**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 þ
              Quarterly
                  Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                  Act of
                  1934 for the Quarterly Period EndedSeptember
                  30, 2006
  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: 0-27384
 
  **CAPITAL
                  CORP OF THE WEST**(Exact
                  name of registrant as specified in its charter)
 
  California
              
              77-0405791(State
                  or other jurisdiction of incorporation or organization)
              
              IRS
                  Employer ID Number
 
  550
                  West Main, Merced, CA 95340(Address
                  of principal executive offices)
 
 Registrant’s
        telephone number, including area code: (209)
        725-2200
 
 Former
        name, former address and former fiscal year, if changed since last report: Not
        applicable
 
 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 þ 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. Large
        accelerated filer  ̈ Accelerated filer þ 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 þ
 
 The
        number of shares outstanding of the registrant’s common stock, no par value, as
        of November 1, 2006 was 10,740,000. No shares of preferred stock, no par
        value,
        were outstanding at November 1, 2006.
  -1-
  **Capital
        Corp of the West**
 Table
        of
        Contents
 PART
        I.
        -- FINANCIAL INFORMATION
 
 Item
                  1. Financial StatementsConsolidated
                  Balance Sheets (unaudited)
              3Consolidated
                  Statements of Income and Comprehensive Income
                  (unaudited)
              4Consolidated
                  Statements of Changes in Shareholders’ Equity
                  (unaudited)
              5Consolidated
                  Statements of Cash Flows
                  (unaudited)
              6Notes
                  to the Consolidated Financial Statements
                  (unaudited)
              7Item
                  2. Management’s Discussion and Analysis of Financial
                  Condition and Results of Operations
              13Item
                  3. Quantitative and Qualitative Disclosures about
                  Market Risk
              29Item
                  4. Controls and Procedures
              29
 
 PART
        II.
        -- OTHER INFORMATION
 
 Item
                  1. Legal Proceedings
              30Item
                  1A. Risk Factors
              30Item
                  2. Unregistered Sales of Equity Securities and Use of
                  Proceeds
              30Item
                  3. Defaults Upon Senior Securities
              30Item
                  4. Submission of Matters to a Vote of Security
                  Holders
              30Item
                  5. Other Information
              30Item
                  6. Exhibits
              30SIGNATURES
              31Exhibit
                  Index
              32
 
  -2-
  **Capital
        Corp of the West**
 **Consolidated
        Balance Sheets**
 (Unaudited)
 (Dollars
                  in thousands)
              
              September
                  30, 2006
              
              December
                  31, 2005**Assets**Cash
                  and noninterest-bearing deposits in other banks
              
              $
              46,104
              
              $
              61,331Federal
                  funds sold
              
              
              49,690
              
              
              30,250Time
                  deposits at other financial institutions
              
              
              350
              
              
              350Investment
                  securities available for sale, at fair value
              
              
              263,526
              
              
              318,155Investment
                  securities held to maturity, at cost; fair value of $170,327 and
                  $178,233
                  at September 30, 2006 and December 31, 2005
              
              
              172,578
              
              
              181,025Loans,
                  net of allowance for loan losses of $14,796 and $14,776 at September
                  30,
                  2006 and December 31, 2005
              
              
              1,251,404
              
              
              1,054,120Interest
                  receivable
              
              
              8,571
              
              
              8,305Premises
                  and equipment, net
              
              
              38,833
              
              
              28,970Goodwill
              
              
              1,405
              
              
              1,405Other
                  intangible assets
              
              
              -
              
              
              23Cash
                  value of life insurance
              
              
              42,762
              
              
              31,796Investment
                  in housing tax credit limited partnerships
              
              
              8,440
              
              
              8,745Other
                  assets
              
              
              29,996
              
              
              32,281Total
                  assets
              
              $
              1,913,659
              
              $
              1,756,756**Liabilities**Deposits:Noninterest-bearing
                  demand
              
              $
              277,152
              
              $
              310,284Negotiable
                  orders of withdrawal
              
              
              197,142
              
              
              216,594Savings
              
              
              404,199
              
              
              426,581Time,
                  under $100
              
              
              282,862
              
              
              216,016Time,
                  $100 and over
              
              
              412,541
              
              
              235,025Total
                  deposits
              
              
              1,573,896
              
              
              1,404,500Other
                  borrowings
              
              
              152,629
              
              
              201,728Junior
                  subordinated debentures
              
              
              31,960
              
              
              16,496Accrued
                  interest, taxes and other liabilities
              
              
              13,101
              
              
              11,787Total
                  liabilities
              
              
              1,771,586
              
              
              1,634,511**Shareholders’
                  Equity**Preferred
                  stock, no par value; 10,000,000 shares authorized; none
                  outstanding
              
              
              -
              
              
              -Common
                  stock, no par value; 54,000,000 shares authorized; 10,736,497 and
                  10,575,361 issued and outstanding at September 30, 2006 and December
                  31,
                  2005
              
              
              63,904
              
              
              59,785Retained
                  earnings
              
              
              80,440
              
              
              65,049Accumulated
                  other comprehensive loss, net
              
              
              (2,271
              )
              
              (2,589
              )Total
                  shareholders’ equity
              
              
              142,073
              
              
              122,245Total
                  Liabilities and Shareholders’ Equity
              
              $
              1,913,659
              
              $
              1,756,756
 See
        accompanying notes to consolidated financial statements
  -3-
 Table
            of Contents
  **Capital
        Corp of the West**
 **Consolidated
        Statements of Income and Comprehensive Income**
 (Unaudited)
 For
                  the three months ended September 30,
              
              For
                  the nine months ended September 30,(Dollars
                  in thousands, except per share data)
              
              2006
              
              2005
              
              2006
              
              2005**Interest
                  income:**Interest
                  and fees on loans
              
              $
              26,009
              
              $
              19,106
              
              $
              73,440
              
              $
              51,572Interest
                  on deposits with other financial institutions
              
              
              5
              
              
              2
              
              
              14
              
              
              17Interest
                  on investments held to maturity:Taxable
              
              
              882
              
              
              1,065
              
              
              2,723
              
              
              3,243Non-taxable
              
              
              950
              
              
              900
              
              
              2,844
              
              
              2,492Interest
                  on investments available for sale:Taxable
              
              
              3,063
              
              
              2,384
              
              
              9,826
              
              
              7,703Non-taxable
              
              
              11
              
              
              11
              
              
              33
              
              
              33Interest
                  on federal funds sold
              
              
              100
              
              
              19
              
              
              193
              
              
              91Total
                  interest income
              
              
              31,020
              
              
              23,487
              
              
              89,073
              
              
              65,151**Interest
                  expense:**Interest
                  on negotiable orders of withdrawal
              
              
              373
              
              
              102
              
              
              1,038
              
              
              160Interest
                  on savings deposits
              
              
              2,259
              
              
              1,406
              
              
              6,041
              
              
              3,515Interest
                  on time deposits, under $100
              
              
              2,666
              
              
              1,578
              
              
              7,443
              
              
              4,248Interest
                  on time deposits, $100 and over
              
              
              4,840
              
              
              1,743
              
              
              10,305
              
              
              4,196Interest
                  on other borrowings
              
              
              2,050
              
              
              1,364
              
              
              6,807
              
              
              4,152Interest
                  on junior subordinated debentures
              
              
              683
              
              
              327
              
              
              1,456
              
              
              972Total
                  interest expense
              
              
              12,871
              
              
              6,520
              
              
              33,090
              
              
              17,243Net
                  interest income
              
              
              18,149
              
              
              16,967
              
              
              55,983
              
              
              47,908Provision
                  for loan losses
              
              
              200
              
              
              1,035
              
              
              400
              
              
              1,356Net
                  interest income after provision for loan losses
              
              
              17,949
              
              
              15,932
              
              
              55,583
              
              
              46,552**Noninterest
                  income:**Service
                  charges on deposit accounts
              
              
              1,550
              
              
              1,554
              
              
              4,475
              
              
              4,447Gain
                  on sale of securities
              
              
              -
              
              
              -
              
              
              622
              
              
              -Increase
                  in cash value of life insurance
              
              
              366
              
              
              310
              
              
              966
              
              
              770Other
              
              
              1,240
              
              
              802
              
              
              3,147
              
              
              2,458Total
                  noninterest income
              
              
              3,156
              
              
              2,666
              
              
              9,210
              
              
              7,675**Noninterest
                  expenses:**Salaries
                  and related expenses
              
              
              7,293
              
              
              5,538
              
              
              21,487
              
              
              16,748Premises
                  and occupancy
              
              
              1,422
              
              
              1,205
              
              
              3,866
              
              
              3,256Equipment
              
              
              1,096
              
              
              1,035
              
              
              3,129
              
              
              2,936Professional
                  fees
              
              
              478
              
              
              418
              
              
              1,952
              
              
              1,620Supplies
              
              
              237
              
              
              236
              
              
              776
              
              
              808Marketing
              
              
              360
              
              
              231
              
              
              1,213
              
              
              855Community
                  support donations
              
              
              264
              
              
              178
              
              
              773
              
              
              573Intangible
                  amortization
              
              
              -
              
              
              11
              
              
              23
              
              
              34Other
              
              
              1,842
              
              
              1,448
              
              
              5,355
              
              
              4,480Total
                  noninterest expenses
              
              
              12,992
              
              
              10,300
              
              
              38,574
              
              
              31,310Income
                  before provision for income taxes
              
              
              8,113
              
              
              8,298
              
              
              26,219
              
              
              22,917Provision
                  for income taxes
              
              
              2,284
              
              
              2,845
              
              
              8,579
              
              
              7,350Net
                  income
              
              $
              5,829
              
              $
              5,453
              
              $
              17,640
              
              $
              15,567Comprehensive
                  income:Unrealized
                  gain (loss) on interest rate floor
              
              $
              135
              
              $
              (177
              )
              $
              (161
              )
              $
              (177
              )Unrealized
                  gain (loss) on securities
              
              
              3,372
              
              
              (894
              )
              
              479
              
              
              (1,381
              )Comprehensive
                  income
              
              $
              9,336
              
              $
              4,382
              
              $
              17,958
              
              $
              14,009Basic
                  earnings per share
              
              $
              0.54
              
              $
              0.52
              
              $
              1.65
              
              $
              1.49Diluted
                  earnings per share
              
              $
              0.53
              
              $
              0.50
              
              $
              1.61
              
              $
              1.44
 See
        accompanying notes to consolidated financial statements
  -4-
 Table
            of Contents
 
 **Capital
        Corp of the West**
 **Consolidated
        Statement of Changes in Shareholders’ Equity**
 (Unaudited)
 
 Common
                  Stock
              
              
              
              Accumulated
                  other(Amounts
                  in thousands)
              
              Number
                  of shares
              
              Amounts
              
              Retained
                  earnings
              
              Comprehensive
                  (loss) gain
              
              TotalBalance,
                  December 31, 2005
              
              
              10,575
              
              $
              59,785
              
              $
              65,049
              
              $
              (2,589
              )
              $
              122,245Exercise
                  of stock options, including tax benefit of $911
              
              
              161
              
              
              4,119
              
              
              -
              
              
              -
              
              
              4,119Net
                  change in fair value of available for sale investment securities,
                  net of
                  tax effect of $347
              
              
              -
              
              
              -
              
              
              -
              
              
              479
              
              
              479Net
                  change in fair value of interest rate floor, net of tax benefit
                  of
                  $117
              
              
              -
              
              
              -
              
              
              -
              
              
              (161
              )
              
              (161
              )Cash
                  dividends
              
              
              -
              
              
              -
              
              
              (2,249
              )
              
              -
              
              
              (2,249
              )Net
                  income
              
              
              -
              
              
              -
              
              
              17,640
              
              
              -
              
              
              17,640Balance,
                  September 30, 2006
              
              
              10,736
              
              $
              63,904
              
              $
              80,440
              
              $
              (2,271
              )
              $
              142,073
 See
        accompanying notes to consolidated financial statements
  -5-
 Table
            of Contents
  **Capital
        Corp of the West**
 **Consolidated
        Statements of Cash Flows**
 (Unaudited)
 Nine
                  months ended
                September
                  30,(Dollars
                  in thousands)
              
              2006
              
              2005**Operating
                  activities:**Net
                  income
              
              $
              17,640
              
              $
              15,567Adjustments
                  to reconcile net income to net cash provided byoperating
                  activities:Provision
                  for loan losses
              
              
              400
              
              
              1,356Depreciation,
                  amortization and accretion, net
              
              
              5,442
              
              
              5,571Origination
                  of loans held for sale
              
              
              (2,380
              )
              
              (5,013
              )Proceeds
                  from sales of loans
              
              
              1,662
              
              
              1,606Increase
                  in cash value of life insurance
              
              
              (966
              )
              
              (770
              )Death
                  benefit income from bank owned life insurance
              
              
              (179
              )
              
              (539
              )Gain
                  on sale of available for sale investment securities
              
              
              (622
              )
              
              -Gain
                  on sale of other real estate owned
              
              
              (190
              )
              
              -Non-cash
                  stock option compensation expense
              
              
              566
              
              
              -Net
                  decrease (increase) in interest receivable & other
                  assets
              
              
              1,964
              
              
              (1,654
              )Net
                  increase in accrued interest, taxes and other liabilities
              
              
              1,314
              
              
              2,758Net
                  cash provided by operating activities
              
              
              24,651
              
              
              18,882**Investing
                  activities:**Investment
                  securities purchased - available for sale securities
              
              
              (2,944
              )
              
              (53,282
              )Investment
                  securities purchased - held to maturity securities
              
              
              (3,659
              )
              
              (28,996
              )Proceeds
                  from maturities of available for sale investment
                  securities
              
              
              38,591
              
              
              51,434Proceeds
                  from maturities of held to maturity investment securities
              
              
              11,404
              
              
              12,204Net
                  decrease in time deposits in other financial institutions
              
              
              -
              
              
              3,000Proceeds
                  from sales of available for sale securities
              
              
              20,483
              
              
              29,537Loans
                  purchased
              
              
              (30,015
              )
              
              -Net
                  increase in loans
              
              
              (169,379
              )
              
              (141,302
              )Purchases
                  of premises and equipment
              
              
              (11,984
              )
              
              (6,097
              )Net
                  purchases of bank owned life insurance
              
              
              (10,000
              )
              
              (2,393
              )Net
                  cash used in investing activities
              
              
              (157,503
              )
              
              (135,895
              )**Financing
                  activities:**Net
                  (decrease) increase in demand, NOW and savings deposits
              
              
              (74,966
              )
              
              57,824Net
                  increase in certificates of deposit
              
              
              244,362
              
              
              76,527Net
                  decrease in other borrowings
              
              
              (49,099
              )
              
              (18,970
              )Issuance
                  of junior subordinated debentures
              
              
              15,464
              
              
              -Payment
                  of cash dividends
              
              
              (2,249
              )
              
              (1,354
              )Issuance
                  of shares pursuant to 401K and ESOP plans
              
              
              -
              
              
              300Exercise
                  of stock options
              
              
              2,642
              
              
              1,149Tax
                  benefits related to exercise of stock options
              
              
              911
              
              
              394Net
                  cash provided by financing activities
              
              
              137,065
              
              
              115,870Net
                  increase (decrease) in cash and cash equivalents
              
              
              4,213
              
              
              (1,143
              )Cash
                  and cash equivalents at beginning of period
              
              
              91,581
              
              
              57,819Cash
                  and cash equivalents at end of period
              
              $
              95,794
              
              $
              56,676**Supplemental
                  disclosure of noncash investing and financing
                  activities:**Interest
                  rate floor unrealized loss, net of taxes
              
              $
              (161
              )
              $
              (177
              )Interest
                  paid
              
              
              31,855
              
              
              17,050Income
                  tax payments
              
              
              8,150
              
              
              5,275Investment
                  securities unrealized gain (loss), net of tax
              
              $
              479
              
              $
              (1,381
              )
 See
        accompanying notes to consolidated financial statements
  -6-
 Table
            of Contents
  Capital
        Corp of the West
 Notes
        to
        Consolidated Financial Statements
 September
        30, 2006 and December 31, 2005
 (Unaudited)
 
 GENERAL
        COMPANY
 
 Capital
        Corp of the West (the “Company”) is a bank holding company incorporated under
        the laws of the State of California on April 26, 1995. On November 1, 1995,
        the
        Company became registered as a bank holding company and is the holder of
        all of
        the capital stock of County Bank (the “Bank”). The Company's primary asset is
        the Bank **** and
        the
        Bank is the Company's primary source of income. As of November 1, 2006, the
        Company had outstanding 10,740,000 shares of Common Stock, no par value,
        held by
        approximately 2,500 shareholders. There were no preferred shares outstanding
        at
        November 1, 2006. The Company had one wholly-owned inactive nonbank subsidiary,
        Capital West Group (“CWG”) at September 30, 2006. The Bank has one wholly-owned
        active nonbank subsidiary, and one wholly-owned inactive nonbank subsidiary.
        The
        active subsidiary is Merced Area Investment & Development, Inc. (“MAID”),
        the inactive subsidiary is County Asset Advisors (“CAA”). All references herein
        to the Company includes direct subsidiaries of the Company as well as the
        Bank
        and the Bank's subsidiaries, unless the context otherwise requires.
 
 GENERAL
        BANK
 
 The
        Bank
        was organized on August 1, 1977, as County Bank of Merced, a California
        state banking corporation. The Bank commenced operations in 1977. In November
        1992, the Bank changed its legal name to County Bank. The Bank's deposits
        are
        insured by the Federal Deposit Insurance Corporation ("FDIC"), up to applicable
        limits. The Bank is a member of the Federal Reserve System.
 
 INDUSTRY
        AND MARKET AREA
 
 The
        Bank
        engages in general commercial banking business primarily in Fresno, Madera,
        Mariposa, Merced, Sacramento, San Francisco, San Joaquin, Santa Clara,
        Stanislaus, and Tuolomne counties. The Bank has twenty-five full service
        branch
        offices; two of which are located in Merced with the branch located in downtown
        Merced currently serving as both a branch and as administrative headquarters.
        There are offices in Atwater, Hilmar, Los Banos, Sonora, Stockton, two offices
        in Modesto and two offices in Turlock. In 1997, the Bank also opened an office
        in Madera and purchased three branch offices from Bank of America in Livingston,
        Dos Palos and Mariposa. During 1999, the Bank opened its first office in
        Fresno,
        and in 2000 expanded its presence in Fresno by adding an additional office.
        On
        January 18, 2001 the Bank opened a loan production office in San Francisco
        that
        during 2001 was converted into a full service branch. During 2003 and 2004,
        the
        Bank added one full service branch facility in Fresno each year. During 2005
        the
        Bank opened a loan production office in Sacramento which was converted into
        a
        full service branch and opened a full service branch in Clovis. During 2006,
        the
        Bank added one full service branch facility in San Jose, Riverbank, and Clovis.
        The Bank’s administrative headquarters also provide accommodations for the
        activities of Bank's wholly-owned real estate subsidiaries.
  
 OTHER
        FINANCIAL NOTES
 
 All
        adjustments which in the opinion of Management are necessary for a fair
        presentation of the Company’s financial position at September 30, 2006 and
        December 31, 2005 and the results of operations for the three and nine month
        periods ended September 30, 2006 and 2005, and the statements of cash flows
        for
        the three and nine months ended September 30, 2006 and 2005 have been included
        therein. The interim results for the three and nine months ended September
        30,
        2006 are not necessarily indicative of results for the full year. These
        consolidated financial statements should be read in conjunction with the
        consolidated financial statements and the notes included in the Company’s Annual
        Report and Form 10-K for the year ended December 31, 2005.
  -7-
 Table
            of Contents
  In
        the
        opinion of management, the accompanying unaudited financial statements have
        been
        prepared in accordance with accounting principles generally accepted in the
        United States and with the instructions to Form 10-Q and Rule 10-01 of
        Regulation S-X.
 
 Cash
        and
        cash equivalents on the Consolidated Statement of Cash Flows include cash,
        noninterest bearing deposits in other banks, and federal funds
        sold.
 
 Basic
        earnings per share (EPS) is computed by dividing net income available to
        common
        shareholders by the weighted average number of common shares outstanding
        during
        the period. Diluted earnings per share is computed by dividing net income
        available to common shareholders by the weighted average number of common
        shares
        outstanding during the period plus potential common shares outstanding. Diluted
        earnings per share reflects the potential dilution that could occur if
        securities or other contracts to issue common stock were exercised or converted
        into common stock or resulted in the issuance of common stock that then shared
        in the earnings of the Company.
 
 The
        following table provides a reconciliation of the numerator and denominator
        of
        the basic and diluted earnings per share computation of the three and nine
        month
        periods ended September 30, 2006 and 2005:
 
 For
                  The Three Months
              
              For
                  The Nine MonthsEnded
                  September 30,
              
              Ended
                  September 30,(Dollars
                  in thousands, except per share data)
              
              2006
              
              2005
              
              2006
              
              2005Basic
                  EPS computation:Net
                  income
              
              $
              5,829
              
              $
              5,453
              
              $
              17,640
              
              $
              15,567Average
                  common shares outstanding
              
              
              10,731
              
              
              10,506
              
              
              10,673
              
              
              10,480Basic
                  EPS
              
              $
              0.54
              
              $
              0.52
              
              $
              1.65
              
              $
              1.49Diluted
                  EPS Computations:Net
                  income
              
              $
              5,829
              
              $
              5,453
              
              $
              17,640
              
              $
              15,567Average
                  common shares outstanding
              
              
              10,731
              
              
              10,506
              
              
              10,673
              
              
              10,480Effect
                  of stock options
              
              
              239
              
              
              342
              
              
              274
              
              
              32910,970
              
              
              10,848
              
              
              10,947
              
              
              10,809Diluted
                  EPS
              
              $
              0.53
              
              $
              0.50
              
              $
              1.61
              
              $
              1.44
 
 INTANGIBLE
        ASSETS
 
 The
        Company has intangible assets consisting of core deposit premiums and goodwill.
        Core deposit premiums are amortized using an accelerated method over a period
        of
        ten years. Intangible assets related to goodwill have not been amortized
        after
        December 31, 2001 but are reviewed at least annually for potential impairment.
        During the third quarter of 2006, management determined there had been no
        impairment of goodwill. As of September 30, 2006 the Company had fully amortized
        core deposit premiums. As of December 31, 2005, the Company had unamortized
        core
        deposit premiums of $23,000. Amortization of core deposit premiums and other
        intangibles was $0 and $11,000 during the third quarter of 2006 and 2005.
        Core
        deposit premiums of $460,000 and $4,340,000 were initially recorded as a
        result
        of purchasing deposits from Town and Country Finance and Thrift in July,
        1996
        and the purchase of three branches from Bank of America in December, 1997,
        respectively.
  -8-
 Table
            of Contents
  BORROWED
        FUNDS
 
 For
        the
        nine months ended September 30, 2006, the Company decreased other borrowings
        which were obtained primarily from the Federal Home Loan Bank and Pacific
        Coast
        Bankers’ Bank. The decrease in other borrowings totaled $49,099,000 for the nine
        months ended September 30, 2006. The Company increased its subordinated
        debentures outstanding from $16,496,000 to $31,960,000 or an increase of
        $15,464,000 for the nine months ended September 30, 2006. The additional
        subordinated debentures were issued primarily to improve liquidity and provide
        a
        long term financing source that qualifies as regulatory capital under existing
        regulations.
 
 Share-Based
        Payment
 
 The
        Company maintains a stock option plan for certain directors, executives,
        and
        officers. The plan stipulates that (i) all options have an exercise price
        equal
        to the fair market value on the date of grant; (ii) all options have a ten-year
        term and become exercisable as follows: 25% at date of issuance and 25% per
        year
        for the subsequent three years; and (iii) all must be exercised within 90
        days
        following termination of employment or they expire. The Company’s stock option
        plan is designed to correlate stock price performance with officer and Director
        compensation. The shares issued pursuant to the Company’s plan are newly issued,
        registered and non-restrictive.
 
 On
        January 1, 2006, the Company began recording share-based
        payment expense
        in accordance with Statement of Financial Accounting Standards No. 123-R,
        Share-based Payment, (“SFAS 123R”) as interpreted by SEC Staff Accounting
        Bulletin No. 107. The Company adopted the modified prospective transition
        method
        provided for under SFAS 123R, and consequently has not retroactively adjusted
        results from prior periods. Under this transition method, compensation cost
        associated with stock option awards now includes quarterly amortization of
        the
        remaining unvested portion of stock options outstanding prior to January
        1,
        2006. Share-based payment expense was recorded as a non-cash expense increase
        in
        salaries and benefits expense, which had the effect of reducing net income,
        earnings per share, and diluted earnings per share. Share-based payment expense
        also had the effect of lowering income from continuing operations reported
        in
        the Consolidated Statement of Cash Flow for 2006. Under SFAS 123R, stock
        options
        are valued at fair value using an acceptable model. Share-based payment expense
        is recorded on a ratable basis in the period in which the stock option vests.
        The Company uses the Black-Scholes-Merton closed form model, an acceptable
        model
        under SFAS 123R, for estimating the fair value of stock options. For the
        valuation of stock options, the Company used the following assumptions: a
        risk
        free rate of 4.8%; a volatility rate of 26.89%; an expected dividend rate
        of
        0.90%; and an expected term of 5.85 years for the quarter ended September
        30,
        2006 and a risk free rate of 4.66%; a volatility rate of 28.85%; an expected
        dividend rate of 0.75%; and an expected term of 5.91 years for the nine months
        ended September 30, 2006. For the valuation of stock options during the year
        ended December 31, 2005, the Company used the following assumptions: a risk
        free
        rate of 3.86%; a volatility rate of 30.46%; an expected dividend rate of
        0.40%;
        and an expected term of 6.32 years.
 
 Prior
        to
        January 1, 2006, the Company accounted for share-based payment expense using
        the
        intrinsic method, where the difference between the exercise price and the
        fair
        market value of the option on the date of grant is recognized as share-based
        payment expense.
  -9-
 Table
            of Contents
  **Information
        as Reported in the Financial Statements**
 
 The
        following table presents the stock option compensation expense included in
        the
        Company’s Consolidated Statements of Income and Comprehensive Income for the
        three and nine months ended September 30, 2006:
 Three
                  Months Ended September 30, 2006
              
              Nine
                  Months Ended September 30, 2006(Dollars
                  in thousands)Stock
                  option compensation expense
              
              $
              131
              
              $
              566Tax
                  benefit recorded related to stock option compensation
                  expense
              
              
              (9
              )
              
              (37
              )Decrease
                  in net income
              
              $
              122
              
              $
              529Effect
                  on:Net
                  income per share - basic
              
              $
              (0.01
              )
              $
              (0.05
              )Net
                  income per share - diluted
              
              $
              (0.01
              )
              $
              (0.05
              )
   Options
        activity during the first nine months of 2006 is as follows:
 (Shares
                  in thousands)
              
              #
                  of shares
              
              Weighted-Average
                  exercise priceOutstanding
                  at January 1, 2006
              
              
              752
              
              $
              17.44Options
                  granted
              
              
              115
              
              $
              33.29Options
                  exercised
              
              
              (163
              )
              $
              15.00Options
                  forfeited
              
              
              (9
              )
              $
              32.84Outstanding
                  at September 30, 2006
              
              
              695
              
              $
              20.44Exercisable
                  at September 30, 2006
              
              
              573
              
              $
              17.74Forfeited
                  during the first nine months of 2006
              
              
              9
              
              $
              32.84
 
 Options
        grants during the first nine months of 2006:
 September
                  30,(Shares
                  in thousands)
              
              2006
              
              2005#
                  of shares
              
              Weighted-Average
                  fair value
              
              #
                  of shares
              
              Weighted-Average
                  fair valueOptions
                  granted
              
              
              115
              
              $
              11.15
              
              
              169
              
              $
              9.83
 
 Option
        vesting activity that occurred during the first nine months of
        2006:
 (Shares
                  in thousands)
              
              #
                  of shares
              
              Weighted-Average
                  fair valueNonvested
                  options at January 1, 2006
              
              
              43
              
              $
              10.60Options
                  granted
              
              
              115
              
              $
              11.15Options
                  vested
              
              
              (27
              )
              $
              11.15Options
                  forfeited
              
              
              (9
              )
              $
              10.60Nonvested
                  options at September 30, 2006
              
              
              122
              
              $
              10.97
  -10-
 Table
            of Contents
  Vested
        option summary information as of September 30, 2006 is as
        follows:
 (Shares
                  and dollars in thousands)
              
              #
                  of shares
              
              Aggregate
                  intrinsic value
              
              Weighted-Average
                  remaining contractual life
              
              Weighted-Average
                  exercise priceVested
                  options exercisable at September 30, 2006
              
              
              573
              
              $
              7,717
              
              
              6.45
              
              $
              17.74Total
                  options outstanding at September 30, 2006
              
              
              695
              
              $
              7,479
              
              
              6.97
              
              $
              20.44
 
 The
        vesting schedule for each option holder’s stock option contract is identical to
        the exercise schedule for each option contract. The total intrinsic value
        of
        options exercised was $919,000 and $266,000 for the quarters ended September
        30,
        2006 and September 30, 2005. Intrinsic value is defined as positive difference
        between the current market price for the underlying stock
        and the strike
        price of an
        option. The exercise price must be less than the current market price of
        the
        underlying stock to have intrinsic value. The total fair value of shares
        vested
        was $566,000 and $947,000 for the nine months ended September 30, 2006 and
        2005.
        Total future compensation expense related to nonvested awards was $1,082,000
        with a weighted average period to be recognized of 2.45 years as of September
        30, 2006. There are 2,570,308 shares authorized for grant under the Company’s
        stock option plan.
 
 Information
        Calculated as if SFAS 123R had been adopted and the stock option valuation
        and
        share-based payment expense were included in prior period Financial
        Statements.
  (Dollars
                  in thousands except per share amounts)
              
              Three
                  Months Ended September 30, 2005
              
              Nine
                  Months Ended September 30, 2005Net
                  income as reported
              
              $
              5,453
              
              $
              15,567Share-based
                  payment expense
              
              
              (228
              )
              
              (947
              )Tax
                  benefit related to share-based payment expense
              
              
              (3
              )
              
              93Net
                  income, proforma
              
              $
              5,222
              
              $
              14,713Basic
                  earnings per share:As
                  reported
              
              $
              0.52
              
              $
              1.49Pro
                  forma
              
              $
              0.49
              
              $
              1.40Diluted
                  earnings per share:As
                  reported
              
              $
              0.50
              
              $
              1.44Pro
                  forma
              
              $
              0.48
              
              $
              1.36Share-based
                  payment expense, net of related tax effects, included in net
                  income:As
                  reported
              
              $
              -
              
              $
              -Pro
                  forma
              
              $
              231
              
              $
              854
 
 Share-based
        payment expense related to stock option activity was recorded at $566,000
        for
        the nine months ended September 30, 2006 compared to $947,000 that would
        have
        been recorded for the nine months ended September 30, 2005. The $381,000
        decrease is related to the November, 2005 action by the Board of Directors
        approving the accelerated vesting of all outstanding stock options at that
        time.
        The Board of Directors performed this action to mitigate the effect of the
        adoption of Financial Accounting Statement 123R. The Company received $3,553,000
        and $1,543,000 in cash related to stock option exercises for the nine months
        ended September 30, 2006 and September 30, 2005. The Company recorded a tax
        benefit related to stock options of $911,000 and $394,000 for the nine months
        ended September 30, 2006 and September 30, 2005.
  On
        November 29, 2005, the Company’s Board of Directors approved the 100% vesting of
        all existing unvested stock options outstanding. All the options affected
        had a
        positive intrinsic value, and were held by certain members of management
        and the
        Board of Directors. The Board took this action so that the Company would
        not be
        required to recognize equity compensation expense in the Consolidated Statements
        of Income and Comprehensive Income on the unvested portion of the stock options
        outstanding as of November 29, 2005. The unvested share-based payment expense
        related to this action was $2,409,000. During the three and nine months ended
        September 30, 2006, the additional amount of share-based payment expense
        that
        would have been recorded if the stock option vesting schedules had not been
        accelerated was $169,000 and $591,000, the tax benefit would have been $32,000
        and $100,000, and net income would have been reduced by $134,000 and
        $491,000.
  -11-
 Table
              of Contents
 **Recent
        Accounting Pronouncements**
 
 In
        February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
        Financial Instruments - an amendment of FASB Statements No. 133 and 140."
        SFAS
        No. 155 simplifies accounting for certain hybrid instruments currently governed
        by SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
        by allowing fair value remeasurement of hybrid instruments that contain an
        embedded derivative that otherwise would require bifurcation. SFAS No. 155
        also
        eliminates the guidance in SFAS No.133 Implementation Issue No. D1, "Application
        of Statement 133 to Beneficial Interests in Securitized Financial Assets,"
        which
        provides such beneficial interests are not subject to SFAS No. 133. SFAS
        No. 155
        amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial
        Assets
        and Extinguishments of Liabilities - a Replacement of FASB Statement No.
        125,"
        by eliminating the restriction on passive derivative instruments that a
        qualifying special-purpose entity may hold. This statement is effective for
        financial instruments acquired or issued after the beginning of an entity’s
        first fiscal year that begins after September 15, 2006. Management does not
        expect the adoption of this statement to have a material impact on the Company’s
        Consolidated Financial Statements.
 
 In
        March
        2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 156,
        "Accounting for Servicing of Financial Assets- an amendment of FASB Statement
        No. 140." SFAS No.156 requires an entity to recognize a servicing asset or
        servicing liability each time it undertakes an obligation to service a financial
        asset by entering into a servicing contract in specific situations.
        Additionally, the servicing asset or servicing liability shall be initially
        measured at fair value; however, an entity may elect the "amortization method"
        or "fair value method" for subsequent balance sheet reporting periods. SFAS
        No.156 is effective as of an entity's first fiscal year beginning after
        September 15, 2006. Early adoption is permitted as of the beginning of an
        entity's fiscal year, provided the entity has not yet issued financial
        statements, including interim financial statements, for any period of that
        fiscal year. Management does not expect the adoption of this statement to
        have a
        material impact on the Company’s Consolidated Financial Statements.
 
 In
        June
        2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
        No. 48 (FIN48), *Accounting
        for Uncertainty in Income Taxes.* FIN 48
        clarifies the accounting for uncertainty in income taxes recognized in an
        enterprise’s financial statements in accordance with FASB Statement No. 109, *Accounting
        for Income Taxes* .
        FIN 48
        requires that management make a determination as to whether each tax position
        is
        more-likely-than-not to be sustained under tax authority examination, based
        on
        the technical merits of the position. If the more-likely-than-not threshold
        is
        met, management must measure the benefit of each position to determine the
        amount of benefit to recognize in the financial statements. Differences between
        tax positions taken in a tax return and amounts recognized in the financial
        statements will generally result in: (a) an increase in a liability for income
        taxes payable or a reduction in an income tax refund; (b) a reduction in
        a
        deferred tax asset or an increase in a deferred tax liability; or both. This
        interpretation is effective for fiscal years beginning after December 15,
        2006.
        Management does not expect the adoption of this interpretation to have a
        material impact on the Company’s Consolidated Financial Statements .
 
 In
        September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
        No.
        157, " *Employers’
        Fair Value Measurements* ”
which
        defines and establishes a framework for measuring fair value used in FASB
        pronouncements that require or permit fair value measurement. This statement
        expands disclosures using fair value to measure assets and liabilities in
        interim and annual periods subsequent to the period of initial recognition.
        SFAS
        No. 157 is effective for financial statements issued for fiscal years after
        November 15, 2007, and interim periods within those years. Management does
        not
        expect the adoption of this statement to have a material impact on the Company’s
        Consolidated Financial Statements.
 
 In
        September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
        No.
        158, " *Employers’
        Accounting for Defined Benefit Pension and Other Post Retirement
        Plans* - an
        amendment of FASB Statements No. 87, 88, 106, and 132R” requires the recognition
        of the funded status of a defined benefit plan, and that gains or losses
        and
        prior service costs or credits that arise during the period that are not
        recognized as net period benefit expenses be recorded in other comprehensive
        income. In addition, benefit plan assets and obligations should generally
        be
        measured as of the fiscal year-end statement of financial position. Disclosure
        is required in the notes to the financial statements about certain effects
        on
        net periodic benefit cost for the next fiscal year that arise from delayed
        recognition of the gains or losses. SFAS No. 158 is effective, for companies
        with publicly traded securities, for fiscal years ending after December 15,
        2006. Management does not expect the adoption of this statement to have a
        material impact on the Company’s Consolidated Financial Statements.
 
 In
        September 2006, the Securities and Exchange Commission (SEC) issued SAB No.
        108,
“ *Quantifying
        Misstatements in Financial Statements* ”
which
        outlined the approach the SEC believes should be used to quantify the
        misstatement of current year financial statements as a result of misstatements
        in prior year financial statements. SAB No. 108 is effective for fiscal years
        ending after November 15, 2006. Management does not expect the adoption of
        this
        bulletin to have a material impact on the Company’s Consolidated Financial
        Statements.
  -12-
 Table
            of Contents
  **Item
        2. Management's Discussion And Analysis Of Financial Condition****And
        Results Of Operations**
 
 The
        following Management's Discussion and Analysis of Financial Condition and
        Results of Operations contain forward-looking statements that are subject
        to
        risks and uncertainties and include information about possible or assumed
        future
        results of operations. Many possible events or factors could affect the future
        financial results and performance of the company. This could cause results
        or
        performance to differ materially from those expressed in our forward-looking
        statements. Words such as “expects”, “anticipates”, “believes”, “estimates”,
“intends,” “plans,” “assumes,” “projects,” “predicts,” “forecasts,” and
        variations of such words and other similar expressions are intended to identify
        such forward-looking statements. These statements are not guarantees of future
        performance and involve certain risks, uncertainties and assumptions which
        are
        difficult to predict. Therefore, actual outcomes and results may differ
        materially from what is expressed or forecasted in, or implied by, such
        forward-looking statements.
 
 Readers
        of the Company’s Form 10-Q should not base their investment decisions solely on
        forward looking statements and should consider all uncertainties and risks
        discussed throughout this report, as well as those discussed in the Company’s
        2005 Annual Report on Form 10-K filed on March 14, 2006. These statements
        are
        representative only on the date hereof, and the Company undertakes no obligation
        to update any forward-looking statements made. Some possible events or factors
        that could occur that may cause differences from expected results include
        the
        following: the Company’s loan growth is dependent on economic conditions, as
        well as various discretionary factors, such as decisions to sell, or purchase
        certain loans or loan portfolios; or sell or buy participations of loans;
        the
        quality and adequacy of management of our borrowers; industry, product and
        geographic concentrations and the mix of the loan portfolio. The rate of
        charge-offs and provision expense can be affected by local, regional and
        international economic and market conditions, concentrations of borrowers,
        industries, products and geographical conditions, the mix of the loan portfolio
        and management’s judgments regarding the collectibility of loans. Liquidity
        requirements may change as a result of fluctuations in assets and liabilities
        and off-balance sheet exposures, which will impact the capital and debt
        financing needs of the Company and the mix of funding sources. Decisions
        to
        purchase, hold, or sell securities are also dependent on liquidity requirements
        and market volatility, as well as on and off-balance sheet positions. Factors
        that may impact interest rate risk include local, regional and international
        economic conditions, levels, mix, maturities, yields or rates of assets and
        liabilities and the wholesale and retail funding sources of the Company.
 
 The
        Company is also exposed to the potential of losses arising from adverse changes
        in market rates and prices which can adversely impact the value of financial
        products, including securities, loans, and deposits. In addition, the banking
        industry in general is subject to various monetary and fiscal policies and
        regulations, which include those determined by the Federal Reserve Board,
        the
        Federal Deposit Insurance Corporation and state regulators, whose policies
        and
        regulations could affect the Company’s results.
 
 Other
        factors that may cause actual results to differ from the forward-looking
        statements include the following: competition with other local and regional
        banks, savings and loan associations, credit unions and other nonbank financial
        institutions, such as investment banking firms, investment advisory firms,
        brokerage firms, mutual funds and insurance companies, as well as other entities
        which offer financial services; interest rate, market and monetary fluctuations;
        inflation; market volatility; general economic conditions; introduction and
        acceptance of new banking-related products, services and enhancements; fee
        pricing strategies, mergers and acquisitions and their integration into the
        Company, civil disturbances or terrorist threats or acts, or apprehension
        about
        the possible future occurrences or acts of this type, outbreak or escalation
        of
        hostilities in which the United States is involved, any declaration of war
        by
        the U.S. Congress or any other national or international calamity, crisis
        or
        emergency changes in laws and regulations, recently issued accounting
        pronouncements, government policies, regulations, and their enforcement
        (including Bank Secrecy Act-related matters, taxing statutes and regulations);
        restrictions on dividends that our subsidiaries are allowed to pay to us;
        the
        ability to satisfy requirements related to the Sarbanes-Oxley Act and other
        regulation on internal control; and management’s ability to manage these and
        other risks. For additional information relating to the risks of the Company's
        business see "Risk Factors" in the Company's Annual Report on Form 10-K.
  -13-
 Table
            of Contents
  **Critical
        accounting policies and estimates**
 
 Management’s
        discussion and analysis of its financial condition and results of operations
        are
        based upon the Company’s consolidated financial statements, which have been
        prepared in accordance with accounting principles generally accepted in the
        United States. The preparation of these financial statements requires the
        Company to make estimates and judgments that affect the reported amounts
        of
        assets, liabilities, revenues and expenses, and related disclosure of contingent
        assets and liabilities. On an on-going basis, the Company evaluates its
        estimates, including those related to the adequacy of the allowance for loan
        losses and reserve for unfunded loan commitments, valuation of deferred income
        taxes and contingencies. The Company bases its estimates on historical
        experience and on various other assumptions that are believed to be reasonable
        under the circumstances, the results of which form the basis for making
        judgments about the carrying values of assets and liabilities that are not
        readily apparent from other sources. Actual results will differ from these
        estimates. (See caption “Allowance for Loan Losses” below in the current Form
        10-Q and in the Company’s 2005 annual report for a more detailed
        discussion).
  The
        following discussion and analysis is designed to provide a better understanding
        of the significant changes and trends related to the Company and its
        subsidiaries' financial condition, operating results, asset and liability
        management, liquidity and capital resources and should be read in conjunction
        with the Consolidated Financial Statements of the Company and the Notes thereto
        included in the Company’s Annual Report and Form 10-K.
  **Results
        Of Operations**
  **Three
        and Nine Months Ended September 30, 2006 Compared With Three and Nine Months
        Ended September 30, 2005**
  OVERVIEW
  For
        the
        three and nine months ended September 30, 2006 the Company reported net income
        of $5,829,000 and $17,640,000. This compares to $5,453,000 and $15,567,000
        for
        the same period in 2005 and represents an increase of $376,000 and $2,073,000
        or
        7% and 13%. Basic and diluted earnings per share were $0.54 and $0.53 for
        the
        three months ended September 30, 2006 and $1.65 and $1.61 for the nine months
        ended September 30, 2006. This compares to basic and diluted earnings per
        share
        of $0.52 and $0.50 for the three months ended September 30, 2005 and $1.49
        and
        $1.44 for the nine months ended September 30, 2005. This was an increase
        of
        $0.02 per share for
        basic
        and $0.03 for diluted earnings per share for the three months ended September
        30, 2006 and
        $0.16 for basic and $0.17 for diluted earnings per share for the nine months
        ended September 30, 2006. The annualized return on average assets was 1.29%
        and
        1.33% for the three and nine months ended September 30, 2006 compared to
        1.39%
        and 1.37% for the three and nine months ended September 30, 2005. The Company's
        annualized return on average equity of 17.05% and 17.91% for the three and
        nine
        months ended September 30, 2006 compared to 18.84% and 18.77% for the three
        and
        nine months ended September 30, 2005.
  NET
        INTEREST INCOME
  The
        Company's primary source of income is net interest income and is determined
        by
        the difference between interest income and fees derived from earning assets
        and
        interest paid on interest bearing liabilities. The following table illustrates
        the results and changes in interest income and interest expense for the three
        and nine months ended September 30, 2006 and September 30,
        2005:
 For
                  the three months ended September 30,
              
              For
                  the nine months ended September 30,(Dollars
                  in thousands)
              
              2006
              
              2005
              
              Percent
                  change
              
              2006
              
              2005
              
              Percent
                  changeTotal
                  interest income
              
              $
              31,020
              
              $
              23,487
              
              
              32
              %
              $
              89,073
              
              $
              65,151
              
              
              37
              %Total
                  interest expense
              
              
              12,871
              
              
              6,520
              
              
              97
              %
              
              33,090
              
              
              17,243
              
              
              92
              %Net
                  interest income
              
              $
              18,149
              
              $
              16,967
              
              
              7
              %
              $
              55,983
              
              $
              47,908
              
              
              17
              %
 
 The
        following table illustrates the average balances affecting interest income
        and
        expense, and interest earned or paid on those balances on a tax adjusted
        basis
        for the periods indicated:
 For
                  the three months ended September 30,
              
              For
                  the nine months ended September 30,(Dollars
                  in thousands)
              
              2006
              
              2005
              
              Percent
                  change
              
              2006
              
              2005
              
              Percent
                  changeAverage
                  interest earning assets
              
              $
              1,674,083
              
              $
              1,444,974
              
              
              16
              %
              $
              1,639,476
              
              $
              1,397,244
              
              
              17
              %Average
                  interest bearing liabilities
              
              $
              1,384,793
              
              $
              1,154,247
              
              
              20
              %
              $
              1,345,609
              
              $
              1,120,036
              
              
              20
              %Average
                  interest rate earned
              
              
              7.42
              %
              
              6.54
              %
              
              13
              %
              
              7.34
              %
              
              6.32
              %
              
              16
              %Average
                  interest rate paid
              
              
              3.69
              %
              
              2.24
              %
              
              65
              %
              
              3.29
              %
              
              2.06
              %
              
              60
              %Net
                  interest margin
              
              
              4.37
              %
              
              4.75
              %
              
              (8
              )%
              
              4.64
              %
              
              4.67
              %
              
              (1
              )%
  The
        level
        of interest income is affected by changes in volume of and rates earned on
        interest-earning assets. Interest-earning assets consist primarily of loans,
        investment securities and federal funds sold. The increase in total interest
        income for the three and nine months ended September 30, 2006 was primarily
        the
        result of an increase in both the volume of interest-earning assets and the
        average interest rates earned. The increase in average interest earning assets
        during 2006 was made possible by increased asset generation from our existing
        branch network, the use of brokered time deposits, and the issuance of
        subordinated debt. The increase in interest rates earned during the three
        and
        nine months ended September 30, 2006 compared to the same period in 2005
        was
        primarily the result of an increase in prevailing market interest rates.
        Short
        term interest rates have increased as Federal Reserve Board’s Open Market
        Committee continued to raise short term rates through June 2006. Interest
        expense is a function of the volume and rates paid on interest-bearing
        liabilities. Interest-bearing liabilities consist primarily of certain deposits
        and borrowed funds. The increase in interest-bearing liabilities during the
        three and nine months of 2006 when compared to the same period in 2005 was
        primarily the result of an increase in internally generated and brokered
        certificates of deposit of $100,000 and over. Brokered deposits totaled
        $124,258,000 as of September 30, 2006 compared to $20,871,000 outstanding
        at
        December 31, 2005, or an increase of $103,387,000 during the first nine months
        of 2006. In addition to the increase in brokered deposits, the Bank made
        a
        concerted effort to retain savings deposits that were previously swept out
        to
        other institutions. This action allowed the Bank to retain $49,840,000 in
        savings deposits on ledger. The increase in interest rates paid during the
        three
        and nine months ended September 30, 2006 when compared to 2005 was primarily
        the
        result of an increase in prevailing interest rates and a change in the mix
        within the deposit portfolio. Time deposits accounted for 44% of the deposit
        portfolio as of September 30, 2006 compared to 32% as of December 31, 2005.
        The
        increase in the time deposit portfolio was coupled with declines in the demand,
        NOW, and savings portion of the deposit portfolio to increase the average
        interest rate paid on interest bearing liabilities. Customers moving funds
        to
        lock in higher certificate of deposit term rates coupled with the use of
        brokered time deposits were the primary reasons for the increased time deposits
        recorded.
  Net
          interest margin provides a measurement of the Company's ability to employ
          funds
          profitably during the period being measured. The Company's decrease in
          net
          interest margin in 2006 was primarily attributable to an increase of 141
          and 128
          basis points in the time deposit portfolio yield paid and an increase in
          average
          balances of $235,749,000 and $178,701,000 in the time deposit portfolio
          during
          the first three and nine months of 2006 compared to the same time period
          in
          2005. Loans as a percentage of average interest-earning assets increased
          to 73%
          and 71% for the three and nine months ended September 30, 2006 compared
          with 70%
          and 68% for the three and nine months ended September 30, 2005. The increase
          in
          loans as a percentage on interest-earning assets is mainly attributable
          to
          increased loan production generated through our branch network. The loan
          growth
          occurred primarily in the secured and unsecured commercial loan segments
          of the
          portfolio. In addition the Bank recorded a reversal in interest income
          of
          $209,000 primarily relating to prior periods where excess interest was
          charged
          to certain loans. This matter combined with certain prior period unclaimed
          tax
          benefits associated with state housing tax credits (see “PROVISION FOR INCOME
          TAXES”) resulted in an inconsequential impact on any period including the
          current period. Management also believes that these two issues are individually
          inconsequential. Net interest income and the net interest margin are presented
          in the table on pages 18 and 19 on a taxable-equivalent basis to consistently
          reflect income from taxable loans and securities and tax-exempt securities
          based
          on a 35% marginal tax rate.
  -14-
 Table
              of Contents
  AVERAGE
        BALANCES AND RATES EARNED AND PAID
  The
        following table presents condensed average balance sheet information for
        the
        Company, together with average interest rates earned and paid on the various
        sources and uses of its funds for each of the periods indicated. Nonaccruing
        loans are included in the calculation of the average balances of loans, but
        the
        nonaccrued interest on such loans is excluded.
 
 AVERAGE
        BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS
 Three
                  months ended
              
              Three
                  months endedSeptember
                  30, 2006
              
              September
                  30, 2005Average
                Balance
              
              Taxable
                Equivalent
                Interest
              
              Taxable
                Equivalent
                Yield/rate
              
              Average
                Balance
              
              Taxable
                EquivalentInterest
              
              Taxable
                EquivalentYield/rate(Dollars
                  in thousands)**Assets**Federal
                  funds sold
              
              $
              7,613
              
              
              100
              
              
              5.21
              %
              $
              2,101
              
              $
              19
              
              
              3.59
              %Time
                  deposits at other financial institutions
              
              
              350
              
              
              5
              
              
              5.67
              
              
              350
              
              
              2
              
              
              2.27Taxable
                  investment securities
              
              
              337,085
              
              
              3,959
              
              
              4.66
              
              
              338,311
              
              
              3,474
              
              
              4.07Nontaxable
                  investment securities
              
              
              103,312
              
              
              1,249
              
              
              4.80
              
              
              95,153
              
              
              1,205
              
              
              5.02Loans,
                  gross:
              
              
              1,225,723
              
              
              26,009
              
              
              8.42
              
              
              1,009,059
              
              
              19,106
              
              
              7.51Total
                  interest-earning assets
              
              $
              1,674,083
              
              $
              31,322
              
              
              7.42
              
              $
              1,444,974
              
              $
              23,806
              
              
              6.54Allowance
                  for loan losses
              
              
              (14,868
              )
              
              
              
              
              
              
              
              (13,968
              )Cash
                  and due from banks
              
              
              43,274
              
              
              
              
              
              
              
              
              46,720Premises
                  and equipment, net
              
              
              37,647
              
              
              
              
              
              
              
              
              25,860Interest
                  receivable and other assets
              
              
              73,820
              
              
              
              
              
              
              
              
              60,418Total
                  assets
              
              $
              1,813,956
              
              
              
              
              
              
              
              $
              1,564,004**Liabilities
                  And Shareholders' Equity**Negotiable
                  order of withdrawal
              
              $
              197,546
              
              $
              372
              
              
              0.75
              
              $
              180,577
              
              $
              102
              
              
              0.22Savings
                  deposits
              
              
              333,695
              
              
              2,259
              
              
              2.69
              
              
              371,188
              
              
              1,406
              
              
              1.50Time
                  deposits
              
              
              666,501
              
              
              7,507
              
              
              4.47
              
              
              430,752
              
              
              3,321
              
              
              3.06Other
                  borrowings
              
              
              155,091
              
              
              2,066
              
              
              5.29
              
              
              155,234
              
              
              1,364
              
              
              3.49Subordinated
                  Debentures
              
              
              31,960
              
              
              667
              
              
              8.28
              
              
              16,496
              
              
              327
              
              
              7.86Total
                  interest-bearing liabilities
              
              
              1,384,793
              
              
              12,871
              
              
              3.69
              
              
              1,154,247
              
              
              6,520
              
              
              2.24Noninterest-bearing
                  deposits
              
              
              276,923
              
              
              
              
              
              
              
              
              281,328Accrued
                  interest, taxes and other liabilities
              
              
              15,471
              
              
              
              
              
              
              
              
              12,660Total
                  liabilities
              
              
              1,677,187
              
              
              
              
              
              
              
              
              1,448,235Total
                  shareholders' equity
              
              
              136,769
              
              
              
              
              
              
              
              
              115,769Total
                  liabilities and shareholders' equity
              
              $
              1,813,956
              
              
              
              
              
              
              
              $
              1,564,004Net
                  interest income and margin
              
              
              
              
              $
              18,451
              
              
              4.37
              %
              
              
              
              $
              17,286
              
              
              4.75
              %
  ( 1)  Tax-equivalent
        adjustments included in the nontaxable investment securities portfolio are
        $288,000 and $294,000 for the three months ended September 30, 2006 and 2005.
        Tax equivalent adjustments included in the taxable investment securities
        created
        by a dividends received deduction were $14,000 and $25,000 for the three
        months
        ended September 30, 2006 and 2005.
 (2)  Amounts
        of interest earned included loan fees of $950,000 and $890,000 and loan costs
        of
        $152,000 and $103,000 for the three months ended September 30, 2006 and 2005,
        respectively.
 (3)  Net
        interest margin is computed by dividing net interest income by total average
        interest-earning assets.
  -15-
 Table
            of Contents
  AVERAGE
        BALANCE SHEET & ANALYSIS OF NET INTEREST EARNINGS
 Nine
                  months ended
              
              Nine
                  months endedSeptember
                  30, 2006
              
              September
                  30, 2005Average
                Balance
              
              Taxable
                Equivalent
                Interest
              
              Taxable
                Equivalent
                Yield/rate
              
              Average
                Balance
              
              Taxable
                EquivalentInterest
              
              Taxable
                Equivalent
                Yield/rate(Dollars
                  in thousands)**Assets**Federal
                  funds sold
              
              $
              5,250
              
              
              193
              
              
              4.92
              %
              $
              4,411
              
              $
              91
              
              
              2.76
              %Time
                  deposits at other financial institutions
              
              
              350
              
              
              14
              
              
              5.35
              
              
              855
              
              
              17
              
              
              2.66Taxable
                  investment securities
              
              
              362,508
              
              
              12,609
              
              
              4.65
              
              
              356,963
              
              
              11,043
              
              
              4.14Nontaxable
                  investment securities
              
              
              102,481
              
              
              3,756
              
              
              4.90
              
              
              87,993
              
              
              3,344
              
              
              5.08Loans,
                  gross:
              
              
              1,168,887
              
              
              73,440
              
              
              8.40
              
              
              947,022
              
              
              51,572
              
              
              7.28Total
                  interest-earning assets
              
              $
              1,639,476
              
              $
              90,012
              
              
              7.34
              
              $
              1,397,244
              
              $
              66,067
              
              
              6.32Allowance
                  for loan losses
              
              
              (15,074
              )
              
              
              
              
              
              
              
              (13,658
              )Cash
                  and due from banks
              
              
              46,146
              
              
              
              
              
              
              
              
              43,495Premises
                  and equipment, net
              
              
              33,733
              
              
              
              
              
              
              
              
              24,465Interest
                  receivable and other assets
              
              
              69,644
              
              
              
              
              
              
              
              
              59,095Total
                  assets
              
              $
              1,773,925
              
              
              
              
              
              
              
              $
              1,510,641**Liabilities
                  And Shareholders' Equity**Negotiable
                  order of withdrawal
              
              $
              205,209
              
              $
              1,038
              
              
              0.68
              
              $
              174,734
              
              $
              160
              
              
              0.12Savings
                  deposits
              
              
              353,195
              
              
              6,041
              
              
              2.29
              
              
              363,763
              
              
              3,515
              
              
              1.29Time
                  deposits
              
              
              577,631
              
              
              17,749
              
              
              4.11
              
              
              398,930
              
              
              8,444
              
              
              2.83Other
                  borrowings
              
              
              187,414
              
              
              6,856
              
              
              4.89
              
              
              166,113
              
              
              4,152
              
              
              3.34Subordinated
                  Debentures
              
              
              22,160
              
              
              1,407
              
              
              8.49
              
              
              16,496
              
              
              972
              
              
              7.88Total
                  interest-bearing liabilities
              
              
              1,345,609
              
              
              33,091
              
              
              3.29
              
              
              1,120,036
              
              
              17,243
              
              
              2.06Noninterest-bearing
                  deposits
              
              
              281,828
              
              
              
              
              
              
              
              
              268,343Accrued
                  interest, taxes and other liabilities
              
              
              15,169
              
              
              
              
              
              
              
              
              11,657Total
                  liabilities
              
              
              
              
              
              
              
              
              
              
              
              1,400,036Total
                  shareholders' equity
              
              
              131,319
              
              
              
              
              
              
              
              
              110,605Total
                  liabilities and shareholders' equity
              
              $
              1,773,925
              
              
              
              
              
              
              
              $
              1,510,641Net
                  interest income and margin
              
              
              
              
              $
              56,921
              
              
              4.64
              %
              
              
              
              $
              48,824
              
              
              4.67
              %
  (1)  Tax-equivalent
        adjustments included in the nontaxable investment securities portfolio are
        $ 879,000
        and $819,000 for the nine months ended September 30, 2006 and 2005. Tax
        equivalent adjustments included in the taxable investment securities created
        by
        a dividends received deduction were $60,000 and $97,000 for the nine months
        ended September 30, 2006 and 2005.
 (2)  Amounts
        of interest earned included loan fees of $2,805,000 and $2,457,000 and loan
        costs of $377,000 and $248,000 for the nine months ended September 30, 2006
        and
        2005, respectively.
 (3)  Net
        interest margin is computed by dividing net interest income by total average
        interest-earning assets.
  -16-
 Table
            of Contents
  NET
        INTEREST INCOME CHANGES DUE TO VOLUME AND RATE
  The
        following table sets forth, for the periods indicated, a summary of the changes
        in interest earned and interest paid resulting from changes in average asset
        and
        liability balances (Volume) and changes in average interest rates (Rate)
        and the
        total net change in interest income and expenses. The changes in interest
        due to
        both rate and volume have been allocated to volume and rate changes in
        proportion to the relationship of the absolute dollar amount of the change
        in
        each.
 
 Net
        Interest Income Variance Analysis:
  Three
                  months endedSeptember
                  30, 2006 compared to September 30, 2005(In
                  thousands)
              
              Volume
              
              Rate
              
              TotalIncrease
                  (decrease) in interest income:Federal
                  funds sold
              
              $
              69
              
              $
              12
              
              $
              81Time
                  deposits at other financial institutions
              
              
              -
              
              
              3
              
              
              3Taxable
                  investment securities
              
              
              (12
              )
              
              496
              
              
              484Tax-exempt
                  investment securities
              
              
              100
              
              
              (56
              )
              
              44Loans
              
              
              4,419
              
              
              2,485
              
              
              6,904Total:
              
              $
              4,576
              
              $
              2,940
              
              $
              7,516Increase
                  in interest expense:Interest
                  bearing demand
              
              $
              10
              
              $
              260
              
              $
              270Savings
                  deposits
              
              
              (152
              )
              
              1,005
              
              
              853Time
                  deposits
              
              
              2,272
              
              
              1,914
              
              
              4,186Other
                  borrowings
              
              
              (1
              )
              
              703
              
              
              702Junior
                  subordinated debentures
              
              
              322
              
              
              18
              
              
              340Total:
              
              $
              2,451
              
              $
              3,900
              
              $
              6,351Increase
                  in net interest income
              
              $
              2,125
              
              $
              (960
              )
              $
              1,165
  
 Nine
                  months endedSeptember
                  30, 2006 compared to September 30, 2005(In
                  thousands)
              
              Volume
              
              Rate
              
              TotalIncrease
                  (decrease) in interest income:Federal
                  funds sold
              
              $
              20
              
              $
              82
              
              $
              102Time
                  deposits at other financial institutions
              
              
              (5
              )
              
              2
              
              
              (3
              )Taxable
                  investment securities
              
              
              174
              
              
              1,391
              
              
              1,565Tax-exempt
                  investment securities
              
              
              452
              
              
              (39
              )
              
              413Loans
              
              
              13,204
              
              
              8,664
              
              
              21,868Total:
              
              $
              13,845
              
              $
              10,100
              
              $
              23,945Increase
                  in interest expense:Interest
                  bearing demand
              
              $
              33
              
              $
              845
              
              $
              878Savings
                  deposits
              
              
              (34
              )
              
              2,560
              
              
              2,526Time
                  deposits
              
              
              4,633
              
              
              4,672
              
              
              9,305Other
                  borrowings
              
              
              586
              
              
              2,118
              
              
              2,704Junior
                  subordinated debentures
              
              
              355
              
              
              80
              
              
              435Total:
              
              $
              5,573
              
              $
              10,275
              
              $
              15,848Increase
                  in net interest income
              
              $
              8,272
              
              $
              (175
              )
              $
              8,097
  Net
        interest income changes that occurred due to volume / rate differences were
        allocated to volume and rate changes based on the relative change in each
        in
        comparison to the total.
  -17-
 Table
            of Contents
  PROVISION
        FOR LOAN LOSSES
  The
        provision for loan losses was $200,000 and $400,000 for the three and nine
        months ended September 30, 2006 compared with $1,035,000 and $1,356,000 for
        the
        three and nine months ended September 30, 2005, a decrease of $835,000 or
        81%
        and $956,000 or 71%. See "Allowance for Loan Losses" elsewhere herein. As
        of
        September 30, 2006 the allowance for loan losses was $14,796,000 or 1.17%
        of
        total loans compared to $14,776,000 or 1.38% of total loans as of December
        31,
        2005. At September 30, 2006, nonperforming assets totaled $3,393,000 or 0.18%
        of
        total assets, nonperforming loans totaled $3,333,000 or 0.26% of total loans
        and
        the allowance for loan losses totaled 444% of nonperforming loans. At December
        31, 2005, nonperforming assets totaled $1,960,000 or 0.11% of total assets,
        nonperforming loans totaled $1,900,000 or 0.18% of total loans and the allowance
        for loan losses totaled 778% of nonperforming loans. No assurance can be
        given
        that nonperforming loans will not increase or that the allowance for loan
        losses
        will be adequate to cover losses inherent in the loan portfolio.
  NONINTEREST
        INCOME
 
 Noninterest
        income increased by $490,000 or 18% to $3,156,000 and $1,535,000 or 20% to
        $9,210,000 for the three and nine months ended September 30, 2006 compared
        with
        $2,666,000 and $7,675,000 for the same period during 2005. Service charges
        on
        deposit accounts decreased by $4,000 or 1% to $1,550,000 and increased by
        $28,000 or 1% to $4,475,000 for the three and nine months ended September
        30,
        2006 compared with $1,554,000 and $4,447,000 for the same period in 2005.
        The
        increase in service charges on deposit accounts for the nine month period
        was
        primarily the result of increased fees associated with increased fees charged
        on
        rejected items. The decrease for the three month period is associated with
        lower
        activity in fee products related to the Company’s bill pay service. The increase
        of $366,000 and $966,000 for the three months and nine months ended September
        30, 2006 in cash surrender value of life insurance policies was the result
        of a
        higher earnings rate and increased balances year over year. In the second
        quarter of 2006 the Company recognized a gain on the sale of securities of
        $622,000. The investment portfolio securities that were sold included
        approximately $6,917,000 in FHLMC preferred stock and $12,882,000 in an
        adjustable rate mutual fund. The FHLMC preferred stock was sold due to a
        recent
        increase in market value that was made possible by an increase in short term
        interest rates that occurred during the second quarter. The investment in
        the
        adjustable rate mutual fund was sold so that the sales proceeds could be
        reinvested in higher yielding investments. An increase in prepayments of
        mortgage notes purchased at a premium by the fund have had a detrimental
        effect
        on the Bank’s total return on this investment. There was no gain on the sale of
        securities recognized for the same time period in 2005 or for the third quarter
        of 2006. Other noninterest income increased by $438,000 or 55% and $689,000
        or
        28% for the three and nine month period ended September 30, 2006 when compared
        to the same period in 2005. The primary reason for the increase in other
        noninterest income is attributable to service fees associated with the addition
        of the asset based lending portfolio, in the first quarter of 2006, of $152,000
        and $389,000, for the three and nine months ended September 30, 2006. In
        addition, the Bank recognized a $190,000 gain on the sale of other real estate
        owned and accrual of a $179,000 of a bank owned life insurance payment in
        the
        third quarter.
 
 NONINTEREST
        EXPENSE **** ****
 
 Noninterest
        expenses increased by $2,692,000 or 26% to $12,992,000 and $7,264,000 or
        23% to
        $38,574,000 for the three and nine months ended September 30, 2006 compared
        with
        $10,300,000 and $31,310,000 for the same period in 2005. The primary components
        of noninterest expenses were salaries and employee benefits, premises and
        occupancy expenses, equipment expenses, professional fees, supplies expenses,
        marketing expenses, intangible amortization and other operating expenses.
  For
        the
        three and nine months ended September 30, 2006, salaries and related expenses
        increased by $1,755,000 or 32% and $4,739,000 or 28% to $7,293,000 and
        $21,487,000. This compares to the $5,538,000 and $16,748,000 for the three
        and
        nine months ended September 30, 2005. The increase was primarily the result
        of
        normal salary progression, increased support staff used to support branch
        operations, the staffing of new branch offices, regulatory compliance support
        functions, and the recognition of share-based payment expense as part of
        salaries and related benefits expense in 2006 due to the adoption of SFAS
        No.
        123R. Premises and occupancy expense increased by $217,000 or 18% and $610,000
        or 19% to $1,422,000 and $3,866,000 for the three and nine months ended
        September 30, 2006. This compares to the $1,205,000 and $3,256,000 recorded
        for
        the same period in 2005. The primary reason for the increase in 2006 was
        related
        to the opening of new branch facilities opened and the remodeling of existing
        facilities. Equipment expenses increased by $61,000 or 6% and increased by
        $193,000 or 7% to $1,096,000 and $3,129,000 for the three and nine months
        ended
        September 30, 2006. This compares with the $1,035,000 and $2,936,000 recorded
        for the three and nine months ended September 30, 2005. The additional equipment
        expenses were primarily the result of branch and department equipment upgrades
        and purchases related to the opening of new branch offices. When
        comparing the results for the three and nine months ended September 30, 2006
        to
        the same periods in September 30, 2005, professional fees increased by $60,000
        or 14% for the three months and increased by $332,000 or 20% for the nine
        months, marketing expenses increased by $129,000 or 56% and $358,000 or 42%,
        supplies expenses increased by $1,000 or 1% and decreased by $32,000 or 4%,
        community support donations increased by $86,000 or 48% and $200,000 or 35%,
        intangible amortization expenses decreased by $11,000 due to being fully
        amoritized, and other noninterest expenses increased $394,000 or 27% and
        $875,000 or 20% from 2005 levels. The increase in marketing expense was
        primarily the result of increased advertising expenses related to branch
        support
        and loan and deposit gathering efforts. The decrease in supplies expenses
        in the
        nine month period was primarily related to decreased administrative supplies
        used at the customer support center. The increased other noninterest expenses
        were primarily the result of increased correspondent bank charges caused
        by
        increased activity, and increased communications costs which were attributable
        to the opening of new facilities. Noninterest expenses associated with branches
        opened since January 1, 2005 approximate $400,000 for third quarter of 2006
        and
        $900,000 for the first nine months of 2006.
  -18-
 Table
            of Contents
  PROVISION
        FOR INCOME TAXES
  The
          Company recorded a decrease in the provision for income taxes of $561,000
          or 20%
          and an increase of $1,229,000 or 17% to $2,284,000 and $8,579,000 for the
          three
          and nine months ended September 30, 2006 compared to the $2,845,000 and
          $7,350,000 recorded for the same time period. During the three and nine
          months
          ended September 30, 2006, the Company recorded an effective tax rate of
          28% and
          33%. For the same time period in 2005, the Company recorded an effective
          tax
          rate of 34% and 32%. The receipt of $179,000 in the third quarter of 2006
          and
          $539,000 in the first quarter of 2005 in nontaxable bank owned life insurance
          death benefits lowered the effective tax rate experienced in 2006 and 2005.
          In
          2006, adjustments related to prior year unclaimed state housing tax credits
          in
          the amount of $187,000 lowered the effective tax rate for the three months
          ended
          September 30, 2006. This matter combined with certain prior period interest
          income reversals of interest income associated with excess interest being
          charged on certain loans (see “NET INTEREST INCOME”) resulted in an
          inconsequential impact on any period including the current period. Management
          also believes that these two issues are individually inconsequential. Excluding
          the bank owned life insurance death benefits and adjustments, the income
          tax
          rate for the first nine months of 2005 would have been 33%, compared to
          34% for
          the same time period in 2006. This decrease in the nine month year over
          year
          income tax rate is primarily due to increased realized housing tax credit
          benefits partially offset by the nondeductibility of incentive stock option
          compensation expense recorded in conformity with SFAS No. 123R during
          2006.
  **Financial
        Condition**
  Total
        assets at September 30, 2006 were $1,913,659,000, an increase of $156,903,000
        or
        9% compared with total assets of $1,756,756,000 at December 31, 2005. Net
        loans
        were $1,251,404,000 at September 30, 2006, an increase of $197,284,000 or
        19%
        compared with net loans of $1,054,120,000 at December 31, 2005. Deposits
        were
        $1,573,896,000 at September 30, 2006, an increase of $169,396,000 or 12%
        compared with deposits of $1,404,500,000 at December 31, 2005. The increase
        in
        total assets of the Company between December 31, 2005 and September 30, 2006
        was
        primarily funded by an increase in time deposit growth. Cash inflows generated
        from the increased deposits were primarily used to fund growth in the loan
        portfolio and to fund infrastructure expenditures related to branch
        expansion.
  Total
        shareholders' equity was $142,073,000 at September 30, 2006, an increase
        of
        $19,828,000 or 16% from the $122,245,000 at December 31, 2005. The growth
        in
        shareholders’ equity between December 31, 2005 and September 30, 2006 was
        primarily achieved through the retention of accumulated earnings.
  OFF-BALANCE
        SHEET COMMITMENTS
  The
        following table shows the distribution of the Company's undisbursed loan
        commitments at the dates indicated.
 
 September
                  30,
              
              December
                  31,(In
                  thousands)
              
              2006
              
              2005Letters
                  of credit
              
              $
              8,219
              
              $
              15,160Commitments
                  to extend credit
              
              
              459,788
              
              
              495,313Total
              
              $
              468,007
              
              $
              510,473
 
 As
        a
        financial services provider; we routinely commit to extend credit, including
        loan commitments, standby letters of credit and financial guarantees. A
        significant portion of commitments to extend credit may expire without being
        drawn upon. These commitments are subject to the same credit policies and
        approval process used for our loans.
 
 -19-
 Table
            of Contents
  CASH
        VALUE OF LIFE INSURANCE
  The
        Bank
        maintains certain cash surrender value life insurance policies to help offset
        some of the cost of employee benefit programs. They are also associated with
        a
        salary continuation plan for the Company's executive management and deferred
        retirement benefits for participating board members. These plans are informally
        linked with universal life insurance policies maintained by the Bank. Income
        from these policies is reflected in noninterest income. At September 30 2006,
        the Bank held $42,762,000 in cash surrender value life insurance, an increase
        of
        $10,966,000 from the $31,796,000 maintained at December 31, 2005. During
        the
        third quarter of 2006, the Company purchased an additional $10,000,000 in
        bank
        owned life insurance.
  INVESTMENT
        IN HOUSING TAX CREDIT LIMITED PARTNERSHIPS
  The
        Bank
        invests in housing tax credit limited partnerships to help meet the Bank’s
        Community Reinvestment Act low income housing investment requirements as
        well as
        to obtain federal and state income tax credits. These partnerships provide
        the
        funding for low-income housing projects that might not otherwise be created.
        The
        Bank had invested a total of $11,973,000 in these investments as of September
        30, 2006 and $11,727,000 as of December 31, 2005.
 
 INVESTMENT
        SECURITIES
 
 At
        September 30, 2006 equity securities included $5,093,000 of preferred stock
        issued by the Federal National Mortgage Association and the Federal Home
        Loan
        Mortgage Corporation. These issues of preferred stock are tied to various
        short
        term indexes ranging from the one year LIBOR interest rate to the five year
        U.S.
        Treasury rate. These securities have AA- credit ratings from the securities
        rating agencies and are callable by the issuer at par. During the second
        quarter
        of 2006 the Company sold $5,908,000 of these securities at a pretax gain
        of
        $1,009,000.
 
 The
        Company holds $2,531,000 of the common stock of Farmers and Merchants bank,
        a
        California based community bank. This investment decision was made based
        on
        management’s desire to invest in community banks that management believes have
        significant long-term appreciation potential. This purchase represents less
        than
        1% of the outstanding shares of Farmers and Merchants bank at the time of
        purchase, and has been accounted for using the cost method.
 
 -20-
 Table
            of Contents
  INTEREST
        RATE FLOOR
 
 During
        the third quarter of 2005, the Company purchased an interest rate floor from
        Wachovia Bank. The interest rate floor provides the Company with partial
        protection against an interest rate downturn on loans that are indexed off
        the
        Prime rate through September 1, 2010. For more information on the interest
        rate
        floor see the Note 1 in the derivative instruments and hedging activities
        section.
 
  The
        fair
        value and notional amounts for the cash flow hedge at September 30, 2006
        and
        December 31, 2005 are presented below:
 September
                  30, 2006
              
              December
                  31, 2005(In
                  thousands)
              
              Fair
                  Value
              
              Notional
                  Amount
              
              Fair
                  Value
              
              Notional
                  AmountPurchased
                  option, interest rate floor
              
              $
              438
              
              $
              100,000
              
              $
              743
              
              $
              100,000
 
 The
        decrease of $305,000 or 41% in the fair value of the interest rate floor
        between
        December 31, 2005 and September 30, 2006 was primarily the result of an
        increasing interest rate environment which caused a corresponding reduction
        in
        the probability that the Company will receive any future cash inflows related
        to
        this contract.
 
 NONPERFORMING
        ASSETS
 
 Nonperforming
        assets include nonaccrual loans, loans 90 days or more past due, restructured
        loans and other real estate owned.
  Nonperforming
        loans are those which the borrower fails to perform in accordance with the
        original terms of the obligation and include loans on nonaccrual status,
        loans
        past due 90 days or more and restructured loans. The Company generally places
        loans on nonaccrual status and accrued but unpaid interest is reversed against
        the current year's income when interest or principal payments become 90 days
        or
        more past due unless the outstanding principal and interest is adequately
        secured and, in the opinion of management, is deemed in the process of
        collection. Interest income on nonaccrual loans is recorded on a cash basis.
        Payments may be treated as interest income or return of principal depending
        upon
        management's opinion of the ultimate risk of loss on the individual loan.
        Cash
        payments are treated as interest income where management believes the remaining
        principal balance is fully collectible. Additional loans not 90 days past
        due
        may also be placed on nonaccrual status if management reasonably believes
        the
        borrower will not be able to comply with the contractual loan repayment terms
        and collection of principal or interest is in question.
  A
        "restructured loan" is a loan on which interest accrues at a below market
        rate
        or upon which certain principal has been forgiven so as to aid the borrower
        in
        the final repayment of the loan, with any interest previously accrued, but
        not
        yet collected, being reversed against current income. Interest is reported
        on a
        cash basis until the borrower's ability to service the restructured loan
        in
        accordance with its terms is reestablished. The Company had no restructured
        loans as of the dates indicated in the table below.
  The
        following table summarizes nonperforming assets of the Company at September
        30,
        2006 and December 31, 2005:
 
 September
                  30, 2006
              
              December
                  31, 2005(Dollars
                  in thousands)Nonaccrual
                  loans
              
              $
              3,333
              
              $
              1,692Accruing
                  loans past due 90 days or more
              
              
              -
              
              
              208Total
                  nonperforming loans
              
              
              3,333
              
              
              1,900Other
                  real estate owned
              
              
              60
              
              
              60Total
                  nonperforming assets
              
              $
              3,393
              
              $
              1,960Nonperforming
                  loans to total loans
              
              
              0.26
              %
              
              0.18
              %Nonperforming
                  assets to total assets
              
              
              0.18
              %
              
              0.11
              %
 
 -21-
 Table
            of Contents
  During
        the first nine months of 2006, eight customers with loans that totaled
        $2,550,000 were placed on nonaccrual status, while four customers with loans
        that totaled approximately $633,000 were removed from nonaccrual
        status.
  The
        increase in nonaccrual loans of $1,641,000 between September 30, 2006 and
        December 31, 2005 was primarily the result of individual customers with specific
        problems and not a degradation of overall credit quality.
  Contractual
        accrued interest income on loans on nonaccrual status as of September 30,
        2006
        and 2005, which would have been recognized if the loans had been current
        in
        accordance with their original terms, was approximately $292,000 and $152,000,
        respectively.
  At
        September 30, 2006, nonperforming assets represented 0.18% of total assets,
        an
        increase of 7 basis points when compared to the 0.11% at December 31, 2005.
        Nonperforming loans represented 0.26% of total loans at September 30, 2006,
        an
        increase of 8 basis points compared to the 0.18% at December 31, 2005.
        Nonperforming loans that were secured by first deeds of trust on real property
        were $1,209,000 and $1,684,000 at September 30, 2006 and December 31, 2005.
        The
        decrease in nonperforming loans that were secured by first deeds of trust
        on
        real property was primarily the result of the foreclosure and sale of property
        secured by a loan during the third quarter resulting in a gain realized from
        the
        sale of $190,000. Other forms of collateral such as inventory and equipment
        secured a portion of the nonperforming loans as of each date. No assurance
        can
        be given that the collateral securing nonperforming loans will be sufficient
        to
        prevent losses on such loans.
  In
        May
        2006, the Bank obtained two properties through foreclosure. During September
        2006, one of these properties was sold.  At September 30, 2006 the Company
        had $60,000 invested in two real estate properties that were acquired through
        foreclosure. At December 31, 2005, the Company had $60,000 invested in one
        real
        estate property that was acquired through foreclosure. These properties were
        carried at the lower of their estimated market value, as evidenced by an
        independent appraisal, or the recorded investment in the related loan, less
        estimated selling expenses. At foreclosure, if the fair value of the real
        estate
        is less than the Company's recorded investment in the related loan, a charge
        is
        made to the allowance for loan losses. The Company expects to sell one of
        two
        properties within the next twelve month period. No assurance can be given
        that
        the Company will sell the properties during 2006 or at any time or for an
        amount
        that will be sufficient to recover the Company’s investment in these properties.
  -22-
 Table
            of Contents
  Management
        defines impaired loans, regardless of past due status on loans, as those
        on
        which principal and interest are not expected to be collected under the original
        contractual loan repayment terms. An impaired loan is charged off at the
        time
        management believes the collection process has been exhausted. At September
        30,
        2006 and December 31, 2005, impaired loans were measured based on the present
        value of future cash flows discounted at the loan's effective rate, the loan's
        observable market price or the fair value of collateral if the loan is
        collateral-dependent. Impaired loans at September 30, 2006 were $3,333,000
        for
        which the Company made provisions to the allowance for loan losses of
        approximately $464,000.
  Except
        for loans that are disclosed above, there were no assets as of September
        30,
        2006, where known information about possible credit problems of the borrower
        causes management to have serious doubts as to the ability of the borrower
        to
        comply with the present loan repayment terms and which may become nonperforming
        assets. Given the scope and extent of the Company's loan portfolio, however,
        it
        is always possible that current credit problems may exist that may not have
        yet
        been identified by the Bank’s credit officers.
  **Allowance
        for Loan Losses**
 
 The
        following table summarizes the loan loss experience of the Company for the
        nine
        months ended September 30, 2006 and 2005, and for the year ended December
        31,
        2005.
 
 September
                  30,
              
              December
                  31,(Dollars
                  in thousands)
              
              2006
              
              2005
              
              2005Allowance
                  for Loan Losses:Balance
                  at beginning of period
              
              $
              14,776
              
              $
              13,605
              
              $
              13,605Provision
                  for loan losses
              
              
              400
              
              
              1,356
              
              
              2,051Charge-offs:Commercial
                  and agricultural
              
              
              942
              
              
              1,078
              
              
              1,664Real
                  estate - mortgage
              
              
              -
              
              
              -
              
              
              -Consumer
              
              
              319
              
              
              240
              
              
              318Total
                  charge-offs
              
              
              1,261
              
              
              1,318
              
              
              1,982RecoveriesCommercial
                  and agricultural
              
              
              763
              
              
              783
              
              
              903Real-Estate
                  - mortgage
              
              
              -
              
              
              -
              
              
              -Consumer
              
              
              118
              
              
              172
              
              
              199Total
                  recoveries
              
              
              881
              
              
              955
              
              
              1,102Net
                  charge-offs
              
              
              380
              
              
              363
              
              
              880Balance
                  at end of period
              
              $
              14,796
              
              $
              14,598
              
              $
              14,776Loans
                  outstanding at period-end
              
              $
              1,266,200
              
              $
              1,027,231
              
              $
              1,068,896Average
                  loans outstanding
              
              $
              1,168,887
              
              $
              947,022
              
              $
              968,492Annualized
                  net charge-offs to average loans
              
              
              0.04
              %
              
              0.05
              %
              
              0.09
              %Allowance
                  for loan lossesTo
                  total loans
              
              
              1.17
              %
              
              1.42
              %
              
              1.38
              %To
                  nonperforming loans
              
              
              443.92
              %
              
              711.75
              %
              
              777.68
              %To
                  nonperforming assets
              
              
              436.07
              %
              
              691.52
              %
              
              753.88
              %
  -23-
 Table
            of Contents
  The
          Company maintains an allowance for loan losses at a level considered by
          management to be sufficient to cover the inherent risks of loss associated
          with
          its loan portfolio under prevailing economic conditions. In determining
          the
          adequacy of the allowance for loan losses, management takes into consideration,
          among other things, growth trends in the portfolio, examination by financial
          institution supervisory authorities, prior loan loss experience for the
          Company,
          concentrations of credit risk, delinquency trends, specific credit risks,
          general economic conditions, the interest rate environment and internal
          and
          external credit reviews. In addition, the risks management considers vary
          depending on the nature of the loan. The normal risks considered by management
          with respect to agricultural loans include, among other things, the fluctuating
          value of the collateral, changes in weather conditions and the availability
          of
          adequate water resources in the Company's local market area. The normal
          risks
          considered by management with respect to real estate construction loans
          include,
          among other things, fluctuation in real estate values, the demand for improved
          commercial and industrial properties and housing, the availability of permanent
          financing in the Company's market area and borrowers' ability to obtain
          permanent financing. The normal risks considered by management with respect
          to
          real estate mortgage loans include, among other things, fluctuations in
          the
          value of real estate. Additionally, the Company relies on data obtained
          through
          independent appraisals for significant properties to determine loss exposure
          on
          nonperforming loans.
  The
          balance in the allowance is affected by the amounts provided from operations,
          amounts charged off and recoveries of loans previously charged off. The
          Company
          recorded a provision for loan losses in the first nine months of 2006 of
          $400,000 compared with $1,356,000 in the same period of 2005. The decrease
          was
          related to the overall improvement in the credit risks associated with
          the
          Bank’s individual credit relationships during the first nine months of 2006
          when
          compared to the same period in 2005. The Company had net chargeoffs of
          $380,000
          for the nine months ended September 30, 2006 compared with net charge-offs
          of
          $363,000 for the same nine months in 2005. The increased chargeoffs occurred
          primarily within the consumer segment of the loan portfolio.
  As
          of
          September 30, 2006, the allowance for loan losses was $14,796,000 or 1.17%
          of
          total loans outstanding, compared with $14,776,000 or 1.38% of total loans
          outstanding as of December 31, 2005 and $14,598,000 or 1.42% of total loans
          outstanding as of September 30, 2005.
  During
          the third quarter of 2006, the Company enhanced its methodology used to
          compute
          the adequacy of the Allowance for Loan Losses. Prior to the third quarter
          2006,
          the Company utilized regulatory guidance as a measuring metric to determine
          the
          level of reserve for loan losses required.
  In
          the
          third quarter of 2006, management completed their data collection and historical
          loss calculations, and began using documented historical loss experience
          by loan
          type to develop a statistically relevant model to reserve for inherent
          losses in
          the loan portfolio. This new methodology resulted in a reserve that was
          materially the equivalent of the figure developed under the prior method.
          There
          was no provision adjustment recorded relevant to this enhancement in
          methodology.
  -24-
 Table
            of Contents
  The
        allowance is based on estimates and ultimate future losses may vary from
        current
        estimates. It is possible that future economic or other factors may adversely
        affect the Company's borrowers, and thereby cause loan losses to exceed the
        current allowance. In addition, there can be no assurance that future economic
        or other factors will not adversely affect the Company's borrowers, or that
        the
        Company's asset quality may not deteriorate through rapid growth, failure
        to
        enforce underwriting standards, failure to maintain appropriate underwriting
        standards, failure to maintain an adequate number of qualified loan personnel,
        failure to identify and monitor potential problem loans or for other reasons,
        and thereby cause loan losses to exceed the current allowance.
  The
        allocation of the allowance to loan categories is an estimate by credit officers
        of the relative risk characteristics of loans in those categories. No assurance
        can be given that losses in one or more loan categories will not exceed the
        portion of the allowance allocated to that category or even exceed the entire
        allowance.
 
 OTHER
        ASSETS
 
 At
        September 30, 2006, the Company recorded a balance in other assets of
        $29,296,000 and $32,281,000 at December 31, 2005. The majority of the balance
        in
        other assets was primarily due to a $13,332,000 and $16,296,000 loan
        participation funding receivable at September 30, 2006 and December 31, 2005.
        During October 2006 and January 2006, the respectively, funding receivables
        were
        collected from the participating banks.
 
 RESERVE
        FOR UNFUNDED LENDING COMMITMENTS
 
 The
        reserve for unfunded lending commitments included in other liabilities at
        September 30, 2006 and 2005, and December 31, 2005, is presented
        below:
 September
                  30,
              
              December
                  31,(Dollars
                  in thousands)
              
              2006
              
              2005
              
              2005Balance
                  at the beginning of period
              
              $
              717
              
              $
              679
              
              $
              679Provision
                  for credit losses
              
              
              (7
              )
              
              24
              
              
              38Balance
                  at the end of period
              
              $
              710
              
              $
              703
              
              $
              717
  EXTERNAL
        FACTORS AFFECTING ASSET QUALITY
  As
        a
        result of the Company's loan portfolio mix, the future quality of its assets
        could be affected by adverse economic trends in its region or in the
        agricultural community. These trends are beyond the control of the Company.
  California
        is an earthquake-prone region. Accordingly, a major earthquake could result
        in
        material loss to the Company. At times the Company's service area has
        experienced other natural disasters such as floods and droughts. The Company's
        properties and substantially all of the real and personal property securing
        loans in the Company's portfolio are located in California. The Company faces
        the risk that many of its borrowers face uninsured property damage, interruption
        of their businesses or loss of their jobs from earthquakes, floods or droughts.
        As a result these borrowers may be unable to repay their loans in accordance
        with their terms and the collateral for such loans may decline significantly
        in
        value. The Company's service area is a largely agricultural region and therefore
        is highly dependent on a reliable supply of water for irrigation purposes.
        The
        area obtains nearly all of its water from the run-off of melting snow in
        the
        mountains of the Sierra Nevada to the east. Although such sources have usually
        been available in the past, water supply can be adversely affected by light
        snowfall over one or more winters or by any diversion of water from its present
        natural courses. Any such natural disaster could impair the ability of many
        of
        the Company's borrowers to meet their obligations to the Company.
  Parts
        of
        California have experienced significant floods during 2006. No assurance
        can be
        given that future flooding will not have an adverse impact on the Company
        and
        its borrowers and depositors.
  -25-
 Table
            of Contents
   LIQUIDITY
  In
        order
        to maintain adequate liquidity, the Company must have sufficient resources
        available at all times to meet its cash flow requirements. The need for
        liquidity in a banking institution arises principally to provide for deposit
        withdrawals, the credit needs of its customers and to take advantage of
        investment opportunities as they arise. The Company may achieve desired
        liquidity from both assets and liabilities. The Company considers cash and
        deposits held in other banks, federal funds sold, other short term investments,
        maturing loans and investments, payments of principal and interest on loans
        and
        investments and potential loan sales as sources of asset liquidity. Deposit
        growth and access to credit lines established with correspondent banks and
        market sources of funds are considered by the Company as sources of liability
        liquidity. The holding company’s primary source of liquidity is from dividends
        received from the Bank. Dividends from the Bank are subject to certain
        regulatory restrictions.
  The
        Company reviews its liquidity position on a regular basis based upon its
        current
        position and expected trends of loans and deposits. These assets include
        cash
        and deposits in other banks, time deposits at other financial institutions,
        available-for-sale securities and federal funds sold. The Company's liquid
        assets totaled $337,070,000 and $410,086,000 on
        September 30, 2006 and December 31, 2005, respectively, and constituted 18%
        and
        23% of total assets on both those dates. Liquidity is also affected by the
        collateral requirements of its public deposits and certain borrowings. Total
        pledged securities were $274,508,000 at September 30, 2006 compared with
        $452,337,000 at December 31, 2005.
  Although
        the Company's primary sources of liquidity include liquid assets and our
        deposit
        base, the Company maintains lines of credit with the Federal Reserve Bank
        of San
        Francisco, Federal Home Loan Bank of San Francisco, Pacific Coast Banker’s Bank,
        Union Bank of California, Wells Fargo Bank and First Tennessee Bank aggregating
        $233,292,000 of which $48,400,000 was outstanding as of September 30, 2006
        and $260,684,000
        of which $93,384,000 was
        outstanding as of December 31, 2005. Management believes that the Company
        maintains adequate amounts of liquid assets to meet its liquidity needs.
        The
        Company's liquidity might be insufficient if deposit withdrawals were to
        exceed
        anticipated levels. Deposit withdrawals can increase if a company experiences
        financial difficulties or receives adverse publicity for other reasons, or
        if
        its pricing, products or services are not competitive with those offered
        by
        other institutions.
  CAPITAL
        RESOURCES
  Capital
        serves as a source of funds and helps protect depositors against potential
        losses. The primary source of capital for the Company has been internally
        generated capital through retained earnings. The Company's shareholders'
        equity
        increased by $19,828,000 or 16% from December 31, 2005 to September 30, 2006.
        This increase was achieved through the retention of accumulated earnings
        and the
        exercise of stock options.
  The
        Company is subject to various regulatory capital requirements administered
        by
        the federal banking agencies. Failure to meet minimum capital requirements
        can
        initiate mandatory and possibly additional discretionary actions by the
        regulators that, if undertaken, could have a material adverse effect on the
        Company’s financial statements. Management believes, as of September 30, 2006,
        that the Company and the Bank met all applicable capital requirements. The
        Company’s leverage capital ratio at September 30, 2006 was 9.60% as compared
        with 8.57% as of December 31, 2005. The Company’s total risk based capital ratio
        at September 30, 2006 was 11.91% as compared to 11.13% as of December 31,
        2005.
  -26-
 Table
            of Contents
   In
        the
        opinion of management, the Company’s and Bank’s actual capital amounts and
        ratios met all regulatory requirements as of September 30, 2006 and are
        summarized as follows:
 (Dollars
                  in thousands)
              
              Actual
              
              For
                  Capital Adequacy Purposes
              
              To
                  Be Well Capitalized Under Prompt Corrective Action
                  Provisions:**The
                  Company:**
              
              Amount
              
              Ratio
              
              Amount
              
              Ratio
              
              Amount
              
              RatioTotal
                  capital (to risk weighted assets)
              
              $
              189,549
              
              
              11.91
              %
              $
              127,335
              
              
              8.0
              %
              $
              159,169
              
              
              10.0
              %Tier
                  1 capital (to risk weighted assets)
              
              
              173,938
              
              
              10.93
              
              
              63,668
              
              
              4.0
              
              
              95,501
              
              
              6.0Leverage
                  ratio(1)
              
              
              173,938
              
              
              9.60
              
              
              72,502
              
              
              4.0
              
              
              90,628
              
              
              5.0**The
                  Bank:**Total
                  capital (to risk weighted assets)
              
              $
              162,680
              
              
              10.27
              %
              $
              126,760
              
              
              8.0
              %
              $
              158,450
              
              
              10.0
              %Tier
                  1 capital (to risk weighted assets)
              
              
              147,069
              
              
              9.28
              
              
              63,380
              
              
              4.0
              
              
              95,070
              
              
              6.0Leverage
                  ratio(1)
              
              
              147,069
              
              
              8.14
              
              
              72,229
              
              
              4.0
              
              
              90,287
              
              
              5.0
 (1)
        The
        leverage ratio consists of Tier 1 capital divided by adjusted quarterly average
        assets. The minimum leverage ratio is 3 percent for banking organizations
        that
        do not anticipate significant growth and that have well-diversified risk,
        excellent asset quality and in general, are considered top-rated
        banks.
 
  The
        Company’s and Bank’s actual capital amounts and ratios met all regulatory
        requirements as of December 31, 2005 and were summarized as
        follows:
  (Dollars
                  in thousands)
              
              Actual
              
              For
                  Capital Adequacy Purposes
              
              To
                  Be Well Capitalized Under Prompt Corrective Action
                  Provisions**The
                  Company:**
              
              Amount
              
              Ratio
              
              Amount
              
              Ratio
              
              Amount
              
              RatioTotal
                  capital (to risk weighted assets)
              
              $
              154,592
              
              
              11.13
              %
              $
              111,151
              
              
              8
              %
              $
              138,939
              
              
              10
              %Tier
                  I capital (to risk weighted assets)
              
              
              139,099
              
              
              10.01
              
              
              55,576
              
              
              4
              
              
              83,364
              
              
              6Leverage
                  ratio(1)
              
              
              139,099
              
              
              8.57
              
              
              64,960
              
              
              4
              
              
              81,200
              
              
              5**The
                  Bank:**Total
                  capital (to risk weighted assets)
              
              $
              141,945
              
              
              10.24
              
              $
              110,868
              
              
              8
              %
              $
              138,585
              
              
              10
              %Tier
                  I capital (to risk weighted assets)
              
              
              126,452
              
              
              9.12
              
              
              55,434
              
              
              4
              
              
              83,151
              
              
              6Leverage
                  ratio(1)
              
              
              126,452
              
              
              7.80
              
              
              64,830
              
              
              4
              
              
              81,038
              
              
              5
 (1)
        The
        leverage ratio consists of Tier 1 capital divided by quarterly average assets.
        The minimum leverage ratio is 3 percent for banking organizations that do
        not
        anticipate significant growth and that have well diversified risk, excellent
        asset quality and in general, are considered top-rated banks.
  The
        Company declares dividends solely at the discretion of the Company’s Board of
        Directors, subject to compliance with regulatory requirements. In order to
        pay
        any cash dividends, the Company must receive payments of dividends or management
        fees from the Bank. There are certain regulatory limitations on the payment
        of
        cash dividends by banks.
  DEPOSITS
  Deposits
        are the Company's primary source of funds. At September 30, 2006, the Company
        had a deposit mix of 26% in savings deposits, 44% in time deposits, 13% in
        interest-bearing checking accounts and 17% in noninterest-bearing demand
        accounts. Noninterest-bearing demand deposits enhance the Company's net interest
        income by lowering its cost of funds.
  -27-
 Table
            of Contents
  The
        Company obtains deposits primarily from the communities it serves. No material
        portion of its deposits has been obtained from or is dependent on any one
        person
        or industry. The Company's business is not seasonal in nature. The Company
        accepts time deposits in excess of $100,000 from customers. These deposits
        are
        priced to remain competitive. At September 30, 2006, the Company had brokered
        deposits of $124,258,000. At December 31, 2005, the Company’s brokered deposits
        totaled $20,861,000. The increase in brokered deposits during the first nine
        months of 2006 was related to loan funding requirements. The Bank has a policy
        target for brokered deposits of no more than 15% of the Bank’s asset base.
        Brokered deposits did not exceed the policy limit as of September 30, 2006.
        The
        Bank increased its policy limit to 15 percent for 7 percent of assets in
        the
        third quarter. This policy change reflects management’s belief that the risks
        related to this higher level of brokered deposits are manageable, and the
        liquidity provided by them is a valuable source of cash inflows that is
        available for making investments or paying down borrowings.
 
 Maturities
        of time certificates of deposits of $100,000 or more outstanding at September
        30, 2006 and December 31, 2005 are summarized as follows:
 (Dollars
                  in thousands)
              
              September
                  30, 2006
              
              December
                  31, 2005Three
                  months or less
              
              $
              145,133
              
              $
              106,874Over
                  three to six months
              
              
              134,287
              
              
              24,365Over
                  six to twelve months
              
              
              111,404
              
              
              39,005Over
                  twelve months
              
              
              21,717
              
              
              64,781Total
              
              $
              412,541
              
              $
              235,025
 
 **Federal
        Funds Purchased and Other Borrowed Funds**
  The
        total
        of federal funds purchased and other borrowed funds decreased by $49,099,000
        or
        24% to $152,629,000 at September 30, 2006 compared to the $201,728,000
        outstanding at December 31, 2005. Other borrowed funds have decreased primarily
        by the repayment of obligations obtained from maturities that occurred within
        the Company’s investment portfolio and the issuance of a $15,464,000
        subordinated debenture, decreasing the need for other borrowings.
 
 In
        December 2005, the Bank entered into a repurchase agreement with an embedded
        LIBOR floor for $100,000,000 with J.P. Morgan. This agreement has a maturity
        date of December 15, 2010. The repurchase agreement will help to insulate
        the
        Company from the effects of a downward rate environment. For more information
        about the agreement, see Note 5 on “Other Borrowings” in the Company’s 2005
        annual report.
 
 **Return
        on Equity and Assets**
 
 Nine
                  Months Ended September 30,
              
              Three
                  Months Ended September 30,
              
              Year
                  ended December 312006
              
              2005
              
              2006
              
              2005Annualized
                  return on average assets
              
              
              1.33
              %
              
              1.37
              %
              
              1.29
              %
              
              1.36
              %Annualized
                  return on average equity
              
              
              17.91
              %
              
              18.77
              %
              
              17.05
              %
              
              18.54
              %Average
                  equity to average assets
              
              
              7.40
              %
              
              7.32
              %
              
              7.54
              %
              
              7.34
              %Dividend
                  payout ratio
              
              
              12.73
              %
              
              10.07
              %
              
              14.79
              %
              
              9.00
              %
  **Impact
        of Inflation**
  The
        primary impact of inflation on the Company is its effect on interest rates.
        The
        Company’s primary source of income is net interest income which is affected by
        changes in interest rates. The Company attempts to limit inflation’s impact on
        its net interest margin through management of rate sensitive assets and
        liabilities and the analysis of interest rate sensitivity. The effect of
        inflation on premises and equipment, as well as on interest expenses, has
        not
        been significant for the periods covered in this report.
 
  -28-
 Table
            of Contents
  **Item
        3. Quantitative and Qualitative Disclosures about Market Risk**
 
 In
        the
        normal course of business, the Company is exposed to market risk which includes
        both price and liquidity risk. Price risk is created from fluctuations in
        interest rates and the mismatch in repricing characteristics of assets,
        liabilities, and off balance sheet instruments at a specified point in time.
        Mismatches in interest rate repricing among assets and liabilities arise
        primarily through the interaction of the various types of loans versus the
        types
        of deposits that are maintained as well as from management's discretionary
        investment and funds gathering activities. Liquidity risk arises from the
        possibility that the Company may not be able to satisfy current and future
        financial commitments or that the Company may not be able to liquidate financial
        instruments at market prices. Risk management policies and procedures have
        been
        established and are utilized to manage the Company's exposure to market risk.
        Quarterly testing of the Company’s assets and liabilities under both increasing
        and decreasing interest rate environments are performed to insure the Company
        does not assume a magnitude of risk that is outside approved policy
        limits.
 
 The
        Company’s success is largely dependent upon its ability to manage interest rate
        risk. Interest rate risk can be defined as the exposure of the Company’s net
        interest income to adverse movements in interest rates. Although the Company
        manages other risks, such as credit and liquidity risk in the normal course
        of
        its business, management considers interest rate risk to be its most significant
        market risk and could potentially have the largest material effect on the
        Company’s financial condition and results of operations. Correspondingly, the
        overall strategy of the Company is to manage interest rate risk, through
        balance
        sheet structure, to be interest rate neutral.
 
 The
        Company’s interest rate risk management is the responsibility of the
        Asset/Liability Management Committee (ALCO), which provides monthly reports
        to
        the Board of Directors. ALCO establishes policies that monitor and coordinate
        the Company’s sources, uses and pricing of funds. ALCO is also involved in
        formulating the economic projections for the Company’s budget and strategic
        plan. ALCO sets specific rate sensitivity limits for the Company. ALCO monitors
        and adjusts the Company’s exposure to changes in interest rates to achieve
        predetermined risk targets that it believes are consistent with current and
        expected market conditions. Balance sheet management personnel monitor the
        asset
        and liability changes on an ongoing basis and provide report information
        and
        recommendations to the ALCO committee in regards to those changes.
 
 It
        is the
        opinion of management there has been no material change in the Company’s market
        risk during the first nine months of 2006 when compared to the level of market
        risk at December 31, 2005. If interest rates were to suddenly and materially
        fall from levels experienced during the first nine months of 2006, the Company
        could become susceptible to an increased level of market risk.
 
 **Item
        4. Controls and Procedures**
 
 EVALUATION
        OF DISCLOSURE CONTROLS AND PROCEDURES
 
 Under
        the
        supervision and with the participation of the Company’s management, including
        its chief executive officer and chief financial officer, the Company conducted
        an evaluation of the effectiveness of the design and operation of its disclosure
        controls and procedures as defined by Rule 13a-15(e) under the Securities
        Exchange Act of 1934.
 
 Based
        on
        the evaluation, the chief executive officer and chief financial officer
        concluded that as of the end of the period covered by this report the disclosure
        controls and procedures were adequate and effective, and that the material
        information required to be included in this report, including information
        from
        the Company’s consolidated subsidiaries, was properly recorded, processed,
        summarized and reported, and was made known to the chief executive officer
        and
        chief financial officer by others within the Company in a timely manner,
        particularly during the period when this quarterly report on Form 10-Q was
        being
        prepared.
  -29-
 Table
            of Contents
  CHANGES
        IN INTERNAL CONTROL OVER FINANCIAL REPORTING
 
 There
        was
        no change in the Company’s internal control over financial reporting that
        occurred during the most recent fiscal quarter that materially affected,
        or is
        reasonably likely to materially affect, the internal control over financial
        reporting.
  **PART
        II - Other Information**
  **Item
        1. Legal Proceedings**
  The
        Company is a party to routine litigation in the ordinary course of its business.
        In the opinion of management, pending and threatened litigation is not likely
        to
        have a material adverse effect on the financial condition or results of
        operations of the Company.
  The
        Bank
        was subject to one lawsuit where the legal costs incurred by the Bank have
        totaled over $250,000, the amount of the Company’s insurance deductible. During
        the month of July 2006, a settlement agreement was executed related to this
        lawsuit. The settlement was funded by the Bank’s insurance carrier and was
        settled to the mutual satisfaction of the parties.
 
 **Item
        1A. Risk Factors**
  See
        “External Factors Affecting Asset Quality” in Part I.
  **Item
        2. Unregistered Sales of Equity Securities and Use of
        Proceeds.**
  None.
  **Item
        3. Defaults Upon Senior Securities.**
  None.
  **Item
        4. Submission of Matters to a Vote of Security
        Holders.**
  None.
  **Item
        5. Other Information.**
  In
        the
        opinion of management, there is no additional information relating to these
        periods being reported which warrants inclusion in the report.
  **Item
        6. Exhibits**
  See
        Exhibit Index
  -30-
 Table
            of Contents
   **SIGNATURES**
  Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        duly caused this report to be signed on its behalf by the undersigned, thereunto
        duly authorized.
  CAPITAL
        CORP OF THE WEST
 (Registrant)
 
 Date:
                  November 9, 2006
              By/s/
                  Thomas T. HawkerThomas
                  T. HawkerPresident
                  andChief
                  Executive Officer
 
 
 Date:
                  November 9, 2006
              By/s/
                  David A. HeaberlinDavid
                  A. HeaberlinChief
                  Financial Officer/Treasurer
  -31-
  **Exhibit
        Index**
 
 Exhibit
              Description31.1
              Certification
                  of Registrant's Chief Executive
                  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200231.2
              Certification
                  of Registrant's Chief Financial
                  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200232.1
              Certification
                  of Registrant’s Chief Executive
                  Officer Pursuant to 18 U.S.C. Section 135032.2
              Certification
                  of Registrant’s Chief Financial
                  Officer Pursuant to 18 U.S.C. Section
                  1350
 
 -32-