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

  •   we may experience higher defaults on our loan portfolio than we expect;
 
  •   changes in management’s estimate of the adequacy of the allowance for loan losses;
 
  •   changes in management’s valuation of our mortgage-backed and related securities portfolio and interest rate contracts;
 
  •   increases in competitive pressure among financial institutions;
 
  •   general economic conditions, either nationally or locally in areas in which we conduct or will conduct our operations, or conditions in financial markets may be less favorable than we currently anticipate;
 
  •   our net income from operations may be lower than we expect;
 
  •   natural disasters;
 
  •   we may lose more business or customers than we expect, or our operating costs may be higher than we expect;
 
  •   the availability of capital to fund our growth and expansion;
 
  •   changes in the interest rate environment and their impact on customer behavior and our interest margins;
 
  •   political and global changes arising from the war on terrorism;
 
  •   the impact of repricing and competitors’ pricing initiatives on loan and deposit products;
 
  •   our ability to adapt successfully to technological changes to meet customers’ needs and developments in the market place;
 
  •   our ability to access cost-effective funding;
 
  •   our ability to successfully complete our strategy to continue to grow our business in California, Kansas and Arizona;
 
  •   our returns from our securities portfolio may be lower than we expect;




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


     Because these forward-looking statements are subject to risks and uncertainties, our actual results may differ materially from those expressed or implied by these statements. (See “Item 1A. Risk Factors”.)You are cautioned not to place undue reliance on our forward-looking statements, which speak only as of the date of this Form 10-K. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. The future results and stockholder values of our common stock may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond our ability to control or predict.

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

Item 1. Business.

General

     We are Harrington West Financial Group, Inc., a Delaware corporation and a diversified, community-based, financial institution holding company headquartered in Solvang, California, with executive offices in Scottsdale, Arizona. We conduct our operations primarily through our wholly-owned subsidiary, Los Padres Bank, FSB, a federally chartered savings bank, located in central California and Scottsdale, Arizona, and its division in the Kansas City metropolitan area, Harrington Bank. Los Padres Bank provides an array of financial products and services for businesses and retail customers through its fifteen full-service offices. At December 31, 2005, we had consolidated total assets of $1.1 billion, total deposits of $669.1 million and stockholders’ equity of $59.6 million.

     We are focused on providing our diversified products and personalized service approach in three distinct markets: (i) the central coast of California, (ii) the Kansas City metropolitan area and (iii) the Phoenix/Scottsdale metropolitan area. Los Padres Bank operates eleven offices on the central coast of California, two offices in the Kansas City metropolitan area under the Harrington Bank brand name, and two banking offices in the Phoenix/Scottsdale, Arizona metropolitan area, since we opened our second office in the Scottsdale Airpark in late March 2005. In 2006, we will open our third Harrington Bank office in Johnson County, Kansas in the Kansas City metro and a Los Padres banking office in Surprise, Arizona in approximately the first quarter 2007. Each of our markets has its own local independent management team operating under the Los Padres or Harrington names. Our loan underwriting, corporate administration and treasury functions are centralized in Solvang, California to create operating efficiencies. Our commercial lending operations are centralized in Mission, Kansas.

     On February 2, 2005, Los Padres Bank entered into an agreement with Western Financial Bank for the purchase and assumption of their office in Thousand Oaks, California. In the purchase agreement, Los Padres Bank purchased $42.9 million in deposits and their associated overdraft protection accounts or lines of credit, all furniture and fixtures and renegotiated the lease for the building. The transaction was completed in May 2005.

     Los Padres Bank is primarily engaged in attracting deposits from individuals and businesses and using these deposits, together with borrowed funds, to originate commercial real estate, commercial business, single-family and multi-family residential and consumer loans. We also generate fee income from the brokering of mortgage loans, deposit services, early prepayments of some loans, and loan originations. We maintain a portfolio of highly liquid mortgage-backed and related securities as a means

of managing our excess liquidity and enhancing our profitability. We utilize various interest rate contracts as a means of managing our interest rate risk. We also operate Harrington Wealth Management Company, which provides trust and investment management services to individuals and small institutional clients on a fee basis, by employing a customized asset allocation approach and investing predominantly in low fee, indexed mutual funds and exchange traded funds.

Lending Activities

      General . At December 31, 2005, Los Padres Bank’s net loan portfolio totaled $672.9 million, representing approximately 59.0% of our $1.1 billion of total assets at that date. Los Padres Bank’s primary focus with respect to its lending operations has historically been the direct origination of single-family residential, multi-family residential, consumer and commercial real estate loans. While we continue to emphasize single-family residential loan products that meet our customer’s needs, we now generally broker such loans on behalf of third party investors in order to generate fee income and have been increasing our emphasis on loans secured by commercial real estate, consumer loans, construction and land acquisition and commercial and industrial loans. We also offer multi-family residential loans.

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

                                                                                 
    December 31,  
    2005     2004     2003     2002     2001  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  
                                    (Dollars in Thousands)                                  
Real estate loans:
                                                                                
Single-family
   $ 115,925       17.0 %   $ 100,485       16.6 %   $ 93,725       17.9 %   $ 116,714       25.8 %   $ 156,150       34.5 %
Multi-family
     80,855       11.9       84,937       14.0       82,090       15.7       71,856       15.9       69,584       15.4  
Commercial
     253,208       37.2       260,759       43.1       234,606       44.8       183,264       40.5       156,431       34.5  
Construction (1)
     70,883       10.4       34,981       5.8       30,835       5.9       19,666       4.4       20,235       4.5  
Land acquisition and development
     36,085       5.3       27,460       4.5       8,312       1.6       14,948       3.3       7,889       1.7  
Commercial and industrial loans
     96,566       14.2       72,240       11.9       56,942       10.8       27,676       6.1       30,838       6.8  
Consumer loans
     26,653       3.9       23,757       3.9       16,613       3.1       17,565       3.9       11,107       2.5  
Other loans (2)
     1,271       0.1       1,044       0.2       1,035       0.2       503       0.1       539       0.1  
 
                                                            
Total loans receivable
     681,446       100.0 %     605,663       100.0 %     524,158       100.0 %     452,192       100.0 %     452,773       100.0 %
 
                                                            
 
                                                                                
Less:
                                                                                
Allowance for loan losses
     (5,661 )             (5,228 )             (4,587 )             (3,797 )             (3,736 )        
Net deferred loan fees
     (2,498 )             (1,730 )             (1,394 )             (1,332 )             (1,102 )        
Net (discounts) premiums
     (397 )             (263 )             319               987               1,774          
 
                                                                      
 
     (8,556 )             (7,221 )             (5,662 )             (4,142 )             (3,064 )        
 
                                                                      
Loans receivable, net
   $ 672,890             $ 598,442             $ 518,496             $ 448,050             $ 449,709          
 
                                                                      


(1)   Includes loans secured by residential and commercial properties. At December 31, 2005, we had $50.6 million of construction loans secured by residential properties,$3.7 million of land and development and $16.6 million of construction loans secured by commercial properties.
 
(2)   Includes loans collateralized by deposit accounts and consumer line of credit loans.


     The following table sets forth certain information at December 31, 2005, regarding the dollar amount of loans maturing in our loan portfolio based on the contractual terms to maturity or scheduled amortization, but does not include potential prepayments. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

                                 
            Due 1-5     Due 5 or more years        
    Due 1 year     years after     after        
    or less     December 31, 2005     December 31, 2005     Total  
    (In Thousands)  
Real estate loans:
                                
Single-family residential
   $ 1,900     $ 8,422     $ 105,603     $ 115,925  
Multi-family residential
     2,845       16,723       61,287       80,855  
Commercial
     14,070       122,024       117,114       253,208  
Construction (1)
     26,530       16,170       28,183       70,883  
Land acquisition and development
     17,511       14,864       3,710       36,085  
Commercial and industrial loans
     47,885       41,853       6,828       96,566  
Consumer loans
     17       775       25,861       26,653  
Other loans (2)
     1,271       —       —       1,271  
 
                        
 
                                
Total
   $ 112,029     $ 220,831     $ 348,586     $ 681,446  
 
                        


(1)   Includes loans secured by residential and commercial properties.
 
(2)   Includes loans collateralized by deposit accounts and consumer line of credit loans.

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

     The following table sets forth the dollar amount of total loans due after one year from December 31, 2005, as shown in the preceding table, which have fixed interest rates or which have floating or adjustable interest rates.

                         
            Floating or        
            adjustable-        
    Fixed rate     rate     Total  
    (In Thousands)  
Real estate loans:
                        
Single-family residential
   $ 57,720     $ 56,306     $ 114,026  
Multi-family residential
     49,858       28,152       78,010  
Commercial
     147,709       91,429       239,138  
Construction (1)
     9,470       34,883       44,353  
Land acquisition and development
     1,003       17,571       18,574  
Commercial and industrial loans
     27,166       21,514       48,680  
Consumer loans(2)
     305       26,331       26,636  
 
                  
 
                        
Total
   $ 293,231     $ 276,186     $ 569,417  
 
                  


(1)   Includes loans secured by residential and commercial properties.
 
(2)   Includes loans collateralized by deposit accounts and consumer lines of credit loans.

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

     Mortgage loan applications are initially processed by loan officers who do not have approval authority. All real estate loans which are either at or below the Federal Home Loan Mortgage Corporation’s (“Freddie Mac”), lending limit and which meet all of the bank’s underwriting guidelines can be approved by designated senior management of Los Padres Bank. All consumer loans up to $250,000 may be approved by designated senior management of Los Padres Bank. All loans in excess of these amounts up to $1.0 million ($500,000 for commercial and industrial loans) require the approval of two members of Los Padres Bank’s Executive Loan Committee, which consists of designated senior management of Los Padres Bank. Loans in excess of $1.0 million ($500,000 for commercial and industrial loans), but not exceeding $5.0 million, require the approval of a majority of Los Padres Bank’s Loan Committee, consisting of designated senior management of Los Padres Bank. All loans in excess of $5.0 million, up to Los Padres Bank’s legal lending limit, must be approved by either Los Padres Bank’s Loan Oversight Committee, comprised of both designated senior management and certain members of the Board of Directors, or the Board of Directors of Los Padres Bank.

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

by readily marketable securities. At December 31, 2005, Los Padres Bank’s regulatory limit on loans-to-one borrower was $12.4 million and its five largest loans or groups of loans-to-one borrower, including related entities, aggregated $12.2 million, $11.8 million, $11.7 million, $11.7 million, and $11.6 million. These five largest loans or loan concentrations were secured by commercial real estate and development of single-family homes. All of these loans or loan concentrations were performing in accordance with their payment terms at December 31, 2005.

     The risks associated with lending are well defined. Credit risk is managed through the adherence, with few exceptions, to specific underwriting guidelines. We rely on our internal credit approval and administrative process to originate loans as well as our internal asset review process, which oversees our loan quality in order to ensure that our underwriting standards are maintained. We believe that the low level of our non-performing assets is evidence of our adherence to our underwriting guidelines.

     As a federally chartered savings bank, Los Padres Bank has general authority to originate and purchase loans secured by real estate located throughout the United States. Despite this nationwide lending authority, we estimate that at December 31, 2005, the majority of the loans in Los Padres Bank’s portfolio are secured by properties located or made to customers residing in each of our primary market areas located in the California central coast, the Kansas City metropolitan area, and the Phoenix/Scottsdale metropolitan area.

      Single-Family Residential Real Estate Loans. Los Padres Bank has historically concentrated its lending activities on the origination of loans secured by first mortgage liens on existing single-family residences. The single-family residential loans originated by Los Padres Bank are generally made on terms, conditions and documentation, which permit the sale of such loans to Freddie Mac, the Federal National Mortgage Association (“Fannie Mae”), and other institutional investors in the secondary market. Since January 2001, as a means of generating additional fee income and in order to reflect management’s decision to emphasize holding higher spread earning loans in its portfolio, Los Padres Bank has been brokering conforming permanent single-family residential loans on behalf of third parties in order to generate fee income. During the years ended December 31, 2005 and 2004, Los Padres Bank brokered $39.0 million and $36.5 million, respectively, of such single-family residential loans on behalf of third parties.

     Los Padres Bank still holds a portfolio of single-family residential loans. Los Padres Bank will retain in its portfolio single-family residential loans that, due to the nature of the collateral, carry higher risk adjusted spreads. Examples of these types of loans include construction loans that have converted into permanent loans and non-conforming single-family loans, whether as a result of a non-owner occupied or rural property, balloon payment or other exception from agency guidelines. At December 31, 2005, Los Padres Bank had $115.9 million of single-family residential loans in its portfolio, which amounted to 17.0% of total loans receivable as of such date. At December 31, 2005, total loans due after one year had $57.7 million or 50.6% of Los Padres Bank’s single-family residential loans with fixed interest rates and $56.3 million or 49.4% with interest rates which adjust in accordance with a designated index. Single-family residential loans have terms of up to 30 years and generally have loan-to-value ratios of 80% or less, or 90% or less to the extent the borrower carries private mortgage insurance for the balance in excess of the 80% loan-to-value ratio.

      Multi-Family Residential and Commercial Real Estate Loans. At December 31, 2005, Los Padres Bank had an aggregate of $80.9 million and $253.2 million invested in multi-family residential and commercial real estate loans, respectively, or 11.9% and 37.2% of total loans receivable, respectively.

     Los Padres Bank’s multi-family residential loans are secured by multi-family properties of five units or more, while Los Padres Bank’s commercial real estate loans are secured by industrial, warehouse

and self-storage properties, office buildings, office and industrial condominiums, retail space and strip shopping centers, mixed-use commercial properties, mobile home parks, nursing homes, hotels and motels. Substantially all of these properties are located in Los Padres Bank’s primary market areas. Los Padres Bank typically originates commercial real estate loans for terms of up to 20 years based upon a 30-year loan amortization period and multi-family residential loans for terms of up to 20 years based upon up to a 30-year amortization schedule. Los Padres Bank will originate these loans on both a fixed-rate or adjustable-rate basis, with the latter adjusting on a periodic basis of up to one year based on the London Interbank Offered Rate (“LIBOR”), the one-year U.S. Treasury index of constant comparable maturities, a designated prime rate, or the 11th District Cost of Funds Index. Adjustable-rate loans may have an established ceiling and floor, and the maximum loan-to-value for these loan products is generally 75%. As part of the criteria for underwriting commercial real estate loans, Los Padres Bank generally requires a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of 1.3:1 or more. It is also Los Padres Bank’s general policy to seek additional protection to mitigate any weaknesses identified in the underwriting process. Additional coverage may be provided through secondary collateral and personal guarantees from the principals of the borrowers.

     Commercial real estate lending entails different and significant risks when compared to single-family residential lending because such loans typically involve large loan balances to single borrowers and because the payment experience on such loans is typically dependent on the successful operation of the project or the borrower’s business. In addition, the balloon payment features of these loans may require the borrower to either sell or refinance the underlying property in order to make the payment. These risks can also be significantly affected by supply and demand conditions in the local market for apartments, offices, warehouses or other commercial space. Los Padres Bank attempts to minimize its risk exposure by requiring that the loan does not exceed established loan-to-value and debt coverage ratios, and by monitoring the operation and physical condition of the collateral.

      Construction Loans. Los Padres Bank originates loans to finance the construction of single-family and multi-family residences and commercial properties located in its primary market area. At December 31, 2005, Los Padres Bank’s construction loans amounted to $70.9 million or 10.4% of total loans receivable, $50.6 million of which were for the construction of residential properties, $3.7 million of which were for land acquisition and the development of residential properties, and $16.6 million of which were for the construction of commercial properties.

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

     Construction lending and acquisition and development lending are generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate. Risk of loss on construction loans and acquisition and development loans is dependent largely upon the accuracy of the initial appraisal of the property’s projected value at completion of construction as well as the estimated cost, including interest, of construction. During the construction phase, a number of factors

could result in delays and cost overruns. If either estimate proves to be inaccurate or the borrower is unable to provide additional funds, the lender may be required to advance funds beyond the amount originally committed to permit completion of the project and/or be confronted at the maturity of the construction loan with a project whose value is insufficient to assure full payment. Los Padres Bank attempts to minimize the foregoing risks primarily by limiting its construction lending to experienced developers and by limiting the total amount of loans to builders for speculative construction projects. It is also Los Padres Bank’s general policy to obtain regular financial statements and tax returns from builders so that it can monitor their financial strength and ability to repay.

      Land acquisition and development. Los Padres Bank has increased its loans for land acquisition and development from $27.5 million at December 31, 2004 to $36.1 million at December 31, 2005. The increase is caused by the expansion of our products to meet our customer needs. Land acquisition and development loans are typically issued with short terms, bearing adjustable-rates of interest based on a designated prime rate or LIBOR and are generally made with loan-to-value ratios of 70% or less.

      Commercial and Industrial Loans . Los Padres Bank is placing increased emphasis on the origination of commercial business loans because of the higher risk-adjusted spreads generally associated with these types of loans. During the year ended December 31, 2005, Los Padres Bank originated $149.7 million in loan commitments of commercial and industrial loans, as compared to $108.5 million and $78.3 million as of December 31, 2004 and 2003, respectively. At December 31, 2005, Los Padres Bank’s commercial and industrial loans amounted to $96.6 million or 14.2% of total loans receivable.

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

      Consumer and Other Loans . Los Padres Bank is authorized to make loans for a wide variety of personal or consumer purposes. Los Padres Bank has been originating consumer loans in recent years in order to provide a wider range of financial services to its customers and because such loans generally carry higher interest rates than mortgage loans. The consumer and other loans offered by Los Padres Bank include home equity lines of credit, home improvement loans, vehicle loans, secured and unsecured personal lines of credit and deposit account secured loans. At December 31, 2005, $27.9 million or 4.1% of Los Padres Bank’s total loans receivable consisted of consumer loans.

     Home equity lines of credit are originated by Los Padres Bank for up to 90% of the appraised value, less the amount of any existing prior liens on the property. Los Padres Bank also offers home improvement loans in amounts up to 80% of the appraised value, less the amount of any existing prior liens on the property. Home improvement loans have a maximum term of 15 years and carry fixed or adjustable interest rates. Home equity lines of credit have a maximum repayment term of 15 years and carry interest rates that adjust monthly in accordance with a designated prime rate. Los Padres Bank will secure each of these types of loans with a mortgage on the property, generally a second mortgage, and may originate the loan even if another institution holds the first mortgage. At December 31, 2005, home equity lines of credit and home improvement loans totaled $26.3 million or 94.3% of Los Padres Bank’s

total consumer loan portfolio and an aggregate of $44.4 million were committed and un-drawn under these loans and lines of credit.

     Los Padres Bank currently offers loans secured by deposit accounts, which amounted to $370,000 or 1.3% of Los Padres Bank’s total consumer and other loan portfolio at December 31, 2005. Such loans are originated for up to 90% of the deposit account balance, with a hold placed on the account restricting the withdrawal of the account balance.

     At December 31, 2005, vehicle loans, secured and unsecured personal line of credit loans amounted to $530,000 or 1.9% of Los Padres Bank’s total consumer and other loan portfolio.

     Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. Los Padres Bank believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and Los Padres Bank intends to continue to offer consumer loans in order to provide a full range of services to its customers.

Asset Quality

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

      Loan Delinquencies . When a borrower fails to make a required payment on a loan, Los Padres Bank attempts to cure the deficiency by contacting the borrower and seeking payment. Contacts are generally made following the sixteenth day after a payment is due, at which time a late payment is assessed. In most cases, deficiencies are cured promptly. If a delinquency extends beyond 16 days, the loan and payment history is reviewed and efforts are made to collect the payment. While Los Padres Bank generally prefers to work with borrowers to resolve such problems, when the account becomes 45 days delinquent, Los Padres Bank will institute foreclosure by issuing a Notice of Intent to Foreclose or other proceedings, as necessary, to minimize any potential loss. After 75 days and the loan is not brought current or no workout agreement has been initiated, a Notice of Default is recorded.

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

     Non-performing loans are defined as non-accrual loans 90 days past due. Non-performing assets are defined as non-performing loans and real estate acquired by foreclosure or deed-in-lieu thereof. Troubled debt restructurings are defined as loans which Los Padres Bank has agreed to modify by accepting below market terms either by granting interest rate concessions or by deferring principal and/or interest payments. The following table sets forth the amounts and categories of our non-performing assets and troubled debt restructurings at the dates indicated.

                                         
    At December 31,  
    2005     2004     2003     2002     2001  
            (Dollars in Thousands)          
Non-accruing loans:
                                        
Single-family residential
   $ —     $ —     $ —     $ 218     $ 56  
 
                                        
Multi-family residential
     —       —       —       —       —  
Commercial real estate
     —       —       —       —       348  
Land acquisition and development
     —       —       —       —       —  
Commercial and industrial
     —       95       8       —       93  
Consumer and other
     —       —       4       —       —  
 
                              
Total non-accruing loans
     —       95       12       218       497  
 
                              
 
                                        
Total non-performing loans
     —       95       12       218       497  
 
                              
 
                                        
Troubled debt restructurings
     —       —       —       —       —  
 
                                        
Real estate owned, net of reserves
     —       —       —       —       —  
 
                              
 
                                        
Total non-performing assets and troubled debt restructurings
   $ —     $ 95     $ 12     $ 218     $ 497  
 
                              
 
                                        
Total non-performing loans and troubled debt restructurings as a percentage of total loans
     0.00 %     0.02 %     0.00 %     0.05 %     0.11 %
 
                              
 
                                        
Total non-performing assets and troubled debt restructurings as a percentage of total assets
     0.00 %     0.01 %     0.00 %     0.03 %     0.07 %
 
                              


     At December 31, 2005, we had no non-performing loans representing a decrease of $95,000 from December 31, 2004. At December 31, 2005, 2004 and 2003, we had zero, one and two non-performing loans, respectively. At December 31, 2005, we had no real estate owned or troubled debt restructurings.

     The interest income that would have been recorded during the years ended December 31, 2005, 2004 and 2003 if Los Padres Bank’s non-accruing loans at the end of such periods had been current in accordance with their terms during such periods is $0, $52,269 and $46,437, respectively. The interest income that was recorded during the years ended December 31, 2005, 2004 and 2003 with respect to Los Padres Bank’s non-accruing loans was $0, $3,000 and $3,000, respectively.

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

little value that continuance as an asset of the institution is not warranted. Los Padres Bank has established another category, designated “special mention,” for assets that do not currently expose Los Padres Bank to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. Assets classified as substandard or doubtful require Los Padres Bank to establish allowances for loan losses based on the methodology described below. If an asset or portion thereof is classified as loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. At December 31, 2005, Los Padres Bank had $6.9 million of classified loans, $6.3 million of which was classified as substandard and $717 thousand were classified as doubtful or loss. As of December 31, 2005, Los Padres Bank had $8.2 million of loans that were designated special mention. Our classified and special mention loans, in addition to the non-performing loans discussed above, are the extent of the loans in our portfolio that give us some repayment concern at this time.

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

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

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

     The formula allowance is calculated by applying adjusted loss rates to these pools. Pool loss rates are established by examining historical charge-off data for groups of loans and adjusting them for a variety of qualitative factors deemed appropriate by management. The analysis of historical loss data in determining the initial loss rates is based on an average ten-year period. Where Los Padres Bank has no or nominal actual charge-off data for certain loan types, industry data and management’s judgment is utilized as representative starting loss rates.

      Formula allowance for large groups of smaller balance homogenous loans . The allocated loan loss allowance for large groups of smaller balance homogenous loans is focused on loss experience for the pool rather than on an analysis of individual loans. Large groups of smaller balance homogenous loans consist of consumer loans and single-family residential loans. The allowance for groups of performing loans is based on historical losses over a ten year period.

      Unallocated Allowance . The unallocated allowance contains amounts that are based on management’s evaluation of conditions that are not directly measured in the determination of the formula

and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following, which existed at the balance sheet date:

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


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

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

     Although our management believes it uses the best information available to establish the level of the allowance, there can be no assurance that additions to such allowance will not be necessary in future periods. Furthermore, various regulatory agencies, as an integral part of their examination process, periodically review our valuation allowance. These agencies may require us to increase the allowance, based on their judgments of the information available to them at the time of the examination.

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

                         
    At December 31,  
    2005     2004     2003  
            (In Thousands)          
Specific reserve
   $ —     $ —     $ 50  
Formula-non homogenous
     5,053       4,477       3,974  
Formula-homogenous
     605       570       474  
Unallocated
     3       181       89  
 
                  
 
   $ 5,661     $ 5,228     $ 4,587  
 
                  


     At December 31, 2005, the formula allowance for non-homogeneous loan allowance increased by $576,000 from December 31, 2004, primarily due to an increase in total non-homogeneous loans and, to a lesser extent, a decrease in criticized loans related to non-homogeneous loans.

     The formula allowance for homogeneous loans increased by $35,000 for the year ended 2005 and increased by $96,000 for the year ended December 31, 2004, as a result of increasing single-family construction loan balances. Los Padres Bank shifted its strategic focus away from originating single-family loans for its portfolio and has opted to originate such loans on a brokered basis due to high competition and the resulting low risk-adjusted spreads.

     Specific reserves are established for impaired loans in accordance with SFAS No. 114. At December 31, 2005, we had $441,000 in specific reserves. In 2004, we reclassified the $50,000 in specific reserves to the general valuation allowance since the loan was no longer impaired as per SFAS No. 114. In 2003, the balance in specific reserves remained constant at $50,000 and related to one single-family loan.

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

                                         
    At and For the Year Ended  
    December 31,  
    2005     2004     2003     2002     2001  
    (Dollars in Thousands)  
Balance at beginning of period
   $ 5,228     $ 4,587     $ 3,797     $ 3,736     $ 3,150  
 
                                        
Charge-offs:
                                        
Real estate loans
                                        
Single-family residential
     —       —       —       —       —  
Multi-family residential
     —       —       —       —       —  
Commercial
     —       —       —       (330 )     —  
Consumer and other loans
     (2 )     (9 )     —       —       (15 )
 
                              
 
                                        
Total charge-offs
     (2 )     (9 )     —       (330 )     (15 )
 
                              
 
                                        
Recoveries
     —       —       —       —       —  
 
                              
 
                                        
Net charge-offs
     (2 )     (9 )     —       (330 )     (15 )
 
                              
 
                                        
Allowance for loan losses acquired in connection with branch purchase (1)
     —       —       —       —       600  
 
                              
Provision (credit) for losses on loans
     435       650       790       391       1  
 
                              
 
                                        
Balance at end of period
   $ 5,661     $ 5,228     $ 4,587     $ 3,797     $ 3,736  
 
                              
Allowance for loan losses as a percent of total net loans outstanding at the end of the period
     0.84 %     0.87 %     0.88 %     0.83 %     0.83 %
 
                              
Ratio of net charge-offs to average loans outstanding during the period
     — %     — %     — %     0.07 %     — %
 
                              


(1)   In November 2001, we acquired from Harrington Bank, FSB the Shawnee Mission, Kansas branch, along with related loans and deposits.


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

                                                                                 
    December 31,  
    2005     2004     2003     2002     2001  
            Percent of             Percent of             Percent of             Percent of             Percent of  
            Loans in             Loans in             Loans in             Loans in             Loans in  
            Each             Each             Each             Each             Each  
            Category to             Category to             Category to             Category to             Category to  
    Amount     Total Loans     Amount     Total Loans     Amount     Total Loans     Amount     Total Loans     Amount     Total Loans  
                                    (Dollars in Thousands)                                  
Real estate loans:
                                                                                
Single-family residential
   $ 265       17.0 %   $ 265       16.6 %   $ 308       17.9 %   $ 390       25.8 %   $ 509       34.5 %
Multi-family residential
     422       11.9       554       14.0       416       15.7       344       15.9       437       15.4  
Commercial
     1,115       37.2       1,072       43.1       1,400       44.8       773       40.5       693       34.4  
Construction
     300       10.4       564       5.8       419       5.9       546       4.4       612       4.6  
Land acquisition and development
     272       5.3       211       4.5       123       1.6       215       3.3       79       1.7  
Commercial and industrial loans
     2,944       14.2       2,076       11.9       1,616       10.8       1,253       6.1       1,172       6.8  
Consumer and other loans
     340       3.9       305       4.1       216       3.1       149       3.9       63       2.6  
Unallocated reserve
     3       .1       181       —       89       .2       127       .1       171       —  
 
                                                         &n