Page 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2007 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number: 001-9383 WESTAMERICA BANCORPORATION (Exact Name of Registrant as Specified in its Charter) CALIFORNIA 94-2156203 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1108 Fifth Avenue, San Rafael, California 94901 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, including Area Code (707) 863-6000 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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer [ X ] Accelerated Filer [ ] Non-Accelerated Filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ x ] Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: Title of Class Shares outstanding as of July 25, 2007 Common Stock, 29,606,194 No Par Value Page 2 TABLE OF CONTENTS <TABLE> <CAPTION> Page ------ <S> <C> Forward Looking Statements 2 PART I - FINANCIAL INFORMATION Item 1 - Financial Statements 3 Notes to Unaudited Condensed Consolidated Financial Statements 7 Financial Summary 10 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3 - Quantitative and Qualitative Disclosures about Market Risk 27 Item 4 - Controls and Procedures 27 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 28 Item 1A - Risk Factors 28 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 28 Item 3 - Defaults upon Senior Securities 28 Item 4 - Submission of Matters to a Vote of Security Holders 29 Item 5 - Other Information 29 Item 6 - Exhibits 29 Signature 30 Exhibit Index 31 Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) 32 Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) 33 Exhibit 32.1 - Certification of Chief Executive Officer Required by 18 U.S.C. Section 1350 34 Exhibit 32.2 - Certification of Chief Financial Officer Required by 18 U.S.C. Section 1350 35 </TABLE> FORWARD-LOOKING STATEMENTS This report on Form 10-Q contains forward-looking statements about Westamerica Bancorporation for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on Management's current knowledge and belief and include information concerning the Company's possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company's ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) a slowdown in the national and California economies; (2) fluctuations in asset prices including, but not limited to, stocks, bonds, real estate, and commodities; (3) economic uncertainty created by terrorist threats and attacks on the United States, the actions taken in response, and the uncertain effect of these events on the national and regional economies; (4) changes in the interest rate environment; (5) changes in the regulatory environment; (6) significantly increasing competitive pressure in the banking industry; (7) operational risks including data processing system failures or fraud; (8) the effect of acquisitions and integration of acquired businesses; (9) volatility of rate sensitive deposits and investments; (10) asset/liability management risks and liquidity risks; (11) changes in liquidity levels in capital markets; and (12) changes in the securities markets. The reader is directed to the Company's annual report on Form 10-K for the year ended December 31, 2006, for further discussion of factors which could affect the Company's business and cause actual results to differ materially from those expressed in any forward-looking statement made in this report. The Company undertakes no obligation to update any forward-looking statements in this report. Page 3 Part I. FINANCIAL INFORMATION Item 1. Financial Statements WESTAMERICA BANCORPORATION CONSOLIDATED BALANCE SHEETS (In thousands) (unaudited) <TABLE> <CAPTION> At June 30, At --------------------------December 31, 2007 2006* 2006 --------------------------------------- <S> <C> <C> <C> Assets: Cash and cash equivalents $164,065 $188,670 $184,442 Money market assets 325 534 567 Investment securities available for sale 582,959 620,294 615,525 Investment securities held to maturity, with market values of: $1,085,464 at June 30, 2007 1,104,132 $1,210,561 at June 30, 2006 1,243,936 $1,155,736 at December 31, 2006 1,165,092 Loans, gross 2,521,738 2,580,612 2,531,734 Allowance for loan losses (53,473) (55,684) (55,330) --------------------------------------- Loans, net of allowance for loan losses 2,468,265 2,524,928 2,476,404 Other real estate owned 613 656 647 Premises and equipment, net 29,169 31,785 30,188 Identifiable intangibles 20,215 24,114 22,082 Goodwill 121,719 121,719 121,719 Interest receivable and other assets 155,607 149,006 152,669 --------------------------------------- Total Assets $4,647,069 $4,905,642 $4,769,335 ======================================= Liabilities: Deposits: Noninterest bearing $1,266,941 $1,330,280 $1,341,019 Interest bearing: Transaction 554,036 606,633 588,668 Savings 809,791 951,819 865,268 Time 704,264 758,315 721,779 --------------------------------------- Total deposits 3,335,032 3,647,047 3,516,734 Short-term borrowed funds 809,261 746,517 731,977 Debt financing and notes payable 36,846 36,993 36,920 Liability for interest, taxes and other expenses 57,948 51,598 59,469 --------------------------------------- Total Liabilities 4,239,087 4,482,155 4,345,100 --------------------------------------- Shareholders' Equity: Authorized - 150,000 shares of common stock Issued and outstanding: 29,732 at June 30, 2007 335,300 31,201 at June 30, 2006 343,490 30,547 at December 31, 2006 341,529 Deferred compensation 2,990 2,734 2,734 Accumulated other comprehensive (loss) income (777) (4,771) 1,850 Retained earnings 70,469 82,034 78,122 --------------------------------------- Total Shareholders' Equity 407,982 423,487 424,235 --------------------------------------- Total Liabilities and Shareholders' Equity $4,647,069 $4,905,642 $4,769,335 ======================================= See accompanying notes to unaudited condensed consolidated financial statements. * Adjusted to adopt SAB No. 108 </TABLE> Page 4 WESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (unaudited) <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Interest Income: Loans $40,727 $41,160 $80,894 $82,266 Money market assets and funds sold 2 2 3 2 Investment securities available for sale Taxable 3,919 4,227 7,989 8,631 Tax-exempt 2,922 3,150 5,974 6,321 Investment securities held to maturity Taxable 5,987 7,407 12,255 15,236 Tax-exempt 5,784 5,931 11,599 11,888 ---------------------------------------------------- Total interest income 59,341 61,877 118,714 124,344 ---------------------------------------------------- Interest Expense: Transaction deposits 528 427 1,051 855 Savings deposits 1,452 924 2,861 1,822 Time deposits 7,540 6,661 14,845 12,577 Short-term borrowed funds 8,718 7,695 17,014 14,366 Notes payable 578 578 1,156 1,176 ---------------------------------------------------- Total interest expense 18,816 16,285 36,927 30,796 ---------------------------------------------------- Net Interest Income 40,525 45,592 81,787 93,548 ---------------------------------------------------- Provision for credit losses 75 150 150 300 ---------------------------------------------------- Net Interest Income After Provision For Credit Losses 40,450 45,442 81,637 93,248 ---------------------------------------------------- Noninterest Income: Service charges on deposit accounts 7,716 7,186 15,244 14,269 Merchant credit card 2,768 2,392 5,217 4,778 Debit card 960 876 1,856 1,704 Financial services commissions 363 363 673 661 Trust fees 304 287 641 569 Mortgage banking 33 49 62 99 Other 2,556 2,908 6,285 5,621 ---------------------------------------------------- Total Noninterest Income 14,700 14,061 29,978 27,701 ---------------------------------------------------- Noninterest Expense: Salaries and related benefits 12,622 13,559 25,189 26,816 Occupancy 3,342 3,267 6,633 6,499 Data processing 1,543 1,531 3,066 3,065 Equipment 1,147 1,315 2,284 2,581 Amortization of intangibles 893 1,016 1,868 2,056 Courier service 857 909 1,705 1,831 Professional fees 409 833 904 1,291 Other 3,893 3,915 7,721 7,690 ---------------------------------------------------- Total Noninterest Expense 24,706 26,345 49,370 51,829 ---------------------------------------------------- Income Before Income Taxes 30,444 33,158 62,245 69,120 Provision for income taxes 8,093 8,664 16,324 18,509 ---------------------------------------------------- Net Income $22,351 $24,494 $45,921 $50,611 ==================================================== Average Shares Outstanding 29,938 31,364 30,139 31,525 Diluted Average Shares Outstanding 30,365 31,932 30,593 32,103 Per Share Data: Basic Earnings $0.75 $0.78 $1.52 $1.61 Diluted Earnings 0.74 0.77 1.50 1.58 Dividends Paid 0.34 0.32 0.68 0.64 See accompanying notes to unaudited condensed consolidated financial statements. </TABLE> Page 5 WESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (In thousands) (unaudited) <TABLE> <CAPTION> Accumulated Compre- Common Deferred hensive Retained Shares Stock Compensation Income Earnings Total ------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> Balance, December 31, 2005 31,882 $343,035 $2,423 $1,882 $87,724 $435,064 Adjustment to initially apply SAB Statement No. 108, net of tax -- -- -- -- $1,756 $1,756 ------------------------------------------------------------------------------ Balance at January 1, 2006 31,882 343,035 2,423 1,882 89,480 436,820 Comprehensive income Net income for the period 50,611 50,611 Other comprehensive income, net of tax: Net unrealized loss on securities available for sale (6,653) (6,653) ------------- Total comprehensive income 43,958 Exercise of stock options 217 7,754 7,754 Stock option tax benefits 617 617 Restricted stock activity 20 727 311 1,038 Stock based compensation 1,274 1,274 Stock awarded to employees 2 126 126 Purchase and retirement of stock (920) (10,043) (37,770) (47,813) Dividends (20,287) (20,287) ------------------------------------------------------------------------------ Balance, June 30, 2006 31,201 $343,490 $2,734 ($4,771) $82,034 $423,487 ============================================================================== Balance, December 31, 2006 30,547 $341,529 $2,734 $1,850 $78,122 $424,235 Comprehensive income Net income for the period 45,921 45,921 Other comprehensive income, net of tax: Net unrealized loss on securities available for sale (2,646) (2,646) Post-retirement benefit transition obligation amortization 19 19 ------------- Total comprehensive income 43,294 Exercise of stock options 74 2,716 2,716 Stock option tax benefits 140 140 Restricted stock activity 12 316 256 572 Stock based compensation 939 939 Stock awarded to employees 3 126 126 Purchase and retirement of stock (904) (10,466) (33,012) (43,478) Dividends (20,562) (20,562) ------------------------------------------------------------------------------ Balance, June 30, 2007 29,732 $335,300 $2,990 ($777) $70,469 $407,982 ============================================================================== See accompanying notes to unaudited condensed consolidated financial statements. </TABLE> Page 6 WESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (unaudited) <TABLE> <CAPTION> For the six months ended June 30, -------------------------- 2007 2006 -------------------------- <S> <C> <C> Operating Activities: Net income $45,921 $50,611 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,892 5,152 Provision for credit losses 150 300 Net amortization of loan fees, net of cost (741) (258) Decrease in interest income receivable 762 2,284 Increase in other assets (6,667) (3,928) Decrease in income taxes payable (953) (1,655) Increase in interest expense payable 27 1,384 Increase in other liabilities 3,120 1,571 Stock option compensation expense 939 1,274 Stock option tax benefits (140) (617) Writedown of equipment 7 186 Originations of loans for resale (271) (500) Proceeds from sale of loans originated for resale 212 505 Writedown on property acquired in satisfaction of debt 34 0 Net Cash Provided by Operating Activities 47,292 56,309 -------------------------- Investing Activities: Net repayments of loans 8,788 90,740 Purchases of investment securities available for sale (26,178) (5,020) Proceeds from maturity of securities available for sale 55,189 35,448 Purchases of investment securities held to maturity 0 0 Proceeds from maturity of securities held to maturity 60,960 93,281 Purchases of FRB/FHLB stock (73) (67) Proceeds from sales of FRB/FHLB stock 73 139 Purchases of property, plant and equipment (752) (706) Net Cash Provided by Investing Activities 98,007 213,815 -------------------------- Financing Activities: Net decrease in deposits (181,702) (199,054) Net increase (decrease) in short-term borrowings 77,284 (28,656) Repayments of notes payable (74) (3,288) Exercise of stock options 2,716 7,754 Stock option tax benefits 140 617 Purchase and retirement of stock (43,478) (47,813) Dividends paid (20,562) (20,287) -------------------------- Net Cash Used in Financing Activities (165,676) (290,727) -------------------------- Net Decrease In Cash and Cash Equivalents (20,377) (20,603) Cash and Cash Equivalents at Beginning of Period 184,442 209,273 -------------------------- Cash and Cash Equivalents at End of Period $164,065 $188,670 ========================== Supplemental Disclosure of Noncash Activities: Loans transferred to other real estate owned $0 $656 Unrealized loss on securities available for sale, net (2,646) (6,653) Supplemental Disclosure of Cash Flow Activity: Interest paid for the period $36,955 $32,181 Income tax payments for the period 17,263 20,860 See accompanying notes to unaudited condensed consolidated financial statements. </TABLE> Page 7 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1: Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. The results of operations reflect interim adjustments, all of which are of a normal recurring nature and which, in the opinion of Management, are necessary for a fair presentation of the results for the interim periods presented. The interim results for the six months ended June 30, 2007 and 2006 are not necessarily indicative of the results expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as well as other information included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006. Note 2: Significant Accounting Policies. Certain accounting policies underlying the preparation of these financial statements require Management to make estimates and judgments. These estimates and judgments may affect reported amounts of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. The most significant of these involve the Allowance for Credit Losses, which is discussed in Note 1 to the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006. In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Prior to SAB 108, the Company had historically focused on the impact of misstatements on the income statement, including the reversing effect of prior year misstatements. With a focus on the income statement, the Company's analysis could lead to the accumulation of misstatements in the balance sheet. In applying SAB 108, the Company must also consider any accumulated misstatements in the balance sheet. SAB 108 permitted companies to initially apply its provisions by recording the cumulative effect of misstatements as adjustments to the balance sheet as of the first day of the fiscal year, with an offsetting adjustment recorded to retained earnings, net of tax. In applying SAB 108, the Company made an adjustment to reduce other liabilities by $3 million. The $3 million overstatement of other liabilities accumulated over seventeen years, as the liability accrued for stock-based compensation exceeded the amount paid to employees. These misstatements had not previously been material to the income statements for any of those prior periods. Comparative amounts as of June 30, 2006 have been adjusted to reflect adoption of SAB 108 as follows (in thousands): <TABLE> <CAPTION> As Originally SAB 108 As Reported Adjustment Adjusted --------------------------------------- <S> <C> <C> <C> Liability for interest, taxes and other expenses $54,598 ($3,000) $51,598 Interest receivable and other assets 150,250 (1,244) 149,006 Retained earnings 80,278 1,756 82,034 </TABLE> In September 2006, the FASB issued FAS 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. FAS 157 is effective for the year beginning January 1, 2008. The Company is currently evaluating the effects of adopting FAS 157 on its consolidated financial statements. In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities -- Including an Amendment of FASB Statement No. 115 ("FAS 159"). This standard permits entities to choose to measure many financial assets and liabilities and certain other items at fair value. An enterprise will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied on an instrument-by-instrument basis, with several exceptions, such as those investments accounted for by the equity method, and once elected, the option is irrevocable unless a new election date occurs. The fair value option can be applied only to entire instruments and not to portions thereof. FAS 159 is effective as of the beginning of an entity's first fiscal year beginning after November 15, 2007. The Company is currently evaluating the effects of adopting FAS 159 on its consolidated financial statements. Note 3: Goodwill and Other Intangible Assets The Company has recorded goodwill and other identifiable intangibles associated with purchase business combinations. Goodwill is not amortized, but is periodically evaluated for impairment. The Company did not recognize impairment during the six months ended June 30, 2007 and June 30, 2006. Identifiable intangibles are amortized to their estimated residual values over their expected useful lives. Such lives and residual values are also periodically reassessed to determine if any amortization period adjustments are indicated. During the second quarter of 2007 and second quarter of 2006, no such adjustments were recorded. Page 8 <TABLE> <CAPTION> The changes in the carrying value of goodwill were ($ in thousands): <S> <C> December 31, 2005 $121,907 Recognition of stock option tax benefits for the exercise of options converted upon merger (193) Fair value measurement adjustments during post-merger allocation period 5 ------------- June 30, 2006 $121,719 ============= December 31, 2006 $121,719 -- ------------- June 30, 2007 $121,719 ============= </TABLE> The gross carrying amount of intangible assets and accumulated amortization was ($ in thousands): <TABLE> <CAPTION> June 30, ---------------------------------------------------- 2007 2006 ---------------------------------------------------- Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization ---------------------------------------------------- <S> <C> <C> <C> <C> Core Deposit Intangibles $24,383 ($10,339) $24,383 ($8,120) Merchant Draft Processing Intangible 10,300 (4,129) 10,300 (2,449) ---------------------------------------------------- Total Intangible Assets $34,683 ($14,468) $34,683 ($10,569) ==================================================== </TABLE> As of June 30, 2007, the current year and estimated future amortization expense for intangible assets was ($ in thousands): <TABLE> <CAPTION> Merchant Core Draft Deposit Processing Intangibles Intangible Total --------------------------------------- <S> <C> <C> <C> Six months ended June 30, 2007 (actual) $1,087 $781 $1,868 Estimate for year ended December 31, 2007 2,153 1,500 3,653 2008 2,021 1,200 3,221 2009 1,859 962 2,821 2010 1,635 774 2,409 2011 1,386 624 2,010 2012 1,230 500 1,730 </TABLE> Note 4: Post Retirement Benefits The Company uses an actuarial-based accrual method of accounting for post-retirement benefits. The Company offers a continuation of group insurance coverage to eligible employees electing early retirement until age 65. The Company pays a portion of these eligible early retirees' insurance premiums which are determined at their date of retirement. The Company reimburses a portion of Medicare Part B premiums for all eligible retirees and spouses over age 65. The following table sets forth the net periodic post-retirement benefit costs (in thousands): <TABLE> <CAPTION> For the six months ended June 30, -------------------------- 2007 2006 -------------------------- <S> <C> <C> Service cost $8 $94 Interest cost 132 106 Amortization of unrecognized transition obligation 30 30 -------------------------- Net periodic cost $170 $230 ========================== The Company does not fund plan assets for any post-retirement benefit plans. </TABLE> Page 9 Note 5: Accounting for Uncertainty in Income Taxes The Company adopted the provisions of FASB Interpretation No.48 Accounting for Uncertainty in Income Taxes, on January 1, 2007. As a result of the implementation of Interpretation 48, the Company did not recognize any increase or decrease for unrecognized tax benefits. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): <TABLE> <S> <C> Balance at January 1, 2007 $792 Additions for tax positions taken in the current period 0 Reductions for tax positions taken in the current period 0 Additions for tax positions taken in prior years 0 Reductions for tax positions taken in prior years 0 Decreases related to settlements with taxing authorities 0 Decreases as a result of a lapse in statue of limitations 0 ------------- Balance at June 30, 2007 $792 ============= </TABLE> The Company does not anticipate any significant increase or decrease in unrecognized tax benefits during 2007. Unrecognized tax benefits at January 1, 2007 and June 30, 2007 include accrued interest and penalties of $137 thousand. If recognized, the entire amount of the unrecognized tax benefits would affect the effective tax rate. The Company classifies interest and penalties as a component of the provision for income taxes. The tax years ended December 31, 2006, 2005, 2004 and 2003 remain subject to examination by the Internal Revenue Service. The tax years ended December 31, 2006, 2005, 2004, 2003, and 2002 remain subject to examination by the California Franchise Tax Board. Included in the balance at January 1, 2007 is $1.6 million in tax positions for which the ultimate deductibility is uncertain. The deductibility of these tax positions will be determined through examination by the appropriate tax jurisdictions or the expiration of the tax statute of limitations. Note 6: Earnings Per Common Share The table below shows earnings per common share and diluted earnings per common share. Basic earnings per share are computed by dividing net income by the average number of shares outstanding during the period. Diluted earnings per share are computed by dividing net income by the average number of shares outstanding during the period plus the impact of common stock equivalents. <TABLE> <CAPTION> For the For the three months six months ended June 30, ended June 30, (In thousands, except per share data) 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Weighted average number of common shares outstanding - basic 29,938 31,364 30,139 31,525 Add exercise of options reduced by the number of shares that could have been purchased with the proceeds of such exercise 427 568 454 578 ---------------------------------------------------- Weighted average number of common shares outstanding - diluted 30,365 31,932 30,593 32,103 ==================================================== Net income $22,351 $24,494 $45,921 $50,611 Basic earnings per share $0.75 $0.78 $1.52 $1.61 Diluted earnings per share $0.74 $0.77 $1.50 $1.58 </TABLE> For the three months ended June 30, 2007 and 2006, options to purchase 901 thousand and 727 shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because the option exercise price exceeded the fair value of the stock such that their inclusion would have had an anti-dilutive effect. Similarly, for the six months ended June 30, 2007 and 2006, options to purchase 911 thousand and 732 shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because they were anti-dilutive. Page 10 WESTAMERICA BANCORPORATION Financial Summary (Dollars in thousands, except per share data) <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Net Interest Income (FTE)*** $46,059 $51,503 $92,973 $105,477 Provision for Loan Losses (75) (150) (150) (300) Noninterest Income 14,700 14,061 29,978 27,701 Noninterest Expense (24,706) (26,345) (49,370) (51,829) Provision for Income Taxes (FTE)*** (13,627) (14,575) (27,510) (30,438) ---------------------------------------------------- Net Income $22,351 $24,494 $45,921 $50,611 ==================================================== Average Shares Outstanding 29,938 31,364 30,139 31,525 Diluted Average Shares Outstanding 30,365 31,932 30,593 32,103 Shares Outstanding at Period End 29,732 31,201 29,732 31,201 As Reported: Basic Earnings Per Share $0.75 $0.78 $1.52 $1.61 Diluted Earnings Per Share $0.74 $0.77 $1.50 $1.58 Return On Assets 1.92% 1.99% 1.97% 2.04% Return On Equity 21.94% 23.12% 22.49% 24.02% Net Interest Margin (FTE)*** 4.36% 4.58% 4.38% 4.65% Net Loan Losses to Average Loans 0.24% 0.04% 0.16% 0.04% Efficiency Ratio** 40.7% 40.2% 40.2% 38.9% Average Balances: Total Assets $4,668,627 $4,948,443 $4,691,007 $5,001,349 Earning Assets 4,245,342 4,515,728 4,266,357 4,560,953 Total Loans, Gross 2,516,114 2,588,220 2,518,085 2,602,085 Total Deposits 3,377,413 3,652,030 3,402,548 3,718,233 Shareholders' Equity 408,564 424,999 411,791 424,916 Balances at Period End:* Total Assets $4,647,069 $4,905,642 Earning Assets 4,209,154 4,445,376 Total Loans, Gross 2,521,738 2,580,612 Total Deposits 3,335,032 3,647,047 Shareholders' Equity 407,982 423,487 Financial Ratios at Period End: Allowance for Loan Losses to Loans 2.12% 2.16% Book Value Per Share $13.72 $13.57 Equity to Assets 8.78% 8.63% Total Capital to Risk Adjusted Assets 10.83% 10.93% Dividends Paid Per Share $0.34 $0.32 $0.68 $0.64 Dividend Payout Ratio 46% 42% 45% 41% The above financial summary has been derived from the Company's unaudited consolidated financial statements. This information should be read in conjunction with those statements, notes and the other information included elsewhere herein. Percentages under the heading "As Reported" are annualized. * Balances at June 30, 2006 have been adjusted to adopt SAB No. 108. ** The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on a tax-equivalent basis and noninterest income). *** Yields on securities and certain loans have been adjusted upward to a "fully taxable equivalent" ("FTE") basis in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate. </TABLE> Page 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Westamerica Bancorporation and subsidiaries (the "Company") reported second quarter 2007 net income of $22.4 million or $0.74 diluted earnings per share. These results compare to net income of $24.5 million or $0.77 per share for the same period of 2006. On a year-to-date basis, the Company reported net income for the six months ended June 30, 2007 of $45.9 million or diluted earnings per share of $1.50, compared with $50.6 million or $1.58 per share for the same period of 2006. Following is a summary of the components of net income for the periods indicated (dollars in thousands except per share data): <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Net interest income (FTE) $46,059 $51,503 $92,973 $105,477 Provision for loan losses (75) (150) (150) (300) Noninterest income 14,700 14,061 29,978 27,701 Noninterest expense (24,706) (26,345) (49,370) (51,829) Provision for income taxes (FTE) (13,627) (14,575) (27,510) (30,438) ---------------------------------------------------- Net income $22,351 $24,494 $45,921 $50,611 ==================================================== Average diluted shares 30,365 31,932 30,593 32,103 Diluted earnings per share $0.74 $0.77 $1.50 $1.58 Average total assets $4,668,627 $4,948,443 $4,691,007 $5,001,349 Net income (annualized) to average total assets 1.92% 1.99% 1.97% 2.04% </TABLE> Net income for the second quarter of 2007 was $2.1 million or 8.8% less than the same quarter of 2006, attributable to lower net interest income (FTE), partially offset by higher noninterest income and decreases in provision for loan losses, noninterest expense and income tax provision (FTE). The decrease in net interest income (FTE) (down $5.4 million or 10.6%) was the net result of lower average interest-earning assets, higher funding costs and lower loan fee income, partially offset by higher yields on earning assets. The provision for loan losses decreased $75 thousand or 50.0% from a year ago, reflecting Management's assessment of credit risk for the loan portfolio. Noninterest income rose $639 thousand or 4.5% mainly due to higher service charges on deposits and merchant credit card income. Noninterest expense decreased $1.6 million or 6.2% mostly due to lower personnel costs. The provision for income taxes (FTE) decreased $948 thousand or 6.5% primarily due to lower profitability. Comparing the first six months of 2007 to the prior year, net income decreased $4.7 million or 9.3%, due to lower net interest income (FTE), partially offset by higher noninterest income and declines in provision for loan losses, noninterest expense and lower tax provision (FTE). The lower net interest income (FTE) was mainly caused by a lower volume of average interest-earning assets and higher funding costs, partially offset by higher yields on earnings assets. The provision for loan losses decreased $150 thousand or 50.0% to reflect Management's view on credit risk. Noninterest income increased $2.3 million or 8.2% largely due to higher service charges on deposits, merchant credit card income and company-owned life insurance proceeds. Noninterest expense declined $2.5 million or 4.7% primarily due to lower personnel costs. The income tax provision (FTE) decreased $2.9 million or 9.6% primarily due to lower profitability. Page 12 Net Interest Income The Company's primary source of revenue is net interest income, or the difference between interest income earned on loans and investments and interest expense paid on interest-bearing deposits and borrowings. Following is a summary of the components of net interest income for the periods indicated (dollars in thousands): <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Interest and fee income $59,341 $61,877 $118,714 $124,344 Interest expense (18,816) (16,285) (36,927) (30,796) FTE adjustment 5,534 5,911 11,186 11,929 ---------------------------------------------------- Net interest income (FTE) $46,059 $51,503 $92,973 $105,477 ==================================================== Average earning assets $4,245,342 $4,515,728 $4,266,357 $4,560,953 Net interest margin (FTE) 4.36% 4.58% 4.38% 4.65% </TABLE> During the periods presented, competition for deposits has intensified due to rising short-term interest rates, loan growth exceeding deposit growth in the banking industry, and other factors. Deposit competition within the banking industry has caused deposit costs to rise, while competitive rates on loans have not changed significantly. The resulting increase in funding costs has not been offset fully by rising yields on loans and investments due to relatively stable intermediate and long-term interest rates. Net interest income (FTE) decreased during the second quarter of 2007 by $5.4 million or 10.6% from the same period in 2006 to $46.1 million, mainly due to lower average earning assets (down $270 million), higher rates paid on interest-bearing liabilities (up 49 basis points or "bp") and lower loan fee income (down $185 thousand), partially offset by higher yields on earning assets (up 11 bp) and a lower volume of interest-bearing liabilities (down $213 million). Comparing the first six months of 2007 with the same period of 2006, net interest income (FTE) decreased $12.5 million or 11.9%, primarily due to lower average earning assets (down $295 million) and higher rates paid on interest-bearing liabilities (up 57 bp), partially offset by higher yields on earning assets (up 12 bp) and lower average balances of interest-bearing liabilities (down $229 million). Interest and Fee Income Interest and fee income (FTE) for the second quarter of 2007 decreased $2.9 million or 4.3% from the same period in 2006. The decline was caused by lower average balances of earning assets and lower loan fees (down $185 thousand), partially offset by higher yields on loans. The average earning asset decrease of $270 million for the second quarter of 2007 compared to the same period in 2006 was due to declines in most earning asset categories except for growth in indirect automobile loans (up $40 million). The loan portfolio declined $72 million mostly due to decreases in commercial loans (down $49 million), commercial real estate loans (down $30 million), residential real estate loans (down $16 million) and personal credit lines (down $12 million). Competitive loan pricing and loosened underwriting standards in the banking industry are limiting the opportunity to originate commercial loans which will remain profitable throughout the duration of the loans, in Management's opinion. Current interest rate spreads between loan origination yields and the rates paid on deposits and other funding sources are very narrow. Such interest rate spreads could be pressured in the near-term as funding costs rise while many loan yields are generally fixed in nature. As a result, the Company has not taken an aggressive posture relative to current loan and investment portfolio growth. The Company has allowed the investment portfolio to decline due to the current interest rate environment, which has very narrow spreads between current interest rates on similar securities and on incremental funding sources. Average total investments decreased $198 million for the second quarter of 2007 compared with the same period in 2006, due to paydowns, calls, and maturities of mortgage backed securities and collateralized mortgage obligations (down $128 million), municipal securities (down $34 million), corporate and other securities (down $20 million) and U.S. government sponsored entity obligations (down $16 million). The average yield on the Company's earning assets increased from 6.01% in the second quarter of 2006 to 6.12% in the same period in 2007. The composite yield on loans rose 11 bp to 6.69% primarily due to increases in yields on construction loans (up 139 bp), taxable commercial loans (up 30 bp), consumer loans (up 31 bp) and residential real estate loans (up 13 bp), partially offset by an 11 bp decline in yields on commercial real estate loans. The investment portfolio yield rose 6 bp to 5.31%, mainly attributable to higher yields on U.S. government sponsored entity obligations (up 18 bp) and corporate and other securities (up 17 bp), partially offset by lower yields on municipal securities (down 5 bp). As investment portfolio volumes have declined over the past year, municipal security volumes have declined at a slower rate than the remainder of the investment portfolio. As a result, municipal securities represented 44 percent of total average investment security volumes during the second quarter 2007, compared to 42 percent during the second quarter 2006. This migration in the composition of the investment portfolio has improved the overall yield of the investment portfolio since municipal security yields exceed the yield of the overall investment portfolio. Comparing the first half of 2007 with the corresponding period a year ago, interest and fee income (FTE) was down $6.4 million or 4.7%. The decrease largely resulted from lower average balances of earning assets and low loan fee income (down $88 thousand), partially offset by higher yields on earning assets. Page 13 Average earning assets decreased $295 million or 6.5% for the first half of 2007 compared with the same period of 2006, due to a $211 million decline in the investment portfolio and a $84 million decrease in the loan portfolio. Lower average investment balances were attributable to mortgage backed securities and collateralized mortgage obligations (down $131 million), municipal securities (down $34 million), corporate and other securities (down $23 million) and U.S. government sponsored obligations (down $23 million). The loan portfolio decline was primarily due to decreases in average balances of commercial loans (down $58 million), commercial real estate loans (down $26 million), personal credit lines (down $12 million) and residential real estate loans (down $10 million), partly offset by a $31 million increase in the average balance of indirect automobile loans. The average yield on earning assets for the first half of 2007 was 6.12% compared with 6.00% in the corresponding period of 2006. The loan portfolio yield for the first half of 2007 compared with the same period of 2006 was higher by 9 bp, primarily due to increases in yields on construction loans (up 138 bp), consumer loans (up 46 bp), taxable commercial loans (up 26 bp) and residential real estate loans (up 12 bp), partially offset by a 16 bp decline in the average yield on commercial real estate loans. The investment portfolio yield rose by 9 bp. The increase resulted mostly from higher yields on U.S. government sponsored obligation (up 21 bp) and corporate and other securities (up 63 bp). Interest Expense Interest expense in the second quarter of 2007 increased $2.5 million or 15.5% compared with the same period in 2006. The increase was attributable to higher rates paid on the interest-bearing liabilities, partially offset by a lower average volume of those liabilities. The average rate paid on interest-bearing liabilities increased from 2.07% in the second quarter of 2006 to 2.56% in the same quarter of 2007, reflecting trends in short-term interest rates. The average rate on federal funds purchased rose 32 bp while the average rate on line of credit and repurchase facilities increased 85 bp. Rates on deposits increased as well, including those on CDs over $100 thousand (up 63 bp), on retail CDs (up 70 bp) and on preferred money market savings (up 219 bp). Interest-bearing liabilities declined $213 million or 6.8% for the second quarter of 2007 over the same period of 2006. Most categories of deposits declined including money market savings (down $139 million), retail CDs (down $31 million), regular savings (down $46 million) and money market checking accounts (down $46 million). The decline was partially offset by a $45 million increase in preferred money market savings and a $76 million increase in federal funds purchased. Comparing the first half of 2007 to the corresponding period of 2006, interest expense rose $6.1 million or 19.9%, due to higher rates paid on interest-bearing liabilities, partially offset by a decline in such liabilities. Rates paid on liabilities averaged 2.51% during the first six months of 2007 compared to 1.94% in the first six months of 2006. The average rate paid on federal funds purchased rose 56 bp. Rates on deposits were also higher. CDs over $100 thousand rose 84 bp and retail CDs increased by 79 bp. Preferred money market savings increased 219 bp. Interest-bearing liabilities declined $229 million or 7.2% over the first half of 2006 mainly due to decreases in money market savings (down $145 million), money market checking accounts (down $56 million), regular savings (down $46 million) and retail CDs (down $33 million). The decline was partially offset by increases in preferred money market savings (up $43 million) and short-term borrowed funds purchased (up $20 million). In all periods, the Company has attempted to increase the balances of more profitable, lower-cost transaction accounts in order to minimize the cost of funds. Page 14 Net Interest Margin (FTE) The following summarizes the components of the Company's net interest margin for the periods indicated: <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Yield on earning assets (FTE) 6.12% 6.01% 6.12% 6.00% Rate paid on interest-bearing liabilities 2.56% 2.07% 2.51% 1.94% ---------------------------------------------------- Net interest spread (FTE) 3.56% 3.94% 3.61% 4.06% Impact of all other net noninterest bearing funds 0.80% 0.64% 0.77% 0.59% ---------------------------------------------------- Net interest margin (FTE) 4.36% 4.58% 4.38% 4.65% ==================================================== </TABLE> During the second quarter of 2007, the net interest margin declined 22 bp compared to the same period in 2006. Rates paid on interest-bearing liabilities climbed faster than yields on earning assets, resulting in a 38 bp decline in net interest spread. The decline in the net interest spread was partially mitigated by the higher net interest margin contribution from noninterest bearing funding sources. While the average balance of these sources decreased $50 million or 3.8%, their margin contribution increased 16 bp because of the higher market rates of interest at which they could be invested. The net interest margin in the first half of 2007 declined by 27 bp when compared with the corresponding period of 2006. Earning asset yields increased 12 bp and the cost of interest-bearing liabilities rose by 57 bp, resulting in a 45 bp decrease in the interest spread. Noninterest bearing funding sources declined $67 million or 5.0%, their margin contribution increased by 18 bp. Page 15 Summary of Average Balances, Yields/Rates and Interest Differential The following tables present, for the periods indicated, information regarding the Company's consolidated average assets, liabilities and shareholders' equity, the amount of interest income from average earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate (FTE) (dollars in thousands). <TABLE> <CAPTION> For the three months ended June 30, 2007 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- <S> <C> <C> <C> Assets: Money market assets and funds sold $459 $2 1.75% Investment securities: Available for sale Taxable 366,904 3,919 4.27% Tax-exempt (1) 235,763 4,259 7.23% Held to maturity Taxable 555,685 5,987 4.31% Tax-exempt (1) 570,417 8,770 6.15% Loans: Commercial: Taxable 324,720 6,993 8.64% Tax-exempt (1) 228,344 3,662 6.43% Commercial real estate 883,942 15,804 7.17% Real estate construction 73,206 1,841 10.09% Real estate residential 496,012 5,881 4.74% Consumer 509,890 7,757 6.10% -------------------------- Total loans (1) 2,516,114 41,938 6.69% -------------------------- Total earning assets (1) 4,245,342 64,875 6.12% Other assets 423,285 ------------- Total assets $4,668,627 ============= Liabilities and shareholders' equity Deposits: Noninterest bearing demand $1,267,032 $-- -- Savings and interest-bearing transaction 1,401,854 1,980 0.57% Time less than $100,000 212,189 1,751 3.31% Time $100,000 or more 496,338 5,789 4.68% -------------------------- Total interest-bearing deposits 2,110,381 9,520 1.81% Short-term borrowed funds 778,841 8,718 4.43% Debt financing and notes payable 36,868 578 6.27% -------------------------- Total interest-bearing liabilities 2,926,090 18,816 2.56% Other liabilities 66,941 Shareholders' equity 408,564 ------------- Total liabilities and shareholders' equity $4,668,627 ============= Net interest spread (1) (2) 3.56% Net interest income and interest margin (1) (3) $46,059 4.36% ========================== (1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate. (2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets. </TABLE> Page 16 <TABLE> <CAPTION> For the three months ended June 30, 2006 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- <S> <C> <C> <C> Assets: Money market assets and funds sold $848 $2 0.95% Investment securities: Available for sale Taxable 398,032 4,227 4.25% Tax-exempt (1) 252,617 4,605 7.29% Held to maturity Taxable 691,209 7,407 4.29% Tax-exempt (1) 584,802 9,057 6.19% Loans: Commercial: Taxable 355,136 7,386 8.34% Tax-exempt (1) 247,225 3,978 6.45% Commercial real estate 914,373 16,590 7.28% Real estate construction 77,151 1,674 8.70% Real estate residential 511,521 5,898 4.61% Consumer 482,814 6,964 5.79% -------------------------- Total loans (1) 2,588,220 42,490 6.58% -------------------------- Total earning assets (1) 4,515,728 67,788 6.01% Other assets 432,715 ------------- Total assets $4,948,443 ============= Liabilities and shareholders' equity: Deposits: Noninterest bearing demand $1,316,927 $-- -- Savings and interest-bearing transaction 1,588,822 1,351 0.34% Time less than $100,000 242,793 1,581 2.61% Time $100,000 or more 503,488 5,080 4.05% -------------------------- Total interest-bearing deposits 2,335,103 8,012 1.38% Short-term borrowed funds 766,936 7,695 3.97% Debt financing and notes payable 37,015 578 6.25% -------------------------- Total interest-bearing liabilities 3,139,054 16,285 2.07% Other liabilities 67,463 Shareholders' equity 424,999 ------------- Total liabilities and shareholders' equity $4,948,443 ============= Net interest spread (1) (2) 3.94% Net interest income and interest margin (1) (3) $51,503 4.58% ========================== (1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate. (2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets. </TABLE> Page 17 <TABLE> <CAPTION> For the six months ended June 30, 2007 --------------------------------------- Interest Rates Average income/ earned/ Balance expense paid --------------------------------------- <S> <C> <C> <C> Assets: Money market assets and funds sold $580 $3 1.04% Investment securities: Available for sale Taxable 371,992 7,989 4.30% Tax-exempt (1) 235,740 8,704 7.38% Held to maturity Taxable 567,553 12,255 4.32% Tax-exempt (1) 572,407 17,613 6.15% Loans: Commercial: Taxable 319,249 13,597 8.59% Tax-exempt (1) 230,181 7,374 6.46% Commercial real estate 892,261 31,739 7.17% Real estate construction 71,970 3,606 10.10% Real estate residential 499,931 11,837 4.74% Consumer 504,493 15,183 6.07% -------------------------- Total loans (1) 2,518,085 83,336 6.67% -------------------------- Total earning assets (1) 4,266,357 129,900 6.12% Other assets 424,650 ------------- Total assets $4,691,007 ============= Liabilities and shareholders' equity: Deposits: Noninterest bearing demand $1,269,036 $-- -- Savings and interest-bearing transaction 1,427,477 3,912 0.55% Time less than $100,000 215,355 3,485 3.26% Time $100,000 or more 490,680 11,360 4.67% -------------------------- Total interest-bearing deposits 2,133,512 18,757 1.77% Short-term borrowed funds 773,116 17,014 4.38% Debt financing and notes payable 36,887 1,156 6.27% -------------------------- Total interest-bearing liabilities 2,943,515 36,927 2.51% Other liabilities 66,665 Shareholders' equity 411,791 ------------- Total liabilities and shareholders' equity $4,691,007 ============= Net interest spread (1)(2) 3.61% Net interest income and interest margin (1) (3) $92,973 4.38% ========================== (1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate. (2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets. </TABLE> Page 18 <TABLE> <CAPTION> For the six months ended June 30, 2006 --------------------------------------- Interest Rates Average Income/ Earned/ Balance Expense Paid --------------------------------------- <S> <C> <C> <C> Assets: Money market assets and funds sold $835 $2 0.48% Investment securities: Available for sale Taxable 404,534 8,631 4.27% Tax-exempt (1) 253,722 9,249 7.29% Held to maturity Taxable 713,479 15,236 4.27% Tax-exempt (1) 586,298 18,182 6.20% Loans: Commercial: Taxable 357,142 14,757 8.33% Tax-exempt (1) 250,250 8,073 6.51% Commercial real estate 918,606 33,404 7.33% Real estate construction 77,750 3,361 8.72% Real estate residential 510,279 11,793 4.62% Consumer 488,058 13,585 5.61% -------------------------- Total loans (1) 2,602,085 84,973 6.58% -------------------------- Total earning assets (1) 4,560,953 136,273 6.00% Other assets 440,396 ------------- Total assets $5,001,349 ============= Liabilities and shareholders' equity: Deposits: Noninterest bearing demand $1,336,214 $-- -- Savings and interest-bearing transaction 1,631,228 2,677 0.33% Time less than $100,000 248,398 3,041 2.47% Time $100,000 or more 502,393 9,536 3.83% -------------------------- Total interest-bearing deposits 2,382,019 15,254 1.29% Short-term borrowed funds 752,622 14,366 3.80% Debt financing and notes payable 37,569 1,176 6.26% -------------------------- Total interest-bearing liabilities 3,172,210 30,796 1.94% Other liabilities 68,009 Shareholders' equity 424,916 ------------- Total liabilities and shareholders' equity $5,001,349 ============= Net interest spread (1)(2) 4.06% Net interest income and interest margin (1) (3) $105,477 4.65% ========================== (1) Interest and rates calculated on a fully taxable equivalent basis using the current statutory federal tax rate. (2) Net interest spread represents the average yield earned on earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and expense (annualized), divided by the average balance of earning assets. </TABLE> Page 19 Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid The following tables set forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components (dollars in thousands). <TABLE> <CAPTION> Three months ended June 30, 2007 compared with three months ended June 30, 2006 --------------------------------------- Volume Rate Total --------------------------------------- <S> <C> <C> <C> Interest and fee income: Money market assets and funds sold ($1) $1 $0 Investment securities: Available for sale Taxable (321) 13 (308) Tax-exempt (1) (305) (41) (346) Held to maturity Taxable (1,440) 20 (1,420) Tax-exempt (1) (222) (65) (287) Loans: Commercial: Taxable (648) 255 (393) Tax-exempt (1) (303) (13) (316) Commercial real estate (547) (239) (786) Real estate construction (89) 256 167 Real estate residential (181) 164 (17) Consumer 401 392 793 --------------------------------------- Total loans (1) (1,367) 815 (552) Total (decrease) increase in interest --------------------------------------- and fee income (1) (3,656) 743 (2,913) --------------------------------------- Interest expense: Deposits: Savings and interest-bearing transaction (175) 804 629 Time less than $100,000 (216) 386 170 Time $100,000 or more (73) 782 709 --------------------------------------- Total interest-bearing deposits (464) 1,972 1,508 --------------------------------------- Short-term borrowed funds 121 902 1,023 Debt financing and notes payable (2) 2 0 --------------------------------------- Total (decrease) increase in interest expense (345) 2,876 2,531 --------------------------------------- Decrease in Net Interest Income (1) ($3,311) ($2,133) ($5,444) ======================================= (1) Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. </TABLE> Page 20 <TABLE> <CAPTION> Six months ended June 30, 2006 compared with six months ended June 30, 2005 --------------------------------------- Volume Rate Total --------------------------------------- <S> <C> <C> <C> Interest and fee income: Money market assets and funds sold ($1) $2 $1 Investment securities: Available for sale Taxable (629) (13) ($642) Tax-exempt (1) (661) 116 ($545) Held to maturity Taxable (3,026) 45 ($2,981) Tax-exempt (1) (428) (141) ($569) Loans: Commercial: Taxable (1,603) 443 ($1,160) Tax-exempt (1) (643) (56) ($699) Commercial real estate (946) (719) ($1,665) Real estate construction (263) 508 $245 Real estate residential (240) 284 $44 Consumer 468 1,130 $1,598 --------------------------------------- Total loans (1) (3,227) 1,590 (1,637) Total (decrease) increase in interest --------------------------------------- and fee income (1) (7,972) 1,599 (6,373) --------------------------------------- Interest expense: Deposits: Savings and interest-bearing transaction (370) 1,605 $1,235 Time less than $100,000 (443) 887 $444 Time $100,000 or more (227) 2,051 $1,824 --------------------------------------- Total interest-bearing deposits (1,040) 4,543 3,503 --------------------------------------- Short-term borrowed funds 400 2,248 $2,648 Debt financing and notes payable (21) 1 ($20) --------------------------------------- Total (decrease) increase in interest expense (661) 6,792 6,131 --------------------------------------- Decrease in Net Interest Income (1) ($7,311) ($5,193) ($12,504) ======================================= (1) Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. </TABLE> Page 21 Provision for Credit Losses The level of the provision for credit losses during each of the periods presented reflects the Company's continued efforts to manage credit costs by enforcing underwriting and administration procedures and aggressively pursuing collection efforts with troubled debtors. The Company provided $75 thousand for loan losses in the second quarter of 2007, compared with $150 thousand in the second quarter of 2006. For the first six months of 2007 and 2006, $150 thousand and $300 thousand were provided in each respective period. The provision reflects management's assessment of credit risk in the loan portfolio for each of the periods presented. For further information regarding net credit losses and the allowance for credit losses, see the "Classified Assets" section of this report. Noninterest Income The following table summarizes the components of noninterest income for the periods indicated (dollars in thousands). <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Service charges on deposit accounts $7,716 $7,186 $15,244 $14,269 Merchant credit card fees 2,768 2,392 5,217 4,778 Debit card fees 960 876 1,856 1,704 ATM fees and interchange 714 717 1,391 1,395 Other service fees 489 488 989 934 Financial services commissions 363 363 673 661 Official check issuance income 314 373 625 706 Trust fees 304 287 641 569 Mortgage banking income 33 49 62 99 Life insurance gains -- -- 822 -- Other noninterest income 1,039 1,330 2,458 2,586 ---------------------------------------------------- Total $14,700 $14,061 $29,978 $27,701 ==================================================== </TABLE> Noninterest income for the second quarter of 2007 increased by $639 thousand or 4.5% from the same period in 2006. Service charges on deposit accounts increased due to management efforts to increase deposit accounts and minimize service charge waivers. Such charge income rose $530 thousand or 7.4% mainly due to a $682 thousand increase in overdraft fees, partially offset by declines in deficit fees charged on analyzed accounts and retail and business checking account service fees. Merchant credit card fees increased $376 thousand or 15.7%. Other noninterest income declined $291 thousand or 21.9% primarily because the 2006 period included a $239 thousand gain on sale of a vacated branch facility. In the first half of 2007, noninterest income increased $2.3 million or 8.2% compared with the same period of the previous year. Service charges on deposit accounts increased $975 thousand or 6.8% mainly due to a $1.4 million increase in overdraft fees, partially offset by declines in deficit fees charged on analyzed accounts (down $203 thousand) and retail and business checking account service fees (down $144 thousand). Merchant credit card fees increased $439 thousand or 9.2%. Debit card fees increased $152 thousand or 8.9% mainly due to increased usage. Other noninterest income increased $694 thousand or 26.8% primarily due to $822 thousand in life insurance proceeds and a $169 thousand increase in interest recoveries on charged off loans, partially offset by the effect of a $239 thousand gain on sale of a vacated branch facility in the first half of 2006. Page 22 Noninterest Expense The following table summarizes the components of noninterest expense for the periods indicated (dollars in thousands). <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Salaries and related benefits $12,622 $13,559 $25,189 $26,816 Occupancy 3,342 3,267 6,633 6,499 Data processing services 1,543 1,531 3,066 3,065 Equipment 1,147 1,315 2,284 2,581 Amortization of deposit intangibles 893 1,016 1,868 2,056 Courier service 857 909 1,705 1,831 Professional fees 409 833 904 1,291 Postage 396 397 806 807 Telephone 354 466 714 898 Stationery and supplies 269 272 583 542 Customer checks 228 263 476 553 Operational losses 171 255 331 443 Loan expense 171 236 338 430 Advertising/public relations 264 219 491 453 Correspondent Service Charges 220 207 445 390 Other noninterest expense 1,820 1,600 3,537 3,174 ---------------------------------------------------- Total $24,706 $26,345 $49,370 $51,829 ==================================================== Average full time equivalent staff 910 904 901 922 Noninterest expense to revenues (FTE) 40.66% 40.18% 40.15% 38.92% </TABLE> Noninterest expense decreased $1.6 million or 6.2% in the second quarter of 2007 compared with the same period in 2006. Salaries and related benefits decreased $937 thousand or 6.9%, mainly due to declines in stock based compensation (down $379 thousand), incentive and bonuses (down $326 thousand) and workers compensation (down $221 thousand). Professional fees decreased $424 thousand or 50.9% mostly due to a $374 thousand decline in legal fees. Equipment expense declined $168 thousand or 12.8% primarily due to lower repair, maintenance and depreciation expenses. Amortization of deposit intangibles decreased $123 thousand or 12.1%. Telephone expense declined $112 thousand or 24.0% largely due to lower rates contained in a new vendor contract. Other noninterest expense rose $220 thousand or 13.8% mostly due to increases in expenses for travel, employee recruiting, public relations and internet banking, and amortization of low-income housing investments as tax benefits are realized. In the first six months of 2007, noninterest expense declined $2.5 million or 4.7% compared with the corresponding period of 2006. Salaries and related benefits declined $1.6 million or 6.1% mostly due to a $303 thousand decrease in regular salary as a result of fewer employees, partially offset by annual merit increases, and declines in stock based compensation (down $558 thousand), incentives and bonuses (down $360 thousand) and workers compensation (down $342 thousand). Professional fees decreased $387 thousand or 29.9% mainly due to lower legal fees (down $331 thousand). Equipment expense declined $297 thousand or 11.5% primarily due to lower repair, maintenance and depreciation expenses. Amortization of deposit intangibles decreased $188 thousand or 9.1%. Telephone expense declined $184 thousand or 20.5% largely due to lower rates contained in a new vendor contract. Courier service expense decreased $126 thousand or 6.9%. A $112 thousand or 25.4% decline in operational losses was mainly attributable to a $141 thousand decrease in sundry losses. Declines were partially offset by increases in other noninterest and occupancy expenses. Other noninterest expense rose $363 thousand or 11.4% mostly due to increases in expenses for travel, employee recruiting, public relations and internet banking, and amortization of low-income housing investments as tax benefits are realized. Occupancy expense increased $134 thousand or 2.1% primarily due to lower depreciation charges. Provision for Income Tax During the second quarter of 2007, the Company recorded income tax expense (FTE) of $13.6 million, $948 thousand or 6.5% lower than the second quarter of 2006. The current quarter provision represents an effective tax rate of 37.9%, compared to 37.3% for the second quarter of 2006 largely because the second quarter of 2006 reflected tax reserve adjustments due to state tax refunds. On a year-to-date basis, the income tax provision (FTE) was $27.5 million for 2007 compared with $30.4 million for 2006. The effective tax rate of 37.5% for the first half of 2007 is lower than the 37.6% for the same period of 2006. The tax provision in 2007 reflected the tax-free nature of $822 thousand in life insurance proceeds, higher dividend received deductions and lower non-deductible life insurance premiums. The tax provision in 2006 reflected tax reserve adjustments upon the conclusion of a state tax audit. Page 23 Classified Assets The Company closely monitors the markets in which it conducts its lending operations and continues its strategy to control exposure to loans with high credit risk and to increase diversification of earning assets. Loan reviews are performed using grading standards and criteria similar to those employed by bank regulatory agencies. Loans receiving lesser grades fall under the "classified" category, which includes all nonperforming and potential problem loans, and receive an elevated level of attention to ensure collection. Other real estate owned is recorded at the lower of cost or market value less estimated disposition costs. The following is a summary of classified loans and other real estate owned on the dates indicated (dollars in thousands): <TABLE> <CAPTION> At June 30, At --------------------------December 31, 2007 2006 2006 --------------------------------------- <S> <C> <C> <C> Classified loans $22,498 $25,682 $20,180 Other real estate owned 613 656 647 --------------------------------------- Classified loans and other real estate owned $23,111 $26,338 $20,827 ======================================= Allowance for loan losses / classified loans 238% 217% 274% </TABLE> Classified loans include loans graded "substandard", "doubtful" and "loss" using regulatory guidelines. At June 30, 2007, $22.0 million of loans or 97.6% of total classified loans are graded "substandard". Such substandard loans accounted for 0.87% of total gross loans at June 30, 2007. Classified loans at June 30, 2007, decreased $3.2 million or 12.4% from a year ago. The decline resulted from 13 loan payoffs totaling $6.1 million, four upgrades totaling $4.8 million and three charge-offs, partially offset by 17 downgrades totaling $10.0 million. A $2.3 million or 11.5% increase in classified loans from December 31, 2006 was generally due to 10 downgrades totaling $5.8 million, partially offset by three upgrades, four payoffs and two chargeoffs. Other real estate owned was $613 thousand, $647 thousand and $656 thousand at June 30, 2007, December 31, 2006 and June 30, 2006, respectively. The reduction in OREO resulted from a reduction in the carrying value based on an updated appraisal, with an offsetting charge to earnings. Nonperforming Loans and Other Real Estate Owned Nonperforming loans include nonaccrual loans and loans 90 days past due as to principal or interest and still accruing. Loans are placed on nonaccrual status when they become 90 days or more delinquent, unless the loan is well secured and in the process of collection. Interest previously accrued on loans placed on nonaccrual status is charged against interest income. In addition, loans secured by real estate with temporarily impaired values and commercial loans to borrowers experiencing financial difficulties are placed on nonaccrual status even though the borrowers continue to repay the loans as scheduled. Such loans are classified as "performing nonaccrual" and are included in total nonperforming assets. When the ability to fully collect nonaccrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Any subsequent interest received is recorded as interest income on a cash basis. The following is a summary of nonperforming loans and other real estate owned on the dates indicated (dollars in thousands): <TABLE> <CAPTION> At June 30, At --------------------------December 31, 2007 2006 2006 --------------------------------------- <S> <C> <C> <C> Performing nonaccrual loans $1,898 $3,899 $4,404 Nonperforming nonaccrual loans 3,140 1,613 61 --------------------------------------- Total nonaccrual loans 5,038 5,512 4,465 Loans 90 days past due and still accruing 179 114 65 --------------------------------------- Total nonperforming loans 5,217 5,626 4,530 Other real estate owned 613 656 647 --------------------------------------- Total $5,830 $6,282 $5,177 ======================================= As a percentage of total loans 0.23% 0.24% 0.20% </TABLE> Nonaccrual loans decreased $474 thousand during the six months ended June 30, 2007. Eighteen loans comprised the $5.0 million nonaccrual loans as of June 30, 2007. Six of those loans were on nonaccrual status throughout the first half 2007, while twelve of the loans were placed on nonaccrual status during the six months ended June 30, 2007. The Company actively pursues full collection of nonaccrual loans. The Company had no "sub-prime" loans as of June 30, 2007, December 31, 2006 and June 30, 2006. Of the loans 90 days past due and still accruing at June 30, 2007, $-0- and $106 thousand were residential real estate loans and automobile loans, respectively. Changes in other real estate owned are discussed above under "Classified Assets". Page 24 The Company had no restructured loans as of June 30, 2007, June 30, 2006 and December 31, 2006. The amount of gross interest income that would have been recorded for nonaccrual loans for the three and six month periods ended June 30, 2007, if all such loans had performed in accordance with their original terms, was $109 thousand and $219 thousand, respectively, compared to $143 thousand and $262 thousand, respectively, for the second quarter and the first half of 2006. The amount of interest income that was recognized on nonaccrual loans from all cash payments, including those related to interest owed from prior years, made during the three and six months ended June 30, 2007, totaled $150 thousand and $269 thousand, respectively, compared to $93 thousand and $153 thousand, respectively, for the comparable periods in 2006. These cash payments represent annualized yields of 12.60% and 11.38%, respectively, for the second quarter and the first six months of 2007 compared to 5.78% and 5.01%, respectively, for the second quarter and the first half of 2006. Total cash payments received during the second quarter of 2007 which were applied against the book balance of nonaccrual loans outstanding at June 30, 2007, totaled approximately $-0- thousand compared with $15 thousand for the same period in 2006. Cash payments received totaled $4 thousand for the six months ended June 30, 2007 compared with $47 thousand for the corresponding period in 2006. Management believes the overall credit quality of the loan portfolio continues to be sound; however, nonperforming assets could fluctuate from period to period. The performance of any individual loan can be affected by external factors such as collateral values, the interest rate environment, economic conditions or factors particular to the borrower. No assurance can be given that additional increases in nonperforming loans and other real estate owned will not occur in the future. Allowance for Credit Losses The Company's allowance for credit losses is maintained at a level considered adequate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall credit loss experience, the amount of past due, nonperforming loans and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the allowance is specifically allocated to impaired and other identified loans whose full collectibility is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. A second allocation is based in part on quantitative analyses of historical credit loss experience, in which criticized and classified credit balances identified through an internal credit review process are analyzed using a linear regression model to determine standard loss rates. The results of this analysis are applied to current criticized and classified loan balances to allocate the reserve to the respective segments of the loan portfolio. In addition, loans with similar characteristics not usually criticized using regulatory guidelines are analyzed based on the historical loss rates and delinquency trends, grouped by the number of days the payments on these loans are delinquent. Last, allocations are made to general loan categories based on commercial office vacancy rates, mortgage loan foreclosure trends, agriculture commodity prices, and levels of government funding. The remainder of the reserve is considered to be unallocated and is established at a level considered necessary based on relevant economic conditions and available data, including unemployment statistics, unidentified economic and business conditions, the quality of lending management and staff, credit quality trends, concentrations of credit, and changing underwriting standards due to external competitive factors. Management considers the $57.2 million allowance for credit losses to be adequate as a reserve against losses as of June 30, 2007. Page 25 The following table summarizes the provision for credit losses, net credit losses and allowance for credit losses for the periods indicated (dollars in thousands): <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ---------------------------------------------------- 2007 2006 2007 2006 ---------------------------------------------------- <S> <C> <C> <C> <C> Balance, beginning of period $58,582 $59,456 $59,023 $59,537 Provision for credit losses 75 150 150 300 Loans charged off (2,244) (645) (3,488) (1,764) Recoveries of previously charged off loans 753 411 1,481 1,299 ---------------------------------------------------- Net credit losses (1,491) (234) (2,007) (465) ---------------------------------------------------- Balance, end of period $57,166 $59,372 $57,166 $59,372 ==================================================== Components: Allowance for loan losses $53,473 $55,684 $53,473 $55,684 Reserve for unfunded credit commitments 3,693 3,688 3,693 3,688 ---------------------------------------------------- Allowance for credit losses $57,166 $59,372 $57,166 $59,372 ==================================================== Allowance for loan losses / loans outstanding 2.12% 2.16% </TABLE> Net credit losses rose in the three months ended June 30, 2007 due to higher charge-offs of commercial loans and overdrafts. Annualized net loan losses to average loans rose to 0.24% percent in the three months ended June 30, 2007, compared to 0.08 percent in the three months ended March 31, 2007. Management expects net credit losses to be lower in the third and fourth quarters of 2007 compared to the second quarter 2007. In Management's opinion, net loan losses to average loans experienced in the years 2006 and 2005 of 0.04 percent and 0.03 percent, respectively, benefited from low interest rates, real estate appreciation and other factors which are not as prevalent in 2007. Management continues to follow conservative credit underwriting policies and practices, and aggressively pursues collection of classified loans and recovery of recognized loan losses. Asset and Liability Management The fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest rate risk. Interest rate risk is one of the most significant market risks affecting the Company. Interest rate risk results from many factors. Assets and liabilities may mature or reprice at different times. Assets and liabilities may reprice at the same time but by different amounts. Short-term and long-term market interest rates may change by different amounts. The remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change. In addition, interest rates may have an indirect impact on loan demand, credit losses, and other sources of earnings such as account analysis fees on commercial deposit accounts, official check fees and correspondent bank service charges. Rising short-term interest rates have slowed the growth of lower-cost deposit products in the banking industry, placing more reliance on higher-cost certificates of deposit and wholesale funding. Competitive loan pricing and loosened underwriting standards in the banking industry are limiting the opportunity to originate commercial loans which will remain profitable throughout the duration of the loans, in Management's opinion. Current interest rate spreads between loan origination yields and the rates paid on deposits and other funding sources are very narrow. Such interest rate spreads could be pressured in the near-term as funding costs rise while many loan yields are generally fixed in nature. As a result, the Company has not taken an aggressive posture relative to current loan growth. The interest rate spread is also very narrow in regard to bond investments. As such, Westamerica has not been making additional investments in bonds. The Company's exposure to interest rate risk has not changed significantly during the first six months of 2007. Loan volumes have declined in most categories, except indirect auto loans which have a shorter duration than the overall loan portfolio. The investment portfolio duration has also shortened as the portfolio balance declines due to paydowns, calls and maturities. These loan and securities trends have slightly reduced the duration of the Company's earning assets, while the duration of its funding has not changed by a meaningful amount. Management continues to monitor the interest rate environment as well as economic conditions and other conditions it deems relevant in managing the Company's exposure to interest rate risk. In adjusting the Company's asset/liability position, Management attempts to manage interest rate risk while enhancing net interest margin and net interest income. At times, depending on expected increases or decreases in general interest rates, the relationship between long and short term interest rates, market conditions and competitive factors, Management may adjust the Company's interest rate risk position in order to manage its net interest margin and net interest income. The Company's results of operations and net portfolio values remain subject to changes in interest rates and to fluctuations in the difference between long and short term interest rates. Page 26 Management assesses interest rate risk by comparing the Company's most likely earnings plan with various earnings models using many interest rate scenarios that differ in the direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. For example, assuming an increase of 100 bp in the federal funds rate and an increase of 60 bp in the 10 year Constant Maturity Treasury Bond yield during the same period, estimated earnings at risk would be approximately 2.8% of the Company's most likely net income plan for the twelve months ending June 30, 2008. Conversely, assuming a decrease of 100 bp in the federal funds rate and a decrease of 30 bp in the 10 year Constant Maturity Treasury Bond yield during the same period, earnings are estimated to improve 1.4% over the Company's most likely income plan for the twelve months ending June 30, 2008. Simulation estimates depend on, and will change with, the size and mix of the actual and projected balance sheet at the time of each simulation. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors. Liquidity The Company's principal source of asset liquidity is investment securities available for sale and principal payments from consumer loans. At June 30, 2007, investment securities available for sale totaled $583 million, representing a decrease of $33 million from December 31, 2006. At June 30, 2007, indirect auto loans totaled $462 million, which were experiencing stable monthly principal payments of approximately $19 million. At June 30, 2007, $490 million in collateralized mortgage obligations ("CMOs") and mortgage backed securities ("MBSs") were held in the Company's investment portfolios. None of the CMOs or MBSs are backed by sub-prime mortgages. The CMOs and MBSs have been experiencing stable principal paydowns of approximately $11 million per month during the last twelve months. In addition, during the three months ended June 30, 2007, the Company had customary lines for overnight borrowings from other financial institutions in excess of $700 million and a $35 million line of credit, under which average borrowings during the quarter were $625 million and $18 million, respectively. Additionally, as a member of the Federal Reserve System, the Company has access to borrowing from the Federal Reserve. The Company's short-term debt rating from Fitch Ratings is F1. Management expects the Company can access short-term debt financing if desired. The Company's long-term debt rating from Fitch Ratings is A with a stable outlook. Management is confident the Company could access additional long-term debt financing if desired. The Company generates significant liquidity from its operating activities. The Company's profitability during the first six months of 2007 and 2006 contributed to substantial operating cash flows of $47.3 million and $56.3 million, respectively. In 2007, operating activities and retained earnings from prior years provided cash for $20.6 million in shareholder dividends and $43.5 million utilized to repurchase common stock. Similarly, in the first half of 2006, operating activities and retained earnings from prior years provided cash for $47.8 million of Company stock repurchases, $20.3 million in shareholder dividends and $3.3 million for repayment of long term debt. The Company's investing activities were also a net source of cash in the first six months of 2007. Proceeds from maturing investment securities of $116.1 million were only partially reinvested, for a net increase in cash of $90.0 million. This cash inflow and a $77 million increase in short-term borrowings offset a $182 million decrease in customers' deposits. The Company's investing activities were a net source of cash in the first six months of 2006. Proceeds from maturing investment securities of $128.7 million were only partially reinvested, for a net increase in cash of $123.7 million. Other investing activities included net loan repayments of $90.7 million. This cash inflow offset a $199.1 million decrease in customers' deposits and a $28.7 million reduction in short-term borrowings. The Company anticipates maintaining its cash levels in 2007 mainly through profitability and retained earnings. It is anticipated that loan demand will be moderate during the remainder of 2007, although such demand will be dictated by economic conditions. A highly competitive environment for deposits has developed as short-term interest rates have increased and banking industry loan growth had exceeded deposit growth. The Company aggressively solicits non-interest bearing demand deposits and money market checking deposits, which are the least sensitive to interest rates. However, higher costing products, including money market savings and certificates of deposit, have been less stable during the recent period of elevated short-term interest rates. The growth of deposit balances is subject to heightened competition and the success of the Company's sales efforts and delivery of superior customer service. Depending on economic conditions, interest rate levels, and a variety of other conditions, deposit growth may be used to fund loans, purchase investment securities or to reduce short-term borrowings. However, due to concerns regarding uncertainty in the general economic environment, competition, possible terrorist attacks and political uncertainty, loan demand and levels of customer deposits are not certain. Shareholder dividends and share repurchases are expected to continue subject to the Board's discretion and continuing evaluation of capital levels, earnings, asset quality and other factors. Westamerica Bancorporation ("the Parent Company") is a separate entity from Westamerica Bank ("the Bank") and must provide for its own liquidity. In addition to its operating expenses, the Parent Company is responsible for interest and principal on outstanding debt and the payment of dividends declared for shareholders. Substantially all of the Parent Company's revenues are obtained from service fees and dividends received from the Bank and, to a lesser extent, other subsidiaries. Payment of such dividends to the Parent Company by the Bank is limited under regulations for Federal Reserve member banks and California law. The amount that can be paid in any calendar year, without prior approval from federal and state regulatory agencies, cannot exceed the net profits (as defined) for that year plus the net profits of the preceding two calendar years less dividends paid. The Company believes that such restrictions will not have an impact on the Parent Company's ability to meet its ongoing cash obligations. Page 27 Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by Management. The Company repurchases shares of its common stock in the open market pursuant to stock repurchase plans approved by the Board with the intention of lessening the dilutive impact of issuing new shares under stock option plans, returning excess capital to shareholders, and other ongoing requirements. These programs have been implemented to optimize the Company's use of equity capital and enhance shareholder value. Pursuant to these programs, the Company collectively repurchased 904 thousand shares and 920 thousand shares in the first half of 2007 and 2006, respectively. The Company's capital position represents the level of capital available to support continued operations and expansion. The Company's primary capital resource is shareholders' equity, which was $408.0 million at June 30, 2007, a decrease of $15.5 million or 3.7% from a year ago, and a decrease of $16.3 million or 3.8% from December 31, 2006. These decreases are reflective of the effect of common stock repurchases, dividends paid to shareholders and a change in accumulated other comprehensive income (loss), offset by the generation of earnings and stock issuance in connection with employee stock option exercises. The Company's ratio of equity to total assets rose to 8.78% at June 30, 2007, from 8.63% a year ago but declined from 8.90% at December 31, 2006. The following summarizes the ratios of capital to risk-adjusted assets for the periods indicated: <TABLE> <CAPTION> At June 30, At Minimum --------------------------December 31, Regulatory 2007 2006 2006 Requirement ---------------------------------------------------- <S> <C> <C> <C> <C> Tier I Capital 9.51% 9.61% 9.77% 4.00% Total Capital 10.83% 10.93% 11.09% 8.00% Leverage ratio 6.34% 6.26% 6.42% 4.00% </TABLE> The risk-based capital ratios declined at June 30, 2007, compared with June 30 and December 31 of 2006, due to a decrease in equity capital, offset in part by a decline in risk-weighted assets. Capital ratios are reviewed by Management on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet the Company's anticipated future needs. All ratios as shown in the table above are in excess of the regulatory definition of "well capitalized". Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors. Interest rate risk as discussed above is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange risk, equity price risk and commodity price risk, are not significant in the normal course of the Company's business activities. Item 4. Controls and Procedures The Company's principal executive officer and principal financial officer have evaluated the effectiveness of the Company's "disclosure controls and procedures," as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, as of June 30, 2007. Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective. The evaluation did not identify any change in the Company's internal control over financial reporting that occurred during the quarter ended June 30, 2007 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Page 28 PART II. OTHER INFORMATION Item 1. Legal Proceedings Due to the nature of the banking business, the Bank is at times party to various legal actions; all such actions are of a routine nature and arise in the normal course of business of the Subsidiary Bank. Item 1A. Risk Factors There are no material changes to the risk factors disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (a) None (b) None (c) Issuer Purchases of Equity Securities The table below sets forth the information with respect to purchases made by or on behalf of Westamerica Bancorporation or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of common stock during the quarter ended June 30, 2007 (in thousands, except per share data). <TABLE> <CAPTION> (c) (d) Total Maximum Number Number of Shares of Shares (b) Purchased that May (a) Average as Part of Yet Be Total Price Publicly Purchased Number of Paid Announced Under the Shares per Plans Plans or Period Purchased Share or Programs* Programs ---------------------------------------------------------------- <S> <C> <C> <C> <C> April 1 through April 30 123 $47.36 123 909 ---------------------------------------------------------------- May 1 through May 31 227 46.92 227 682 ---------------------------------------------------------------- June 1 through June 30 106 45.75 106 576 ---------------------------------------------------------------- Total 456 $46.77 456 576 ================================================================ </TABLE> * Includes 5 thousand, 5 thousand and 3 thousand shares purchased in April, May and June, respectively, by the Company in private transactions with the independent administrator of the Company's Tax Deferred Savings/Retirement Plan (ESOP). The Company includes the shares purchased in such transactions within the total number of shares authorized for purchase pursuant to the currently existing publicly announced program. The Company repurchases shares of its common stock in the open market to optimize the Company's use of equity capital and enhance shareholder value and with the intention of lessening the dilutive impact of issuing new shares to meet stock performance, option plans, and other ongoing requirements. Shares were repurchased during the second quarter of 2007 pursuant to a program approved by the Board of Directors on August 24, 2006 authorizing the purchase of up to 2,000,000 shares of the Company's common stock from time to time prior to September 1, 2007. Item 3. Defaults upon Senior Securities None Page 29 Item 4. Submission of Matters to a Vote of Security Holders Proxies for the Annual Meeting of shareholders held on April 26, 2007, were solicited pursuant Regulation 14A of the Securities Exchange Act of 1934. The Report of Inspector of election indicates that 25,767,381 shares of the Common Stock of the Company, out of 30,321,619 shares outstanding on the February 26, 2007 record date, were present, in person or by proxy, at the meeting. There were no "broker non-votes" because the election of directors is considered "routine" under applicable exchange rules and therefore, on this matter, brokers were able to vote shares for which no direction was provided by the beneficial owner. The following matter was submitted to a vote of the shareholders: 1. - Election of directors: For Withheld -------------------------- Etta Allen 25,425,415 341,966 Louis E. Bartolini 25,321,932 445,449 E.Joseph Bowler 23,410,140 2,357,241 Arthur C. Latno, Jr. 23,517,235 2,250,146 Patrick D. Lynch 25,415,292 352,089 Catherine C. MacMillan 25,350,072 417,309 Ronald A. Nelson 23,497,385 2,269,996 David L. Payne 25,460,104 307,277 Edward B. Sylvester 25,443,643 323,738 Shareholders were to cast their vote for or to withhold their vote. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) The exhibit list required by this item is incorporated by reference to the Exhibit Index filed with this report. Page 30 SIGNATURES - ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. WESTAMERICA BANCORPORATION (Registrant) July 31, 2007 /s/ John "Robert" Thorson - ------------- ------------------------- Date John "Robert" Thorson Senior Vice President and Chief Financial Officer (Chief Financial and Accounting Officer) Page 31 Exhibit Index Exhibit 31.1: Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) Exhibit 31.2: Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) Exhibit 32.1: Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2: Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002