Summary of WESTAMERICA BANCORPORATION

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion addresses information pertaining to the financial condition and results of operations of Westamerica Bancorporation and Subsidiaries (the "Company") that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 51 through 83, as well as with the other information presented throughout the Report. Critical Accounting Policies
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the banking industry. Application of these principles requires management to make certain estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management.
The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the Allowance for Loan Losses accounting to be the accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
The Allowance for Loan Losses represents management's estimate of the amount of loss in the loan portfolio that can be reasonably estimated as of the balance sheet date. Determining the amount of the Allowance for Loan Losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and interpretation of current economic trends, uncertainties and conditions, all of which may be susceptible to significant change. A discussion of the factors driving changes in the amount of the Allowance for Loan losses is included in the "Credit Quality" discussion below.
Acquisition
On February 6, 2009, the Bank entered a Purchase and Assumption Agreement (the "Agreement") with the Federal Deposit Insurance Corporation) as Receiver ("Receiver") of County Bank ("County"). At February 6, 2009, County's accounting records reflected total assets to be purchased by the Bank of approximately $1.6 billion, total loans to be purchased by the Bank of approximately $1.3 billion, and total deposits to be assumed by the Bank of approximately $1.2 billion. Under the terms of the Agreement, the Bank purchased substantially all assets of County, including loans, investment securities and other assets, excluding premises, equipment and company owned life insurance. The Bank has a short-term option to purchase certain premises and equipment from the Receiver. Under the terms of the Agreement, the Bank also assumed all the deposits, secured liabilities, and certain other liabilities of County. The Agreement also provided a loss sharing arrangement over certain assets, primarily loans and loan collateral received in satisfaction of loans receivable. Losses on covered assets up to $269 million are shared 80% by the Receiver and 20% by the Bank. Losses on covered assets exceeding $269 million are shared 95% by the Receiver and 5% by the Bank. The loss sharing agreement has a term of three years for all loans other than residential loans which have a term of ten years. The agreement covers only the assets and liabilities of County Bank. Assets, liabilities and trust preferred debt of County Bank's former parent company Capital Corp of the West have not been purchased or assumed by Westamerica Bank or the Company.

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The Company will apply the mark-to-market provisions of FAS 141R to account for the purchase of assets and assumption of liabilities, including recognition of a core deposit intangible asset. Accounting rules also require recognition of the FDIC's estimated loss assistance with respect to the loans and other real estate owned.
Net Income
The Company reported net income for 2008 of $59.8 million or $2.04 diluted earnings per share, compared with $89.8 million or $2.98 diluted earnings per share for 2007. The 2008 results included a $62.7 million charge for securities losses and "other than temporary impairment" securities losses in the value of FHLMC and FNMA preferred stock and other common stock. At December 31, 2008, the recorded value of FHLMC and FNMA stock was $822 thousand. Additionally, results for 2008 included a $5.7 million gain on the sale of VISA common stock from Visa's initial public offering ("IPO"), $2.3 million in reduced expenses as known litigation contingencies were satisfied as a part of the VISA IPO, and approximately $1.0 million reduction in the tax provision primarily due to adjusting the estimated tax provision to actual amounts on the filed 2007 federal tax return. The securities gains and losses, satisfaction of litigation contingencies, and tax provision adjustment combined to reduce 2008 net income by $30.7 million or diluted earnings per share by $1.05. The 2007 results included a $2.3 million litigation expense for the Bank's proportionate share of Visa's litigation exposure for which Visa's members are responsible. The 2007 period also included $822 thousand in company-owned life insurance proceeds and a $700 thousand income tax refund, derived from an amended 2003 tax return, which reduced income tax expense. The expense for Visa litigation, insurance proceeds and the income tax refund combined to increase 2007 net income by $232 thousand.

Components of Net Income

Year ended December 31,
($ in thousands except per share amounts)                     2008                2007                2006

Net interest and fee income *                             $  196,257          $  185,348          $  204,703
Provision for loan losses                                     (2,700 )              (700 )              (445 )
Noninterest income                                            (2,056 )            59,278              55,347
Noninterest expense                                         (100,761 )          (101,428 )          (101,724 )

Income before income taxes *                                  90,740             142,498             157,881
Taxes *                                                      (30,905 )           (52,722 )           (59,075 )

Net income                                                $   59,835          $   89,776          $   98,806

Net income per average fully-diluted share                $     2.04          $     2.98          $     3.11
Net income as a percentage of average shareholders'
equity                                                         14.77 %             22.11 %             23.38 %
Net income as a percentage of average total assets              1.42 %              1.93 %              2.01 %

* Fully taxable equivalent (FTE)

Comparing 2008 to the prior year, net income decreased $29.9 million, due to securities losses and "other than temporary impairment" charges on FHLMC and FNMA preferred stock and other common stock and a higher loan loss provision, partially offset by higher net interest income (FTE), a gain on sale of VISA common stock and lower tax provision (FTE). The higher net interest income (FTE) was mainly caused by lower funding costs, partially offset by a lower volume of average interest-earning assets and lower yields on loans. The provision for loan losses increased $2.0 million to reflect Management's assessment of increased credit risk and the appropriate level of the allowance for loan losses. Noninterest income in 2008 was a loss of $2.1 million compared with $59.3 million in 2007 mainly due to the losses and impairment charges on FHLMC and FNMA preferred stock and other common stock, $822 thousand gain from life insurance proceeds in 2007 and a $950 thousand decrease in fees on the issuance of official checks, partially offset by the $5.7 million gain on sale of VISA common stock. Noninterest expense decreased $667 thousand or 0.7%, primarily the net result of the reversal of a $2.3 million accrual for known Visa related litigation and lower amortization of identifiable intangible assets, partially offset by higher data processing and personnel costs and legal fees. The income tax provision (FTE) decreased $21.8 million largely due to lower pretax income and the $1 million tax adjustment for the filed 2007 federal income tax return.
Net income for 2007 decreased $9.0 million, or 9.1%, compared to net income for 2006 primarily due to lower net interest income (FTE) and an increased provision for credit losses, partially offset by higher noninterest income, lower noninterest expense and a lower tax provision. 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 earning assets. The provision for loan losses increased $255 thousand to reflect Management's assessment of credit risk for the loan portfolio. Noninterest income increased $3.9 million or 7.1% largely due to higher service charges on deposits, merchant credit card processing fees, debit card income and company-owned life insurance proceeds. Noninterest expense declined $296 thousand or 0.3% primarily due to lower personnel costs and

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intangible asset amortization, decreases in equipment costs, professional fees, a reduction in the reserve for unfunded commitments, partially offset by the $2.3 million Visa litigation charge and an increase in data processing costs. The tax provision (FTE) decreased $6.4 million primarily due to lower pretax income and a $700 thousand refund from an amended tax return.
The Company's return on average total assets was 1.42% in 2008, compared to 1.93% and 2.01% in 2007 and 2006, respectively. Return on average equity in 2008 was 14.77%, compared to 22.11% and 23.38% in 2007 and 2006, respectively. Net Interest Income
The Company's primary source of revenue is net interest income, or the difference between interest income earned on loans and investment securities and interest expense on interest-bearing deposits and other borrowings. Net interest income (FTE) in 2008 increased $10.9 million or 5.9% from 2007, to $196.3 million. Comparing 2007 to 2006, net interest income (FTE) declined $19.4 million or 9.5%.

Components of Net Interest Income

            Year ended December 31,
            (in thousands)                 2008          2007          2006

            Interest and fee income     $ 208,469     $ 235,872     $ 246,515
            Interest expense              (33,243 )     (72,555 )     (65,268 )
            FTE adjustment                 21,031        22,031        23,456

            Net interest income (FTE)   $ 196,257     $ 185,348     $ 204,703

            Net interest margin (FTE)        5.13 %        4.40 %        4.57 %

The Company's net interest margin expanded in 2008 compared with 2007. The Federal Reserve's Open Market Committee (FOMC) reduced the target federal funds rate from 5.25% in August 2007 to between zero and 0.25% in December 2008 in ten increments. As a result, short-term interest rates declined and the Company managed to reduce the interest rates paid on deposits and other interest-bearing liabilities during 2008 compared with 2007. In 2008, the Company's loan and investment yields were less sensitive to changes in interest rates resulting in a lesser reduction in such yields compared with the rates paid on deposits and other funding sources. Offsetting some of the benefit of the expanding margin was the reduction in the level of average interest-earning assets and lower yields on loans resulting in a reduction of interest and fee income (FTE) of $28.4 million or 11.0% in 2008 relative to 2007.
Comparing 2008 with 2007, average earning assets decreased $390.8 million or 9.3% in 2008 compared with 2007, due to a $311.6 million decline in the investment portfolio and a $79.2 million decrease in the loan portfolio. Lower average investment balances were largely attributable to U.S. government sponsored entity obligations (down $138 million), mortgage backed securities and collateralized mortgage obligations (down $105 million), municipal securities (down $41 million) and corporate and other securities (down $30 million). The average balance of corporate and other securities declined largely due to sales and impairment of FHLMC and FNMA preferred stock. The loan portfolio decline was primarily due to decreases in the average balances of commercial real estate loans (down $44 million), residential real estate loans (down $25 million), tax-exempt commercial loans (down $17 million), partly offset by an $8 million increase in the average balance of consumer loans, primarily automobile loans. The average yield on the Company's earning assets decreased from 6.12% in 2007 to 6.00% in 2008. The composite yield on loans fell 35 basis points ("bp") to 6.30% due to decreases in yields on taxable commercial loans (down 155 bp), real estate construction loans (down 332 bp), consumer loans (down 21 bp) and commercial real estate loans (down 9 bp), partially offset by higher yields on tax-exempt commercial loans (up 10 bp) and residential real estate loans (up 10 bp). Real estate construction loans and commercial lines of credit have variable interest rates based on the prime lending rate. The prime lending rate averaged 8.11% in 2007 compared to 5.70% in 2008, reducing the yields earned on real estate construction loans and commercial lines of credit. The investment portfolio yield increased 14 bp to 5.48%, mainly due to higher yields on U.S. Government sponsored entity obligations (up 9 bp), mortgage backed securities and collateralized mortgage obligations (up 6 bp) and municipal securities (up 5 bp), partially offset by corporate and other securities (down 105 bp). Other securities yields declined mostly due to reduced dividends on FHLMC preferred stock. As investment portfolio balances have declined over the past year, municipal security balances have declined at a slower rate than the remainder of the investment portfolio. As a result, average municipal securities represented 52% of total average investment security balances during 2008, compared with 45% during 2007. 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.

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In Management's opinion, current economic conditions are not conducive for generating profitable loan growth. Recent downward pressure on real estate values create a cautious view toward real estate lending, and economic pressure on consumers has reduced demand for automobile and other consumer loans. Additionally, yields available on the highest quality investment securities do not offer an adequate profit margin over the cost of funding. As a result, the Company has not taken an aggressive posture relative to current loan and investment portfolio growth.
Net interest income in 2008 included $2.1 million in dividends on FNMA and FHLMC preferred stock, however, there will be no dividend income from such preferred stock in 2009. Seventy percent of such dividends are excludable from taxable income for federal income tax purposes.
Interest expense in 2008 decreased $39.3 million or 54.2% compared with 2007. The decrease was attributable to lower rates paid on the interest-bearing liabilities and lower average balances of those liabilities. The average rate paid on interest-bearing liabilities decreased from 2.50% in 2007 to 1.29% in 2008. Rates paid on most interest-bearing liabilities moved with general market conditions. Rates on deposits decreased 72 bp to 1.07% primarily due to decreases in rates paid on CDs over $100 thousand (down 239 bp), preferred money market savings (down 121 bp) and retail CDs (down 62 bp). Rates on short-term borrowings also decreased 246 bp mostly due to lower rates on federal funds purchased (down 296 bp) and line of credit and repurchase facilities (down 189 bp). Interest-bearing liabilities declined $337.4 million or 11.6% in 2008 over 2007. Short-term borrowings declined $210 million primarily due to a $185 million decrease in federal funds purchased. Most categories of deposits declined including money market savings (down $68 million), money market checking accounts (down $28 million), regular savings (down $18 million), Retail CDs (down $16 million) and CDs over $100 thousand (down $14 million). The decline was partially offset by a $20 million increase in preferred money market savings.
Interest and fee income (FTE) decreased in 2007 by $12.1 million or 4.5% from 2006, the net result of a lower volume of average earning assets, partially mitigated by higher yields on earning assets. Average earning assets declined by $264 million. Management allowed the investment portfolio to liquidate in 2007 as, in Management's opinion, rates available on high quality securities did not provide yields adequate to support long-term profitability. Average investment security balances decreased $198 million due to declines in the average balances of mortgage backed securities and collateralized mortgage obligations (down $125 million), municipal securities (down $34 million), U.S. government sponsored entity obligations (down $22 million) and other securities (down $17 million). The decline in loans is due to heightened competition with reduced yields and liberalized underwriting standards. Management maintained more conservative underwriting standards and higher pricing relative to competitors, which limited loan origination volumes. The loan portfolio declined $65 million mainly due to decreases in the average volumes of commercial loans (down $51 million), commercial real estate loans (down $37 million), residential real estate loans (down $17 million) and consumer credit lines (down $10 million), offset in part by a $45 million increase in indirect automobile loans. Management grew indirect automobile loan volumes as rates on loan originations exceeded the average existing portfolio rates, causing the yield to increase on such loans.
The average yield on the Company's earning assets increased from 6.03% in 2006 to 6.12% in 2007. The composite yield on loans rose 5 bp to 6.65% due to increases in rates earned on indirect auto and other consumer loans (up 30 bp), residential real estate loans (up 11 bp) and construction loans (up 36 bp), partially offset by decreases in yields on taxable commercial loans (down 4 bp) and tax-exempt commercial loans (down 5 bp). The investment portfolio yield increased 8 bp to 5.34%, mainly caused by increases in the yield on US. Government sponsored entity obligations (up 16 bp) and mortgage backed securities and collateralized mortgage obligations (up 4 bp) and corporate and other securities (up 33 bp), partially offset by a 5 bp decline in municipal securities. The decline in the yield on municipal securities was attributable to yields on maturities, calls and serial payments exceeding yields on securities remaining in the portfolio.
Interest expense in 2007 increased $7.3 million or 11.2% compared 2006. The increase was attributable to higher rates paid on the interest- bearing liabilities, partially offset by lower average balances of interest-bearing deposits. Competition for deposits was heightened in 2007 due to loan growth exceeding deposit growth in the banking industry. The level of short-term interest rates also supported consumer demand for interest-bearing deposit products. Due to both of these general conditions, interest rates rose on deposits and banks competed fiercely for deposit balances. The average rate paid on interest-bearing liabilities increased from 2.11% in 2006 to 2.50% in 2007. Rates on deposits increased 34 bp to 1.79% primarily due to increases in rates paid on preferred money market savings (up 169 bp), non-public CDs over $100 thousand (up 67 bp) and CDs less than $100 thousand (up 58 bp). Rates on short-term borrowings also increased 27 bp mostly due to higher rates on federal funds (up 11 bp) and line of credit and repurchase facilities (up 59 bp). Interest-bearing liabilities declined $186 million in 2007 compared with 2006. Interest- bearing deposits decreased $210 million primarily due to decreases in money market savings (down $132 million), regular savings (down $45 million), money market checking accounts (down $49 million), non-public CDs over $100 thousand (down $29 million). The decline was partially offset by increases in preferred money market savings (up $47 million) and public CDs (up $27 million).

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The following tables present information regarding the consolidated average assets, liabilities and shareholders' equity, the amounts of interest income earned from average earning assets and the resulting yields, and the amount of interest expense paid on average interest-bearing liabilities and the resulting rates paid. 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 exempt from federal income taxation at the current statutory tax rate. Distribution of Assets, Liabilities & Shareholders' Equity and Yields, Rates &

Interest Margin

                                                       Year Ended December 31, 2008
                                                                  Interest        Rates
                                                   Average         Income/       Earned/
(dollars in thousands)                             Balance         Expense        Paid

Assets
Money market assets and funds sold               $        817     $       3          0.37 %
Investment securities:
Available for sale
Taxable                                               205,138         8,854          4.32 %
Tax-exempt (1)                                        196,993        13,795          7.00 %
Held to maturity
Taxable                                               436,041        19,237          4.41 %
Tax-exempt (1)                                        551,120        34,328          6.23 %
Loans:
Commercial
Taxable                                               318,075        22,341          7.02 %
Tax-exempt (1)                                        208,155        13,575          6.52 %
Commercial real estate                                835,925        58,913          7.05 %
Real estate construction                               76,086         4,863          6.39 %
Real estate residential                               468,140        22,683          4.85 %
Consumer                                              526,175        30,908          5.87 %

Total Loans (1)                                     2,432,556       153,283          6.30 %

Earning assets (1)                                  3,822,665       229,500          6.00 %
Other assets                                          397,098

Total assets                                     $  4,219,763

Liabilities and shareholders' equity
Deposits:
Noninterest bearing demand                       $  1,181,679            --            --
Savings and interest-bearing transaction            1,301,556         5,642          0.43 %
Time less than $100,000                               193,889         5,209          2.69 %
Time $100,000 or more                                 489,326        10,331          2.11 %

Total interest-bearing deposits                     1,984,771        21,182          1.07 %
Short-term borrowed funds                             549,438         9,958          1.81 %
Debt financing and notes payable                       33,807         2,103          6.22 %

Total interest-bearing liabilities                  2,568,016        33,243          1.29 %
Other liabilities                                      64,992
Shareholders' equity                                  405,076

Total liabilities and shareholders' equity       $  4,219,763

Net interest spread (2)                                                              4.71 %
Net interest income and interest margin (1)(3)                    $ 196,257          5.13 %