OREGON PACIFIC BANCORP - Annual Report: 2002 (Form 10-K)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission file number: 000-50165

OREGON PACIFIC BANCORP

P.O. Box 22000
Florence, OR 97439
(Address of principal executive offices)

Registrant’s telephone number: (541) 997-7121

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:
Common stock, no par value

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
           Yes [X]     No [   ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [   ]     No [X]

     The aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of February 28, 2003, was $14,393,874.

     The number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicable date: 2,140,353 shares of no par value common stock on March 15, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant’s proxy statement dated March 21, 2003, for the 2003 Annual Meeting of Shareholders (“Proxy Statement”) and the 2002 Annual Report to Shareholders are incorporated by reference in Parts II and III hereof.

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OREGON PACIFIC BANCORP
FORM 10-K
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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

     This report contains a number of forward looking statements about our anticipated business, operations, financial performance and cash flows. Statements in this report that relate to future plans, events and circumstances are provided to describe management’s intentions and expectations based on currently available information, and readers should not construe these statements as assurances or guarantees. As with any predictions, these statements are inherently difficult to make with any degree of assurance, and actual results may differ materially and adversely from management’s expectations described herein. Likewise, management’s plans described in this report may not come to pass because unforeseen events may force management to deviate from its expressed intentions. Forward-looking statements often can be identified by the use of predictive or prospective terms such as “expect,” “anticipate,” “believe,” “plan,” “intend,” and words of similar construction or meaning. Some of the events or circumstances that may cause our actual results to deviate from management’s expectations include the impact of competition and local and regional economic factors upon our customer base, our deposits and our loan portfolio; economic and regulatory limits on our ability to grow our assets and manage our business; customer acceptance of our products; interest rate fluctuations that may adversely impact our revenues and expenses; and the impact of impairment charges upon our intangible and other assets. Other factors that may adversely impact our performance are discussed in this report as well as other disclosures we make from time to time in our filings with the Securities and Exchange Commission or other federal agencies. Readers also should note that forward-looking statements expressed in this report are made as of the date of this report, and management cannot undertake to update those statements to reflect future events or circumstances.

ITEM 1. BUSINESS

GENERAL

     Oregon Pacific Bancorp (the “Company), an Oregon Corporation and financial bank holding company, became the holding company of Oregon Pacific Banking Co. (the “Bank”) effective January 1, 2003. The Company is headquartered in Florence, Oregon.

     The Bank is an Oregon banking corporation organized under the Oregon Bank Act on December 17, 1979. The Bank is a full-service commercial bank that provides a broad range of depository and lending services to commercial enterprises, governmental entities and individuals. The Bank expanded in 2002 from its main office and a full-service Safeway store branch, both located in Florence to three additional locations including Roseburg, Coos Bay and Sutherlin. Additional financial services provided by the Bank include trust and asset management services and investment and brokerage services. Such services are provided at the main office in Florence and at offices in Roseburg and Coos Bay, Oregon.

     The Company operates through a two-tiered corporate structure. At the holding company level the affairs of the Company are overseen by a Board of Directors elected by the shareholders of the Company at the annual meeting of shareholders. The business of the bank is overseen by a Board of Directors of the Company, the sole owner of the Bank. Currently the respective members of the Board of Directors of the Bank and the Company are identical.

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BUSINESS STRATEGY

     The Company’s strategy is to build on the Bank’s position as a leading community-based provider of financial services in its service areas. The key to success of this strategy is to continue to provide exceptional personal service to the communities and to deliver a high level of service to the customers with prompt, accurate, and friendly banking services. The Bank seeks to maintain high asset quality through strict adherence to established credit policies, trained personnel, and periodic loan reviews. The Bank’s primary marketing focus is on small to medium-sized businesses and on professionals and individuals in Florence, Coos Bay, Roseburg, Sutherlin, Eugene-Springfield, and other coastal and inland regions in Oregon.

CONSUMER PRODUCTS AND SERVICES

     The Bank offers a broad range of deposit and loan products and services tailored to meet the banking requirements of its service areas. Some of these are detailed below.

     Deposit Products. The Bank’s consumer deposit products include several noninterest-bearing checking account products priced at various levels, interest-bearing checking and savings accounts, money market accounts, and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase certain types or maturities of deposit liabilities. The Bank strives to establish customer relations to attract core deposits in noninterest-bearing transactional accounts, which reduces its cost of funds.

     Technology-Based Products and Services. The Bank uses both traditional and new technology to support its focus on personal service. These include a VISA check card (debit card) program, convenient ATM’s, and a telephone banking service (“Banking on Call”) that allows 24-hour telephone access to customers’ accounts. The Bank maintains an internet site that describes services provided by the Bank and permits loan applications.

     Consumer Loans. Although the Bank does not actively solicit consumer loans, the Bank provides loans to individual borrowers, as a convenience to existing customers, for a variety of purposes including secured and unsecured personal loans, home equity and personal lines of credit, and motor vehicle loans.

     Senior Customer Services. Since a significant portion of the Bank’s consumer market in Florence consists of senior citizens, the Bank offers several special products and programs aimed at this group. These include a reduced rate checking account and other products targeted to the senior market. The Bank also services customers living at Spruce Point, an assisted living facility, via its mobile branch.

     Investment Products. Through an arrangement with a registered securities broker-dealer, an investment and brokerage service department under the assumed name “Oregon Pacific Financial Services” offers a wide range of financial products and services to consumers at the Bank’s main branch and at its office in Roseburg, Oregon. The Bank joined with a new securities broker-dealer, UVEST Investment Services, beginning February 8, 2002. Mutual

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funds, traditional and Roth IRAs, SEPs, tax sheltered annuities, and other financial products and retirement planning services are available.

     Trust and Asset Management Services. The Bank operates a full service trust department located at its main branch and in Coos Bay. The department functions as a trustee for irrevocable trusts, agent for living trusts and estate settlement, or custodian for self-directed IRAs.

     Other Services. Other services offered include safe deposit boxes; letters of credit; travelers’ checks; direct deposit of payroll, social security and dividend payments; and automatic payment of insurance premiums and mortgage loans.

LENDING ACTIVITIES

     The Bank provides a broad range of real estate and commercial lending services. Currently, the primary focus of the Bank’s lending activities involves residential real estate financing, both for its own loan portfolio and for resale in the secondary market, and commercial loans, including loans to professionals and real estate construction loans. The Bank’s customers are primarily small to medium-sized businesses and contractors with annual revenues typically ranging from $100,000 to $1,000,000.

     Mortgage Loans. The Bank originates conventional and federally insured residential mortgage loans, mostly for sale in the secondary market. The Bank has mortgage loan representation in Florence, Roseburg, Coos Bay, and along the Oregon coast, north of Florence. The Bank believes that its local decision-making, which allows for quick response to a mortgage loan request, and sales of loans to the Federal Home Loan Mortgage Bank (Freddie Mac) that are serviced locally, provide personalized, quality service to its customers.

     Real Estate Construction Loans. The Bank makes construction loans to individuals and contractors to construct single-family primary residences or second homes and, to a much lesser extent, small multi-family residential projects. These loans generally have maturities of 6 to 9 months. Interest rates are typically adjustable, although fixed-rate loans are also made under appropriate conditions.

     Construction financing generally is considered to involve a higher degree of risk than long-term financing on improved, occupied real estate. The risk of loss on construction loans depends largely on the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project and to protect its security position. At or prior to maturity of the loan, the Bank may also be confronted with a project with insufficient value to ensure full repayment. The Bank’s underwriting, monitoring and disbursement practices for construction financing are intended to ensure that sufficient funds are available to complete the construction projects. The Bank endeavors to limit its risk through underwriting procedures requiring the use of only approved, qualified appraisers, dealing only with qualified builders/borrowers, and closely monitoring construction projects through completion and sale.

     Commercial Loans. The Bank offers customized loans to its commercial customers including operational lines of credit, equipment, accounts receivable, and inventory financing.

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Commercial real estate loans are available for the construction, purchasing, and refinancing of commercial and rental properties. A significant portion of the Bank’s loan portfolio consists of commercial loans. Lending decisions are based on careful evaluation of the financial strength, management, and credit history of the borrower and the quality of the collateral securing the loan. The Bank typically requires personal guarantees and secondary sources of repayment. Most commercial loans are secured by real property, although such loans may finance other commercial activities. Where warranted by the borrower’s overall financial condition, loans may be made on an unsecured basis.

     For all of its loans, the Bank at all times seeks to maintain sound loan underwriting standards with written loan policies, appropriate individual limits, and loan committee reviews. In the case of large loan commitments or loan participations, loans are reviewed by the loan committee of the Board of Directors. Underwriting standards are designed to achieve a high-quality loan portfolio, compliance with lending regulations, and the desired mix of loan maturities and industry concentrations. Management seeks to minimize credit losses by closely monitoring the financial condition of its borrowers and the value of collateral.

MARKETING

     The Bank’s ability to increase its market share is driven by a marketing plan consisting of several key components. A principal objective is to offer appropriate products and services to existing customers and attempt to increase the business relationships the Bank shares with these customers. The Bank regularly examines the desirability and profitability of adding new products and services to those currently offered. The Bank promotes specific products by media advertising, but relies also on referrals and direct contacts for new business. The Bank recognizes the importance of community service and supports employee involvement in community activities. This participation allows the Bank to make a contribution to the communities it serves, which management believes increases its visibility in its market area and thereby increases business opportunities.

COMPETITION

     The market for banking services, including deposit and loan products, is highly competitive. The Bank’s competitors for deposits are commercial banks, savings and loan associations, credit unions, money market funds, issuers of corporate and government securities, insurance companies, brokerage firms, mutual funds, and other financial service providers. These competitors may offer deposit rates greater than the Bank can or is willing to offer. The Bank competes for deposits by offering a variety of accounts at rates generally competitive with financial institutions in its market areas.

     The Bank’s competition for loans comes principally from commercial banks, savings and loan associations, mortgage companies, finance companies, insurance companies, credit unions, and other institutional lenders. The Bank competes for loan originations through the level of interest rates and loan fees charged, its array of commercial and mortgage loan products, and the efficiency and quality of its services to borrowers. Lending activity can also be affected by the availability of lendable funds, local and national economic conditions, current interest rate levels, and loan demand. The Bank competes with larger commercial banks by emphasizing a community bank orientation and efficient personal service to customers.

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     A newer source of competition is the array of on-line banking services offered by traditional commercial banks and other financial service providers, and by newly formed companies that use the Internet to advertise and sell competing products. However, Bank management believes that for the foreseeable future its customers will continue to want the personal, locally-based services that it offers. The Bank currently has a website and may consider offering some on-line banking services to its customers in the future.

     The Bank believes its philosophy of offering financial services with a personal touch in conjunction with modern technology enables it to compete effectively with other financial service providers. The Bank’s lending officers and senior management have significant experience in their respective marketplaces enabling them to maintain close working relationships with their customers. Management believes that this positions the Bank to succeed in spite of competitors potentially having branches in more locations, larger lending capabilities due to their greater size, or capabilities to provide other services, such as international banking services, that the Bank does not provide.

EMPLOYEES

     As of December 31, 2002, the Bank had 88 full-time equivalent employees compared to 66 at December 31, 2001. This growth is indicative of the three branches opened in 2002. None of our employees are represented by a collective bargaining group. Management considers our relations with employees to be excellent.

WEBSITE ACCESS TO PUBLIC FILINGS

     The Company began filing period and other required reports with the Securities and Exchange Commission in 2003. These filings, including exhibits, may be accessed over the Internet through the website maintained by the Securities and Exchange Commission at http://www.sec.gov. No Internet access to the Bank’s filings with the Federal Reserve Bank prior to 2003 is available.

SUPERVISION AND REGULATION

GENERAL

     The Company and the Bank are extensively regulated under federal and state law. These laws and regulations are primarily intended to protect depositors, not shareholders of the Company. The discussion below describes and summarizes certain statutes and regulations. These descriptions and summaries are qualified in their entirety by reference to the particular statute or regulation. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Bank. The operations of the Bank may also be affected by changes in the policies of banking and other government regulators. Management cannot accurately predict the nature or extent of the effects on its business and earnings that fiscal or monetary policies, or new federal or state laws, including tax laws, may have in the future.

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FEDERAL AND STATE BANK REGULATION

     General. The Bank is an Oregon state-chartered bank, with deposits insured by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is a Federal Reserve member bank. Accordingly, the Bank files financial and other reports periodically with, and is regularly examined by, the Oregon Director of Banks (“Oregon Director”), FDIC, and the Federal Reserve.

     CRA. The Community Reinvestment Act (the “CRA”) requires that, in connection with examinations of financial institutions within their jurisdiction, the Federal Reserve or the FDIC evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. The Bank received an outstanding rating on the most recent CRA examination.

     Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal Company shareholders, or any related interests of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, and follow credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with persons not covered above and who are not employees; and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the affected bank or any officer, director, employee, agent, or other person participating in the conduct of the affairs of that bank, the imposition of a cease and desist order, and other regulatory sanctions.

     FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act (the “FDICIA”), each federal banking agency has prescribed, by regulation, non-capital safety and soundness standards for institutions under its authority. These standards cover internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution which fails to meet these standards must develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. Management believes that the Bank meets all such standards, and therefore, does not believe that these regulatory standards materially affect the Bank’s business operations.

INTERSTATE BANKING LEGISLATION

     Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”), bank holding companies are permitted to acquire banks located in any state regardless of the state law in effect at the time. The Interstate Act also provides for the nationwide interstate branching of banks. Under the Interstate Act, both national and state chartered banks, including Oregon, are permitted to merge across state lines and thereby create interstate branch networks.

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BANK HOLDING COMPANY REGULATION - FEDERAL REGULATIONS

     As a bank holding company, the Company is subject to the Bank Holding Company Act of 1956 (“BHCA”), as amended, which places the Company under the supervision of the Board of Governors of the Federal Reserve System (“FRB”). BHCA limits the business of bank holding companies to owning or controlling banks and engaging in other activities related to banking.

     The Company must obtain the approval of the FRB: (1) before acquiring direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of such a bank; (2) before merging or consolidating with another bank holding company; and (3) before acquiring substantially all of the assets of any additional banks. The Company is also required by the BHCA to file annual and quarterly reports and such other reports as may be required from time to time by the FRB. In addition, the FRB conducts periodic examinations of the Company.

     Under FRB policy, a bank holding company is expected to act as a source of financial and managerial strength to, and commit resources to support, each of its subsidiaries. Any capital loans the Company makes to its subsidiary are subordinate to deposits and to certain other indebtedness of the subsidiary. The Crime Control Act of 1990 provides that, in the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment the bank holding company has made to a federal bank regulatory agency to maintain the capital of a subsidiary and this obligation will be entitled to a priority of payment.

     The Company and the subsidiary are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Company nor its subsidiary may condition an extension of credit to a customer on either (1) a requirement that the customer obtain additional services provided by it or (2) an agreement by the customer to refrain from obtaining other services from a competitor. The bank anti-tying rules do not apply to the non-bank subsidiaries of a bank holding company.

     The Change in Bank Control Act of 1978, as amended, prohibits a person or group of persons from acquiring “control” of a bank holding company unless the FRB has been given 60 days prior written notice of the proposed acquisition, and within that time period, the FRB has not issued a notice disapproving the proposed acquisition, or extended for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to the expiration of the disapproval period if the FRB issues written notice of its intent not to disapprove the action. Under a rebuttal resumption established by the FRB, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act would, under the circumstances set forth in the presumption, constitute the acquisition of control. In addition, any “company” would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% if the “company” is a bank holding company) or more of the outstanding shares of the Company, or obtain control over the Company.

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BANK HOLDING COMPANY REGULATION - STATE REGULATIONS

     As a corporation chartered under the laws of the State of Oregon, the Company is subject to certain limitations and restrictions under applicable Oregon corporate law. These include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records, and minutes, and observance of certain corporate formalities.

DEPOSIT INSURANCE

     The deposits of the Bank are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund (“BIF”) administered by the FDIC. The Bank is required to pay quarterly deposit insurance premium assessments to the FDIC.

     The FDICIA includes provisions to reform the Federal Deposit Insurance System, including the implementation of risk-based deposit insurance premiums. The FDICIA also permits the FDIC to make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources, or for any other purpose the FDIC deems necessary. The FDIC has implemented a risk-based insurance premium system under which banks are assessed insurance premiums based on how much risk they present to the BIF. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. The Bank’s FDIC insurance expense for 2002 was approximately $13,000.

REGULATORY DIVIDEND RESTRICTIONS

     The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends which would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. Also, under the Oregon Bank Act, the Oregon Director may suspend the payment of dividends if it is determined that the payment would cause a bank’s remaining stockholders’ equity to be inadequate for the safe and sound operation of the bank. Other than the laws and regulations noted above, which apply to all banks and bank holding companies, the Company is not currently subject to any regulatory restrictions on its dividends.

CAPITAL ADEQUACY

     Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. If capital falls below minimum guideline levels, the holding company or bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities.

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     The FDIC and Federal Reserve use risk-based capital guidelines for banks and bank holding companies. These are designed to make such capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the Federal Reserve has noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimum. The current guidelines require all bank holding companies and federally regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier I capital.

     Tier I capital for state member banks includes common shareholders’ equity, qualifying noncumulative perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less certain intangible assets. Tier II capital includes: (i) the allowance for loan losses of up to 1.25% of risk-weighted assets; (ii) any qualifying perpetual preferred stock which exceeds the amount which may be included in Tier I capital; (iii) hybrid capital instruments and equity-contract notes; (iv) subordinated debt and intermediate-term preferred stock of up to 50% of Tier I capital; (v) and unrealized holding gains on equity securities. Total capital is the sum of Tier I and Tier II capital, less reciprocal holdings of other banking organizations’ capital securities, and investments in unconsolidated subsidiaries.

     The assets of banks and bank holding companies receive risk-weights of 0%, 20%, 50%, and 100%. In addition, certain off-balance sheet items are given credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in total risk-weighted assets.

     Most loans are assigned to the 100% risk category, except for first mortgage loans fully secured by residential property, which carry a 50% rating. Most investment securities are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of, or obligations guaranteed by, the United States Treasury or agencies of the federal government, which have 0% risk-weight. In converting off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing financial obligations, are given a 100% conversion factor. Transaction-related contingencies such as bid bonds, other standby letters of credit and undrawn commitments, including commercial credit lines with an initial maturity of more than one year, have a 50% conversion factor. Short-term, self-liquidating trade contingencies are converted at 20%, and short-term commitments have a 0% factor.

     The Federal Reserve also employs a leverage ratio, which is Tier I capital as a percentage of total assets less intangibles, to be used as a supplement to risk-based guidelines. The principal objective of the leverage ratio is to constrain the maximum degree to which a state member bank may leverage its equity capital base. The Federal Reserve requires a minimum leverage ratio of 4% for banks not having a composite rating of one under the uniform rating system of banks. However, for all but the most highly rated state member banks, and for banks seeking to expand, the Federal Reserve expects an additional cushion of at least 1% to 2%.

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     The FDICIA created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under regulations adopted by the FDIC, an institution is assigned to one of five capital categories, depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. Institutions which are deemed to be “undercapitalized” depending on the category to which they are assigned are subject to certain mandatory supervisory corrective actions.

EFFECTS OF GOVERNMENT MONETARY POLICY

     The earnings and growth of the Bank are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve can and does implement national monetary policy for such purposes as curbing inflation and combating recession, but its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.

CHANGES IN REGULATIONS

     On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the “Act”) implementing legislative reforms intended to address corporate and accounting fraud. The Act, which applies to the Company with securities registered under the Securities Exchange Act of 1934. Among other things, the Act and the accompanying regulation include the following:

     Certification and Accountability. The Act requires the chief executive officer and chief financial officer to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement.

     Enhanced Financial Disclosures and Reporting Requirements. The legislation accelerates the time frame for disclosures by public companies and insiders, and the Company must more promptly disclose any material changes in its financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in the Company’s securities within two business days of the change.

     Audit Committee Requirements. The Act expands the responsibilities of the Company’s audit committee including oversight of the Company’s auditor. The Act also requires the independence of all members and at least one member to be a “financial expert”. The “financial expert” does not have to be disclosed in this report; however, the Company will be required to make such a disclosure in its next annual report for fiscal year ending 2003.

     Code of Ethics. The Act also requires issuers to disclose whether they have adopted a code of ethics for their senior financial officers, and if not, the reason therefore, as well as any changes to, or waiver of any provision of, the code of ethics. The Company is not required to disclose whether it has such a code of ethics in place in this report; however, the Company will be required to make such a disclosure in its next annual report for the fiscal year ending 2003.

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ITEM 2. PROPERTIES

The Bank also owns land on which it is building permanent offices in Roseburg and Coos Bay, both of which are expected to be finished and occupied in late fall 2003. Land next to the Coos Bay property on which the customer parking lot will be located is leased. Leases include multiple renewal options for Florence’s Safeway branch and Real Estate Mortgage office and the Sutherlin branch. Leases for Roseburg and Coos Bay, where permanent facilities are to be built, are subject to short-term lease agreements. The lease for the Coos Bay land has a mandatory purchase option at the end of five or ten years at the seller’s discretion for $330,000 or $360,000, respectively.

ITEM 3. LEGAL PROCEEDINGS

     Management is not presently aware of any pending or threatened claims against the Bank that would have a material effect on its operations or performance. In the normal course of its business, the Bank is a party to various debtor-creditor legal actions. These include cases filed as a plaintiff in collection and foreclosure cases, and the enforcement of creditors’ rights in bankruptcy proceedings.

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

     At a special meeting of Bank stockholders on December 19, 2002, Bank shareholders approved the formation of a holding company, Oregon Pacific Bancorp. 1,557,829 shares were represented either in person or by proxy with 97.4% voting to approve the request. To consummate the formation, each Bank shareholder exchanged their shares of Bank stock for Bancorp stock on a one-for-one basis, effective January 1, 2003.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Wedbush Morgan Securities, Inc. in Portland, Oregon is a market maker in the Company’s stock. The stock is quoted on the OTC Bulletin Board run by NASDAQ, under the symbol OPBC. At February 28, 2003, the stock was held by approximately 679 shareholders.

     The following table sets forth the high and low bid information for the Bank’s stock (prior to the holding company) for each calendar quarter of 2001 and 2002 and through February 28, 2003 (Bancorp stock). The information was obtained from Wedbush Morgan Securities, Inc. and reflects inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.

     The Bank paid cash dividends of $.18 and $.75 per share for the years 2002 and 2001, respectively. Payment of dividends has been at the discretion of the Bank’s Board of Directors. Any future decision regarding dividends will depend on future earnings, future capital needs and the Company’s operating financial condition, among other factors. Oregon law also generally prohibits dividends where the effect of paying them would be, in the judgment of the Board of Directors, to cause the Company to be unable to pay its debts as they become due in the usual course of business and if the Company’s total assets would not at least equal the sum of its total liabilities.

     The transfer agent and registrar for the Common Stock is Registrar and Transfer, Cranford, New Jersey as of March 2003.

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ITEM 6. SELECTED FINANCIAL DATA

     The following table sets forth certain information concerning the consolidated financial condition, operating results, and key operating ratios for Oregon Pacific Banking Co. at the dates and for t he periods indicated. This information does not purport to be complete, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of Oregon Pacific Banking Co. and Notes thereto.

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

Introduction

     Oregon Pacific Banking Co.’s goal is to grow its earning assets while maintaining a high return on equity and keeping asset quality high. The key to this, in the Bank’s view, is to emphasize personal, quality banking products and services for its customers, to hire and retain competent management and administrative personnel, and to respond quickly to customer demand and growth opportunities. The Bank also intends to continue expansion into markets where opportunities exist due to mergers and acquisitions and to increase its market penetration in its existing markets through the introduction of new or existing financial services products.

     For the year ended December 31, 2002, net income was $822,000, representing a decrease of 8.16% from net income of $895,000 earned during the year ended December 31, 2001. Net income for 2001 was up 2.40% from net income of $874,000 earned during the year ended December 31, 2000. Diluted earnings per share were $0.39, $0.42, and $0.40 for the years ended December 31, 2002, 2001, and 2000, respectively. Return on average assets was 0.88% for the year ended December 31, 2002, compared with 1.14% for the year ended December 31, 2001, and 1.22% in 2000. Return on average equity was 10.86% for the year ended December 31, 2002, compared with 11.95% for the year ended December 31, 2001, and 11.59% for the year ended December 31, 2000. The decrease in earnings for the year ended December 31, 2002, versus the comparable period in 2001 can be attributed primarily to startup and operating costs of three new full service branches in Roseburg, Coos Bay, and Sutherlin, Oregon during 2002 even though net interest income plus noninterest income increased by 27.90% over the prior year.

     Bank assets grew from $86.59 million to $107.02 million, or 23.59% from year-end 2001 to 2002, and 21.00% from December 31, 2000 to December 31, 2001 from $71.56 million. Most of the growth was an increase in commercial loans in the new market areas, as net loans grew from $52.84 million to $70.99 million, an increase of 34.35% from year-end 2001 to 2002, and from $41.50 million, an increase of 27.33% the year before. The net growth in earning assets in 2002 was funded by a growth in customer deposits augmented by calls and sales of investments and Federal Home Loan Bank borrowings. Stockholders’ equity increased in 2002 as the Bank maintained much of the income to facilitate growth, but capital ratios decreased due to the faster growth of assets.

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     Return on average daily assets and equity and certain other ratios for the periods indicated are presented below:

Critical Accounting Policies and Estimates

     This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures included elsewhere in this Form 10-K, are based upon our audited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used, including the adequacy of the allowance for loan losses and contingencies and litigation. Estimates are based upon historical experience, current economic conditions, and other factors that management considers reasonable under the circumstances. These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources as well as assessing and identifying the accounting treatments of commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. The following critical accounting policies involve the more significant judgments and assumptions used in the preparation of the consolidated financial statements.

     The allowance for loan losses is established to absorb known and inherent losses attributable to loans outstanding and related off-balance-sheet commitments. The adequacy of the allowance is monitored on an ongoing basis and is based on management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio, the trend in the loan portfolio’s risk ratings, current economic conditions, loan concentrations, loan growth rates,

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past-due and non-performing trends, evaluation of specific loss estimates for all significant problem loans, historical charge-off and recovery experience, and other pertinent information. As of December 31, 2002, approximately 80% of the Bank’s loan portfolio is secured by real estate and a significant depreciation in real estate values in Oregon would cause management to increase the allowance for loan losses.

     The Bank applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option plans. Accordingly, compensation costs are recognized as the difference between the exercise price of each option and the market price of the Bank’s stock at the date of each grant. Had compensation cost for the Bank’s 2002, 2001, and 2000 grants for stock-based compensation plans been determined consistent with SFAS No. 123, its net income and earnings per common share for December 31, 2002, 2001, and 2000 would approximate the pro forma amounts below (in thousands, except per share data).