accounting Policies” above.

Financial Condition

          Assets and Deposits.   Our total assets increased during the six months ended June 30, 2003 by $44,566,000 or 7.4% from our total assets at December 31, 2002.  Contributing to that increase was an increase of $22,648,000, or 5.1% in the volume of loans outstanding.  At June 30, 2003, the volume of demand, money market and savings deposits at the Bank was $48,392,000, or 10.8%, higher than at December 31, 2002, while the volume of time deposits, including TCDs, was $4,294,000, or 5.1%, lower than at December 31, 2002.

          Liquidity Management.  We have established liquidity management policies which are designed to achieve a matching of sources and uses of funds in order to enable us to fund our customers’ requirements for loans and for deposit withdrawals. In accordance with those policies, we maintain a number of short-term sources of funds to meet periodic increases in loan demand and in deposit withdrawals and maturities.  At June 30, 2003, the principal sources of liquidity consisted of $34,745,000 of cash and demand balances due from other banks and $29,500,000 in Federal funds sold and overnight repurchase agreements which, together, totaled $64,245,000, as compared to $58,965,000 at December 31, 2002.  Other sources of liquidity include $74,400,000 in securities available-for-sale, of which approximately $210,000 mature within one year; and $8,514,000 in interest bearing deposits at other financial institutions, which mature in 6 months or less.  Additionally, substantially all of our installment loans and leases, the amount of which aggregated $3,685,000 at June 30, 2003, require regular installment payments from customers, providing us with a steady flow of cash funds.

          We also have a line of credit from the Federal Home Loan Bank, the amount of which was $34,818,000 as of June 30, 2003.  Borrowings under that credit line are secured by a pledge of some of our outstanding loans.  No borrowings were outstanding under that line of credit at June 30, 2003. We also have established loan facilities that would enable us to borrow up to $13,000,000 of Federal funds from other banks and we have an account with the Federal Reserve Bank of San Francisco that will also allow us to borrow at its discount window should the need arise.  Finally, if necessary, we could obtain additional cash by means of sales of time certificates of deposit into the “CD” market.  However, as a general rule, it has been and continues to be our policy to make use of borrowings under the credit line or loan facilities to fund short term cash requirements, before selling securities or reducing deposit balances at other banks and before selling time certificates of deposit.  

          We believe that our cash and cash equivalent resources, together with available borrowings under our line of credit and other credit facilities, will be sufficient to enable us to meet increases in demand for loans and leases and increases in deposit withdrawals that might occur in the foreseeable future.

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          Capital Resources and Dividends.  It has been and continues to be the objective of our Board of Directors to retain earnings that are needed to meet capital requirements under applicable government regulations and to support our growth.  At the same time, it is the policy of the Board of Directors to pay cash dividends if earnings exceed the amounts required to meet that objective.  Pursuant to that policy, the Company has paid regular quarterly cash dividends since September of 1999 and, in July 2003, the Board of Directors declared a quarterly cash dividend of $0.12 per share, which will be paid on August 20, 2003 to shareholders of record as of August 6, 2003.  That is the 16^th consecutive quarterly cash dividend declared since the current dividend policy was adopted by the Board of Directors.  However, the Board may change the amount or frequency of cash dividends to the extent that it deems necessary or appropriate to achieve our objective of maintaining capital in amounts sufficient to support our growth.  For example the retention of earnings in previous years enabled us to fund the opening of four new banking offices and extend the Bank’s market areas, all of which have contributed to our increased profitability and the maintenance of our capital adequacy ratios well above regulatory requirements.

          We continue to evaluate and explore opportunities to expand our market into areas such as eastern Los Angeles County, western San Bernardino County, north Orange County and northern Riverside County, all of which are contiguous to our existing markets.  The number of independent banks based in our market areas has declined significantly, due to a consolidation in the banking industry that occurred approximately two to three years ago. We believe that this consolidation has created opportunities for us to increase our market share in those areas.  We have taken advantage of those opportunities by establishing a substantial number of new customer relationships and increasing the volume of our demand, savings and money market deposit balances.  We also believe that there are still additional expansion and growth opportunities that we may take advantage of in the future.

          Stock Repurchase Program.  In January of 2003 the Board of Directors authorized a stock repurchase program that provides for the Company to repurchase up to $5,000,000 of its common stock.  Repurchases may be made from time-to-time in the open market or in privately negotiated transactions when opportunities to do so at favorable prices present themselves, in compliance with Securities and Exchange Commission (SEC) guidelines.   Through July 31, 2003, we had repurchased a total of 148,005 shares of our common stock pursuant to that program for an aggregate price of approximately $2,747,000. 

          Sale of Trust Preferred Securities.  In December of 2002, we completed a private sale of $8,000,000 of trust preferred securities to an institutional investor as part of a pooled securitization transaction by that investor.   The trust preferred securities mature in 30 years, and are redeemable at our option beginning after five years.  We are required to make quarterly interest payments, initially at a rate of 4.66%, which re-sets quarterly at the three-month LIBOR (London Inter Bank Offered Rate) rate plus 3.05%, and is currently at 4.26%.  The trust preferred securities are subordinated to other borrowings that may be obtained by the Company in the future and qualify as Tier 1 capital for regulatory purposes ( see discussion “Regulatory Capital Requirements” below). 

          During the second quarter of the current year, $4 million of the net proceeds from the sale of the trust preferred securities was used to purchase Bank-owned life insurance policies on key management employees of the Bank, with the Bank as the beneficiary under such policies.  The purposes of bank-owned life insurance (commonly known in the banking industry as “BOLI”) are (i) to enable the Bank to offer employee retirement and benefit plans designed to attract and retain key management employees, by providing the Bank with a source of funds (primarily from the cash surrender value of such policies) that the Bank can use to fund the payment of benefits under those plans, and (ii) to protect the Bank against the costs or losses that could occur as a result of the death of any key management employee.  The remainder of the proceeds from the sale of the trust preferred securities will be used to fund the continued growth of the Bank and may also be used to repurchase our common stock under our stock repurchase plan.

          Regulatory Capital Requirements.  Federal banking agencies require banks to maintain a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital (essentially, the sum of a bank’s capital stock and retained earnings, less any intangibles) to risk-adjusted assets of 4%.  In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total average assets, referred to as the leverage ratio.  For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to average assets must be 5%.  In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, federal and state bank regulatory agencies have the discretion to set minimum capital

18

requirements for specific banking institutions at rates significantly above the minimum guidelines and ratios and encourage banks to maintain their ratios above those minimums as a matter of prudent banking practices.

          The risk-based capital ratio is determined by weighting our assets in accordance with certain risk factors and, the higher the risk profile the assets, the greater is the amount of capital that is required in order to maintain an adequate risk-based capital ratio, which generally is at least 8%.  Additionally, the level of supervision to which a bank will be subject by federal bank regulatory authorities will depend largely on extent to which a bank meets or exceeds federally mandated leverage capital ratios.  A bank that maintains a leverage capital ratio of 5% or more will generally be categorized by federal bank regulatory agencies as “well capitalized” and, therefore, as a general matter will be subject to less extensive regulatory supervision than banks with lower leverage capital ratios.  However, a bank with a leverage capital ratio exceeding 5% may be “downgraded” by its primary federal regulatory agency due to other factors.

          The Bank has been categorized as a “well capitalized” institution by its primary federal banking agency and its Tier 1 capital and Tier 1 risk-based capital ratios exceed minimum regulatory requirements and compare favorably with those of the banks and bank holding companies in its Peer Group.

          The following table compares, as of June 30, 2003, the actual capital ratios of the Company and the Bank to the capital ratios that they are required to meet under applicable banking regulations:

	Company Actual			Bank Actual			For Capital Adequacy Purposes			To Be Categorized as Well Capitalized
Total Capital to Risk Based Assets		13.8	%		13.4	%		8.0	%		10.0	%
Tier 1 Capital to Risk Weighted Assets		12.8	%		12.5	%		4.0	%		6.0	%
Tier 1 Capital to Average Assets		10.3	%		10.1	%		4.0	%		5.0	%

Forward Looking Information and Uncertainties Regarding Future Financial Performance

          Statements contained in this Report that are not historical facts or that discuss our expectations or beliefs regarding our future operations or future financial performance, or financial or other trend in our business, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and they often include the words “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “project,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.”  Such forward-looking statements are based on current information and assumptions about future events over which we do not have control and that information is subject to a number of risks and uncertainties that could cause our financial condition or operating results in the future to differ significantly from those expected at the current time.  Certain of those risks and uncertainties are discussed above in the section of the Report entitled “Management’s Discussion and Analysis of Finance Condition and Results of Operation.”  In addition, included among the risks and uncertainties that could affect our future financial performance or financial condition are the following:

                    Increased Competition.  Increased competition from other financial institutions, mutual funds and securities brokerage and investment banking firms that offer competitive loan and investment products could require us to reduce interest rates and loan fees in order to attract new loans or to increase interest rates that we offer on time deposits, either or both of which could, in turn, reduce our interest income or increase our interest expense, thereby reducing our net interest income and margins. 

                    Possible Adverse Changes in Economic Conditions.  Adverse changes in economic conditions, either national or local, could (i) reduce loan demand that could, in turn, reduce interest income and net interest margins; (ii) weaken the financial capability of borrowers to meet their loan obligations, resulting in increases in loan losses that would require increases in reserves for possible loan losses through additional charges against income; and (iii) lead to reductions in real property values that, due to our reliance on real property to secure many of our loans,

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could make it more difficult for us to prevent losses from being incurred on non-performing loans through the sale of such real properties.

                    Possible Adverse Changes in Federal Reserve Board Monetary Policies.  Changes in national economic conditions, such as increases in inflation or declines in economic output often prompt changes in Federal Reserve Board monetary policies that could increase the cost of funds to us or reduce yields on interest earning assets and, thereby, reduce net interest margins and net interest income.  As discussed above, in the past two years, the Federal Reserve Board has lowered market rates of interest in an effort to stimulate the national economy.  Those reductions caused our net interest margin to decline and could continue to do so in the future.

                    Real Estate Mortgage Loans.  Approximately 90% of the Bank’s loans are secured by deeds of trust or mortgages on real property.  Although a significant portion of these loans were made to businesses for commercial purposes and the primary source of payment for these loans is the cash that they generate from their operations, a significant decline in real property values in Southern California could result in a deterioration in some of those loans that would necessitate increases in the loan loss reserve and could result in loan write-offs that would adversely affect our earnings.

                    Changes in Regulatory Policies.  Changes of federal and state bank regulatory policies, such as increases in capital requirements or in loan loss reserves, or changes in required asset/liability ratios, could adversely affect earnings by reducing yields on earning assets or increasing operating costs.

                    Effects of Growth.  It is our intention to take advantage of opportunities to increase our business, either through acquisitions of other banks, the establishment of new banking offices or the offering of new products or services to our customers.  If we do acquire any other banks or open any additional banking offices or begin offering new products or services, we are likely to incur additional operating costs that may adversely affect our operating results, at least on an interim basis.

          Additional information regarding these risks and uncertainties is contained in our Annual Report on Form 10K for the fiscal year ended December 31, 2002, as filed with the Securities and Exchange Commission and readers of this Report are urged to review the Annual Report as well. Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report.  The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          Market risk is the risk of loss to future earnings, to fair values of assets or to future cash flows that may result from changes in the price or value of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates and other market conditions. Market risk is attributed to all market risk sensitive financial instruments, including loan and investment securities, deposits and borrowings. We do not engage in trading or hedging activities or participate in foreign currency transactions for our own account. Accordingly, our exposure to market risk is primarily a function of our asset and liability management activities and of changes in market rates of interest that can cause or require increases in the rates we pay on deposits that may take effect more rapidly or may be greater than the increases in the interest rates we are able to charge on loans and the yields that we can realize on our investments. The extent of that market risk, depends on a number of variables, including the sensitivity to changes in market interest rates and the maturities of our interest earning assets and our deposits. See “Results of Operations -- Rate Sensitivity” in Item 2 of Part I of this Report.

          We use a dynamic simulation model to forecast the anticipated impact of changes in market interest rates on our net interest income.  That model is used to assist management in evaluating, and in determining and adjusting strategies designed to reduce, our exposure to these market risks, which may include, for example, changing the mix of earning assets or interest-bearing deposits.  See Note 7 to our Condensed Consolidated Financial Statements contained in Part I of this Report for further information with respect to that dynamic simulation model that, based on certain assumptions, attempts to quantify the impact that simulated upward and downward interest rate changes would have on our net interest income.

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ITEM 4. CONTROLS AND PROCEDURES

          The Company’s management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) in effect as of June 30, 2003.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2003, the Company’s disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to them by others within these entities.

          There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to June 30, 2003.  As no significant deficiencies or material weaknesses were found, no corrective actions were taken.

PART II— OTHER INFORMATION

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

          Our Annual Meeting of Stockholders was held on May 13, 2003. There were two matters voted on at the Annual Meeting.  The first was the election of two Class II Directors for a term of three years ending at the Annual Meeting of Stockholders to be held in 2006.  The only persons nominated at the Annual Meeting for election as Class II Directors were the nominees of the Board of Directors, who are identified below.  The second was the adoption of the Foothill Independent Bancorp 2003 Stock Incentive Plan.

          Directors Elected at Annual Meeting.  Set forth below is the name of the Class II Directors that were elected at the Annual Meeting and the respective numbers of votes cast for their election and the respective number of votes withheld.  As the election was uncontested, there were no broker non-votes.

CLASS II NOMINEES AND DIRECTORS	VOTES “FOR”	VOTES “WITHHELD”
George Sellers	4,944,693	236,306
Douglas F. Tessitor	4,947,623	233,376

          Directors Continuing in Office. The terms of office of the following incumbent Class I and Class III directors extend to 2005 and 2004, respectively and, therefore, they did not stand for re-election at the 2003 Annual Meeting:

Class I Directors	Class III Directors
George E. Langley	Richard Galich
Max Williams	William V. Landecena
	O.L. Mestad

          Adoption of the Foothill Independent Bancorp 2003 Stock Incentive Plan.  Approval of the 2003 Stock Incentive Plan required the affirmative vote of the holders of a majority of the shares that were voted on this Proposal at the Meeting.  The Proposal was approved by the number of votes as set forth below.  Broker non-votes were counted for quorum purposes but were not counted as present for purposes of determining whether the required affirmative vote was received. 

Shares Voted		Shares Abstaining
For	Against
3,304,892	668,051	74,918

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ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K
	(a)	Exhibits:
		Exhibit No.	Description of Exhibit
		31.1	Certification of Chief Executive Officer under Section 302 of the Sarbanes–Oxley Act of 2002
		31.2
			Certification of Chief Financial Officer under Section 302 of the Sarbanes–Oxley Act of 2002
		32.1
			Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes–Oxley Act of 2002
		32.2
			Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes–Oxley Act of 2002
	(b)	Reports on Form 8-K:
	The Company filed a Current Report on Form 8-K dated July 24, 2003 to furnish, under Item 12 of that Report, a copy of its press release announcing its results of operations for the quarter ended, and its financial condition as of, June 30, 2003.

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SIGNATURES

          Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 11, 2003	FOOTHILL INDEPENDENT BANCORP
	By:	/s/ CAROL ANN GRAF
		Carol Ann Graf, Senior Vice President and Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit No.	Description of Exhibit
31.1	Certification of Chief Executive Officer under Section 302 of the Sarbanes–Oxley Act of 2002
31.2	Certification of Chief Financial Officer under Section 302 of the Sarbanes–Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes–Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes–Oxley Act of 2002

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