**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


Washington,
DC 20549


______________________________________________





**FORM
10-K**





ANNUAL
REPORT PURSUANT TO SECTION 13 or 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934







For the fiscal year
ended December 31, 2004 Commission
File No. 0-20862





**VINEYARD
NATIONAL BANCORP**


(Exact
Name of Registrant as Specified in its Charter)





California
      (State
      of other jurisdiction of
      incorporation
      or organization)
    
    33-0309110
      (IRS
      Employer
      Identification
      Number)9590
      Foothill Boulevard
      Rancho
      Cucamonga, California
      (Address
      of principal executive offices)
    
    91730
      (Zip
      Code)





Registrant’s
telephone number, including area code: (909) 581-1668





Securities
registered pursuant to Section 12(b) of the Act: None





Securities
registered pursuant to Section 12(g) of the Act:





**Common
Stock, no par value**





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




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




Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes x No o




The
aggregate value of the 7,317,263 shares of Common Stock of the registrant issued
and outstanding, which excludes 1,513,093 shares held by all directors and
executive officers of the registrant as a group, was approximately $146.0
million based on the last closing sales price on a share of Common Stock of
$19.95 as of June 30, 2004.




9,534,681
shares of Common Stock of the registrant were outstanding at February 22,
2005.




DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of the registrant’s definitive Proxy Statement for its 2005 Annual Meeting of
Shareholders are incorporated by reference in Part III of this Form
10-K.













**TABLE
OF CONTENTS**







PART
      I
    
    PAGEITEM
      1.
    Business
    4ITEM
      2.
    Properties
    37ITEM
      3.
    Legal
      Proceedings
    38ITEM
      4.
    Submission
      of Matters to a Vote of Security Holders
    38PART
      IIITEM
      5.
    Market
      for Registrant’s Common Equity, Related StockholderMatters
      and Issuer Purchases of Equity Securities
    38ITEM
      6.
    Selected
      Financial Data
    41ITEM
      7.
    Management’s
      Discussion and Analysis of Financial Conditionand
      Results of Operations
    42ITEM7A.
    Quantitative
      and Qualitative Disclosures About Market Risk
    55ITEM
      8.
    Financial
      Statements and Supplementary Data
    56ITEM
      9.
    Changes
      in and Disagreements With Accountants on Accountingand
      Financial Disclosure
    90ITEM
      9A.
    Controls
      and Procedures
    90ITEM
      9B.
    Other
      Information
    93PART
      IIIITEM
      10.
    Director
      and Executive Officers of the Registrant
    93ITEM
      11.
    Executive
      Compensation
    93ITEM
      12.
    Security
      Ownership of Certain Beneficial Owners and Management
    93ITEM
      13.
    Certain
      Relationships and Related Transactions
    93ITEM
      14.
    Principal
      Accountant Fees and Services
    93PART
      IVITEM
      15.
    Exhibits
      and Financial Statement Schedules
    93








2





**Forward-looking
Statements**





Except
for historical information contained herein, the matters discussed in this Form
10-K contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements represent estimates,
projections and statements of our beliefs concerning future events, business
plans, objectives, expected operating results and the assumptions upon which
those statements are based. Forward-looking statements include without
limitation, any statement that may predict, forecast, indicate or imply future
results, performance or achievements, and are typically identified with words
such as “believe,” “anticipate,” “expect,” “estimate,” “project,” “intend,”
“will,” “may,” or words or phases of similar meaning. Vineyard National Bancorp
(the “Company”) cautions that the forward-looking statements are based largely
on the expectations of the Company and are subject to a number of known and
unknown risks and uncertainties that are subject to change based on factors
which are, in many instances, beyond the Company’s control. Actual results,
performance or achievements could differ materially from those contemplated,
expressed, or implied by the forward-looking statements contained herein. For a
discussion of some of the risks and uncertainties that might cause such a
difference, see Item 1. Business; Risk Factors. Investors should not place undue
reliance on forward-looking statements as a prediction of actual results. The
Company will not update the forward-looking statements to reflect actual results
or changes in the factors affecting the forwarding-looking statements.





3





**PART
I**





**ITEM
1. B** **usiness**





**Vineyard
National Bancorp**





Vineyard
National Bancorp (the “Company”) was incorporated under the laws of the State of
California on May 18, 1988 and commenced business on December 16, 1988 when,
pursuant to a reorganization, the Company acquired all of the voting stock of
Vineyard Bank, a California-chartered commercial bank (the “Bank”). As a bank
holding company, the Company is registered under and subject to the Bank Holding
Company Act of 1956, as amended. The Company’s principal asset is the capital
stock of the Bank, a $1.3 billion (asset) commercial bank, and the business of
the Bank is carried on as a wholly-owned subsidiary of the Company. On November
12, 2002, the Company’s common stock was listed on the NASDAQ National Market
System and is publicly traded under the symbol “VNBC”. Prior to that, the
Company’s common stock was traded on the NASDAQ SmallCap Stock Market under the
same symbol. In July 2003, the Bank completed the acquisition of Southland
Business Bank, a California-chartered commercial bank (“Southland Bank”),
located in Irwindale, California (See Item 8. Financial Statements and
Supplementary Data; Note #10 - Acquisitions.). The Company had approximately
2,800 **** shareholders
that own approximately 9,534,681 shares of the Company’s common stock as of
February 22, 2005.





The
Company’s principal business is to serve as a holding company for the Bank and
for other banking or banking-related subsidiaries which the Company may
establish or acquire. The Company may, in the future, consider acquiring other
businesses or engaging in other activities as permitted under the Federal
Reserve Board (the “FRB”) regulations.





The
Company’s principal source of income is dividends from the Bank. Legal
limitations are imposed on the amount of dividends that may be paid and loans
that may be made by the Bank to the Company (See Item 1. Business; Supervision
and Regulation; Dividends and Other Transfer of Funds).





As of
December 31, 2004, the Company had total consolidated assets of $1.3 billion,
total consolidated net loans of $1.0 billion, total consolidated deposits of
$965.5 million and total consolidated stockholders’ equity of $85.2
million.





The
Company makes available free of charge on its website
at www.vineyardbank.com
itsannual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments thereto, as soon as reasonably
practicable after the Company files such reportswith, or furnishes them
to, the Securities and Exchange Commission (“SEC”). Investors are encouraged to
access these reports and the other information about the Company’s business on
its website.





**Vineyard
Bank**





The Bank
was organized as a national banking association under federal law and commenced
operations under the name Vineyard National Bank on September 10, 1981. In
August 2001, the Bank changed its name to Vineyard Bank and converted its
charter to a California-chartered commercial bank and now operates under the
supervision of the California Department of Financial Institutions (the “DFI”)
and the Federal Deposit Insurance Corporation (the “FDIC”). The Bank determined
that it could better serve its customers by converting to a state bank, which
provided the Bank with increased lending limits. The Bank’s deposit accounts are
insured by the FDIC up to the maximum amount permitted by law.





The Bank
is a community bank, dedicated to relationship banking and the success of its
customers. The Bank is primarily involved in attracting deposits from
individuals and businesses and using those deposits, together with borrowed
funds, to originate commercial business and commercial real estate loans,
primarily to small businesses, churches and private schools, single-family
construction loans (both tract and coastal loans), Small Business Administration
(“SBA”) loans, income property loans and, to a lesser extent, various types of
consumer loans. The Bank is focused on serving the needs of commercial
businesses with annual sales of less than $25 million, retail community
businesses, single-family residential developers and builders, individuals and
local public and private organizations. The Bank has experienced substantial
growth in recent years as it has expanded its core deposit franchise through its
nine banking centers and increased its originations of commercial and
residential construction loans along with income property loans.





4





The Bank
operates nine full-service banking centers, which are located in each of the
communities of Rancho Cucamonga, Chino, Diamond Bar, La Verne, Crestline, Lake
Arrowhead, Irwindale, Manhattan Beach and Corona, all of which are located in
Los Angeles, Riverside and San Bernardino counties in California. The Inland
Empire area of Riverside and San Bernardino counties is located approximately 50
miles east of Los Angeles, California. The Rancho Cucamonga office also serves
as the Company’s headquarters. In addition, the Bank operates two SBA loan
production offices located in San Diego and Anaheim, California and an income
property loan production office located in Irvine, California.





Since the
hiring of its current president and chief executive officer in October 2000, the
Bank has experienced significant growth pursuant to the execution of its
strategic business plan, which emphasizes growth through the expansion of its
lending products and deposit services. As the Bank has implemented its growth
strategy, it has added additional executive management personnel with developed
business banking and service skills, concentrating on a sales and service
approach to its banking business. The Bank’s management team has focused its
efforts into developing a customer-oriented service philosophy, while expanding
the Bank’s lending products by creating various specialty lending groups. The
Bank believes that expanding many of its existing relationships will prove to be
an effective source of new business opportunities. The Bank is focused on
providing relationship banking services to the following markets: (i) the
Inland Empire region of Southern California, which primarily includes San
Bernardino and Riverside counties; (ii) the coastal communities surrounding
Los Angeles, California; (iii) the San Gabriel Valley region of Los
Angeles; and (iv) the coastal communities of south Orange County and San Diego.
The Bank has targeted these markets because of its experience in and knowledge
of, as well as the anticipated continued growth and potential for development
in, these markets.





*Expanded
Product Offering.* During
the last four years, the Bank has emphasized the growth of its commercial loan
portfolio and has augmented its traditional commercial and residential loans and
services with several specialty lending and depository services.





·
    In
      2001, the Bank began originating high-end market single-family
      construction loans within the coastal community of Los Angeles County,
      California (primarily Manhattan Beach, Hermosa Beach, Palos Verdes and
      Redondo Beach), where it believes it has a competitive advantage based on
      the Bank’s familiarity and knowledge of the market. These types of
      construction loans typically range from $1.0 million to
      $5.0 million. The Bank’s single-family residential coastal
      construction loans amounted to $299.0 million and $212.7 million at
      December 31, 2004 and 2003, respectively, net of participations sold of
      $59.6 million and $1.5 million,
respectively.





·
    In
      2002, the Bank began originating single-family residential tract
      construction loans secured by newly constructed entry level homes. These
      loans are primarily originated within the Inland Empire of Southern
      California. The Bank intends to continue expanding its market presence for
      these types of loans to Palm Desert and Temecula, and further expand into
      south Orange County leading to San Diego. These types of construction
      loans typically range from $3.0 million to $10.0 million. The
      Bank’s single-family residential tract construction loans amounted to
      $129.9 million and $104.5 million at December 31, 2004 and 2003,
      respectively, net of participations sold of $1.7 million and $11.6
      million, respectively.





·
    In
      2002, the Bank also began originating SBA loans and religious loans, which
      are comprised of loans to churches and private schools, throughout its
      market area. The Bank emphasizes these types of loans, as they are a
      complement to the Bank’s focus on strengthening and supporting the local
      community. SBA loans amounted to $18.0 million and $15.1 million at
      December 31, 2004 and 2003, respectively, net of guaranteed participations
      sold of $29.0 million and $12.9 million, respectively. Religious loans
      amounted to $23.8 million and $15.9 million at December 31, 2004 and
      2003, respectively. The Bank anticipates significantly increasing the
      origination of these types of loans.





5




·
    In
      2003, the Bank established an income property lending division to service
      the growing markets for commercial real estate and apartments in Southern
      California. Commercial real estate loans generated from this division
      typically range from $2.0 million to $10.0 million, while apartment loans
      typically range from $0.5 million to $5.0 million. At December 31, 2004
      and 2003, the balance of loans generated from this division amounted to
      $91.6 million and $2.4 million, respectively, for commercial real estate
      loans and $177.9 million and $19.6 million, respectively, for apartment
      loans.





·
    In
      order to expand the Bank’s core deposit franchise, the Community Banking
      Group of the Bank has focused on offering competitive interest rate
      products and providing value-added consumer services by introducing
      additional products and services. Each of the Bank’s nine full-service
      banking centers has a business plan catering specifically to the needs of
      consumers in that banking center market. Based on the demographics of the
      target market, each banking center tailors its offering of financial
      services and products for its customer base. Business deposits have been
      pursued by offering an expanded courier network, by introduction of cash
      management products and by specific targeting of small business customers.
      The Company’s core deposit franchise has been built around the community
      banking system, which has resulted in deposit growth of 60.0% for the year
      ended December 31, 2004 and 109.8% for the year ended December 31,
      2003. Consolidated total deposits amounted to $965.5 million at
      December 31, 2004 and $603.3 million at December 31, 2003. Non-interest
      bearing demand deposits amounted to $127.5 million at December 31,
      2004 and $94.2 million at December 31,
2003.





·
    In
      2004, the Bank began expanding its loan production offices located in
      Manhattan Beach, San Diego, Anaheim and Irvine, California, to accommodate
      the Private Reserve Group of the Bank. The Private Reserve Group will
      provide exclusive and flexible relationship management to entrepreneurs
      and high-end customers, and will focus on cash management and specialty
      deposit relationships. The Bank intends to convert these loan production
      offices into full-service depository banking centers in 2005.





Each of
the foregoing specialty lending groups and depository services bring diversity
to the Bank’s existing product lines, offering its customers greater flexibility
while providing additional opportunities for the Bank to serve new customers
within its primary market areas.





The
Bank’s growth in loans, net of unearned income and deferred fees, was 72.0% for
the year ended December 31, 2004 and 135.7% for the same period in 2003. As part
of the Bank’s goal of balanced lending, net increases in its loan portfolio are
intended to produce a distribution mix of 10-20% in commercial loans, 0-5% in
SBA loans, 15-35% in commercial real estate loans, 20-40% in single-family
coastal construction, 15-30% in single-family tract construction, 15-25% in
multi-family loans, 5-15% in consumer loans, 0-5% in commercial real estate
construction loans and 0-5% in land loans.





Beginning
in 2004, the Bank has proactively managed the product concentrations within the
loan portfolio by selling participations and purchasing loans. These activities
will continue to be an integral part of the Bank’s strategic plan to diversify
risk, income sources and product/geographic concentrations within the loan
portfolio.





The
Bank’s net growth in deposits was 60.0% in 2004 and 109.8% in 2003. The intended
distribution of deposits is 10-25% in NOW and non-interest bearing demand
deposits, 30-50% in money market deposits and 30-50% in savings and time
deposits.





*Relationship
Banking Facilities* . The
Company continues to emphasize the relationship banking focus that was initiated
in 2001. The Company continues to seek and retain experienced banking
professionals with developed banking and service skills who share its
customer-oriented service philosophy. The Company believes that relationship
banking is best delivered in well-appointed and efficient banking centers that
provide the appropriate tools and environment for its customers. To that end,
the Bank’s facilities are being redesigned to incorporate user-friendly
technology and personal service to facilitate its focus on relationship banking.





6


**


*Strategic
Expansion.* The
Company has experienced significant growth over the last several years in its
branch network and its asset size. This growth was a result of the successful
completion of Phase I of a strategic plan which includes six phases. The
objective of Phase I was to increase the number of offices and product lines in
the Company’s existing geographic markets. The Bank opened a new banking center
in Corona, California in the second quarter of 2003 and converted its loan
production office in Manhattan Beach, California into a full-service banking
center during the third quarter of 2003. In addition, the Bank opened an
additional loan production office in Irvine, California during the third quarter
of 2003. The Company’s acquisition of Southland Bank was consummated in July
2003. As a result of the acquisition, the Company acquired a banking center in
Irwindale, California.





In early
2004, the Bank opened a new SBA loan production office in Anaheim, California.
The Bank also entered into a lease of a building in Corona, California to house
the credit administration, central operations, and data center, amongst other
departments. The Company additionally entered into an office lease in San
Rafael, California, which will serve as a future banking site, and will help to
increase the Company’s operations in that geographic area. These locations were
selected to support the Company’s significant growth and are aligned with its
strategic expansion. The Company will continue to expand its branch network
through new offices in selected markets and opportunistic acquisitions.





Phase II
of the Company’s strategic plan calls for contiguous expansion into the
surrounding communities of the Company’s current markets, possible de novo
offices and the continued branding and strategic marketing of the Vineyard Bank
brand in target geographic and product markets.





Phase III
of the Company’s strategic plan emphasizes non-contiguous expansion through
possible strategic acquisitions or de novo offices in new markets. Possible new
markets include the Palm Desert and Temecula corridors and south Orange County
in Southern California.





Phase IV
of the Company’s strategic plan emphasizes expansion in the coastal communities
of California through possible strategic acquisitions or de novo offices within
markets with similar demographics as Manhattan Beach. This phase also entails
the distribution of existing products to these new markets and placement of
local management in different geographic regions of the Bank.





The main
emphasis of Phase V of the Company’s strategic plan is to strengthen the
strategic points of the coastal communities’ expansion initiative, recruit local
talent within each new market community and continue to build the infrastructure
and delivery systems of the Bank.





Phase VI
of the Company’s plan calls for locally-managed regional communities which offer
similar product lines and are all supported by a strong corporate infrastructure
and the Vineyard Bank brand.





*Asset
Growth.* The
Company’s total assets as of December 31, 2004 were $1.3 billion as
compared to $887.8 million as of December 31, 2003. The Company
believes it can grow its assets while maintaining its asset quality. The
Company’s lending professionals are well experienced and follow policies and
procedures that it believes provide for a rigorous underwriting of all loans
originated by the Bank. At December 31, 2004, the Bank had no non-performing
loans or other real estate owned. In summary, the Company continues to realize
its strategic plan and expand its marketing efforts in nine primary
areas:





·
    Community-based
      core deposit growth;


·
    Single
      family coastal construction lending;


·
    Single
      family tract (entry level) construction
lending;


·
    Commercial
      real estate;


·
    Multi-family
      properties;


·
    Small
      business and commercial lending;


·
    SBA
      lending;


·
    Religious
      financial services (lending and depository);
and


·
    Specialized
      depository and cash management services for commercial
      business.





7





**Risk
Factors**





**The
Company is implementing a business strategy that may result in increased
volatility of earnings.**





The
Company’s business strategy is focused on the expansion of construction,
commercial real estate, multifamily and commercial business lending. At
December 31, 2000, approximately $56.4 million or 70.4% of the Bank’s
loan portfolio was made up of residential and commercial construction,
commercial real estate and commercial business loans. As of December 31, 2004,
these types of loans had increased to approximately $717.8 million or 69.7%
of the Bank’s loan portfolio and are anticipated to increase further as the
Company continues to implement its business strategy. In addition, the Company
established an income property lending division in 2003 to service the growing
market for apartments in Southern California. Apartment loans increased from
$28.0 million at December 31, 2003 to $189.9 million at December 31, 2004. The
significant increase in apartment loans during the year ended December 31, 2004
is primarily due to the concentrated origination efforts of the income property
lending division and the purchase of an apartment loan pool in the amount of
$85.0 million in March 2004.





These
types of lending activities, while potentially more profitable, are generally
more sensitive to regional and local economic conditions, making loss levels
more difficult to predict. Collateral evaluation in these types of loans
requires a more detailed analysis of financial statements at the time of loan
approval and on an on-going basis. A decline in real estate values, particularly
in California, would reduce the value of the real estate collateral securing the
Bank’s loans and increase the risk that the Bank would incur losses if borrowers
defaulted on their loans. In addition, the repayment of commercial real estate
loans and apartment loans generally is dependent, in large part, on the
successful operation of the property securing the loan or the business conducted
on the property securing the loan. Also, loan balances for commercial real
estate, commercial business and residential construction tract loans are
typically larger than those for permanent single-family and consumer loans.
Accordingly, when there are defaults and losses on these types of loans, they
are often larger on a per loan basis than those for permanent single-family and
consumer loans. A secondary market for most types of commercial real estate and
commercial business loans is not readily liquid, so the Bank has less
opportunity to mitigate credit risk by selling part or all of its interest in
these loans.





**The
Company’s growth may not be managed successfully.**





The
Company has grown substantially from $110.8 million of total assets and
$99.6 million of total deposits at December 31, 2000 to $1.3 billion
of total assets and $965.5 million of total deposits at December 31, 2004.
The Company expects to continue to experience significant growth in the amount
of its assets, the level of its deposits and the scale of its operations. The
Company may not be able to manage this growth effectively. If the Company does
not manage its growth effectively, it may not be able to achieve its business
plan, and its business and prospects could be harmed. In this regard, the
Company has experienced significant growth in its loan portfolio during the past
four years. Consequently, its loan portfolio is relatively unseasoned. While
there were no non-performing loans in the Company’s loan portfolio at December
31, 2004, there are no assurances that this will continue into the future. The
Company’s growth subjects it to increased capital and operating commitments. The
Company must recruit experienced individuals that have the required skills that
it needs to grow its specialty lines of business. As a result of the increase in
the Company’s personnel, its expenses associated with salaries and other
benefits have increased in recent periods.





The
additional customer products, services, branch enhancements and the
implementation of these items have placed and will continue to place a strain on
its personnel, systems, and resources. The Company cannot be certain that it
will be able to obtain and train qualified individuals to implement its business
strategy in a timely, cost effective and efficient manner.





8


****


**Potential
acquisitions may disrupt the Company’s business, dilute shareholder value and
adversely affect its operating results.**





In July
2003, the Company completed its acquisition of Southland Bank. The Company may
continue to grow by acquiring banks, related businesses or branches of other
banks that it believes provide a strategic fit with its business. To the extent
that the Company grows through acquisitions, it cannot be certain that it will
be able to adequately or profitably manage this growth. Acquiring other banks,
businesses or branches involves risks commonly associated with acquisitions,
including:





·
    potential
      exposure to unknown or contingent liabilities of banks, businesses or
      branches the Company acquires;


·
    exposure
      to potential asset quality issues of the acquired banks, businesses or
      branches;


·
    difficulty
      and expense of integrating the operations and personnel of banks,
      businesses or branches the Company
acquires;


·
    potential
      disruption to the Company’s business;


·
    potential
      diversion of management’s time and
attention;


·
    the
      possible loss of key employees and customers of the banks, businesses or
      branches the Company acquires;


·
    difficulty
      in estimating the value of the banks, businesses or branches to be
      acquired; and


·
    potential
      changes in banking or tax laws or regulations that may affect the banks or
      businesses to be acquired.





**The
Company’s continued pace of growth may require it to raise additional capital in
the future, but that capital may not be available or may not be on terms
acceptable to the Company when it is needed.**





The
Company is required by federal regulatory authorities to maintain adequate
levels of capital to support its operations. The Company anticipates that its
existing capital resources will satisfy its capital requirements for the
foreseeable future. However, the Company may decide to raise additional capital
to support continued growth, either internally or through acquisitions. The
Company’s ability to raise additional capital, if needed, will depend on
conditions in the capital markets at that time, which are outside the Company’s
control, and on its financial performance. Accordingly, the Company cannot be
certain of its ability to raise additional capital if needed or on terms
acceptable to the Company. If the Company cannot raise additional capital when
needed, its ability to further expand its operations through internal growth and
acquisitions could be materially impaired.





**The
Company’s business strategy relies upon its Chief Executive Officer and other
key employees.**





Norman
Morales has been the Company’s president and chief executive officer since
October 2000. Mr. Morales developed numerous aspects of the Bank’s current
business strategy and the implementation of such strategy depends heavily upon
the active involvement of Mr. Morales. The loss of Mr. Morales’
services could have a negative impact on the implementation and success of the
Company’s business strategy. The Bank’s success will also depend in large part
upon its ability to attract and retain highly qualified management, technical
and marketing personnel to execute the strategic plan. The Bank will need to
retain persons with skills in areas that are new and unfamiliar in order to
manage the Bank’s specialty lines of business. Competition for qualified
personnel, especially those in management, sales and marketing, is intense. The
Company cannot be certain that the Bank will be able to attract and retain these
persons.





**The
Company’s business is subject to various lending risks which could adversely
impact its results of operations and financial condition.**





*Residential
Real Estate Construction Loans.* The Bank
makes residential real estate construction loans to individuals and developers
for the construction of residential properties. These loans include
single-family coastal construction loans which are targeted at high-end units
located along the coastal communities of Southern California. The Bank will
originate these loans whether or not the property is under contract for sale.
Residential real estate construction loans also include single-family tract
construction loans which target the construction of entry level units. The Bank
has significantly increased the amount of residential real estate construction
loans in its loan portfolio, both in dollar amounts and as a percentage of the
Bank’s total loans. At December 31, 2004, $428.9 million or 41.7% of the
Company’s total loan portfolio consisted of residential real estate construction
loans (which exclude commercial real estate construction loans) as compared to
$3.1 million or 3.8% of the Company’s total loan portfolio at
December 31, 2000.





9





The
Company’s construction loans are based upon estimates of costs and value
associated with the completed project. These estimates may be inaccurate.
Construction lending involves additional risks when compared with permanent
residential lending because funds are advanced upon the security of the project,
which is of uncertain value prior to its completion. Because of the
uncertainties inherent in estimating construction costs, as well as the market
value of the completed project and the effects of governmental regulation of
real property, it is relatively difficult to evaluate accurately the total funds
required to complete a project and the related loan-to-value ratio. Construction
lending also typically involves higher loan principal amounts and is often
concentrated with a small number of builders. In addition, generally during the
term of a construction loan, no payment from the borrower is required since the
accumulated interest is added to the principal of the loan through an interest
reserve. Construction loans often involve the disbursement of substantial funds
with repayment substantially dependent on the success of the ultimate project
and the ability of the borrower to sell or lease the property or obtain
permanent take-out financing, rather than the ability of the borrower or
guarantor to repay principal and interest. If the Company’s appraisal of the
value of the completed project proves to be overstated, it may have inadequate
security for the repayment of the loan upon completion of construction of the
project and may incur a loss. The Company’s ability to continue to originate a
significant amount of construction loans is dependent on the continued strength
of the housing market in the coastal communities of Los Angeles and Orange
counties in California and in the Inland Empire region of Southern California.
To the extent there is a decline in the demand for new housing in these
communities, it is expected that the demand for construction loans would
decline, the Company’s liquidity would substantially increase and its net income
would be adversely affected.





*Commercial
Real Estate Loans.* The Bank
originates commercial real estate loans for individuals and business for various
purposes which are secured by commercial real estate, which includes loans made
to religious organizations and private schools. At December 31, 2004,
$216.6 million or 21.0% of the Company’s total loan portfolio consisted of
commercial real estate loans as compared to $40.1 million or 50.1% of its total
loan portfolio at December 31, 2000.





The
Company’s commercial real estate loans involve higher principal amounts than
other loans, and repayment of these loans may be dependent, in large part, on
the successful operation of the property securing the loan or the business
conducted on the property securing the loan. These loans may be more adversely
affected by conditions in the real estate markets or in the economy generally.
For example, if the cash flow from the borrower’s project is reduced due to
leases not being obtained or renewed, the borrower’s ability to repay the loan
may be impaired. In addition, many of the Company’s commercial real estate loans
are not fully amortizing and contain large balloon payments upon maturity. Such
balloon payments may require the borrower to either sell or refinance the
underlying property in order to make the balloon payment.





*Multifamily
Residential Real Estate Loans.* The
Company’s multifamily loans are subject to collateral risk similar to other real
estate secured products. While the Bank’s primary lending markets have
experienced strong demand for affordable housing, valuations have increased
significantly over the past several years and could be negatively impacted by a
decrease in investor demand. At December 31, 2004, $189.9 million, or 18.4% of
the Company’s total loan portfolio consisted of multifamily residential real
estate loans as compared to $1.0 million, or 1.3% of its total loan portfolio at
December 31, 2000.





*Commercial
Business Loans.* The
Bank’s commercial business loans generally consist of loans to small businesses,
including SBA loans. At December 31, 2004, $36.1 million or 3.5% of the
Company’s total loan portfolio consisted of commercial business loans as
compared to $10.7 million or 13.3% of its total loan portfolio at
December 31, 2000.





10





Repayment
of the Company’s commercial business loans is often dependent on the cash flows
of the borrower, which may be unpredictable, and the collateral securing these
loans may fluctuate in value. The Company’s commercial business loans are
primarily made based on the identified cash flow of the borrower and secondarily
on the underlying collateral provided by the borrower. Most often, this
collateral consists of accounts receivable, inventory or equipment. Credit
support provided by the borrower for most of these loans and the probability of
repayment is based on the liquidation of the pledged collateral and enforcement
of a personal guarantee, if any exists. As a result, in the case of loans
secured by accounts receivable, the availability of funds for the repayment of
these loans may be substantially dependent on the ability of the borrower to
collect amounts due from its customers. The collateral securing other loans may
depreciate over time, may be difficult to appraise and may fluctuate in value
based on the success of the business.





**The
Company’s allowance for loan losses may prove to be insufficient to absorb
probable losses inherent in its loan portfolio.**





Like all
financial institutions, every loan the Company makes carries a certain risk that
it will not be repaid in accordance with its terms or that any collateral
securing it will not be sufficient to assure repayment. This risk is affected
by, among other things:





·
    cash
      flow of the borrower and/or the project being
financed;


·
    in
      the case of a collateralized loan, the changes and uncertainties as to the
      future value of the collateral;


·
    the
      credit history of a particular borrower;


·
    changes
      in economic and industry conditions; and


·
    the
      duration of the loan.





At
December 31, 2004, the Company’s allowance for loan losses as a percentage of
gross loans was 1.3%. Regulatory agencies, as an integral part of their
examination process, review the Company’s loans and allowance for loan losses.
Although management believes the Company’s loan loss allowance is adequate to
absorb probable losses in its loan portfolio, management cannot predict these
losses or whether the allowance will be adequate or that regulators will not
require the Company to increase this allowance. Any of these occurrences could
materially and adversely affect its business, financial condition, prospects and
profitability.





**The
Company’s business is subject to general economic risks that could adversely
impact its results of operations and financial condition.**





*Changes
in economic conditions, particularly an economic slowdown in California, could
hurt the Company’s business.* The
Company’s business is directly affected by political and market conditions,
broad trends in industry and finance, legislative and regulatory changes,
changes in governmental monetary and fiscal policies and inflation, all of which
are beyond the Company’s control. Deterioration in economic conditions, in
particular an economic slowdown within California, could result in the following
consequences, any of which could hurt the Company’s business materially:





·
    loan
      delinquencies may increase;


·
    problem
      assets and foreclosures may increase;


·
    demand
      for the Company’s products and services may decline;
and


·
    collateral
      for loans made by the Company, especially real estate, may decline in
      value, in turn reducing a client’s borrowing power, and reducing the value
      of assets and collateral associated with its loans held for
      investment.





*A
downturn in the California real estate market could hurt the Company’s
business.* The
Company’s business activities and credit exposure are concentrated in
California. A downturn in the California real estate market could hurt the
Company’s business because many of its loans are secured by real estate located
within California. As of December 31, 2004, approximately 95.5% of the Company’s
loan portfolio consisted of loans secured by real estate located in California.
If there is a significant decline in real estate values, especially in
California, the collateral for the Company’s loans will provide less security.
As a result, the Company’s ability to recover on defaulted loans by selling the
underlying real estate would be diminished, and it would be more likely to
suffer losses on defaulted loans. Real estate values in California could be
affected by, among other things, earthquakes and other natural disasters
particular to California.





11


**


*The
Company may suffer losses in its loan portfolio despite its underwriting
practices* . The
Company seeks to mitigate the risks inherent in its loan portfolio by adhering
to specific underwriting practices. These practices include analysis of a
borrower’s prior credit history, financial statements, tax returns and cash flow
projections, valuation of collateral based on reports of independent appraisers
and verification of liquid assets. Although the Company believes that its
underwriting criteria are appropriate for the various kinds of loans it makes,
the Company may incur losses on loans that meet its underwriting criteria, and
these losses may exceed the amounts set aside as reserves in its allowance for
loan losses.





**The
Company’s business is subject to interest rate risk and variations in interest
rates may negatively affect its financial performance.**





Like
other financial institutions, the Company’s operating results are largely
dependent on its net interest income. Net interest income is the difference
between interest earned on loans and securities and interest expense incurred on
deposits and borrowings. Its net interest income is impacted by changes in
market rates of interest, the interest rate sensitivity of its assets and
liabilities, prepayments on its loans and securities and limits on increases in
the rates of interest charged on its loans. The Company expects that it will
continue to realize income from the differential or “spread” between the
interest earned on loans, securities and other interest-earning assets, and
interest paid on deposits, borrowings and other interest-bearing liabilities.
Net interest spreads are affected by the difference between the maturities and
repricing characteristics of interest-earning assets and interest-bearing
liabilities.





The
Company cannot control or accurately predict changes in market rates of
interest. The following are some factors that may affect market interest rates,
all of which are beyond the Company’s control:





·
    inflation;


·
    slow
      or stagnant economic growth or recession;


·
    unemployment;


·
    money
      supply and the monetary policies of the
FRB;


·
    international
      disorders; and


·
    instability
      in domestic and foreign financial markets.





The
Company is vulnerable to a sharp increase in interest rates in the short-run
because its interest-earning assets generally have longer repricing terms than
its interest-bearing liabilities. Under such circumstances, material and
prolonged increases in interest rates will negatively affect the Company’s
market value of equity. In addition, loan volume and yields are affected by
market interest rates on loans, and rising interest rates generally are
associated with a lower volume of loan originations. In addition, an increase in
the general level of interest rates may adversely affect the ability of certain
borrowers to pay the interest on and principal of their obligations.
Accordingly, changes in levels of market interest rates could materially and
adversely affect the Company’s net interest spread, asset quality, loan
origination volume, securities portfolio, and overall profitability. Although
the Company attempts to manage its interest rate risk, the Company cannot be
certain that it can minimize its interest rate risk.





**The
Company’s ability to service its debt, pay dividends, and otherwise pay its
obligations as they come due is substantially dependent on capital distributions
from the Bank, and these distributions are subject to regulatory limits and
other restrictions.**





A
substantial source of the Company’s income from which it services its debt and
pays its obligations and dividends is the receipt of dividends from the Bank.
The availability of dividends from the Bank is limited by various statutes and
regulations. It is possible, depending upon the financial condition of the Bank,
and other factors, that the applicable regulatory authorities could assert that
payment of dividends or other payments, including payments to the Company, is an
unsafe or unsound practice. In the event the Bank is unable to pay dividends to
the Company, the Company may not be able to service its debt, pay its
obligations or pay dividends on its outstanding common stock. The inability to
receive dividends from the Bank would adversely affect the Company’s business,
financial condition, results of operations and prospects.





12


****


**The
Company faces strong competition from other financial institutions, financial
service companies and other organizations offering services similar to those
offered by the Company, which could hurt its business.**





The Bank
faces direct competition from a significant number of financial institutions,
many with a state-wide or regional presence, and in some cases a national
presence, in both originating loans and attracting deposits. The Bank’s primary
competitors in its market areas are Bank of America, Wells Fargo, Citizen’s
Business Bank, Foothill Independent Bank, PFF Bank, Washington Mutual, Union
Bank of California and Bank of the West. Competition in originating loans comes
primarily from other banks, mortgage companies and consumer finance institutions
that make loans in the Bank’s primary market areas. The Bank also faces
substantial competition in attracting deposits from other banking institutions,
money market and mutual funds, credit unions and other investment vehicles.





In
addition, banks with larger capitalization and non-bank financial institutions
that are not governed by bank regulatory restrictions have large lending limits
and are better able to serve the needs of larger customers. Many of these
financial institutions are also significantly larger and have greater financial
resources than the Company or the Bank, have been in business for a long period
of time and have established customer bases and name recognition.





The Bank
competes for loans principally on the basis of interest rates and loan fees, the
types of loans which it originates, and the quality of service which it provides
to borrowers. The Bank’s ability to attract and retain deposits requires that it
provide customers with competitive investment opportunities with respect to rate
of return, liquidity, risk and other factors. To effectively compete, the Bank
may have to pay higher rates of interest to attract deposits, resulting in
reduced profitability. If the Bank is not able to effectively compete in its
market area, its profitability may be negatively affected, limiting its ability
to pay the Company dividends.





**The
Company continually encounters technological change, and it may have fewer
resources than many of its competitors to continue to invest in technological
improvements.**





The
financial services industry is undergoing rapid technological changes, with
frequent introductions of new technology-driven products and services. The
effective use of technology increases efficiency and enables financial
institutions to better serve customers and to reduce costs. The Company’s future
success will depend, in part, upon its ability to address the needs of its
clients by using technology to provide products and services that will satisfy
client demands for convenience, as well as to create additional efficiencies in
its operations. Many of the Company’s competitors have substantially greater
resources to invest in technological improvements. The Company may not be able
to effectively implement new technology-driven products and services or be
successful in marketing these products and services to its customers.





**The
Company is subject to extensive regulation which could adversely affect its
business.**





The
Company’s operations are subject to extensive regulation by federal, state and
local governmental authorities and are subject to various laws and judicial and
administrative decisions imposing requirements and restrictions on part or all
of its operations. The Company believes that it is in substantial compliance in
all material respects with applicable federal, state and local laws, rules and
regulations. Because the Company’s business is highly regulated, the laws, rules
and regulations applicable to it are subject to regular modification and change.
There are currently proposed various laws, rules and regulations that, if
adopted, would impact the Company’s operations. If these or any other laws,
rules or regulations are adopted in the future, they could make compliance much
more difficult or expensive, restrict the Company’s ability to originate or sell
loans, further limit or restrict the amount of commissions, interest or other
charges earned on loans originated or sold by the Company or otherwise
materially and adversely affect its business, financial condition, prospects or
profitability.





13


****


**The
state of California is currently in a severe deficit, which could adversely
affect the Company’s business.**





The
Company’s business is headquartered and mainly conducted within the state of
California, which is currently in the midst of a severe deficit. In the event of
a continued increase in the California deficit, the Company’s operations could
be adversely impacted by additional taxes or expenses imposed by the state
and/or increased regulatory restrictions.





**Distribution
of Assets, Liabilities, and Stockholders’ Equity; Interest Rates and Interest
Differential**





The
Company’s earnings depend primarily upon the difference between the income it
receives from its loan portfolio and investment securities and its cost of
funds, principally interest paid on savings, time deposits and borrowings.
Interest rates charged on the Company’s loans are affected principally by the
demand for loans, the supply of money available for lending purposes, and
competitive factors. In turn, these factors are influenced by general economic
conditions and other constraints beyond the Company’s control, such as
governmental economic and tax policies, general supply of money in the economy,
governmental budgetary actions, and the actions of the FRB (See Item 1.
Business; Effect of Governmental Policies and Recent Legislation.)






14





**Loan
Portfolio**




The
following table sets forth the amount of loans outstanding for each of the past
five years.





**(Dollars
      in thousands)**
    
    **December
      31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Amount**
    
    **Percent**
    
    **Amount**
    
    **Percent**
    
    **Amount**
    
    **Percent**
    
    **Amount**
    
    **Percent**
    
    **Amount**
    
    **Percent**Commercial
      and industrial
    
    $
    36,095
    
    
    3.5
    %
    $
    26,827
    
    
    4.5
    %
    $
    19,232
    
    
    7.6
    %
    $
    20,219
    
    
    14.7
    %
    $
    10,665
    
    
    13.3
    %Real
      estate construction:Single-family
      coastal
    
    
    298,984
    
    
    29.1
    %
    
    212,727
    
    
    35.5
    %
    
    89,547
    
    
    35.3
    %
    
    29,506
    
    
    21.4
    %
    
    3,057
    
    
    3.8
    %Single-family
      tract
    
    
    129,900
    
    
    12.6
    %
    
    104,511
    
    
    17.4
    %
    
    14,171
    
    
    5.6
    %
    
    -
    
    
    -
    
    
    -
    
    
    -Commercial
    
    
    36,215
    
    
    3.5
    %
    
    20,947
    
    
    3.5
    %
    
    6,494
    
    
    2.5
    %
    
    3,748
    
    
    2.7
    %
    
    2,531
    
    
    3.2
    %Real
      estate mortgage:Commercial
    
    
    216,609
    
    
    21.0
    %
    
    153,632
    
    
    25.6
    %
    
    93,122
    
    
    36.7
    %
    
    52,458
    
    
    38.0
    %
    
    40,099
    
    
    50.1
    %Multifamily
      residential
    
    
    189,912
    
    
    18.4
    %
    
    27,986
    
    
    4.7
    %
    
    1,131
    
    
    0.5
    %
    
    1,091
    
    
    0.8
    %
    
    1,040
    
    
    1.3
    %Other
      residential
    
    
    118,962
    
    
    11.6
    %
    
    47,886
    
    
    8.0
    %
    
    22,349
    
    
    8.8
    %
    
    17,972
    
    
    13.0
    %
    
    10,152
    
    
    12.7
    %Consumer
      loans
    
    
    2,905
    
    
    0.3
    %
    
    4,887
    
    
    0.8
    %
    
    5,659
    
    
    2.2
    %
    
    8,318
    
    
    6.0
    %
    
    12,049
    
    
    15.1
    %Loans
      held for sale
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    2,112
    
    
    0.8
    %
    
    4,471
    
    
    3.3
    %
    
    235
    
    
    0.3
    %All
      other loans (including overdrafts)
    
    
    137
    
    
    -
    
    
    29
    
    
    -
    
    
    60
    
    
    -
    
    
    184
    
    
    0.1
    %
    
    180
    
    
    0.2
    %1,029,719
    
    
    100.0
    %
    
    599,432
    
    
    100.0
    %
    
    253,877
    
    
    100.0
    %
    
    137,967
    
    
    100.0
    %
    
    80,008
    
    
    100.0
    %Less:Unearned
      income and deferred loan fees
    
    
    (2,682
    )
    
    
    
    
    (2,425
    )
    
    
    
    
    (626
    )
    
    
    
    
    (389
    )
    
    
    
    
    (484
    )Allowance
      for possible loan losses
    
    
    (13,001
    )
    
    
    
    
    (7,537
    )
    
    
    
    
    (3,003
    )
    
    
    
    
    (1,450
    )
    
    
    
    
    (784
    )Total
      Net Loans
    
    $
    1,014,036
    
    
    
    
    $
    589,470
    
    
    
    
    $
    250,248
    
    
    
    
    $
    136,128
    
    
    
    
    $
    78,740











15





At
December 31, 2004, the Company’s loan balance, net of unearned income and
deferred fees, increased 72.0% as compared to December 31, 2003, primarily due
to the significant growth in real estate construction and real estate mortgage
loans. The Company’s business development efforts, which began in early 2001 and
continued through 2002, 2003 and 2004, were focused on the expansion of its real
estate construction lending, with the introduction of high-end single family
construction lending in early 2001 and single family tract construction in late
2002. The Bank concentrates its commercial and real estate lending in its
immediate market area where economic condition trends are closely
monitored.





The
high-end single family construction loans are geographically concentrated in the
coastal communities of Los Angeles and Orange counties in California, where loan
commitments are in the $1.0 million to $5.0 million range. In 2004, gross
commitments generated for this loan product were $439.5 million. The projected
equilibrium level for this product is expected to be in excess of $250 million
in funded loan balances as new commitments are generated, loan participations
are sold and existing constructions are completed. As of December 31, 2004, 88%
of such loans originated by the Bank will mature within one year and 12% will
mature within one to two years.





The Bank
also originates single family tract construction loans. These loans typically
are made on houses that sell in the range of $0.2 million to $0.4 million. The
Bank began offering this product in late 2002 and gross commitments generated
for this loan product for the year ended December 31, 2004 were $351.6 million.
Loan requests for this loan product are generally between $3.0 million and $10.0
million. The projected equilibrium level for this product is expected to be in
excess of $150 million in funded loan balances. Single family tract construction
loans typically have shorter terms than the Bank’s other loan products. As of
December 31, 2004, 96% of such loans originated by the Bank will mature within
one year and 4% will mature within one to two years.





In 2003,
the Bank established an income property lending division to service the growing
markets for commercial real estate and apartments in Southern California. The
Bank’s origination of income property loans is expected to be over $600 million
over the next three years. Commercial real estate loans generated from this
division typically range from $2.0 million to $10.0 million, while apartment
loans typically range from $0.5 million to $5.0 million. For the year ended
December 31, 2004, new loan commitments generated by the income property lending
division included $95.8 million of commercial real estate loans and $115.8
million of apartment loans. At December 31, 2004, the balances of loans
generated from the income property lending division included $91.6 million of
commercial real estate loans and $177.9 million of residential real estate
loans, which is comprised mainly of $173.5 million of apartment loans. Of the
Bank’s commercial real estate loans as of December 31, 2004, 11% will mature
within one year, 17% will mature within one to five years, and 72% will mature
over five years. As of December 31, 2004, 93% of the multifamily loans will
mature after five years.





The Bank
also provides one-to-four family residential real estate financing for shorter
duration than traditional mortgage loans. This category includes equity lines of
credit, first trust deeds and junior lien loans. As of December 31, 2004, 69% of
such loans will mature within one year, 10% will mature from within one to five
years, and 21% will mature over five years.





In late
2002, the Bank began its SBA lending division to expand on its commercial and
business banking product lines. SBA loans are generally made pursuant to a
federal government program designed to assist small businesses in obtaining
financing. The federal government guarantees SBA loans as an incentive for
financial institutions to make loans to small businesses. In 2004, the Bank
funded $33.0 million of SBA loans. The Bank sells the guaranteed portion of the
SBA loan which is approximately 75% to 85% of the originated balance at a
premium sale price between 105% and 110%. In 2004, the Bank sold $19.6 million
of SBA loans, resulting in gain on sale and broker fee income of $3.0
million.





The Bank
also originates consumer loans, which are loans to individuals consisting
primarily of personal loans, automobile loans and individual lines of credit.
Consumer loans declined by $2.0 million or 40.6% at December 31, 2004 as
compared to December 31, 2003 as the Bank moved away from indirect and dealer
loans beginning in 2000, concentrating on direct lending to its core customer
base. Consumer loans continue to provide traditional high fixed rate loans with
a steady stream of regular income. Although these types of loans typically
involve higher risks than other types of loans, the Company mitigates such risk
by making more loans in smaller denominations. Consumer loan originations are
expected to increase in 2005 as part of the Private Reserve Group’s focus on
consumer product lending.





16





There
were no whole loans held for sale at December 31, 2004 and 2003.





**Maturities
and Sensitivities to Interest Rates**





The
following table shows the maturities on gross loans outstanding at December 31,
2004.




**(Dollars
      in Thousands)**
    
    **Maturing****Within
      One Year**
    
    **One
      to Five Years**
    
    **After
      Five Years**
    
    **Total**Commercial
      and industrial
    
    $
    17,813
    
    $
    12,884
    
    $
    5,398
    
    $
    36,095Real
      estate construction:Single-family
      coastal
    
    
    262,972
    
    
    36,012
    
    
    -
    
    
    298,984Single-family
      tract
    
    
    125,118
    
    
    4,782
    
    
    -
    
    
    129,900Commercial
    
    
    32,058
    
    
    4,157
    
    
    -
    
    
    36,215Real
      estate mortgage:Commercial
    
    
    24,648
    
    
    35,748
    
    
    156,213
    
    
    216,609Residential
    
    
    113,909
    
    
    6,616
    
    
    188,349
    
    
    308,874Consumer
      loans
    
    
    1,418
    
    
    1,230
    
    
    257
    
    
    2,905All
      other loans (including overdrafts)
    
    
    137
    
    
    -
    
    
    -
    
    
    137Total
    
    $
    578,073
    
    $
    101,429
    
    $
    350,217
    
    $
    1,029,719Loans
      with predetermined interest rates
    
    $
    10,635
    
    $
    35,984
    
    $
    27,663
    
    $
    74,282Loans
      with floating or adjustable interest rates
    
    
    567,438
    
    
    65,445
    
    
    322,554
    
    
    955,437Total
    
    $
    578,073
    
    $
    101,429
    
    $
    350,217
    
    $
    1,029,719


**Investment
Portfolio**





The
following table shows the Company’s investment portfolio at December 31, 2004,
2003 and 2002, respectively.





**(Dollars
      in Thousands)**
    
    **December
      31,****2004**
    
    **2003**
    
    **2002****Amortized
      Cost**
    
    **Fair
      Value**
    
    **Amortized
      Cost**
    
    **Fair
      Value**
    
    **Amortized
      Cost**
    
    **Fair
      Value**Available-for-sale:U.S.
      agency securities
    
    $
    11,033
    
    $
    10,501
    
    $
    10,359
    
    $
    9,905
    
    $
    -
    
    $
    -Mortgage-backed
      securities
    
    
    215,045
    
    
    210,933
    
    
    194,943
    
    
    190,163
    
    
    87,364
    
    
    87,553Mutual
      funds
    
    
    2,042
    
    
    2,046
    
    
    2,000
    
    
    2,000
    
    
    -
    
    
    -Total
      securities
    
    $
    228,120
    
    $
    223,480
    
    $
    207,302
    
    $
    202,068
    
    $
    87,364
    
    $
    87,553





The
following table sets forth the maturity distribution of the investment portfolio
at December 31, 2004, as well as the weighted average yield for each range of
maturities. Mutual funds of $2.0 million are excluded from the table, as they do
not have a stated maturity date.





**(Dollars
      in Thousands)**
    
    **Maturing****After
      Five Years**
    
    **Weighted**
    
    **After**
    
    **Weighted**
    
    **Total
      Balance as of****Through
      Ten Years**
    
    **Average
      Yield**
    
    **Ten
      Years**
    
    **Average
      Yield**
    
    **December
      31, 2004**U.S
      agency securities
    
    $
    -
    
    
    -
    
    $
    10,501
    
    
    6.49
    %
    $
    10,501Mortgage-backed
      securities
    
    
    19,803
    
    
    3.01
    %
    
    191,130
    
    
    4.17
    %
    
    210,933Total
    
    $
    19,803
    
    
    3.01
    %
    $
    201,631
    
    
    4.30
    %
    $
    221,434





17





The
Company’s investment portfolio at December 31, 2004 increased $21.4 million or
10.6% compared to December 31, 2003. The increase in investment securities was
part of management’s strategy of augmenting earning assets to generate greater
yields. All securities are classified as available-for-sale and are carried at
fair market value. The Company holds no securities that should be classified as
trading securities and has determined that since its securities may be sold
prior to maturity because of interest rate changes, liquidity needs, or to
better match the repricing characteristics of funding sources, its entire
portfolio is classified as available-for-sale. No securities are classified as
held-to-maturity.





The table
below shows the Company’s investment securities’ gross unrealized losses and
fair value by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2004. The
Company has reviewed individual securities classified as available-for-sale to
determine whether a decline in fair value below the amortized cost basis is
other-than-temporary. If it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the debt security
not impaired at acquisition, an other-than-temporary impairment shall be
considered to have occurred. If an other-than-temporary impairment occurs, the
cost basis of the security would be written down to its fair value as the new
cost basis and the write down accounted for as a realized loss.




**(Dollars
      in Thousands)**
    
    **Less
      than 12 months**
    ****
    **12
      months or Longer**
    ****
    **Total**
    ********
    ****
    ****
    ****
    **Gross**
    ****
    ****
    ****
    **Gross**
    ****
    ****
    ****
    **Gross**
    ********
    ****
    ****
    ****
    **Unrealized**
    ****
    ****
    ****
    **Unrealized**
    ****
    ****
    ****
    **Unrealized**
    ********
    ****
    ****
    ****
    **Holding**
    ****
    ****
    ****
    **Holding**
    ****
    ****
    ****
    **Holding**
    ********
    ****
    **Fair
      Value**
    ****
    **Losses**
    ****
    **Fair
      Value**
    ****
    **Losses**
    ****
    **Fair
      Value**
    ****
    **Losses**U.S.
      agency securities
    
    $
    -
    
    $
    -
    
    $
    10,501
    
    $
    (532
    )
    $
    10,501
    
    $
    (532
    )Mortgage
      backed securities
    
    
    56,497
    
    
    (225
    )
    
    139,523
    
    
    (4,003
    )
    
    196,020
    
    
    (4,228
    )Mutual
      Funds
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
    
    $
    56,497
    
    $
    (225
    )
    $
    150,024
    
    $
    (4,535
    )
    $
    206,521
    
    $
    (4,760
    )





Despite
the unrealized loss position of these securities, the Company has concluded, as
of December 31, 2004, that these investments are not other-than-temporarily
impaired. This assessment was based on the following factors: i) the length of
time and the extent to which the market value has been less than cost; ii) the
financial condition and near-term prospects of the issuer; iii) the intent and
ability of the Company to retain its investment in a security for a period of
time sufficient to allow for any anticipated recovery in market value; and iv)
general market conditions which reflect prospects for the economy as a whole,
including interest rates and sector credit spreads.





The
Company accounts for investments in accordance with Statement of Financial
Accounting Standards No. 115, “ *Accounting
for Certain Investments in Debt and Equity Securities* ”, which
addresses the accounting for investments in equity securities that have readily
determinable fair values and for investments in all debt securities. Securities
are classified in three categories and accounted for as follows: debt and equity
securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity and are measured at amortized cost;
debt and equity securities bought and held principally for the purpose of
selling in the near term are classified as trading securities and are measured
at fair value, with unrealized gains and losses included in earnings; debt and
equity securities not classified as either held-to-maturity or trading
securities are deemed as available-for-sale and are measured at fair value, with
unrealized gains and losses, net of applicable taxes, reported in a separate
component of stockholders’ equity.




****


**Asset/Liability
Management**





Generally,
where rate-sensitive assets exceed rate-sensitive liabilities, the net interest
margin is expected to be positively impacted during periods of increasing
interest rates and negatively impacted during periods of decreasing interest
rates. When rate-sensitive liabilities exceed rate-sensitive assets generally
the net interest margin will be negatively affected during periods of increasing
interest rates and positively affected during periods of decreasing interest
rates. However, because interest rates for different asset and liability
products offered by depository institutions respond in a different manner, both
in terms of responsiveness as well as the extent of the responsiveness to
changes in the interest rate environment, the interest rate sensitivity gap is
only a general indicator of interest rate sensitivity.





18





The
Company concentrates on a core customer base with enhanced relationships
crossing over multiple deposit and loan product lines. For the year ended
December 31, 2004, the Company’s deposits were comprised of 13.2% of
non-interest bearing deposits, 46.7% of money market, NOW, and savings deposits,
and 40.1% of time certificates of deposit. Although the savings products are
interest-bearing, their longer term maturities make them less interest rate
sensitive. In addition, time certificates of deposit have rates fixed until
maturity. The Company does not offer variable rate certificates of deposit. The
Company has, on average, approximately 94% of all deposits classified as “core”
deposits and only 6% considered “non-core” for the year ended December 31, 2004.
Non-core deposits are defined by the Company as time certificates of deposit in
denominations over $100,000 for which the customer has no other products or
accounts with the Company and which have not renewed two times or more. As a
result, the Company has been successful in retaining time certificates of
deposit as they mature and reprice into the current interest rate environment.





Within
the Company’s loan portfolio, variable rate loans are typically structured with
floor rates which protect the Company from interest rate risk in a declining
rate environment. Due to the low interest rate environment in 2004, many of the
loans reached their floor rates, and this feature, combined with the fixed rate
portion of the portfolio, have allowed the Company to substantially mitigate the
compression of net interest margins that traditionally accompanies a low
interest rate scenario. For the year ended December 31, 2004, the Company has
maintained a net interest margin of 4.7% which is consistent with net interest
margin of 4.7% for the year ended December 31, 2003.




19





The table
below sets forth information concerning the interest rate sensitivity of the
Company’s consolidated assets and liabilities as of December 31, 2004. Assets
and liabilities are classified by the earliest possible repricing date or
maturity date, whichever comes first.





**(Dollars
      in Thousands)****Three**
    
    **Over
      Three**
    
    **Over
      One**
    
    
    
    **Non-****Months
      or**
    
    **Through
      12**
    
    **Through**
    
    **Over
      Five**
    
    **interest****Less**
    
    **Months**
    
    **Five
      Years**
    
    **Years**
    
    **Bearing**
    
    **Total**AssetsFederal
      funds sold
    
    $
    2,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2,000Investment
      securities
    
    
    2,046
    
    
    
    
    $
    12,903
    
    $
    208,531
    
    
    
    
    
    223,480Other
      investments
    
    
    
    
    
    
    
    
    
    
    
    12,235
    
    
    
    
    
    12,235Gross
      loans
    
    
    628,803
    
    $
    31,215
    
    
    125,318
    
    
    244,383
    
    
    
    
    
    1,029,719Noninterest-earning
      assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    44,063
    
    
    44,063Total
      assets
    
    $
    632,849
    
    $
    31,215
    
    $
    138,221
    
    $
    465,149
    
    $
    44,063
    
    $
    1,311,497Liabilities
      and stockholders' equityNon
      interest-bearing deposits
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    127,466
    
    $
    127,466Interest-bearing
      deposits
    
    $
    489,698
    
    $
    252,136
    
    $
    96,246
    
    
    
    
    
    
    
    
    838,080Federal
      Home Loan Bank advances
    
    
    162,000
    
    
    
    
    
    15,000
    
    
    
    
    
    
    
    
    177,000Subordinated
      debt
    
    
    5,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000Securities
      of trust holding
    
    
    71,139
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    71,139Other
      liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,585
    
    
    7,585Stockholders'
      equity
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,227
    
    
    85,227Total
      liabilities and stockholders' equity
    
    $
    727,837
    
    $
    252,136
    
    $
    111,246
    
    $
    -
    
    $
    220,278
    
    $
    1,311,497Interest
      rate sensitivity gap
    
    $
    (94,988
    )
    $
    (220,921
    )
    $
    26,975
    
    $
    465,149
    
    $
    (176,215
    )Cumulative
      interest rate sensitivity gap
    
    $
    (94,988
    )
    $
    (315,909
    )
    $
    (288,934
    )
    $
    176,215
    
    $
    -


The
Company realizes income principally from the differential or spread between the
interest earned on loans, investments and other interest-earning assets and the
interest paid on deposits and borrowings. The Company, like other financial
institutions, is subject to interest rate risk to the degree that its
interest-earning assets reprice differently than its interest-bearing
liabilities. The Company’s primary objective in managing its interest rate risk
is to minimize the adverse impact of changes in interest rates on the Company’s
net interest income and capital, while maintaining an asset-liability balance
sheet mix that produces the most effective and efficient returns.





A sudden
and substantial increase or decrease in interest rates may adversely impact the
Company’s income to the extent that the interest rates associated with the
assets and liabilities do not change at the same speed, to the same extent, or
on the same basis. The Company has adopted formal policies and practices to
monitor its interest rate risk exposure. As a part of its risk management
practices, the Company uses the Economic Value of Equity (“EVE”) and Earnings at
Risk (“EAR”) to monitor its interest rate risk.





The
Company's overall strategy is to minimize the adverse impact of immediate
incremental changes in market interest rates (rate shock) on EVE and EAR. The
EVE is defined as the present value of assets, minus the present value of
liabilities. The EAR is defined as the net interest income, which is interest
income less interest expense. The attainment of this goal requires a balance
between profitability, liquidity and interest rate risk exposure. To minimize
the adverse impact of changes in market interest rates, the Bank simulates the
effect of instantaneous interest rate changes on EVE at period end and EAR over
a one year horizon.




20





The table
below shows the estimated impact of changes in interest rates on EVE and EAR on
December 31, 2004, assuming shifts of 100 to 200 basis points in both
directions:




**(Dollars
      in Thousands)****Economic
      Value of Equity**
    
    **Earnings
      at Risk****Cumulative**
    
    **Cumulative**
    
    **Cumulative**
    
    **Cumulative****Dollar**
    
    **Percentage**
    
    **Dollar**
    
    **Percentage****Simulated
      Rate Changes**
    
    **Change**
    
    **Change**
    
    **Change**
    
    **Change**+200
      Basis Points
    
    $
    (13,094
    )
    
    -5.9
    %
    $
    3,528
    
    
    5.8
    %+100
      Basis Points
    
    
    (6,050
    )
    
    -2.7
    %
    
    1,660
    
    
    2.7
    %-100
      Basis Points
    
    
    3,492
    
    
    1.6
    %
    
    2,596
    
    
    4.2
    %-200
      Basis Points
    
    
    6,681
    
    
    3.0
    %
    
    6,904
    
    
    11.3
    %


The
amount and percentage changes represent the cumulative dollar and percentage
change in each rate change scenario from the base case. These estimates are
based upon a number of assumptions, including: the nature and timing of interest
rate levels including yield curve, prepayments on loans and securities, pricing
strategies on loans and deposits, replacement of asset and liability cashflows
and other assumptions. While the assumptions used are based on current economic
and local market conditions, there is no assurance as to the predictive nature
of these conditions including how customer preferences or competitor influences
might change.





At
December 31, 2004, the Company's estimated changes in EVE and EAR were within
the operating ranges established by the Board of Directors.





**Potential
Problem Loans**





The
policy of the Company is to continually evaluate the loan portfolio to ensure
loans are accurately risk rated. The loan portfolio is periodically subject to a
third party independent review to evaluate the risk ratings. In addition, as an
integral part of its regular examination of the Company, the banking regulatory
agencies also identify problem loans. There are three classifications for
problem loans: “substandard,” “doubtful,” and “loss.”





Substandard
loans have one or more defined weaknesses and are characterized by the distinct
possibility that the Company will sustain some loss if the deficiencies are not
corrected. Doubtful loans have the weaknesses of substandard loans with the
additional characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions and values,
questionable. A loan classified loss is considered uncollectible and of such
little value that the continuance as an asset of the institution is not
warranted.





Another
category designated “special mention” is maintained for loans which do not
currently expose the Company to a sufficient degree of risk to warrant
classification as substandard, doubtful or loss but do possess credit
deficiencies or potential weaknesses deserving management’s close
attention.





As of
December 31, 2004, the Company’s classified loans consisted of $2.0 million as
substandard and $0.1 million as doubtful, representing 0.2% of the gross loan
portfolio. As of December 31, 2003, the Company’s classified loans consisted of
$2.5 million as substandard and $0.1 million as doubtful, representing 0.4% of
the gross loan portfolio.





With the
exception of these loans, management is not aware of any loans as of December
31, 2004, where the known credit problems of the borrower would cause it to have
serious doubts as to the ability of such borrowers to comply with their present
loan repayment terms. Management cannot predict the extent to which the current
economic environment may persist or worsen or the full impact such environment
may have on the Company’s loan portfolio. Furthermore, management cannot predict
the results of any subsequent examinations of the Company’s loan portfolio by
the banking regulatory agencies. Accordingly, there can be no assurance that
other loans will be classified as discussed above.





21


****


**Loan
Concentrations**





The
Company does not have loans made to borrowers who are engaged in similar
activities where the aggregate amount of the loans exceeds 10% of the loan
portfolio that are not broken out as a separate category in the loan portfolio.





**Other
Interest-Earning Assets**





Other
than the classified loans discussed above, the Company does not have any
interest-earning assets for which management believes that recovery of the
interest on and principal thereof is at significant risk.





**Estimating
Loan Losses**





The Bank
estimates loan losses based on guidance established by the Financial Accounting
Standards Board (“FASB”) Statement No. 5, “ *Accounting
for Contingencies”* and FASB
Statement No. 114, “ *Accounting
by Creditors for Impairment of a Loan”* , as well
as within standards established by regulatory Interagency Policy Statements on
the Allowance for Loan and Lease Losses (“ALLL”). A detailed ALLL analysis is
prepared quarterly. The Bank segments its portfolio into pools with similar
characteristics, primarily based on loan product types and loan risk ratings.
The Bank’s loan risk rating system generally corresponds with regulatory
interagency classification definitions. Estimated loss rates are established by
first examining historical charge-off data for similar pools of loans. Where the
Bank has no or nominal actual charge-off data (as is the case for real estate
secured loan pools), management evaluates industry and direct peer data to
estimate loss rates. In addition, management makes adjustments for conditions it
believes may directly impact loss potential in the portfolio, including the
following:





·
    Trends
      in past due and impaired loans.


·
    Trends
      in charge-offs and recoveries.


·
    Trends
      in loan volume and loan terms.


·
    Changes
      in credit policies and underwriting.


·
    Experience
      and ability of lending management and staff.


·
    External
      factors including national and local economic trends and conditions,
      duration of the current business cycle, competition, legal and regulatory
      requirements, as well as reasonably foreseeable events that may affect
      collectibility of loans.


·
    Industry
      conditions.


·
    Concentration
      of credit risk.





Other
allocations may be warranted from time to time for certain risk factors that
affect multiple pools, or, which are not adequately addressed through
qualitative adjustments.





For
classified loans that are impaired, the Bank will establish a specific reserve
consistent with its measurement of impairment. For pools of classified loans for
which no impairment amount exists, management will use reasonable estimates
based on all current information, including historical loss rates, economic
conditions and industry trends *.* The
estimated ALLL represents the sum of the estimates of probable loss for each
loan pool plus specific reserves.





Management
also performs additional analyses to validate the reasonableness of the Bank’s
estimate of loss. These include calculating the ALLL using the ‘Examiner
Benchmark’ approach described in regulatory guidance, as well as evaluating the
Bank’s ALLL compared to the level of ALLL that is determined by relevant peer
data ratios.





The
allowance for loan and lease losses should not be interpreted as an indication
that charge-offs will occur in the estimated amounts or proportions, or that the
reserves indicate future charge-off trends. Furthermore, the portion allocated
to each loan category is not the total amount available for future losses that
might occur within such categories as the total reserve is a general reserve
applicable to the entire portfolio.





22





Maintaining
an accurate internal loan risk rating system is integral to the estimation of
loan losses. The originating loan officer assigns borrowers an initial risk
rating to all non-consumer loans, which is based primarily on a thorough
analysis of each borrower’s financial capacity in conjunction with industry and
economic trends. Such risk ratings are reviewed for appropriateness by credit
administration personnel during the loan approval process. Post origination,
loans are monitored on an ongoing basis by the appropriate lending group and by
credit administration personnel to identify factors which could impact the
ability of the borrower to perform under the contract. Risk ratings are adjusted
as necessary. The accuracy of risk ratings are validated on an ongoing basis by
independent loan review as well as through regulatory examinations.





The
following table sets forth an analysis of the Company’s loan loss experience, by
category, for the past five years.





**(Dollars
      in Thousands)**
    
    **December
      31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000**Allowance
      for possible loan losses balance,beginning
      of year
    
    $
    7,537
    
    $
    3,003
    
    $
    1,450
    
    $
    784
    
    $
    764Charge-offsCommercial
      and industrial
    
    
    67
    
    
    123
    
    
    117
    
    
    69
    
    
    305Real
      estate-mortgage
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Consumer
      loans
    
    
    325
    
    
    20
    
    
    124
    
    
    60
    
    
    61392
    
    
    143
    
    
    241
    
    
    129
    
    
    366RecoveriesCommercial
      and industrial
    
    
    95
    
    
    44
    
    
    78
    
    
    3
    
    
    110Real
      estate-mortgage
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Consumer
      loans
    
    
    27
    
    
    28
    
    
    89
    
    
    19
    
    
    20122
    
    
    72
    
    
    167
    
    
    22
    
    
    130Net
      charge-offs
    
    
    270
    
    
    71
    
    
    74
    
    
    107
    
    
    236Provision
      for possible loan losses
    
    
    5,734
    
    
    3,710
    
    
    1,430
    
    
    773
    
    
    256Allowance
      relating to acquired loan portfolio
    
    
    -
    
    
    895
    
    
    197
    
    
    -
    
    
    -Allowance
      for possible loan losses, end of year
    
    $
    13,001
    
    $
    7,537
    
    $
    3,003
    
    $
    1,450
    
    $
    784Ratio
      of net charge-offs during the year to averageloans
      outstanding during the year
    
    
    0.0
    %
    
    0.0
    %
    
    0.0
    %
    
    0.1
    %
    
    0.3
    %Ratio
      of allowance for possible loan lossesto
      loans at year-end
    
    
    1.3
    %
    
    1.3
    %
    
    1.2
    %
    
    1.1
    %
    
    1.0
    %








23





**Non-Accrual,
Past Due and Restructured Loans and Other Real Estate
Owned**





The
following table sets forth the amounts and categories of the Company’s
non-performing assets and the amount of the Company’s other real estate owned at
the dates indicated.





**(Dollars
      in Thousands)**
    
    **As
      of December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Accruing
      Loans More than 90 Days Past Due**Aggregate
      loan amountsCommercial
      and industrial
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -Real
      estate-mortgage
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Consumer
      loans
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    25Total
      loans past due more than 90 daysand
      still accruing
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    25**Renegotiated
      loans**
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -**Non-accrual
      loans**Aggregate
      loan amountsCommercial
      and industrial
    
    
    -
    
    
    173
    
    
    -
    
    
    -
    
    
    131Real
      estate-mortgage
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    176Consumer
      loans
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
      non-accrual loans
    
    
    -
    
    
    173
    
    
    -
    
    
    -
    
    
    307Total
      non-performing loans
    
    $
    -
    
    $
    173
    
    $
    -
    
    $
    -
    
    $
    332**Other
      Real Estate Owned**
    
    $
    -
    
    $
    111
    
    $
    -
    
    $
    -
    
    $
    -





If
interest on non-accrual loans had been recognized at the original interest
rates, interest income would have increased approximately $38,000, $11,000, $0,
$0 and $9,000 for the years ended December 31, 2004, 2003, 2002, 2001, and 2000,
respectively. There was approximately $21,000 of interest income recognized on
non-performing assets for the year ended December 31, 2004. There was no
interest income recognized on non-performing assets for the same periods then
ended in 2003, 2002, 2001 and 2000.





The
quality of the Company’s loan portfolio continued to perform well as compared to
peer group standards. At December 31, 2004, the Company had no non-performing
loans and no other real estate owned through foreclosure. The Company will
continue to monitor and modify its allowance for possible loan losses as
conditions dictate. Management believes that, based on information currently
available, the Company’s allowance for possible loan losses at December 31, 2004
was at a level to cover all known and inherent losses in its loan portfolio at
such date that were both probable and reasonable to estimate. In the future,
management may adjust the level of its allowance for possible loan losses as
economic and other conditions dictate. In addition, the FDIC and the DFI as an
integral part of their examination process periodically review the Company’s
allowance for possible loan losses. Such agencies may require the Company to
adjust the allowance based upon their judgment.





**Allowance
for Possible Loan Loss by Category**





The
allowance for possible loan losses was $13.0 million and $7.5 million at
December 31, 2004 and 2003, respectively, representing approximately 1.3% of
total loans at each year end. Actual net charge offs for the years ending
December 31, 2004 and 2003 were $0.3 million and $0.1 million,
respectively, representing 0.03% and 0.02%, respectively, of total average
loans. The increase in the ALLL was principally related to the expansion of the
Company’s loan portfolio.




24




The
following table sets forth the Company’s allowance for possible loan losses by
loan category and the percent of loans in each category to total loans at the
dates indicated.




**(Dollars
      in Thousands)**
    
    **As
      of December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Percent
      of**
    
    
    
    **Percent
      of**
    
    
    
    **Percent
      of**
    
    
    
    **Percent
      of**
    
    
    
    **Percent
      of****Loans
      in**
    
    
    
    **Loans
      in**
    
    
    
    **Loans
      in**
    
    
    
    **Loans
      in**
    
    
    
    **Loans
      in****Allowance**
    
    **Each**
    
    **Allowance**
    
    **Each**
    
    **Allowance**
    
    **Each**
    
    **Allowance**
    
    **Each**
    
    **Allowance**
    
    **Each****for
      Possible**
    
    **Category
      to**
    
    **for
      Possible**
    
    **Category
      to**
    
    **for
      Possible**
    
    **Category
      to**
    
    **for
      Possible**
    
    **Category
      to**
    
    **for
      Possible**
    
    **Category
      to****Loan
      Losses**
    
    **Total
      Loans**
    
    **Loan
      Losses**
    
    **Total
      Loans**
    
    **Loan
      Losses**
    
    **Total
      Loans**
    
    **Loan
      Losses**
    
    **Total
      Loans**
    
    **Loan
      Losses**
    
    **Total
      Loans**Commercial
      and industrial
    
    $
    919
    
    
    3.5
    %
    $
    791
    
    
    4.5
    %
    $
    506
    
    
    8.4
    %
    $
    497
    
    
    18.0
    %
    $
    180
    
    
    13.6
    %Real
      estate construction:Single-family
      coastal
    
    
    4,079
    
    
    29.1
    %
    
    2,479
    
    
    35.5
    %
    
    1,053
    
    
    35.3
    %
    
    298
    
    
    21.4
    %
    
    -
    
    
    3.8
    %Single-family
      tract
    
    
    1,838
    
    
    12.6
    %
    
    1,407
    
    
    17.4
    %
    
    245
    
    
    5.6
    %
    
    -
    
    
    -
    
    
    -
    
    
    -Commercial
    
    
    367
    
    
    3.5
    %
    
    255
    
    
    3.5
    %
    
    74
    
    
    2.5
    %
    
    38
    
    
    2.7
    %
    
    15
    
    
    3.2
    %Real
      estate mortgage:Commercial
    
    
    1,275
    
    
    21.0
    %
    
    964
    
    
    25.6
    %
    
    602
    
    
    36.7
    %
    
    372
    
    
    38.0
    %
    
    101
    
    
    50.1
    %Residential
    
    
    2,140
    
    
    30.0
    %
    
    490
    
    
    12.7
    %
    
    141
    
    
    9.3
    %
    
    126
    
    
    13.8
    %
    
    29
    
    
    14.0
    %Consumer
      and other loans
    
    
    127
    
    
    0.3
    %
    
    33
    
    
    0.8
    %
    
    32
    
    
    2.2
    %
    
    72
    
    
    6.1
    %
    
    24
    
    
    15.3
    %Other
      risks
    
    
    2,256
    
    
    -
    
    
    1,118
    
    
    -
    
    
    350
    
    
    -
    
    
    47
    
    
    -
    
    
    435
    
    
    -Total
    
    $
    13,001
    
    
    100.0
    %
    $
    7,537
    
    
    100.0
    %
    $
    3,003
    
    
    100.0
    %
    $
    1,450
    
    
    100.0
    %
    $
    784
    
    
    100.0
    %


25




**Sources
of Funds**






**General**




The
Company’s primary sources of funds for use in its lending and investing
activities consist of deposits, advances from the Federal Home Loan Bank
(“FHLB”) of San Francisco, and sales of, maturities and principal and interest
payments on loans and securities. In addition, proceeds raised by the Company
from sales of preferred or common stock and the issuance of junior subordinated
debentures have been down streamed primarily into the Bank. The Company closely
monitors rates and terms of competing sources of funds and utilize those sources
it believes to be the most cost effective and consistent with its asset and
liability management policies.




**Deposits**




The
primary source of the Bank’s funding comes from deposits. The Company offers
various deposit products which include non-interest bearing demand deposits,
interest-bearing savings deposits and time deposits. Savings deposits include
savings, NOW and money market deposit accounts.





The
average amount of and the average rate paid on deposits of the Company are
summarized below:





**(Dollars
      in Thousands)**
    
    **Years
      Ended December 31,****2004**
    
    **2003**
    
    **2002****Average**
    
    **Average**
    
    **Average**
    
    **Average**
    
    **Average**
    
    **Average****Balance**
    
    **Rate**
    
    **Balance**
    
    **Rate**
    
    **Balance**
    
    **Rate**Non-interest
      bearing demand deposits
    
    $
    115,045
    
    
    0.0
    %
    $
    75,370
    
    
    0.0
    %
    $
    55,936
    
    
    0.0
    %Savings
      deposits(1)
    
    
    385,001
    
    
    2.0
    %
    
    201,528
    
    
    1.9
    %
    
    89,489
    
    
    2.0
    %Time
      deposits
    
    
    323,996
    
    
    2.5
    %
    
    162,996
    
    
    2.7
    %
    
    73,394
    
    
    3.6
    %Total
      Deposits
    
    $
    824,042
    
    
    1.9
    %
    $
    439,894
    
    
    1.9
    %
    $
    218,819
    
    
    2.0
    %


_____________





(1) Includes
savings, NOW and money market deposit accounts.





Set forth
below is a maturity schedule of domestic time certificates of deposit of
$100,000 or more at the indicated period:





**(Dollars
      in Thousands)**
    
    **As
      of December 31, 2004**Three
      months or less
    
    $
    18,953Over
      three through six months
    
    
    71,302Over
      six through 12 months
    
    
    66,756Over
      one through five years
    
    
    46,971$
    203,982




**Short-term
Borrowings**





The
Company utilizes borrowings as a source of funds, such as FHLB advances, federal
funds purchased, issuances of junior subordinated debentures and lines of
credit. In March 2004, the Company obtained a $15.0 million line of credit and a
$5.0 million offering line of credit with a correspondent bank. The $5.0 million
offering line of credit is at the discretion of the correspondent bank at the
time of request for funding by the Company. There was no outstanding balance
under these lines of credit as of December 31, 2004.





In
addition, the Bank had unsecured borrowing lines with six correspondent banks
totaling $66.0 million as well as an advance line with the FHLB which allows the
Bank to borrow up to 40% of its total assets as of December 31, 2004. The Bank’s
advance line with the FHLB is collateralized by investment securities and/or
eligible loans. In December 2002, the Company borrowed from a correspondent bank
$5.0 million on a line of credit which was entirely paid off using a portion of
the net proceeds from its Series B Preferred Stock offering in the third quarter
of 2003.





26





Set forth
below is a schedule of outstanding short-term borrowings (maturing less than or
equal to one year) at the dates specified:





**(Dollars
      in Thousands)**
    
    **As
      of December 31,****2004**
    
    **2003**
    
    **2002**Federal
      Funds Purchased
    
    $
    -
    
    $
    -
    
    $
    -FHLB
      Advances
    
    
    162,000
    
    
    167,000
    
    
    20,000Line
      of Credit
    
    
    -
    
    
    -
    
    
    5,000Total
      Short-term borrowings
    
    $
    162,000
    
    $
    167,000
    
    $
    25,000






The
weighted average interest rate of short-term borrowings as of December 31, 2004
was 1.89%. The maximum amount of short-term borrowings outstanding at any
month-end during fiscal year 2004 was $237.0 million at March 31,
2004.




**Capital
Issuances**





The
Company has obtained funds through the issuance of a series of seven junior
subordinated debentures. At December 31, 2004, the Company had an aggregate of
$71.1 million of junior subordinated debentures outstanding. The terms of these
junior subordinated debentures are discussed in Note # 9 to the Company’s
audited financial statements included in Item 8 hereof. As of December 31, 2004,
the weighted average interest rate being paid on the Company’s junior
subordinated debentures was 5.2%. At December 31, 2004, the Company’s annual
interest payments with respect to its outstanding junior subordinated debentures
amounted to $2.6 million in the aggregate, based on the applicable interest rate
at that date. Such interest payments are currently expected to be funded by
operating income of the Bank.





During
2004, the Company has also obtained funds through the sale of $29.2 million, net
of fees and expenses, of common stock in two private placement transactions. The
terms of these transactions are discussed in Note #16 to the Company’s audited
financial statements included in Item 8 hereof.





On
December 18, 2002, the Company issued 50 shares of 7.0% Series A Preferred Stock
(“Series A Preferred Stock”) at $50,000 per share to eight individual investors
for aggregate gross proceeds of $2.5 million. The Series A Preferred Stock was
not convertible into common stock and was redeemable at the option of the
Company at face value, plus any unpaid dividends declared. With each share of
Series A Preferred Stock, the Company issued a warrant (the “Series A Warrant”)
to purchase 4,410 shares of the Company’s common stock at an exercise price of
$6.80 per share as adjusted to reflect the Company’s two-for-one stock split and
5% stock dividends. Each Series A Warrant must be exercised prior to December
18, 2005 or it will expire pursuant to its terms. On May 19, 2004, the Company
redeemed all 50 outstanding shares of its Series A Preferred Stock pursuant to
their terms at a redemption price of $50,000 per share plus accrued interest,
for an aggregate approximate amount of $2.5 million. As of December 31, 2004,
152,510 shares of common stock have been issued through the exercise of Series A
Warrants, and an aggregate of 67,990 shares of additional common stock may be
issued pursuant to the outstanding Series A Warrants.





On
September 19, 2003, the Company issued 1,150,000 shares of 5.6% noncumulative
convertible Series B Preferred Stock (“Series B Preferred Stock”) at $25.00 per
share for aggregate proceeds of approximately $28.8 million. Each share of
Series B Preferred Stock was convertible at the shareholder’s option at any time
into shares of the Company’s common stock at a conversion price of $16.61 per
share of common stock. The Series B Preferred Stock was redeemable at the option
of the Company at $25.00 per share, plus any unpaid dividends declared, on or
after September 19, 2005. The Series B Preferred Stock was also redeemable at
the option of the Company prior to September 19, 2005, in whole or in part, at
$25.00 per share if the last reported sale price of the Company’s common stock
has equaled or exceeded 125% of the Series B Preferred Stock conversion price of
$16.61 per share for at least 30 consecutive trading days. On May 4, 2004, the
Company announced that it would redeem all 1,150,000 outstanding shares of its
Series B Preferred Stock on June 3, 2004. Holders of the Series B Preferred
Stock had the right to convert their shares of Series B Preferred Stock into
shares of common stock. Prior to the redemption date, 1,147,595 shares of Series
B Preferred Stock elected to convert into 1,727,182 shares of common stock. On
June 3, 2004, the Company redeemed the remaining 2,405 shares of its Series B
Preferred Stock outstanding at a redemption price of $25.00 per share, plus
declared and unpaid dividends, for an aggregate approximate amount of $0.3
million. All share and per share data has been adjusted to reflect the
two-for-one stock split in August 2004 and the 5% stock dividends paid in
January 2004.




27


****


**Return
on Equity and Assets**




The
following table sets forth the Company’s ratios of net income to average total
assets (return on assets), net income to average total equity (return on
equity), cash dividend payout ratio (cash dividends per common share paid to
basic earnings per common share) and average equity to average total assets
(equity to asset ratio).




**2004**
    
    **2003**
    
    **2002**Return
      on average assets
    
    
    1.2
    %
    
    1.3
    %
    
    1.1
    %Return
      on average equity
    
    
    23.5
    %
    
    28.1
    %
    
    22.2
    %Cash
      dividend payout ratio
    
    
    6.7
    %
    
    2.1
    %
    
    0.0
    %Stockholders'
      equity to asset ratio
    
    
    5.1
    %
    
    4.6
    %
    
    5.0
    %





The
Company initiated a cash dividend program in 2003 with an initial declaration of
$0.01 per share. The Company has continued to increase its quarterly dividend
and has paid $0.04, $0.03, $0.03 and $0.02 per share cash dividend in November
2004, August 2004, May 2004 and February 2004, respectively.





In
addition, a two-for-one stock split was paid in August 2004, and 5% stock
dividends were paid in January 2004 and January 2003. All share and per share
data has been adjusted to reflect these stock dividends and stock split. The
terms of the stock dividends and stock split are discussed in Note #15 to the
Company’s audited financial statements included in Item 8 hereof.





**Competition**





The
Company faces substantial competition for deposits and loans throughout its
market areas. The primary factors in competing for deposits are interest rates,
personalized services, the quality and range of financial services, convenience
of office locations and office hours. Competition for deposits comes primarily
from other commercial banks, savings institutions, credit unions, money market
funds and other investment alternatives. The primary factors in competing for
loans are interest rates, loan origination fees, the quality and range of
lending services and personalized services. Competition for loans comes
primarily from other commercial banks, savings institutions, mortgage banking
firms, credit unions and other financial intermediaries.





The
Company faces competition for deposits and loans throughout its market areas not
only from local institutions but also from out-of-state financial intermediaries
which have opened loan production offices or which solicit deposits in its
market areas. Many of the financial intermediaries operating in the Company’s
market areas offer certain services, such as trust, investment and international
banking services, which the Company does not offer directly. Additionally, banks
with larger capitalization and financial intermediaries not subject to bank
regulatory restrictions have large lending limits and are thereby able to serve
the needs of larger customers.





**Effect
of Governmental Policies and Recent Legislation**





The
Company’s business is not only affected by general economic conditions but is
also influenced by the monetary and fiscal policies of the federal government
and the policies of regulatory agencies, particularly the FRB. The FRB
implements national monetary policies (with objectives such as curbing inflation
and combating recession) by its open-market operations in United States
Government securities, by adjusting the required level of reserves for financial
institutions subject to its reserve requirements and by varying the discount
rates applicable to borrowings by depository institutions. The actions of the
FRB in these areas influence the growth of bank loans, investments and deposits
and also affect interest rates charged on loans and paid on deposits. The nature
and impact of any future changes in monetary policies cannot be
predicted.





28





From time
to time, legislation is enacted which has the effect of increasing the cost of
doing business, limiting or expanding permissible activities or affecting the
competitive balance between banks and other financial institutions. Proposals to
change the laws and regulations governing the operations and taxation of banks,
bank holding companies and other financial institutions are frequently made in
Congress, in the California legislature and before various bank regulatory and
other professional agencies (See Item 1. Business; Supervision and
Regulation.)






**Supervision
and Regulation**





**General**





Bank
holding companies and banks are extensively regulated under both federal and
state law. The regulation is intended primarily for the protection of depositors
and the deposit insurance fund and not for the benefit of shareholders of the
Company. Set forth below is a summary description of the material laws and
regulations which relate to the operations of the Company and the Bank. This
description does not purport to be complete and is qualified in its entirety by
reference to the applicable laws and regulations.





In recent
years significant legislative proposals and reforms affecting the financial
services industry have been discussed and evaluated by Congress, the state
legislature and before the various bank regulatory agencies. These proposals may
increase or decrease the cost of doing business, limiting or expanding
permissible activities, or enhance the competitive position of other financial
service providers. The likelihood and timing of any such proposals or bills and
the impact they might have on the Company and its subsidiary cannot be
predicted.





**The
Company**





The
Company is a registered bank holding company and is subject to regulation under
the Bank Holding Company Act of 1956, as amended (“BHCA”). Accordingly, the
Company's operations, and its subsidiary are subject to extensive regulation and
examination by the Board of Governors of the Federal Reserve
System.





The
Company is required to file with the FRB quarterly and annual reports and such
additional information as the FRB may require pursuant to the BHCA. The FRB
conducts periodic examinations of the Company and its subsidiary. The FRB may
require that the Company terminate an activity or terminate control of or
liquidate or divest certain subsidiaries or affiliates when the FRB believes the
activity or the control of the subsidiary or affiliate constitutes a significant
risk to the financial safety, soundness or stability of its banking subsidiary.
The FRB also has the authority to regulate provisions of certain bank holding
company debt, including authority to impose interest ceilings and reserve
requirements on such debt. Under certain circumstances, the Company must file
written notice and obtain approval from the FRB prior to purchasing or redeeming
its equity securities.





Under the
BHCA and regulations adopted by the FRB, a bank holding company and its
nonbanking subsidiaries are prohibited from requiring certain tie-in
arrangements in connection with an extension of credit, lease or sale of
property or furnishing of services. For example, with certain exceptions, a bank
may not condition an extension of credit on a promise by its customer to obtain
other services provided by it, its holding company or other subsidiaries, or on
a promise by its customer not to obtain other services from a competitor. In
addition, federal law imposes certain restrictions on transitions between the
Company and its subsidiaries. Further, the Company is required by the FRB to
maintain certain levels o f capital
(See Item 7. Management Discussion and Analysis of Financial Condition and
Results of Operations; Capital Resources. )





29





Directors,
officers and principal shareholders of the Company have had and will continue to
have banking transactions with the Bank in the ordinary course of business. Any
loans and commitments to lend included in such transactions are made in
accordance with applicable law, on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons of similar creditworthiness, and on terms not
involving more than the normal risks of collection or presenting other
unfavorable features.





The
Company is prohibited by the BHCA, except in certain statutorily prescribed
instances, from acquiring direct or indirect ownership or control of more than
5% of the outstanding voting share of any company that is not a bank or bank
holding company and from engaging directly or indirectly in activities other
than those of banking, managing or controlling banks or furnishing services to
its subsidiary. However, the Company, subject to the prior approval of the FRB,
may engage in any, or acquire shares of companies engaged in, activities that
are deemed by the FRB to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto.





Under
FRB’s regulations, a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and may not conduct
its operations in an unsafe or unsound manner. In addition, it is the FRB's
policy that in serving as a source of strength to its subsidiary banks, a bank
holding company should stand ready to use available resources to provide
adequate capital funds to its subsidiary banks during periods of financial
stress or adversity and should maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the FRB to be an unsafe and unsound banking practice or a
violation of the FRB's regulations or both.





The
Company's securities are registered with the SEC under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). As such, the Company is subject to
the information, proxy solicitation, insider trading and other requirements and
restrictions of the Exchange Act (See Item 1. Business; Supervision and
Regulation; Sarbanes-Oxley Act of 2002.)





**The
Bank**





The Bank,
as a California chartered bank, is subject to primary supervision, periodic
examination, and regulation by the DFI and the FDIC. To a lesser extent, the
Bank is also subject to certain regulations promulgated by the FRB. If, as a
result of an examination of the Bank, the FDIC should determine that the
financial condition, capital resources, asset quality, earnings prospects,
management, liquidity, or other aspects of the Bank's operations are
unsatisfactory or that the Bank or its management is violating or has violated
any law or regulation, various remedies are available to the FDIC. Such remedies
include the power to enjoin "unsafe or unsound" practices, to require
affirmative action to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to
direct an increase in capital, to restrict the growth of the Bank, to assess
civil monetary penalties, to remove officers and directors and ultimately to
terminate the Bank's deposit insurance, which for a California chartered bank
would result in a revocation of the Bank's charter. The DFI has many of the same
remedial powers.





Various
requirements and restrictions under the laws of the State of California and the
United States affect the operations of the Bank. State and federal statues and
regulations relate to many aspects of the Bank's operations, including reserves
against deposits, ownership of deposit accounts, interest rates payable on
deposits, loans, investments, mergers and acquisitions, borrowings, dividends,
locations of banking centers and capital requirements. Furthermore, the Bank is
required to maintain certain levels of capital (See Item 7. Management
Discussion and Analysis of Financial Condition and Results of Operations;
Capital Resources.)





30





Following
a regular joint examination by the FDIC and the DFI in November 2003, the Bank’s
Board of Directors approved and signed a voluntary agreement (the “Agreement”)
with the FDIC and DFI on July 7, 2004. In relation to the Bank’s significant
growth over the last several years, the Bank continues to assess and develop its
policies and procedures to facilitate the successful implementation of its
strategic plan and capital adequacy plan while maintaining the safety and
soundness of the Bank. The adoption of the Agreement formalizes many of the
actions that the Bank has already taken to strengthen its operational
procedures, broaden its directorship and augment its senior management team. The
Bank continues to maintain capital ratios in excess of regulatory requirements.
Operating performance and asset quality continues to be strong, and deposit
generation and liquidity continues to be satisfactory to support its operations.




Prior to
entering into the Agreement, the Bank’s existing three-year strategic plan and
capital adequacy plan called for a measured growth. In accordance with the
Agreement, the Bank will notify the FDIC and DFI of any deviations beyond its
strategic plan, including any growth beyond 25% of its total assets per annum,
which level is within the existing strategic plan’s framework. Consistent with
the terms of the Agreement, the Bank added one new director to its Board of
Directors by December 31, 2004, and subsequently added another director in
January 2005. The Bank believes it is in fulfillment of the Agreement, and the
Agreement will not materially adversely affect the successful implementation of
the Company’s strategic business plan, the Company’s financial condition or
results of operations, or the Company’s previously announced earnings
guidance.




**Dividends
and Other Transfer of Funds**





Dividends
from the Bank constitute the principal source of income to the Company. The
Company is a legal entity separate and distinct from the Bank. The Company’s
ability to pay cash dividends is limited by California law. Under California
law, shareholders of the Company may receive dividends when and as declared by
the Board of Directors out of funds legally available for such purpose. With
certain exceptions, a California corporation may not pay a dividend to its
shareholders unless (i) its retained earnings equal at least the amount of the
proposed dividend, or (ii) after giving effect to the dividend, the
corporation’s assets would equal at least 1.25 times its liabilities and, for
corporations with classified balance sheets, the current assets of the
corporation would be at least equal to its current liabilities or, if the
average of the earnings of the corporation before taxes on income and before
interest expense for the two preceding fiscal years was less than the average of
the interest expense of the corporation for those fiscal years, at least equal
to 1.25 times its current liabilities.





The FDIC
and the DFI have authority to prohibit the Bank from engaging in activities
that, in their opinion, constitute unsafe or unsound practices in conducting its
business. It is possible, depending upon the financial condition of the bank in
question and other factors, that the FDIC and the DFI could assert that the
payment of dividends or other payments might, under some circumstances, be an
unsafe or unsound practice. Furthermore, the FDIC and the FRB have established
guidelines with respect to the maintenance of appropriate levels of capital by
banks or bank holding companies under their jurisdiction. Compliance with the
standards set forth in such guidelines and the restrictions that are or may be
imposed under the prompt corrective action provisions of federal law could limit
the amount of dividends which the Bank or the Company may pay. An insured
depository institution is prohibited from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions if after such transaction the institution would be
undercapitalized. The DFI may impose similar limitations on the Bank (See
Item. 1 Business; Supervision and Regulation; Prompt Corrective
Action.)





The Bank
is subject to certain restrictions imposed by federal law on any extensions of
credit to, or the issuance of a guarantee or letter of credit on behalf of, the
Company or other affiliates, the purchase of, or investments in, stock or other
securities thereof, the taking of such securities as collateral for loans, and
the purchase of assets of the Company or other affiliates. Such restrictions
prevent the Company and other affiliates from borrowing from the Bank unless the
loans are secured by marketable obligations of designated amounts. Furthermore,
such secured loans and investments by the Bank to or in the Company or to or in
any other affiliates are limited, individually, to 10% of the Bank's capital and
surplus (as defined by federal regulations), and such secured loans and
investments are limited, in the aggregate, to 20% of the Bank's capital and
surplus (as defined by federal regulations). California law also imposes certain
restriction with respect to transactions involving the Company and other
controlling persons of the Bank. Additional restrictions on transaction with
affiliates may be imposed on the Bank under the prompt corrective action
provisions of federal law (See Item. 1 Business; Supervision and Regulation;
Prompt Corrective Action.)





31


****


**Capital
Requirements**





The FRB
and the FDIC have established risk-based minimum capital guidelines with respect
to the maintenance of appropriate levels of capital by United States banking
organizations. These guidelines are intended to provide a measure of capital
that reflects the degree of risk associated with a banking organization's
operations for both transactions reported on the balance sheet as assets and
transactions, such as letters of credit and recourse arrangements, which are
recorded as off balance sheet items. Under these guidelines, nominal dollar
amounts of assets and credit equivalent amounts of off balance sheet items are
multiplied by one of several risk adjustment percentages, which range from 0%
for assets with low credit risk, such as certain U.S. Treasury securities, to
100% for assets with relatively high credit risk, such as commercial
loans.





The
federal banking agencies require a minimum ratio of qualifying total capital to
risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to
risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal
banking regulators require banking organizations to maintain a minimum amount of
Tier 1 capital to average assets, referred to as the leverage ratio. For a
banking organization rated in the highest of the five categories used by
regulators to rate banking organizations, the minimum leverage ratio must be 3%.
In addition to these uniform risk-based capital guidelines and leverage ratios
that apply across the industry, the regulators have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above minimum guidelines and ratios.





**Prompt
Corrective Action**





The
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among
other things, identifies five capital categories for insured depository
institutions (well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized) and requires the
respective federal regulatory agencies to implement systems for "prompt
corrective action" for insured depository institutions that do not meet minimum
capital requirements within such categories. FDICIA imposes progressively more
restrictive constraints on operations, management and capital distributions,
depending on the category in which an institution is classified. Failure to meet
the capital guidelines could also subject a banking institution to capital
raising requirements. An "undercapitalized" institution must develop a capital
restoration plan. At December 31, 2004, the Bank exceeded all of the required
ratios for classification as "well capitalized."





An
institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized, or undercapitalized, may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or practice warrants such treatment. At each
successive lower capital category, an insured depository institution is subject
to more restrictions.





Banking
agencies have also adopted regulations which mandate that regulators take into
consideration (i) concentrations of credit risk; (ii) interest rate risk (when
the interest rate sensitivity of an institution's assets does not match the
sensitivity of its liabilities or its off-balance-sheet position); and (iii)
risks from non-traditional activities, as well as an institution's ability to
manage those risks, when determining the adequacy of an institution's capital.
This evaluation will be made as a part of the institution's regular safety and
soundness examination. In addition, the banking agencies have amended their
regulatory capital guidelines to incorporate a measure for market risk. In
accordance with the amended guidelines, the Company and any company with
significant trading activities must incorporate a measure for market risk in its
regulatory capital calculations.




32





In
addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the supervising agencies for unsafe or unsound practices in conducting their
businesses for violations of law, rule, regulation or any condition imposed in
writing by the agency or any written agreement with the agency. Enforcement
actions vary commensurate with the severity of the violation.





**Safety
and Soundness Standards**





The
federal banking agencies have adopted guidelines designed to assist the federal
banking agencies in identifying and addressing potential safety and soundness
concerns before capital becomes impaired. The guidelines set forth operational
and managerial standards relating to: (i) internal controls, information systems
and internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits. In
addition, the federal banking agencies have also adopted safety and soundness
guidelines with respect to asset quality and earnings standards. These
guidelines provide six standards for establishing and maintaining a system to
identify problem assets and prevent those assets from deteriorating. Under these
standards, any insured depository institution should: (i) conduct periodic asset
quality reviews to identify problem assets; (ii) estimate the inherent losses in
problem assets and establish reserves that are sufficient to absorb estimated
losses; (iii) compare problem asset totals to capital; (iv) take appropriate
corrective action to resolve problem assets; (v) consider the size and potential
risks of material asset concentrations; and (vi) provide periodic asset quality
reports with adequate information for management and the board of directors to
assess the level of asset risk. These guidelines also set forth standards for
evaluating and monitoring earnings and for ensuring that earnings are sufficient
for the maintenance of adequate capital and reserves.





**Premiums
for Deposit Insurance**





The
Company's deposit accounts are insured by the Bank Insurance Fund ("BIF"), as
administered by the FDIC, up to the maximum permitted by law. Insurance of
deposits may be terminated by the FDIC upon a finding that the institution has
engaged in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operation, or has violated any applicable law, regulation, rule, order,
or condition imposed by the FDIC or the institution's primary
regulator.





The FDIC
charges an annual assessment for the insurance of deposits, which as of December
31, 2004, ranged from 0 to 27 **** basis
points per $100 of insured deposits, based on the risk a particular institution
poses to its deposit insurance fund. The risk classification is based on an
institution's capital group and supervisory subgroup assignment. An
institution's risk category is based upon whether the institution is well
capitalized, adequately capitalized, or less than adequately capitalized. Each
insured depository institution is also assigned to one of the following
"supervisory subgroups": Subgroup A, B or C. Subgroup A institutions are
financially sound institutions with few minor weaknesses; Subgroup B
institutions are institutions that demonstrate weaknesses which, if not
corrected, could result in significant deterioration; and Subgroup C
institutions are institutions for which there is a substantial probability that
the FDIC will suffer a loss in connection with the institution unless effective
action is taken to correct the areas of weakness. Insured institutions are not
allowed to disclose their risk assessment classification and no assurance can be
given as to what the future level of premiums will be.





**The
Community Reinvestment Act ("CRA")**





The Bank
is subject to certain fair lending requirements and reporting obligations
involving lending, investing and other CRA activities. CRA requires the Company
to identify the communities served by the Company's offices and to identify the
types of credit and investments the Company is prepared to extend within such
communities including low and moderate income neighborhoods. It also requires
the Company's regulators to assess the Company's performance in meeting the
credit needs of its community and to take such assessment into consideration in
reviewing application for mergers, acquisitions, relocation of existing
branches, opening of new branches and other transactions. A bank may be subject
to substantial penalties and corrective measures for a violation of certain fair
lending laws. The federal banking agencies may take compliance with such laws
and CRA in consideration when regulating and supervising other banking
activities.





33





A bank's
compliance with its CRA obligations is determined based on a performance-based
evaluation system which bases CRA ratings on an institution's lending, service
and investment performance. An unsatisfactory rating may be the basis for
denying a merger application. The Bank's latest CRA examination was completed by
the FDIC. The Bank received an overall rating of satisfactory in complying with
its CRA obligations.





**Financial
Services Modernization Legislation**





In
November 1999, the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) was enacted.
The GLB Act repeals provisions of the Glass-Steagall Act which restricted the
affiliation of Federal Reserve member banks with firms “engaged principally” in
specified securities activities, and which restricted officer, director or
employee interlocks between a member bank and any company or person “primarily
engaged” in specified securities activities.





In
addition, the GLB Act contains provisions that expressly preempt any state law
restricting the establishment of financial affiliations, primarily related to
insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms and other financial service providers by revising and expanding
the BHCA framework to permit a holding company to engage in a full range of
financial activities through a new entity known as a “financial holding
company.” “Financial activities” is broadly defined to include not only banking,
insurance and securities activities, but also merchant banking and additional
activities that the FRB, in consultation with the Secretary of the Treasury,
determines to be financial in nature, incidental to such financial activities or
complementary activities that do not pose a substantial risk to the safety and
soundness of depository institutions or the financial system generally.





The GLB
Act provides that no company may acquire control of an insured savings
association unless that company engages, and continues to engage, only in the
financial activities permissible for a financial holding company, unless the
company is grandfathered as a unitary savings and loan holding company. The GLB
Act grandfathers any company that was a unitary savings and loan holding company
on May 4, 1999 or became a unitary savings and loan holding company pursuant to
an application pending on that date.





The GLB
Act also permits national banks to engage in expanded activities through the
formation of financial subsidiaries. A national bank may have a subsidiary
engaged in any activity authorized for national banks directly or any financial
activity, except for insurance underwriting, insurance investments, real estate
investment or development, or merchant banking, which may only be conducted
through a subsidiary of a financial holding company. Financial activities
include all activities permitted under new sections of the BHCA or permitted by
regulation.





To the
extent that the GLB Act permits banks, securities firms and insurance companies
to affiliate, the financial services industry may experience further
consolidation. The GLB Act is intended to grant to community banks powers as a
matter of right that larger institutions have accumulated on an ad hoc basis and
which unitary savings and loan holding companies already possess. Nevertheless,
the GLB Act may have the result of increasing the amount of competition that the
Company faces from larger institutions and other types of companies offering
financial products, many of which may have substantially more financial
resources than the Company has.





**Regulation
W**





Transactions
between a bank and its “affiliates” are governed by Sections 23A and 23B of the
Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and
23B to insured nonmember banks in the same manner and to the same extent as if
they were members of the Federal Reserve System. The FRB has also recently
issued Regulation W, which codifies prior regulations under Sections 23A and 23B
of the Federal Reserve Act and provides interpretative guidance with respect to
affiliate transactions. Affiliates of a bank include, among other entities, the
bank’s holding company and companies that are under common control with the
bank. The Company is considered to be an affiliate of the Bank. In general,
subject to certain specified exemptions, a bank or its subsidiaries are limited
in their abilities to engage in “covered transactions” with
affiliates:





34




·
    to
      an amount equal to 10% of the bank’s capital and surplus, in the case of
      covered transactions with any one affiliate; and


·
    to
      an amount equal to 20% of the bank’s capital and surplus, in the case of
      covered transactions with all affiliates.





In
addition, a bank and its subsidiaries may engage in certain transactions only on
terms and under circumstances that are substantially the same, or at least as
favorable to the bank or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies.





**USA
Patriot Act of 2001**





On
October 26, 2001, President Bush signed the USA Patriot Act of 2001 (the
“Patriot Act”). The Patriot Act has imposed substantial new record-keeping and
due diligence obligations on banks and other financial institutions, with a
particular focus on detecting and reporting money-laundering transactions
involving domestic or international customers. The U.S. Treasury Department has
issued and will continue to issue regulations clarifying the Patriot Act’s
requirements. The Patriot Act requires all “financial institutions,” as defined,
to establish certain anti-money laundering compliance and due diligence
programs.





**Sarbanes-Oxley
Act of 2002**





On July
30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the
“SOA”), implementing legislative reforms intended to address corporate and
accounting improprieties. The SOA generally applies to all companies, both U.S.
and non-U.S., that file or are required to file periodic reports with the SEC
under the Exchange Act. The SOA includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and securities
exchanges to adopt extensive additional disclosure, corporate governance and
other related rules and mandates further studies of specified issues by the SEC
and the Comptroller General.





The
Company has adopted a code of ethics (“Code of Ethics”) that applies to its
executive officers. A copy of the Code of Ethics is filed as an exhibit hereto.





**Accounting
Changes**





In
December 2004, FASB issued FASB Statement No. 123R “ *Share-Based
Payment* ”, which
is a revision to Statement of Financial Accounting Standards (“SFAS”) No.123,
“ *Accounting
for Stock-Based Compensation* ”, and
addresses the accounting for transactions in which an enterprise receives
employee services in exchange for (a) equity instruments of the enterprise or
(b) liabilities that are based on the fair value of the enterprise’s equity
instruments or that may be settled by the issuance of such equity instruments.
This statement eliminates the ability to account for share-based compensation
transactions using APB No. 25, and generally would require instead that such
transactions be accounted for using a fair-value-based method. The revised
statement does not change the accounting in FASB Statement No. 123, *Accounting
for Stock-Based Compensation* , for
transactions in which an enterprise exchanges its equity instruments for
services of parties other than employees or changes the accounting for employee
stock ownership plans, which are subject to American Institute of Certified
Public Accountants (“AICPA”) Statement of Position 93-6, *Employers’
Accounting for Employee Stock Ownership Plans* . The
phase-in period for this statement begins in the third quarter of 2005, at which
time the Company will account for stock-based compensation based on this new
pronouncement. The Company is in the process of determining the impact that the
adoption of SFAS No. 123R will have on the financial condition or operating
results of the Company.




35





In
December 2003, the AICPA issued Statement of Position 03-3, Accounting for
Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”). SOP 03-3
addresses accounting for differences between contractual cash flows and cash
flows expected to be collected from an investor’s initial investment in loans or
debt securities (loans) acquired in a transfer if those differences are
attributable, at least in part, to credit quality. SOP 03-3 does not apply to
loans originated by the entity. SOP 03-3 limits the yield that may be accreted
(accretable yield) to the excess of the investor’s estimate of undiscounted
expected principal, interest, and other cash flows over the investor’s initial
investment in the loan. SOP 03-3 requires that the excess of contractual cash
flows over cash flows expected to be collected not be recognized as an
adjustment of yield, loss accrual, or valuation allowance. SOP 03-3 prohibits
investors from displaying accretable yield and nonaccretable difference in the
balance sheet. Subsequent increases in cash flows expected to be collected
generally should be recognized prospectively through adjustment of the loan’s
yield over its remaining life. Decreases in cash flows expected to be collected
should be recognized as impairment. SOP 03-3 is effective for loans acquired in
fiscal years beginning after December 15, 2004. The adoption of SOP 03-3 is not
expected to have a material impact on the financial condition or operating
results of the Company.





In May
2003, the FASB issued SFAS No. 150, “ *Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity* ” (“SFAS
No. 150”). SFAS No. 150 established standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances.) Many of those instruments were previously classified as
equity. SFAS No. 150 is generally effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. The adoption of SFAS
No. 150 did not have a material impact on the financial condition or operating
results of the Company.





**Employees**





At
December 31, 2004, the Company had 244 full-time equivalent employees as
compared to approximately 187 in 2003. The Company believes that its employee
relations are satisfactory.





36


****


**ITEM
2. Properties**




The
following table sets forth certain information with respect to the Bank’s
offices at December 31, 2004.





**Office
      Location**
    
    **Leased/Owned**
    
    **Lease
      Expiration Date**9590
      Foothill Boulevard(1)
      (2)
    
    Owned
    
    N/ARancho
      Cucamonga, California 917305455
      Riverside Drive(1)
    
    Owned
    
    N/AChino,
      California 9171023840
      Lake Drive(1)
    
    Owned
    
    N/ACrestline,
      California 92325222
      S. Promenade, 2ndfloor(7)
    
    Leased
    
    Month
      to MonthCorona,
      CA 928798748
      Industrial Lane(5)
    
    Leased
    
    Month
      to MonthRancho
      Cucamonga, California 91731500
      State College Boulevard, Suite 1210(3)
    
    Leased
    
    January
      2005Orange,
      CA 928681200
      S. Diamond Bar Boulevard(1)
    
    Leased
    
    April
      2005Diamond
      Bar, California 917658105
      Irvine Center Drive, Suite 600(4)
    
    Leased
    
    March
      2007Irvine,
      California 9261827177
      Highway 189, Suite G(8)
    
    Leased
    
    March
      2007Blue
      Jay, California 923172100
      S. Foothill Boulevard(1)
    
    Leased
    
    October
      2009LaVerne,
      California 9175016008-14
      Foothill Boulevard(1)
    
    Leased
    
    December
      2009Irwindale,
      California 91706500
      State College Boulevard, Suite 530(9)
    
    Leased
    
    January
      2010Orange,
      CA 9286828200
      Hwy 189, Suite K-100(6)
    
    Leased
    
    July
      2013Lake
      Arrowhead, California 923521230
      Rosecrans Avenue, 6thfloor(1)
    
    Leased
    
    August
      2013Manhattan
      Beach, California 902651016
      Irwin Street(7)
    
    Leased
    
    January
      2014San
      Rafael, California 949091260
      Corona Pointe(7)
    
    Leased
    
    September
      2014Corona,
      CA 928797676
      Hazard Center Drive, Suite 200(3)
    
    Leased
    
    November
      2014San
      Diego, California 92107200
      S. Main Street, Suites 150 & 320(1)
      (7)
    
    Leased
    
    December
      2018Corona,
      California 92878


___________________





(1) This
location serves as a full-service banking center of the Bank.


(2) This
location also serves as the Company’s corporate headquarters.




37





(3) This
location serves as an SBA loan production office of the Bank.


(4) This
location serves as an administrative and loan production office.


(5) This
location serves as the Bank’s warehouse facility.


(6) This
location replaced the full-service banking center previously located in Blue
Jay, California.


(7) This
location serves as an administrative office.


(8) This
location serves as an ATM room.


(9) In
February 2005, this location replaced the existing Anaheim SBA loan production
office in Orange, California.







**ITEM
3. Legal Proceedings**





In the
normal course of business, the Company is subject to legal actions and
complaints.  At December 31, 2004, management is not aware of any material
pending legal action or complaint asserted against the Company.








**ITEM
4. Submission of Matters to Vote of Security Holders**





No
matters were submitted to a vote of the Company’s stockholders during the fourth
quarter of 2004.








**PART
II**




**ITEM
5. Market for the Registrant’s Common Stock, Related Stockholder
Matters** **,
and Issuer Purchases of Equity Securities**


The
Company’s common stock has been listed on the NASDAQ National Market System
under the symbol “VNBC” since November 2002. Prior to such time, the Company’s
common stock was listed on the NASDAQ SmallCap Market under the same symbol.





**Common
Stock**





In June
2004, the Company issued and sold 800,000 shares of its common stock to
institutional investors through a private placement, which raised $15.2 million
in additional capital, net of fees and expenses. The Company also granted the
investors warrants (the “Warrants”) to purchase up to 160,000 additional shares
of common stock for $25.00 per share. The Company contributed $10.0 million of
the proceeds from this private placement to the Bank to support the continued
growth of the Bank, and the remaining proceeds were used by the Company for
general corporate purposes. RBC Capital Markets Corporation served as placement
agent for the private offering. The Company filed a registration statement with
the SEC to register all of the shares of common stock issued in the June 2004
private placement and the shares of common stock issuable upon exercise of the
Warrants. The registration statement was declared effective on August 3, 2004.





In
December 2004, the Company issued and sold 483,100 shares of its common stock to
institutional investors through a private placement, which raised $14.0 million
in additional capital, net of fees and expenses. The Company also granted the
investors the right (the “Right”) to purchase an additional 120,775 shares of
common stock for $31.05 per share. The Company used the proceeds from this
private placement to payoff the ESOP loan held by a third party bank, repayment
of other debt, and other general corporate purposes. RBC Capital Markets
Corporation served as placement agent for the private offering. The Company
filed a registration statement with the SEC to register all of the shares of
common stock issued in the December 2004 private placement and the shares of
common stock issuable upon exercise of the Rights. The registration statement
was declared effective on February 4, 2005. The common stock, Warrants and
Rights were offered and sold pursuant to an exemption to the registration
requirements under Section 4(2) of the Securities Act of 1933, as amended
(“Securities Act”). (See Note #16 to the Company’s audited financial statements
included in Item 8 hereof.)




38


****


**Junior
Subordinated Debentures**




In March
2004, the Company’s special purpose business trust, Vineyard Statutory Trust V,
issued $10.3 million of trust preferred securities in a private placement
offering. In connection with this transaction, the Company issued certain junior
subordinated debentures and guarantees.





In May
2004, the Company’s special purpose business trust, Vineyard Statutory Trust VI,
issued $12.4 million of trust preferred securities in a private placement
offering. In connection with this transaction, the Company issued certain junior
subordinated debentures and guarantees.





In
December 2004, the Company’s special purpose business trust, Vineyard Statutory
Trust VII, issued $10.3 million of trust preferred securities in a private
placement offering. In connection with this transaction, the Company issued
certain junior subordinated debentures and guarantees. The net proceeds from the
issuance of the junior subordinated debentures were used primarily to repay debt
of the Company. The Company and each of the statutory trusts relied on the
exemption from the registration requirements set forth in Rule 144A of the
Securities Act.





The
following table summarizes the high and low closing prices at which the shares
of the common stock of the Company have traded during the periods indicated,
based upon trades of which management of the Company has knowledge. Quoted
prices reflect inter-dealer prices, without retail mark-up, or commission and
may not necessarily represent actual transactions. The Company’s stock prices in
the following table have been adjusted to reflect the Company’s two-for-one
stock split in August 2004 and the 5% stock dividends paid in January 2003 and
January 2004.





**Sales
      Prices of****Common
      Stock****High**
    
    **Low**2004First
      Quarter
    
    $
    22.18
    
    $
    17.58Second
      Quarter
    
    $
    24.00
    
    $
    17.25Third
      Quarter
    
    $
    28.95
    
    $
    20.58Fourth
      Quarter
    
    $
    34.65
    
    $
    28.112003First
      Quarter
    
    $
    8.05
    
    $
    7.04Second
      Quarter
    
    $
    10.48
    
    $
    7.43Third
      Quarter
    
    $
    14.65
    
    $
    9.91Fourth
      Quarter
    
    $
    17.86
    
    $
    13.89





As of
February 22, 2005, the Company had approximately 2,800 shareholders that own
approximately 9,534,681 shares of common stock.





The
Company initiated a cash dividend program in 2003. The Company paid $0.04,
$0.03, $0.03, and $0.02 per share cash dividend in November 2004, August 2004,
May 2004, and February 2004. During August and November of 2003, the Company
paid $0.01 and $0.02 per share cash dividend, respectively. In addition, the
Company paid $0.05 per share cash dividend in February 2005. The Company’s
primary source of income is dividends from the Bank, and the Bank is subject to
certain regulatory restrictions which may limit its ability to pay dividends to
the Company (See Item 1. Business; Supervision and Regulation; Dividends and
Other Transfer of Funds.)







39





The table
below summarizes the Company’s monthly repurchases and redemptions of its common
equity securities during the three months ended December 31, 2004.




**Period**
    
    **Total
      Number of Shares Purchased**
    
    **Average
      Price Paid Per Share**
    
    **Total
      Number of Shares Purchased as Part of Publicly Announced Plans or Programs
      (1)**
    
    **Approximate
      Dollar Value of Shares that May Yet Be Purchased Under the Plans or
      Programs**October
      1 - 31, 2004
    
    
    5,000
    
    $
    29.26
    
    
    5,000
    
    $
    1,973,000November
      1 - 30, 2004
    
    
    -
    
    
    N/A
    
    
    -
    
    $
    1,973,000December
      1 - 31, 2004
    
    
    -
    
    
    N/A
    
    
    -
    
    $
    1,973,000Total
    
    
    5,000
    
    $
    29.26
    
    
    5,000


___________________




(1)
    In
      July 2002, the Company adopted a stock repurchase program in the initial
      amount of $2.0 million. In December 2003, the Company approved an increase
      in its stock repurchase program of $5.0 million for a total amount of $7.0
      million. Under its stock repurchase program, the Company has been
      acquiring its common stock shares in the open market. The Company’s stock
      repurchase program does not have an expiration date. During January 2005,
      the Company announced a $5.0 million increase to the stock repurchase
      program.







40





**ITEM
6. Selected Financial Data**





The table
set forth below for the fiscal years ended December 31, 2004, 2003 and 2002 are
derived from the audited consolidated financial statements of the Company
examined by Vavrinek, Trine, Day & Co., LLP, certified public accountants
(“VTD”), included in Item 8 hereof and should be read in conjunction with those
consolidated financial statements. The selected financial data for the fiscal
years ended December 31, 2001 and 2000 are derived from audited financial
statements examined by VTD which are not included herein.





**(Dollars
      in Thousands, except per share data)**
    
    **Years
      Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Income
      Statement Data**Interest
      Income
    
    $
    75,056
    
    $
    39,537
    
    $
    19,170
    
    $
    11,602
    
    $
    8,965Interest
      Expense
    
    $
    22,054
    
    $
    11,383
    
    $
    5,837
    
    $
    3,586
    
    $
    2,048Net
      Interest Income
    
    $
    53,002
    
    $
    28,154
    
    $
    13,333
    
    $
    8,016
    
    $
    6,917Provision
      for Possible Loan Losses
    
    $
    (5,734
    )
    $
    (3,710
    )
    $
    (1,430
    )
    $
    (773
    )
    $
    (256
    )Other
      Income
    
    $
    5,457
    
    $
    5,828
    
    $
    3,928
    
    $
    2,191
    
    $
    1,582Other
      Expenses
    
    $
    29,069
    
    $
    16,740
    
    $
    10,742
    
    $
    8,295
    
    $
    7,174Income
      Before Taxes
    
    $
    23,656
    
    $
    13,532
    
    $
    5,089
    
    $
    1,139
    
    $
    1,069Income
      Tax (Provision)/Benefit
    
    $
    (9,669
    )
    $
    (5,540
    )
    $
    (2,081
    )
    $
    17
    
    $
    (449
    )Net
      Income
    
    $
    13,987
    
    $
    7,992
    
    $
    3,008
    
    $
    1,156
    
    $
    620Earnings
      Per Share of Common Stock(1)Basic
    
    $
    1.72
    
    $
    1.21
    
    $
    0.63
    
    $
    0.28
    
    $
    0.15Diluted
    
    $
    1.55
    
    $
    1.09
    
    $
    0.52
    
    $
    0.25
    
    $
    0.15Weighted
      Average Number of Shares(1)Basic
    
    
    7,692,057
    
    
    6,097,036
    
    
    4,779,253
    
    
    4,119,506
    
    
    4,110,174Diluted
    
    
    8,929,760
    
    
    7,193,604
    
    
    6,033,591
    
    
    5,289,104
    
    
    4,112,962Ratio
      of net charge-offs during the year toaverage
      loans outstanding during the year
    
    
    0.0
    %
    
    0.0
    %
    
    0.0
    %
    
    0.1
    %
    
    0.3
    %Return
      on average assets
    
    
    1.2
    %
    
    1.3
    %
    
    1.1
    %
    
    0.8
    %
    
    0.6
    %Return
      on average equity
    
    
    23.5
    %
    
    28.1
    %
    
    22.2
    %
    
    11.7
    %
    
    7.0
    %Cash
      dividend declared per common share (2)
    
    $
    0.12
    
    $
    0.03
    
    $
    -
    
    $
    -
    
    $
    -Stockholders’
      equity to asset ratio
    
    
    5.1
    %
    
    4.6
    %
    
    5.0
    %
    
    6.8
    %
    
    7.9
    %**Balance
      Sheet Data**Assets
    
    $
    1,311,497
    
    $
    887,800
    
    $
    385,852
    
    $
    191,659
    
    $
    110,753Deposits
    
    $
    965,546
    
    $
    603,326
    
    $
    287,533
    
    $
    159,381
    
    $
    99,583Net
      Loans
    
    $
    1,014,036
    
    $
    589,470
    
    $
    250,248
    
    $
    136,128
    
    $
    78,740Stockholders'
      Equity
    
    $
    85,227
    
    $
    52,175
    
    $
    19,958
    
    $
    10,455
    
    $
    9,295Ratio
      of allowance for possible loan lossesto
      loans at year-end
    
    
    1.3
    %
    
    1.3
    %
    
    1.2
    %
    
    1.1
    %
    
    1.0
    %


**___________________**





(1)
    Basic
      earnings per share excludes dilution and is computed by dividing income
      available to common stockholders by the weighted-average number of common
      shares outstanding for the period. 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 entity. The weighted average number of shares and the earnings per
      share were adjusted to reflect the Company’s two-for-one stock split in
      August 2004 and 5% stock dividends in January 2004 and January
      2003.





(2)
    Cash
      dividends declared per common share have been adjusted to reflect the 5%
      stock dividends paid in January 2004 and January 2003 and the two-for-one
      stock split in August 2004.









41





**ITEM
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations**





**Overview**





The
Company is a bank holding company. The Company’s principal asset is the capital
stock of the Bank, a California-chartered commercial bank, headquartered in the
Inland Empire region of Southern California. The Company is dedicated to
relationship banking and the success of its customers. The Company caters to the
needs of small-to-mid-size commercial businesses, retail community businesses,
single family residence developers/builders, individuals and local public and
private organizations by offering specialty product solutions. The Company
attracts deposits from the communities where it has established banking centers
by offering competitive interest rate products and providing value-added
consumer services. The Company also strives to add value for its shareholders by
optimizing its net interest margin and expanding the volume of its earning
assets. In the past four years, the Company has grown significantly; however,
its business is subject to various risks which are discussed in “Business; Risk
Factors” in Item 1 hereof. Management has implemented several strategies to
manage risks such as interest rate risk and liquidity (See “Business” in Item 1
hereof).





The
Company’s growth has enabled it to recognize economies of scale, which presents
a better opportunity for the Company’s operations. Based on historical results
and current economic forecasts, management anticipates that the Company will
continue to grow in 2005. However, due to risk factors that are beyond the
control of the Company, actual results could differ from management’s
estimates.





Management’s
discussion and analysis of financial condition and results of operations is
intended to provide a better understanding of the significant changes in trends
relating to the Company’s financial condition, results of operations, liquidity
and interest rate sensitivity. The following discussion and analysis should be
read in conjunction with the Consolidated Financial Statements of the
Company.





**Critical
Accounting Policies and Estimates**





Accounting
policies are integral to understanding the results reported. The Company’s
accounting policies are described in detail in Item 8. Financial Statements and
Supplementary Data; Note #1 - Summary of Significant Accounting Policies.





Critical
accounting policies are those that are important to the portrayal of the
Company’s financial condition and operating results, and which involves
significant estimates and assumptions, complex analysis and management judgment.
These estimates and assumptions affect the reported amounts of assets,
liabilities, revenues, expenses and related disclosure of contingent
liabilities. Changes in the evaluation of these factors may significantly impact
the financial condition and operating results of the Company.





The
Company has identified the policies below as critical to the Company’s business
operations and the understanding of the financial condition and operating
results of the Company.





**Investment
Securities**





In
accordance with SFAS No. 115, *"Accounting
for Certain Investments in Debt and Equity Securities,"* which
addresses the accounting for investments in equity securities that have readily
determinable fair values and for investments in all debt securities, securities
are classified in three categories and accounted for as follows: debt securities
that the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and are measured at amortized cost; debt and
equity securities bought and held principally for the purpose of selling in the
near term are classified as trading securities and are measured at fair value,
with unrealized gains and losses included in earnings; debt and equity
securities deemed as available-for-sale are measured at fair value, with
unrealized gains and losses reported in a separate component of stockholders'
equity. Gains or losses on sales of investment securities are determined on the
specific identification method. Premiums and discounts on investment securities
are amortized or accreted using the interest method over the expected lives of
the related securities. For mortgage-backed securities, the amortization or
accretion is based on estimated average lives of the securities. The lives of
these securities can fluctuate based on the amount of prepayments received on
the underlying collateral of the securities. We use estimates for the fair
values and average lives of these mortgage-backed securities based on the
information received from third parties whose business it is to compile mortgage
related data and develop a consensus of that data.





42


****


**Allowance
for Loan and Lease Losses**





The
allowance for loan and lease losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in the loan
and lease portfolio. The amount of the allowance is based on management's
evaluation of the collectibility of the loan portfolio, including the nature of
the portfolio, credit concentrations, trends in historical loss experience,
specific impaired loans and economic conditions. The allowance is increased by a
provision for loan and lease losses, which is charged to expense and reduced by
charge-offs, net of recoveries.





**Income
Taxes**





The
Company accounts for income taxes by deferring income taxes based on estimated
future tax effects of temporary differences between the tax and book basis of
assets and liabilities considering the provisions of enacted tax laws. These
differences result in deferred tax assets and liabilities, which are included in
the Company’s balance sheets. Our judgment is required in determining the amount
and timing of recognition of the resulting deferred tax assets and liabilities,
including projections of future taxable income.





**Results
of Operations**





Net
income for the periods ending December 31, 2004, 2003 and 2002, was $14.0
million, $8.0 million and $3.0 million, respectively, representing an increase
of 75.0% for the year ended 2004 compared to the year ended 2003 and an increase
of 165.7% for the year ended 2003 as compared to the year ended 2002. On a per
diluted share basis, net income was $1.55, $1.09 and $0.52 for the years ended
December 31, 2004, 2003 and 2002, respectively. Prior period earnings per share
were adjusted for the Company’s two-for-one stock split in August 2004 and 5%
stock dividends paid in January 2003 and January 2004.





The
Company’s net interest income before its provision for possible loan losses
increased by $24.8 million or 88.3% for the year ended December 31, 2004 as
compared with the same period in 2003 and increased by $14.8 million or 111.2%
for the year ended December 31, 2003 as compared with the same period in 2002.
Non-interest income decreased by $0.4 million or 6.4% for the year ended
December 31, 2004 as compared with the same period in 2003 and increased by $1.9
million or 48.4% for the year ended December 31, 2003 as compared with the same
period in 2002. Thus, total net revenue (defined as net interest income and
non-interest income) for the year ended December 31, 2004 increased by $24.4
million or 72.0% as compared with the same period in 2003. Total net revenue for
the year ended December 31, 2003 increased by $16.7 million or 96.9% as compared
with the same period in 2002.





The
Company’s earnings are derived predominately from net interest income, which is
the difference between the interest earned on loans and securities and the
interest paid on deposits and borrowings. The net interest margin is the net
interest income divided by the average interest earning assets. Net interest
income and net interest margin are affected by several factors including (1) the
level of, and the relationship between, the dollar amount of interest earning
assets and interest bearing liabilities; (2) the relationship between repricing
or maturity of the Company’s variable rate and fixed rate loans and securities,
and its deposits and borrowings; and (3) the magnitude of the Company’s
non-interest earning assets, including non-accrual loans and other real estate
loans .





Beginning
in early 2001, the Company began to implement an asset/liability management
strategy that was built around the risk elements of interest rate, asset
duration and funding risks. A component of this strategy was to deploy excess
liquidity previously invested in federal funds into higher yielding
mortgage-backed securities with shorter duration and higher cash flow
components. The Company increased the investment portfolio accordingly, which
enhanced the Company’s overall yields and better addressed the risk elements
identified above. In doing so, the Company began to realize excessive
prepayments on call options on certain of its mortgage-backed security
investments and liquidated those securities prior to market premium erosion
while generating gains on sale of investment securities.





43





Investment
securities at December 31, 2004 and 2003 were $223.5 million and $202.1 million,
respectively, representing an increase of $21.4 million or 10.6%. The increase
in investment securities in 2004 provided an increase of $0.2 million in
interest income for the year ended December 31, 2004 over the prior period
ended December 31, 2003. Interest income from investment securities for the
years ended December 2004, 2003 and 2002 was $8.6 million, $8.4 million and $2.6
million, respectively. The Company decreased its investment in **** overnight
federal funds by $37.4 million for the year ended December 31, 2004 as compared
with the same period ended December 31, 2003. As a result, the interest
income from overnight federal funds decreased by approximately $45,000 for the
year ended December 31, 2004 compared with the same period in 2003.
Interest income from overnight federal funds for the years ended
December 31, 2004, 2003 and 2002 was $0.1 million for each
period.





For the
year ended December 31, 2004, operating results demonstrated a significant
growth over the same periods in 2003 and 2002 as the volume of earning assets
increased. The growth in the Company’s earning assets was funded by the growth
in deposits, the increased borrowings and the issuance of common stock. The
catalyst for the Company’s growth in deposits continues to be its efforts to
attract stable, core deposits from within the Bank’s community markets. Total
deposits at December 31, 2004 totaled $965.5 million, representing an increase
of $362.2 million or 60.0% as compared to December 31, 2003. Total borrowings
have increased as a result of the issuance of $33.0 million in junior
subordinated debentures during 2004. In addition, the Company raised $29.2
million, net of fees and expenses, through the issuance of common stock in
private placement transactions during June 2004 and December 2004.





During
2001, the prime rate decreased by 475 basis points or 50% from its level at year
end 2000 to 4.75%. During the fourth quarter of 2002, the prime rate decreased
an additional 50 basis points from its level at year end 2001 to 4.25%. The
prime rate remained at 4.25% until June 24, 2003, when it was lowered to 4.00%.
The prime rate remained at 4.00% at December 31, 2003. During 2004, the FRB
began to increase the overnight borrowing rate. As a result, the prime rate
increased to 4.25% on July 1, 2004. The prime rate further increased to 4.50%,
4.75%, 5.00% and 5.25% in August 2004, September 2004, November 2004 and
December 2004, respectively. The prime rate was 5.25% at December 31, 2004.





During
2004, management changed the mix of interest-earning assets by strategically
moving interest-earning assets into higher yielding asset categories from lower
yielding interest-earning asset categories, therefore increasing the average
yield on total interest-earning assets for the year ended December 31, 2004. The
average yield on interest-earning assets increased by 10 basis points from 6.6%
at December 31, 2003 to 6.7% at December 31, 2004. As of December 31, 2004, the
majority of the variable rate loan portfolio was above its designated rate
floors, causing the Company to be more asset sensitive. The majority of these
accounts, which had hit their rate floors during the declining rate environment
of 2001 through 2004, have begun to reprice faster than the liabilities due to
the rising interest rate environment in the latter half of 2004. The average
cost of interest-bearing liabilities increased by 10 basis points from 2.2% at
December 31, 2003 to 2.3% at December 31, 2004. Consequently, the net interest
margin for the year ended December 31, 2004 remained stable at 4.7%, as compared
to the prior year end. As interest-bearing deposit accounts are less elastic
than interest-earning loans in a rising interest rate environment, the Company
anticipates a continued increase in the net interest margin during the current
rising interest rate environment.





Total
non-interest expense was $29.1 million, $16.7 million and $10.7 million for the
years ended December 31, 2004, 2003 and 2002, respectively. This represented an
increase of $12.3 million or 73.6% for the year ended December 31, 2004 as
compared with the same period in 2003 and an increase of $6.0 million or 55.8%
for the year ended December 31, 2003 as compared with the same period in 2002.
The largest item contributing to non-interest expense was salaries and benefits
which represents approximately 50%-60% of total non-interest expense for each of
those years. In order to support its growth, the Company hired additional
employees for business development and various experienced managers over the
past three years. The Company’s efficiency ratio, which is a measure of
non-interest expense divided by net interest income plus non-interest income,
was 49.7%, 49.3% and 62.2% for the years ended December 31, 2004, 2003 and 2002,
respectively. The improved efficiency ratio partly reflects the Company’s
recognition of economies of scale.





44





The
quality of the Company’s loan portfolio continued to perform well as compared to
peer group standards, sustaining only $0.3 million in net charge-offs or 0.03%
of average loans in 2004 and $0.1 million in net charge-offs or 0.02% of average
loans in 2003. The Company’s continued growth of its loan portfolio necessitated
an increase in its provision made to the allowance for possible loan losses in
the amount of $5.7 million, $3.7 million and $1.4 million for the years ended
December 31, 2004, 2003 and 2002, respectively. The allowance for possible loan
losses remained at 1.3% of gross loans at December 31, 2004 and at December 31,
2003. At December 31, 2004, the Company reported no non-performing loans or
other real estate owned. At December 31, 2003, the Company had approximately
$0.2 million of non-performing loans and approximately $0.1 million of other
real estate owned through foreclosure. At December 31, 2002, there were no
non-performing loans or other real estate owned.





For the
years ended December 31, 2004, 2003 and 2002, the provision for federal and
state income taxes was $9.7 million, $5.5 million and $2.1 million,
respectively, representing an effective tax rate of 40.9% for each year.





**Net
Interest Income**





Total
interest income for the years ended December 31, 2004, 2003 and 2002 was $75.1
million, $39.5 million and $19.2 million, respectively, while total interest
expenses was $22.1 million, $11.4 million and $5.8 million, respectively.
Therefore, the net interest income was $53.0 million, $28.2 million and $13.3
million for each of the years ended December 31, 2004, 2003 and 2002,
respectively, for a net interest margin of 4.7%, 4.7% and 5.3%, respectively.





Although
the net interest margin remained constant for the year ended December 31, 2004,
the net interest income increased $24.8 million or 88.3%, from $28.2 million for
the year ended December 31, 2003 to $53.0 million for same period in 2004 as the
volume of earning assets increased. Net interest income increased $14.8 million
or 111.2%, from $13.3 million for the year ended December 31, 2002 to $28.2
million for the same period ended 2003. The prime rate was 4.25% at December 31,
2002 and 4.00% at December 31, 2003. This decrease of 25 basis points compressed
the net interest margin until the loan floors stabilized this margin. Then
during 2004, the FRB began to raise interest rates. The prime rate was raised
five times and was 5.25% at December 31, 2004. As a result, the Company
experienced some expansion in the average yield on loans during the last quarter
of 2004, as existing loans paid off and new loans were originated at higher
market rates. The increased rates during the latter portion of 2004, along with
a change in mix of earning assets from lower yielding assets to higher yielding
assets, generated an average yield on interest-earning assets for the year ended
December 31, 2004 of 6.7%, as compared with 6.6% for the same period in 2003.





During
2004, the Company was liability-sensitive in the short-run, which caused it to
experience a slight increase in the average cost of interest-bearing
liabilities. As interest rates began to increase in the second half of fiscal
2004, variable rate loans that were below their floors began to move above the
floors. For the year ended December 31, 2004, the average cost of
interest-bearing liabilities was 2.3%, as compared to the average cost of 2.2%
for the same period ended 2003.





Loan fee
income, which is included in interest income, also stabilized interest income
during a period of declining interest rates. For the year ended December 31,
2004, loan fee income represented $9.6 million of the $66.4 million in loan
income, or 14.4% of total loan-related income. For the year ended December 31,
2003, loan fee income represented $4.8 million of the $31.1 million in loan
income, or 15.4% of total loan-related income. For the year ended
December 31, 2002, loan fee income was $2.7 million of the $16.5 million in
total loan income, or 16.4% of total loan-related income. Construction loans and
commercial real estate loans generate the bulk of all loan fee income. The
Company continues its emphasis in single-family coastal construction loans from
its Manhattan Beach loan production office which began in 2001, concentrating on
the coastal communities of Los Angeles county. In late 2002, the Company began
the product line of single-family tract home construction loans serving
Riverside, Los Angeles and San Bernardino counties in California. The loan fees
generated from these construction loan products continue to generate greater
loan yields. Construction loans generally have a duration of 12 months. As a
result, construction loans generate higher yields than longer term loans because
the loan fees are recognized over the shorter life of the construction loan
compared to longer term loans.





45





For the
year ended December 31, 2004, the Company’s deposits were comprised of 13.2% of
non-interest bearing deposits, 46.7% of money market, NOW and savings deposits,
and 40.1% of time certificates of deposit; while the composition of deposits for
the year ended December 31, 2003 was 17.1%, 45.8% and 37.1%, respectively. For
the year ended December 31, 2004, the cost of deposits was 2.2% as compared with
2.3% for the same period in 2003. In conjunction with the cost of deposits
increasing as interest rates on deposits increased, interest expense on deposits
increased $7.5 million for the year ended December 31, 2004 as compared with the
same period in 2003 as the volume of interest-bearing deposits increased.
Aggregate interest expense on deposits was $15.7 million, $8.3 million and $4.4
million for the years ended December 31, 2004, 2003 and 2002, respectively.





An
additional form of funding for the Bank’s growth was debt issued by the Company.
In 2004 and 2003, the Company issued $33.0 million and $20.6 million,
respectively, in junior subordinated debentures. In December 2002, the Company
issued $5.2 million in junior subordinated debentures, $5.0 million in
subordinated debt and also borrowed from a correspondent bank $5.0 million on a
line of credit which was entirely paid off during 2003 with a portion of the net
proceeds from the Company’s Series B Preferred Stock offering. Those instruments
bear variable interest rates indexed to LIBOR and are adjusted on a quarterly
basis. Furthermore, FHLB advances at December 31, 2004 totaled $177.0 million,
representing a decrease of $5.0 million as compared to December 31, 2003. As
market rates began to increase, the interest rates on those variable notes also
increased. The consolidated cost of funds for the Company for the year ended
December 31, 2004 was 2.3%, up slightly from 2.2% for the year ended December
31, 2003. Such instruments contributed to an increase in interest expense of
approximately $3.2 million for the year ended December 31, 2004 as compared with
the same period in 2003. Interest expense on borrowings and fed funds purchased
was $6.3 million, $3.1 million and $1.4 million for the years ended December 31,
2004, 2003 and 2002, respectively.








46





The
following table presents the distribution of the Company’s average assets,
liabilities, and stockholders’ equity in combination with the total dollar
amounts of interest income from average interest earning assets and the
resultant yields without giving effect for any tax exemption, and the dollar
amounts of interest expense and average interest bearing liabilities, expressed
both in dollars and rates. Loans include non-accrual loans where non-accrual
interest is excluded.







**(Dollars
      in Thousands)**
    
    **For
      the years ended December 31,**
    ********
    ****
    **2004**
    ****
    **2003**
    ********
    ****
    **Average**
    ****
    ****
    ****
    **Average**
    ****
    **Average**
    ****
    ****
    ****
    **Average**
    ********
    ****
    **Balance**
    ****
    **Interest**
    ****
    **Yield/Cost**
    ****
    **Balance**
    ****
    **Interest**
    ****
    **Yield/Cost**AssetsLoans
      (5)
    
    $
    908,829
    
    $
    66,374
    
    
    7.3
    %
    $
    405,973
    
    $
    31,080
    
    
    7.7
    %Investment
      securities
    
    
    197,958
    
    
    8,187
    
    
    4.1
    %
    
    177,138
    
    
    8,088
    
    
    4.6
    %Federal
      funds sold
    
    
    5,428
    
    
    53
    
    
    1.0
    %
    
    9,324
    
    
    98
    
    
    1.1
    %Other
      investments (1)
    
    
    11,667
    
    
    442
    
    
    3.8
    %
    
    5,995
    
    
    271
    
    
    4.5
    %Total
      Interest-earning assets
    
    
    1,123,882
    
    
    75,056
    
    
    6.7
    %
    
    598,430
    
    
    39,537
    
    
    6.6
    %Other
      assets
    
    
    47,747
    
    
    
    
    
    
    
    
    27,923Less:
      allowance for possible loan losses
    
    
    (10,472
    )
    
    
    
    
    
    
    
    (4,990
    )Total
      average assets
    
    $
    1,161,157
    
    
    
    
    
    
    
    $
    621,363Liabilities
      and Stockholders' EquitySavings
      deposits (2)
    
    $
    385,001
    
    
    7,789
    
    
    2.0
    %
    $
    201,528
    
    
    3,820
    
    
    1.9
    %Time
      deposits
    
    
    323,996
    
    
    7,953
    
    
    2.5
    %
    
    162,996
    
    
    4,461
    
    
    2.7
    %Subordinated
      debt
    
    
    5,000
    
    
    241
    
    
    4.8
    %
    
    5,000
    
    
    226
    
    
    4.5
    %Junior
      subordinated debentures
    
    
    54,080
    
    
    2,630
    
    
    4.9
    %
    
    20,634
    
    
    1,000
    
    
    4.8
    %Short
      term borrowings
    
    
    211,690
    
    
    3,441
    
    
    1.6
    %
    
    122,570
    
    
    1,876
    
    
    1.5
    %Total
      interest-bearing liabilities
    
    
    979,767
    
    
    22,054
    
    
    2.3
    %
    
    512,728
    
    
    11,383
    
    
    2.2
    %Demand
      deposits
    
    
    115,045
    
    
    
    
    
    
    
    
    75,370Other
      liabilities
    
    
    6,749
    
    
    
    
    
    
    
    
    4,784Total
      average liabilities
    
    
    1,101,561
    
    
    
    
    
    
    
    
    592,882Stockholders'
      equity
    
    
    59,596
    
    
    
    
    
    
    
    
    28,481Total
      liabilities andstockholders'
      equity
    
    $
    1,161,157
    
    
    
    
    
    
    
    $
    621,363Net
      interest spread(3)
    
    
    
    
    
    
    
    
    4.4
    %
    
    
    
    
    
    
    
    4.4
    %Net
      interest incomeand
      net interest margin (4)
    
    
    
    
    $
    53,002
    
    
    4.7
    %
    
    
    
    $
    28,154
    
    
    4.7
    %





*(Footnotes
on the following page)*








47








**(Dollars
      in Thousands)**
    
    **For
      the year ended December 31, 2002**
    ********
    ****
    **Average**
    ****
    ****
    ****
    **Average**
    ********
    ****
    **Balance**
    ****
    **Interest**
    ****
    **Yield/Cost**AssetsLoans
      (5)
    
    $
    191,598
    
    $
    16,457
    
    
    8.6
    %Investment
      securities
    
    
    54,063
    
    
    2,567
    
    
    4.7
    %Federal
      funds sold
    
    
    5,165
    
    
    82
    
    
    1.6
    %Other
      investments (1)
    
    
    1,194
    
    
    64
    
    
    5.4
    %Total
      Interest-earning assets
    
    
    252,020
    
    
    19,170
    
    
    7.6
    %Other
      assets
    
    
    19,478Less:
      allowance for possible loan losses
    
    
    (2,089
    )Total
      average assets
    
    $
    269,409Liabilities
      and Stockholders' EquitySavings
      deposits (2)
    
    
    89,489
    
    
    1,783
    
    
    2.0
    %Time
      deposits
    
    
    73,394
    
    
    2,631
    
    
    3.6
    %Subordinated
      debt
    
    
    208
    
    
    8
    
    
    3.8
    %Convertible
      debentures
    
    
    2,150
    
    
    314
    
    
    14.6
    %Junior
      subordinated debentures
    
    
    12,417
    
    
    717
    
    
    5.8
    %Short
      term borrowings
    
    
    20,776
    
    
    384
    
    
    1.8
    %Total
      interest-bearing liabilities
    
    
    198,434
    
    
    5,837
    
    
    2.9
    %Demand
      deposits
    
    
    55,936Other
      liabilities
    
    
    1,486Total
      average liabilities
    
    
    255,856Stockholders'
      equity
    
    
    13,553Total
      liabilities andstockholders'
      equity
    
    $
    269,409Net
      interest spread (3)
    
    
    
    
    
    
    
    
    4.7
    %Net
      interest incomeand
      net interest margin (4)
    
    
    
    
    $
    13,333
    
    
    5.3
    %


____________________





(1) The
yield for securities that are classified as available-for-sale is based on
historical amortized cost balances.


(2) Includes
savings, NOW, and money market deposit accounts.


(3) Net
interest spread represents the average yield earned on interest earning assets
less the average rate paid on interest bearing liabilities.


(4) Net
interest margin is computed by dividing net interest income by total average
earning assets.


(5)Interest
on loans includes loan fees, which totaled $9.6 million, $4.8 million and $2.7
million for the year ended December 31, 2004, 2003 and 2002,
respectively.







48





The
following table sets forth changes in interest income and interest expense for
each major category of interest earning asset and interest bearing liability,
and the amount of change attributable to volume and rate changes for the year
indicated. The
variances attributable to simultaneous volume and rate changes have been
allocated to the change due to volume and the change due to rate categories in
proportion to the relationship of the absolute dollar amounts attributable
solely to the change in volume and to the change in rate.





**(Dollars
      in Thousands)**
    
    **2004-2003**
    
    **2003-2002****Volume**
    
    **Rate**
    
    **Total**
    
    **Volume**
    
    **Rate**
    
    **Total**Increase
      (Decrease) in:Interest
      income:Loans
      (1)
    
    $
    37,454
    
    $
    (2,160
    )
    $
    35,294
    
    $
    18,807
    
    $
    (4,184
    )
    $
    14,623Investment
      securities
    
    
    890
    
    
    (797
    )
    
    93
    
    
    5,374
    
    
    153
    
    
    5,527Other
      investments
    
    
    241
    
    
    (64
    )
    
    177
    
    
    263
    
    
    (62
    )
    
    201Federal
      funds sold
    
    
    (41
    )
    
    (4
    )
    
    (45
    )
    
    66
    
    
    (50
    )
    
    1638,544
    
    
    (3,025
    )
    
    35,519
    
    
    24,510
    
    
    (4,143
    )
    
    20,367Increase
      (Decrease) in:Interest
      expense:Savings
      deposits (2)
    
    $
    3,985
    
    $
    (16
    )
    $
    3,969
    
    $
    2,987
    
    $
    (950
    )
    $
    2,037Time
      deposits
    
    
    4,409
    
    
    (917
    )
    
    3,492
    
    
    3,210
    
    
    (1,380
    )
    
    1,830Borrowings
    
    
    1,493
    
    
    72
    
    
    1,565
    
    
    1,983
    
    
    (502
    )
    
    1,481Convertible
      debentures,subordinated
      debt and juniorsubordinated
      debentures
    
    
    1,635
    
    
    10
    
    
    1,645
    
    
    684
    
    
    (486
    )
    
    19811,522
    
    
    (851
    )
    
    10,671
    
    
    8,864
    
    
    (3,318
    )
    
    5,546Increase
      (Decrease)in
      Net interest income
    
    $
    27,022
    
    $
    (2,174
    )
    $
    24,848
    
    $
    15,646
    
    $
    (825
    )
    $
    14,821


_____________





(1)
    Interest
      on loans includes loan fees, which totaled $9.6 million, $4.8 million and
      $2.7 million for the year ended December 31, 2004, 2003 and 2002,
      respectively.


(2)
    Includes
      savings, NOW, and money market deposit
accounts.





**Provision
for Possible Loan Losses**





For the
years ended December 31, 2004, 2003 and 2002, the provision for loan losses was
$5.7 million, $3.7 million and $1.4 million, respectively. The provision for
loan losses was increased to support the increasing loan balances for each of
those years.





The
Company’s allowance for possible loan losses was $13.0 million or 1.3% of gross
loans at December 31, 2004 as compared to $7.5 million or 1.3% of gross loans at
December 31, 2003. The provision for possible loan losses was increased to
support the increasing loan balances for each of the periods as well as to
reflect the inherent risk of construction and commercial loans. Additions to the
reserve are effected through the provision for possible loan losses.





Although
the Company maintains an allowance for possible loan losses at a level it
considers to be adequate to provide for losses, based on presently known
conditions, there can be no assurance that such losses will not exceed the
estimated amounts, thereby adversely affecting future results of operations. The
calculation for the adequacy of the allowance for possible loan losses, and
therefore the requisite amount of the provision for possible loan losses, is
based on several factors, including underlying loan collateral, delinquency
trends, borrower’s cash flow and historic loan loss experience. All of these
factors can change without notice based on market and economic conditions and
other factors.





**Non-Interest
Income**





Non-interest
income for the years ended December 31, 2004, 2003 and 2002 was $5.5 million,
$5.8 million and $3.9 million, respectively, for a decrease of $0.4 million or
6.4% for the year ended December 31, 2004 as compared with the same period in
2003 and an increase of $1.9 million or 48.4% for the year ended December 31,
2003 as compared with the same period in 2002.





49





In the
fourth quarter 2002, the Company began its SBA lending department. The
guaranteed portion of the SBA loans originated is eventually sold. Those SBA
loans sold, combined with other loans held for sale and sold during the year,
generated gains amounting to $3.0 million in 2004 as compared to $2.1 million in
2003 and $0.6 million in 2002.





For the
year ended December 31, 2004, gain from the sale of investment securities
amounted to $0.4 million as compared to $2.1 million for the year ended December
31, 2003 and $1.3 million for the year ended December 31, 2002. The gain was a
result of management’s ability to manage liquidity needs, interest rate risk,
and strategic planning in meeting capital requirements during a period when
market rates were favorable; therefore, the Company realized gains upon sale
from its available-for-sale investment portfolio.





During
2002, the Company received $0.5 million in litigation recovery from its former
insurance couriers. This stems from a reimbursement of legal fees advanced by
the Bank over a period of several years in the early to mid 1990’s. This amount
is included in “other income” on the Company’s Consolidated Statements of
Income.





**Non-Interest
Expenses**





The
Company’s non-interest expense for the years ended December 31, 2004, 2003 and
2002 was $29.1 million, $16.7 million and $10.7 million, respectively. The
increase for the year ended December 31, 2004 was $12.3 million or 73.6% as
compared with the same period in 2003 and the increase for the year ended
December 31, 2003 was $6.0 million or 55.8% as compared with the same period in
2002. Non-interest expense, consisted primarily of (i) salaries and employee
benefits; (ii) occupancy expenses; (iii) furniture and equipment expense; and
(iv) marketing, office supplies, postage and telephone, insurance, data
processing, professional fees and other non-interest expense.





Salaries
and employee benefits is the largest component of non-interest expense.
Beginning with the appointment of the Company’s current Chief Executive Officer
in the fourth quarter of 2000, management has implemented several structural
changes within the operations of the Company in order to support its strategic
plan initiatives. In each of the following areas, a seasoned and experienced
individual has been recruited, from other local financial institutions to head
their respective area: credit administration, loan operations and construction
support, single family residential construction business development, marketing,
information technology, community banking, finance and human resources.
Additional personnel have been placed in business development capacities for
commercial and community banking. With the addition of these individuals to the
Company’s existing personnel, the Company has been able to produce significant
growth in deposits and loans in 2004, 2003 and 2002, while providing the
infrastructure needed to support its longer-term growth. These changes have
increased the Company’s compensation expense by $7.7 million or 86.0% to $16.7
million for the year ended December 31, 2004 as compared to the same period in
2003 and by $3.8 million or 72.7% to $9.0 million for the year ended December
31, 2003 as compared to $5.2 million for the same period in 2002.





Occupancy
expense amounted to $2.4 million, $1.5 million and $0.9 million for the years
ended December 31, 2004, 2003 and 2002, respectively. This represents an
increase of $0.9 million or 63.8% for the year ended December 31, 2004 as
compared with the same period in 2003 and an increase of $0.6 million or 68.2%
for the year ended December 31, 2003 as compared with the same period in 2002.
The increases in occupancy expense are primarily due to the Company’s expansion.
In 2004, the Company opened an SBA lending office in Anaheim, California, as
well as an administrative office in San Rafael, California, which will be used
for the Company’s strategic expansion into that area of California. In 2003, the
Bank opened a banking center in Corona, California and converted its loan
production office in Manhattan Beach, California into a full-service banking
center. In addition, the Bank opened a loan production office in Irvine,
California in 2003 and acquired a banking center in Irwindale, California from
the Southland Bank acquisition. In 2002, the loan production office in Manhattan
Beach was expanded to accommodate additional staff as the single family coastal
construction loan production increased. In addition, the Company began its SBA
lending department in the fourth quarter of 2002. As a result, the Company
opened offices in San Diego and Beverly Hills for the production of SBA loans.
The Beverly Hills office lease was terminated in 2003, and was replaced with the
current Anaheim SBA office.





50





With the
Company’s expansion in its banking network, expense related to furniture and
fixtures also increased over the years. Expense related to furniture and
fixtures was $2.4 million, $1.2 million and $0.8 million for the years ended
December 31, 2004, 2003 and 2002, respectively. This represents an increase of
$1.2 million or 101.1% for the year ended December 31, 2004 as compared with the
same period in 2003 and an increase of $0.4 million or 52.4% for the year ended
December 31, 2003 as compared with the same period in 2002.





Other
expenses were $7.5 million, $5.1 million and $3.9 million for the years ended
December 31, 2004, 2003 and 2002, respectively. Other expenses increased
$2.5 million or 48.2% for the year ended December 31, 2004 as compared with the
same period in 2003 and increased $1.2 million or 31.1% for the year ended
December 31, 2003 as compared with the same period in 2002. The increases in
other expenses in both 2004 and 2003 are due primarily to the Company’s
implementation of its strategy to grow its business. All categories of
non-interest expense have increased, including professional services, insurance,
telephone and other overhead, as the number of employees has increased and the
volume of loans and deposits production has increased.





**Income
Tax**





The
Company’s provision for federal and state taxes for the years ended December 31,
2004, 2003 and 2002 was $9.7 million, $5.5 million and $2.1 million,
respectively, representing an effective tax rate of 40.9% for both periods.








**Financial
Condition**





**Assets**





At
December 31, 2004, total assets were $1.3 billion as compared with $887.8
million at December 31, 2003. Total assets at December 31, 2004 were comprised
primarily of $1.0 billion in loans, net of unearned income, and $223.5 million
in investment securities. This is an increase of $424.6 million or 72.0% in
loans, net of unearned income and deferred fees, and an increase of $21.4
million or 10.6% in investment securities from December 31, 2003.





During
the last three years, the Company has emphasized the growth of its commercial
loan portfolio and has augmented its traditional commercial and residential
loans and services with several specialty lending and depository services. In
2001, the Bank began originating high-end single-family construction loans
within the coastal community of Los Angeles County, California (primarily
Manhattan Beach, Hermosa Beach, Palos Verdes and Redondo Beach) where it
believes it has significant market share. In 2002, the Bank began originating
single-family residential tract construction loans secured by newly constructed
entry level homes. In 2002, the Bank also began originating SBA loans and
religious loans, which are comprised of loans to churches and private schools,
throughout its market area. In 2003, the Bank established an income property
lending division to service the growing markets for commercial real estate and
apartments in Southern California. As a result of the Company’s strategic
expansion, the Company’s loan portfolio has increased
significantly.





The
increase in investment securities is part of management’s strategy of augmenting
earning assets to generate greater yields. Beginning in early 2001, the Company
began to implement an asset/liability management strategy that was built around
the risk elements of interest rate, asset duration and funding risks. A
component of this strategy was to deploy excess liquidity previously invested in
federal funds into higher yielding mortgage-backed securities with shorter
duration and higher cash flow components. The Company increased the investment
portfolio accordingly, which enhanced the Company’s overall yields and better
addressed the risk elements identified above.





51


****


**Liabilities**





Deposits
represent the Bank’s primary source of funds for funding the Bank’s loan
activities. At December 31, 2004, the Bank increased its deposits by $362.2
million or 60.0% as compared to December 31, 2003. The increase was primarily
due to an increase of $164.1 million or 69.1% in money market accounts and an
increase of $157.1 million or 68.3% in time deposits (“TCD’s”) over the prior
year.





The
Bank’s main focus is to increase its core deposit base through relationships. In
order to expand the Bank’s core deposit franchise, the Bank has focused on
offering competitive interest rate products and providing value-added consumer
services by introducing additional products and services. Each of the Bank’s
nine full-service banking centers has a business plan catering specifically to
the needs of consumers in that banking center market. Based on the demographics
of the target market, each banking center tailors its offering of financial
services and products for its customer base. Business deposits have been pursued
by offering an expanded courier network, by introduction of cash management
products and by specific targeting of small business customers. The Bank’s core
deposit franchise has been built around the community banking system, which has
resulted in deposit growth of 60.0% for the year ended December 31, 2004 and
109.8% for the year ended December 31, 2003 as compared to prior periods.
Consolidated total deposits amounted to $965.5 million at December 31, 2004
and $603.3 million at December 31, 2003. Non-interest bearing demand deposits
amounted to $127.5 million at December 31, 2004 and $94.2 million at
December 31, 2003.





At
December 31, 2004, the Bank had 9,366 demand deposit accounts with an aggregate
balance of $138.3 million and an average balance of approximately $14,800. In
addition, the Bank’s NOW and money market accounts represented 4,382 accounts
with an aggregate balance of $435.3 million and an average balance of
approximately $99,300. Savings deposits represented 3,458 accounts with an
aggregate balance of $15.8 million and an average balance of approximately
$4,600. TCD’s increased to 6,387 accounts with an aggregate balance of $387.1
million and an average balance of approximately $60,600 at December 31, 2004.
Included in the $387.1 million of TCD’s are TCD’s with an account balance of
$100,000 or more equaling $204.0 million at December 31, 2004.





At
December 31, 2003, the Bank had 8,960 demand deposit accounts with an aggregate
balance of $103.9 million and an average balance of approximately $11,500. In
addition, the Bank’s NOW and money market accounts represented 2,708 accounts
with an aggregate balance of $263.6 million and an average balance of
approximately $97,300. Savings deposits remained relatively steady with 3,809
accounts with an aggregate balance of $15.5 million and an average balance of
approximately $4,000. TCD’s increased to 4,093 accounts with a balance of $230.0
million with an average balance of approximately $56,100 at December 31, 2003.
Included in the $230.0 million of TCD’s are TCD’s with an account balance of
$100,000 or more equaling $116.7 million at December 31, 2003.





FHLB
advances were $177.0 million and $182.0 million at December 31, 2004 and 2003,
respectively. The tremendous growth in deposits allowed this balance to remain
relatively constant even though the loan portfolio grew significantly during
2004.





In March
2004, the Company obtained a $15.0 million line of credit and a $5.0 million
offering line of credit (collectively, the “credit facility”) with a
correspondent bank. The $5.0 million offering line of credit is at the
discretion of the correspondent bank at the time of request for funding by the
Company. There was no outstanding balance under either credit facility as of
December 31, 2004.




The
Company issued $10.3 million, $12.4 million, and $10.3 million of Floating Rate
Junior Subordinated Deferrable Interest Debentures in December 2004, May 2004
and March 2004, respectively. During both September and December 2003, the
Company issued $10.3 million of Floating Rate Junior Subordinated Deferrable
Interest Debentures. The Company’s Floating Rate Junior Subordinated Deferrable
Interest Debentures increased from $17.5 million at December 31, 2002 to $38.1
million at December 31, 2003, and to $71.1 million at December 31, 2004.
Additionally, the Company had $5.0 million of subordinated debentures
outstanding at December 31, 2004, 2003 and 2002. Most of the proceeds from these
issuances were down streamed to the Bank as working capital to support the
Bank’s growth.





52


****


**Stockholders’
Equity**





At
December 31, 2004 and 2003, stockholders’ equity was $85.2 million and $52.2
million, respectively. The increase in stockholders’ equity was due primarily to
$14.0 million of net income for the year ended December 31, 2004 and the private
placement of common stock during June 2004 and December 2004, resulting in $29.2
million of proceeds, net of issuance costs. These increases were partially
offset by the purchase of $7.0 million of common stock to fund the Company’s
Employee Stock Ownership Plan (“ESOP”), which was initiated in April 2004 (See
Note #13 to the Company’s audited financial statements included in Item 8 hereof
for a discussion of the ESOP).





**Liquidity**





The
Company relies on asset-liability management to assure adequate liquidity and to
maintain an appropriate balance between interest sensitive-earning assets and
interest-bearing liabilities. Liquidity management involves the ability to meet
the cash flow requirements of customers. Typical demands on liquidity are
deposit run-off from demand deposits and savings accounts, maturing time
deposits, which are not renewed, and anticipated funding under credit
commitments to customers. Interest rate sensitivity management seeks to avoid
fluctuating interest margins to enhance consistent growth of net interest income
through periods of changing interest rates.





The
Bank’s Asset-Liability Management Committee manages the Company’s liquidity
position, the parameters of which are approved by the Board of Directors. The
liquidity position of the Bank is monitored daily. The Bank’s loan to deposit
and borrowing ratio was 88% and 75% at December 31, 2004 and 2003, respectively.
The Bank’s policy is to strive for a loan to deposit and borrowing ratio between
79% and 96%. This range is determined based on a 10% deviation above and below
the Bank’s peer group.





Management
believes the level of liquid assets is sufficient to meet current and
anticipated funding needs. Liquid assets represent approximately 18.3% of total
consolidated assets at December 31, 2004. The liquidity contingency process
outlines authorities and a reasonable course of action in case of unexpected
liquidity needs. The Bank has unsecured borrowing lines with six correspondent
banks totaling $66.0 million as well as an advance line with the FHLB allowing
the bank to borrow up to 40% of the Bank’s total assets as of December 31, 2004.
This advance line is collateralized by investment securities and/or eligible
loans.





Interest
rate sensitivity varies with different types of interest-earning assets and
interest-bearing liabilities. The Bank intends to maintain interest-earning
assets, comprised primarily of both loans and investments, and interest-bearing
liabilities, comprised primarily of deposits, maturing or repricing in similar
time horizons in order to minimize or eliminate any impact from interest rate
changes.








53





The table
below sets forth the Company’s known contractual obligations at December 31,
2004:





**(Dollars
      in Thousands)**
    
    **Payment
      due by period**
    ********
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ******Contractual
      Obligations**
    ****
    **Total**
    ****
    **Less
      than 1 year**
    ****
    **1-3
      years**
    ****
    **3-5
      years**
    ****
    **More
      than 5 years**Time
      Deposits
    
    $
    387,061
    
    $
    290,815
    
    $
    96,246
    
    $
    -
    
    $
    -Long-Term
      Debt Obligations
    
    
    253,139
    
    
    162,000
    
    
    15,000
    
    
    -
    
    
    76,139Capital
      Lease Obligations
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Operating
      Lease Obligations
    
    
    21,621
    
    
    2,227
    
    
    4,385
    
    
    4,265
    
    
    10,744Purchase
      Obligations
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Other
      Long-Term Liabilities Reflectedon
      the Registrant's Balance Sheetunder
      GAAP
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
    
    $
    661,821
    
    $
    455,042
    
    $
    115,631
    
    $
    4,265
    
    $
    86,883





**Capital
Resources**





The Bank
is subject to various regulatory capital requirements administered by federal
banking agencies. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the financial
condition or operating results of the Company and the Bank. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank’s assets, liabilities and certain off-balance sheet items
as calculated under regulatory accounting practices. The Bank’s capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of total
and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as
defined) and of Tier 1 capital (as defined) to average assets (as defined).





The Bank
will be categorized as well-capitalized based upon its year-end ratios. To be
categorized as well-capitalized, the Bank must maintain minimum ratios as set
forth in the table below. The following table also sets forth the Bank’s and the
Company’s actual capital amounts and ratios.





54








**(Dollars
      in Thousands)**
    
    
    
    
    
    Capital
      NeededTo
      Be WellCapitalized
      UnderFor
      Capital
    
    Prompt
      CorrectiveActual
      Regulatory
    
    Adequacy
      Purposes
    
    Action
      ProvisionsCapital
    
    
    
    Capital
    
    
    
    CapitalAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio**As
      of December 31, 2004**Total
      capital to risk-weighted assets:Bank
    
    $
    160,509
    
    
    13.49
    %
    $
    95,159
    
    
    8.00
    %
    $
    118,949
    
    
    10.00
    %Consolidated
    
    $
    174,212
    
    
    14.60
    %
    $
    95,474
    
    
    8.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to risk-weighted assets:Bank
    
    $
    147,508
    
    
    12.40
    %
    $
    47,580
    
    
    4.00
    %
    $
    71,369
    
    
    6.00
    %Consolidated
    
    $
    116,280
    
    
    9.74
    %
    $
    47,737
    
    
    4.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to average assets:Bank
    
    $
    147,508
    
    
    11.33
    %
    $
    52,066
    
    
    4.00
    %
    $
    65,083
    
    
    5.00
    %Consolidated
    
    $
    116,280
    
    
    8.90
    %
    $
    52,276
    
    
    4.00
    %
    
    N/A
    
    
    N/A**As
      of December 31, 2003**Total
      capital to risk-weighted assets:Bank
    
    $
    93,311
    
    
    13.85
    %
    $
    53,911
    
    
    8.00
    %
    $
    67,411
    
    
    10.00
    %Consolidated
    
    $
    105,439
    
    
    15.57
    %
    $
    54,189
    
    
    8.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to risk-weighted assets:Bank
    
    $
    85,774
    
    
    12.73
    %
    $
    26,974
    
    
    4.00
    %
    $
    40,424
    
    
    6.00
    %Consolidated
    
    $
    73,007
    
    
    10.78
    %
    $
    27,107
    
    
    4.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to average assets:Bank
    
    $
    85,774
    
    
    10.34
    %
    $
    33,174
    
    
    4.00
    %
    $
    41,474
    
    
    5.00
    %Consolidated
    
    $
    73,007
    
    
    8.77
    %
    $
    33,307
    
    
    4.00
    %
    
    N/A
    
    
    N/A





**Off-Balance
Sheet Arrangements**





In the
normal course of business, the Company is a party to financial instruments with
off-balance-sheet risk. These financial instruments include commitments to
extend credit and letters of credit. To varying degrees, these instruments
involve elements of credit and interest rate risk in excess of the amount
recognized in the statement of financial position. The Company's exposure to
credit loss in the event of non-performance by the other party to the financial
instruments for undisbursed loan funds and letters of credit is represented by
the contractual amount of those instruments. At December 31, 2004 and 2003, the
amounts of the Company’s undisbursed loan funds were $439.4 million and $361.4
million, respectively, and obligations under standby and commercial letters of
credit were $1.7 million and $0.7 million, respectively .
Undisbursed commitments to lend to Directors and Officers of the Company were
$0.7 million and $0.4 million at December 31, 2004 and 2003, respectively (See
Item 8. Financial Statements and Supplementary Data; Note #5 - Related Party
Transactions; Note #12 - Commitments and Contingencies).







**ITEM
7A. Quantitative and Qualitative Disclosures About Market
Risk**





See
“Business; Risk Factors” and “Business; Asset Liability Management” in Item 1
hereof.





55


****


**ITEM
8.**  **Financial
Statements and Supplementary Data**






**INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS OF**


**VINEYARD
NATIONAL BANCORP**














**Independent
      Auditors' Report**
    57**Financial
      Statements**Consolidated
      Balance SheetsDecember
      31, 2004 and 2003
    58Consolidated
      Statements of IncomeFor
      the Years Ended December 31, 2004, 2003 and 2002
    59Consolidated
      Statement of Changes in Stockholders' EquityFor
      the Years Ended December 31, 2004, 2003 and 2002
    60Consolidated
      Statements of Cash FlowsFor
      the Years Ended December 31, 2004, 2003 and 2002
    62**Notes
      to Consolidated Financial Statements**
    64










56







***Report
of Independent Registered Public Accounting Firm***










Board of
Directors


Vineyard
National Bancorp


Rancho
Cucamonga, California





We have
audited the accompanying consolidated balance sheets of Vineyard National
Bancorp and subsidiary (the “Company”) as of December 31, 2004 and 2003, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2004.
These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Vineyard National and
subsidiary as of December 31, 2004 and 2003, and the results of its operations,
changes in its stockholders' equity, and its cash flows for each of the three
years in the period ended December 31, 2004, in conformity with U.S. generally
accepted accounting principles.





We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Vineyard National Bancorp
and subsidiary’s internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 9, 2005 expressed an unqualified opinion
thereon.





/s/
Vavrinek, Trine, Day & Company LLP


Rancho
Cucamonga, California


March 9,
2005










57





**VINEYARD
NATIONAL BANCORP AND SUBSIDIARY**


**CONSOLIDATED
BALANCE SHEETS**


**DECEMBER
31, 2004 AND 2003**





**(Dollars
      in Thousands)**
    
    December
      31,2004
    
    2003**ASSETS**Cash
      and due from banks
    
    $
    20,551
    
    $
    18,842Federal
      funds sold
    
    
    2,000
    
    
    39,400Total
      Cash and Cash Equivalents
    
    
    22,551
    
    
    58,242Investment
      securities, available-for-sale
    
    
    223,480
    
    
    202,068Loans,
      net of unearned income
    
    
    1,027,037
    
    
    597,007Less:
      Allowance for loan losses
    
    
    (13,001
    )
    
    (7,537
    )Net
      Loans
    
    
    1,014,036
    
    
    589,470Bank
      premises and equipment, net
    
    
    12,399
    
    
    9,545Accrued
      interest
    
    
    5,423
    
    
    3,107FHLB
      and other stock, at cost
    
    
    12,235
    
    
    9,195Deferred
      income tax asset
    
    
    8,196
    
    
    8,471Other
      assets
    
    
    13,177
    
    
    7,702**TOTAL
      ASSETS**
    
    $
    1,311,497
    
    $
    887,800**LIABILITES
      AND STOCKHOLDERS' EQUITY**LiabilitiesDepositsNon-interest-bearing
    
    $
    127,466
    
    $
    94,162Interest-bearing
    
    
    838,080
    
    
    509,164Total
      Deposits
    
    
    965,546
    
    
    603,326FHLB
      advances
    
    
    177,000
    
    
    182,000Subordinated
      debentures
    
    
    5,000
    
    
    5,000Junior
      subordinated debentures
    
    
    71,139
    
    
    38,147Accrued
      interest and other liabilities
    
    
    7,585
    
    
    7,152**TOTAL
      LIABILITIES**
    
    
    1,226,270
    
    
    835,625**COMMITMENTS
      AND CONTINGENCIES (Note #6 and #12)**
    
    
    -
    
    
    -Stockholders'
      EquityContributed
      capitalPerpetual
      preferred stock - authorized 10,000,000 sharesSeries
      A - no par value, issued and outstanding 0 and 50shares
      in 2004 and 2003, respectively
    
    
    -
    
    
    2,450Series
      B - no par value, issued and outstanding0
      and 1,150,000 in 2004 and 2003, respectively
    
    
    -
    
    
    26,549Common
      stock - no par value, authorized 15,000,000 shares;issued
      and outstanding 9,581,941 and 6,291,430 sharesin
      2004 and 2003, respectively
    
    
    70,536
    
    
    9,739Additional
      paid-in capital
    
    
    3,772
    
    
    3,307Unallocated
      ESOP shares
    
    
    (6,856
    )
    
    -Stock
      dividends to be distributed
    
    
    -
    
    
    4,981Retained
      earnings
    
    
    20,513
    
    
    8,237Accumulated
      other comprehensive loss, net of income taxes
    
    
    (2,738
    )
    
    (3,088
    )**TOTAL
      STOCKHOLDERS' EQUITY**
    
    
    85,227
    
    
    52,175**TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY**
    
    $
    1,311,497
    
    $
    887,800





The
accompanying notes are an integral part of these financial
statements.





58





**VINEYARD
NATIONAL BANCORP AND SUBSIDIARY**


**CONSOLIDATED
STATEMENTS OF INCOME**


**FOR
THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**





**(Dollars
      in thousands, except per share amounts)**
    
    2004
    
    2003
    
    2002**Interest
      Income**Interest
      and fees on loans
    
    $
    66,374
    
    $
    31,080
    
    $
    16,457Interest
      on investment securities - taxable
    
    
    8,629
    
    
    8,354
    
    
    2,631Interest
      on federal funds sold
    
    
    53
    
    
    98
    
    
    82Interest
      on deposits in other financial institutions
    
    
    -
    
    
    5
    
    
    -**TOTAL
      INTEREST INCOME**
    
    
    75,056
    
    
    39,537
    
    
    19,170**Interest
      Expense**Interest
      on savings deposits
    
    
    102
    
    
    76
    
    
    113Interest
      on NOW and money market deposits
    
    
    7,687
    
    
    3,744
    
    
    1,670Interest
      on time deposits in denominations of $100,000 or more
    
    
    4,246
    
    
    2,282
    
    
    1,352Interest
      on other time deposits
    
    
    3,707
    
    
    2,179
    
    
    1,279Interest
      on federal funds purchased and other borrowings
    
    
    6,312
    
    
    3,102
    
    
    1,423**TOTAL
      INTEREST EXPENSE**
    
    
    22,054
    
    
    11,383
    
    
    5,837**NET
      INTEREST INCOME**
    
    
    53,002
    
    
    28,154
    
    
    13,333**Provision
      for Loan and Lease Losses**
    
    
    (5,734
    )
    
    (3,710
    )
    
    (1,430
    )**NET
      INTEREST INCOME AFTER****PROVISION
      FOR LOAN****AND
      LEASE LOSSES**
    
    
    47,268
    
    
    24,444
    
    
    11,903**Other
      Income**Fees
      and service charges
    
    
    1,783
    
    
    1,484
    
    
    1,473Gain
      on sale of SBA loans and SBA broker fee income
    
    
    2,973
    
    
    1,988
    
    
    384Gain
      on sale of mortgage loans
    
    
    -
    
    
    129
    
    
    195Net
      gain on sale of investment securities
    
    
    388
    
    
    2,137
    
    
    1,285Other
      income
    
    
    313
    
    
    90
    
    
    591**TOTAL
      OTHER INCOME**
    
    
    5,457
    
    
    5,828
    
    
    3,928**Other
      Expenses**Salaries
      and employee benefits
    
    
    16,712
    
    
    8,983
    
    
    5,201Occupancy
      expense of premises
    
    
    2,419
    
    
    1,477
    
    
    878Furniture
      and equipment expense
    
    
    2,391
    
    
    1,189
    
    
    780Other
      expenses
    
    
    7,547
    
    
    5,091
    
    
    3,883**TOTAL
      OTHER EXPENSES**
    
    
    29,069
    
    
    16,740
    
    
    10,742**INCOME
      BEFORE INCOME TAXES**
    
    
    23,656
    
    
    13,532
    
    
    5,089**INCOME
      TAX EXPENSE**
    
    
    9,669
    
    
    5,540
    
    
    2,081**NET
      INCOME**
    
    $
    13,987
    
    $
    7,992
    
    $
    3,008**EARNINGS
      PER SHARE****BASIC**
    
    $
    1.72
    
    $
    1.21
    
    $
    0.63**DILUTED**
    
    $
    1.55
    
    $
    1.09
    
    $
    0.52





The
accompanying notes are an integral part of these financial
statements.





59





**VINEYARD
NATIONAL BANCORP AND SUBSIDIARY**


**CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY**


**FOR
THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**





**(Dollars
      in Thousands)**
    
    
    
    
    
    
    
    
    
    Stock
    
    
    
    
    
    AccumulatedPerpetual
    
    Common
      Stock
    
    Additional
    
    Dividend
    
    
    
    
    
    OtherPreferred
    
    Number
      of
    
    
    
    Paid-in
    
    To
      Be
    
    Comprehensive
    
    Retained
    
    ComprehensiveStock
    
    Shares
    
    Amount
    
    Capital
    
    Distributed
    
    Income
    
    Earnings
    
    (Loss)
      Income
    
    Total**Balance
      December 31, 2001**
    
    $
    -
    
    
    1,876,126
    
    $
    2,151
    
    $
    3,307
    
    $
    -
    
    
    
    
    $
    5,032
    
    $
    (35
    )
    $
    10,455Five
      percent stock dividenddistributed
      in January 2003
    
    
    
    
    
    93,654Five
      percent stock dividenddistributed
      in January 2004
    
    
    
    
    
    98,050Two-for-one
      stock splitdistributed
      in August 2004
    
    
    
    
    
    2,067,830Issuance
      of preferred stock
    
    
    2,450
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,450Stock
      options exercised
    
    
    
    
    
    194,040
    
    
    350
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    350Conversion
      of convertible debentures
    
    
    
    
    
    1,653,750
    
    
    3,551
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,551Stock
      dividend to be distributed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,026
    
    
    
    
    
    (2,026
    )
    
    
    
    
    -Comprehensive
      incomeNet
      Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    3,008
    
    
    3,008
    
    
    
    
    
    3,008Unrealized
      security holding gains(net
      of $644 tax provision)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    889
    
    
    
    
    
    889
    
    
    889Less
      reclassification adjustmentfor
      realized gains (netof
      $539 tax provision)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (745
    )
    
    
    
    
    (745
    )
    
    (745
    )Total
      comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    3,152**Balance
      December 31, 2002**
    
    
    2,450
    
    
    5,983,450
    
    
    6,052
    
    
    3,307
    
    
    2,026
    
    
    
    
    
    6,014
    
    
    109
    
    
    19,958Issuance
      of common stock
    
    
    
    
    
    349,044
    
    
    3,200
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,200Issuance
      of preferred stock
    
    
    26,549
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,549Stock
      options exercised
    
    
    
    
    
    143,320
    
    
    317
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    317Warrants
      exercised
    
    
    
    
    
    4,410
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30Purchase
      of common stock
    
    
    
    
    
    (188,794
    )
    
    (1,884
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,884
    )Stock
      dividends distributed
    
    
    
    
    
    
    
    
    2,024
    
    
    
    
    
    (2,024
    )
    
    
    
    
    
    
    
    
    
    
    -Cash
      paid for fractional shares forstock
      dividend distribution
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Cash
      paid for fractional sharesfor
      the Southland Bank purchase
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    (2
    )Stock
      dividend to be distributed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,981
    
    
    
    
    
    (4,981
    )
    
    
    
    
    -Cash
      dividends paid on common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (149
    )
    
    
    
    
    (149
    )Cash
      dividends paid on preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (637
    )
    
    
    
    
    (637
    )Comprehensive
      incomeNet
      Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    7,992
    
    
    7,992
    
    
    
    
    
    7,992Unrealized
      security holdinglosses
      (net of$1,345
      tax benefit)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,936
    )
    
    
    
    
    (1,936
    )
    
    (1,936
    )Less
      reclassification adjustmentfor
      realized gains(net
      of $876 tax provision)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,261
    )
    
    
    
    
    (1,261
    )
    
    (1,261
    )Total
      comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    4,795**Balance,
      December 31, 2003**
    
    $
    28,999
    
    
    6,291,430
    
    $
    9,739
    
    $
    3,307
    
    $
    4,981
    
    
    
    
    $
    8,237
    
    $
    (3,088
    )
    $
    52,175











60








**VINEYARD
NATIONAL BANCORP AND SUBSIDIARY**


**CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY**


**FOR
THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**


**(continued)**





**(Dollars
      in Thousands)**
    
    
    
    
    
    
    
    
    
    Stock
    
    
    
    
    
    
    
    AccumulatedPerpetual
    
    Common
      Stock
    
    Additional
    
    Dividend
    
    
    
    
    
    
    
    OtherPreferred
    
    Number
      of
    
    
    
    Paid-in
    
    To
      Be
    
    Comprehensive
    
    Retained
    
    Unallocated
    
    ComprehensiveStock
    
    Shares
    
    Amount
    
    Capital
    
    Distributed
    
    Income
    
    Earnings
    
    ESOP
    
    (Loss)
      Income
    
    Total**Balance
      December 31, 2003**
    
    $
    28,999
    
    
    6,291,430
    
    $
    9,739
    
    $
    3,307
    
    $
    4,981
    
    
    
    
    $
    8,237
    
    $
    -
    
    $
    (3,088
    )
    $
    52,175Issuance
      of common stock
    
    
    
    
    
    1,283,100
    
    
    29,200
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,200Stock
      options exercised
    
    
    
    
    
    214,329
    
    
    745
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    745Warrants
      exercised
    
    
    
    
    
    148,100
    
    
    1,007
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,007Tax
      benefit from exercise ofnon-qualified
      stock options
    
    
    
    
    
    
    
    
    
    
    
    473
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    473Purchase
      of common stock
    
    
    
    
    
    (82,200
    )
    
    (1,612
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,612
    )Purchase
      of common stockto
      pre-fund ESOP
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,997
    )
    
    
    
    
    (6,997
    )Allocation
      of ESOP shares
    
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    141
    
    
    
    
    
    133Redemption
      of Series Apreferred
      stock
    
    
    (2,450
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,450
    )Redemption
      and conversion ofSeries
      B preferred stockto
      common stock
    
    
    (26,547
    )
    
    1,727,182
    
    
    26,491
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (56
    )Cash
      paid for fractional shares forSeries
      B stock conversion
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )Stock
      dividends distributed
    
    
    
    
    
    
    
    
    4,966
    
    
    
    
    
    (4,966
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    -Cash
      paid for fractional shares forstock
      dividend distribution
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15
    )Cash
      paid in excess of cost to redeemSeries
      A preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (51
    )
    
    
    
    
    
    
    
    (51
    )Cash
      paid in excess of cost to redeemand
      convert Series B preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    
    (20
    )Cash
      dividends paid on common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (938
    )
    
    
    
    
    
    
    
    (938
    )Cash
      dividends paid on preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (702
    )
    
    
    
    
    
    
    
    (702
    )Comprehensive
      incomeNet
      Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    13,987
    
    
    13,987
    
    
    
    
    
    
    
    
    13,987Unrealized
      security holding gains(net
      of $85 tax provision)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    121
    
    
    
    
    
    
    
    
    121
    
    
    121Less
      reclassification adjustmentfor
      realized gains(net
      of $159 tax provision)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    229
    
    
    
    
    
    
    
    
    229
    
    
    229Total
      comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    14,337**Balance,
      December 31, 2004**
    
    **$**
    **-**
    
    
    9,581,941
    
    $
    70,536
    
    $
    3,772
    
    $
    -
    
    
    
    
    $
    20,513
    
    $
    (6,856
    )
    $
    (2,738
    )
    $
    85,227








The
accompanying notes are an integral part of these financial
statements.





61





**VINEYARD
NATIONAL BANCORP AND SUBSIDIARY**


**CONSOLIDATED
STATEMENTS OF CASH FLOWS**


**FOR
THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**





**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002**Cash
      Flows from Operating Activities**Net
      Income
    
    $
    13,987
    
    $
    7,992
    
    $
    3,008Adjustments
      to Reconcile Net Income to NetCash
      Provided By Operating ActivitiesDepreciation
    
    
    2,042
    
    
    956
    
    
    668Investment
      securities accretion/amortization
    
    
    781
    
    
    576
    
    
    515Amortization
      of intangible assets
    
    
    11
    
    
    4
    
    
    -Amortization
      of SBA servicing assets
    
    
    269
    
    
    82
    
    
    1Allocation
      of ESOP shares
    
    
    133
    
    
    -
    
    
    -FHLB
      dividends
    
    
    (426
    )
    
    (186
    )
    
    (43
    )Reinvestment
      of mutual fund dividends
    
    
    (42
    )
    
    -
    
    
    -Provision
      for possible loan losses
    
    
    5,734
    
    
    3,710
    
    
    1,430Loss
      on disposal of equipment
    
    
    -
    
    
    27
    
    
    1(Decrease)
      / increase in taxes payable
    
    
    (2,273
    )
    
    (1,542
    )
    
    2,732(Decrease)
      / increase in deferred taxes
    
    
    31
    
    
    (2,779
    )
    
    (1,529
    )Increase
      in other assets
    
    
    (3,045
    )
    
    (3,632
    )
    
    (70
    )(Increase)
      / decrease in cash surrendervalue
      of life insurance policies
    
    
    51
    
    
    40
    
    
    46Decrease
      in loans held for sale
    
    
    -
    
    
    2,112
    
    
    2,359Increase
      in unearned loan fees
    
    
    257
    
    
    1,799
    
    
    235Increase
      in interest receivable
    
    
    (2,316
    )
    
    (1,548
    )
    
    (586
    )(Decrease)/increase
      in interest payable
    
    
    (154
    )
    
    790
    
    
    (5
    )Increase
      in accrued expense and other liabilities
    
    
    1,320
    
    
    1,766
    
    
    407Gain
      on sale of loans
    
    
    (1,614
    )
    
    (1,136
    )
    
    (339
    )Gain
      on sale of other real estate owned
    
    
    (56
    )
    
    -
    
    
    -Gain
      on sale of investment securities, net
    
    
    (388
    )
    
    (2,137
    )
    
    (1,285
    )Total
      Adjustments
    
    
    315
    
    
    (1,098
    )
    
    4,537**Net
      Cash Provided By Operating Activities**
    
    
    14,302
    
    
    6,894
    
    
    7,545**Cash
      Flows From Investing Activities**Proceeds
      from maturities of investment securities,available-for-sale
    
    
    -
    
    
    20,000
    
    
    21,500Proceeds
      from sales of mortgage-backedsecurities
      available-for-sale
    
    
    60,843
    
    
    232,231
    
    
    137,421Purchase
      of investment securities available-for-sale
    
    
    -
    
    
    (2,000
    )
    
    (36,007
    )Purchase
      of mortgage-backed securities available-for-sale
    
    
    (112,458
    )
    
    (394,497
    )
    
    (188,466
    )Proceeds
      from principal reductions and maturitiesof
      mortgage-backed securities available-for-sale
    
    
    30,446
    
    
    25,890
    
    
    9,567Purchase
      of FHLB and other stock, net
    
    
    (3,670
    )
    
    (6,739
    )
    
    (2,050
    )Policy
      additions to life insurance
    
    
    (230
    )
    
    (231
    )
    
    (124
    )Redemption
      of FHLB stock
    
    
    1,056
    
    
    -
    
    
    -Net
      cash provided from acquisition
    
    
    -
    
    
    12,766
    
    
    -Recoveries
      on loans previously written off
    
    
    122
    
    
    72
    
    
    166Net
      loans made to customers and principalcollections
      of loans
    
    
    (429,065
    )
    
    (326,154
    )
    
    (117,971
    )Capital
      expenditures
    
    
    (5,014
    )
    
    (4,271
    )
    
    (883
    )Proceeds
      from sale of other real estate owned
    
    
    167
    
    
    -
    
    
    -Proceeds
      from sale of property, plant and equipment
    
    
    8
    
    
    -
    
    
    2**Net
      Cash Used in Investing Activities**
    
    
    (457,795
    )
    
    (442,933
    )
    
    (176,845
    )








62





**VINEYARD
NATIONAL BANCORP AND SUBSIDIARY**


**CONSOLIDATED
STATEMENTS OF CASH FLOWS**


**FOR
THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**


**(continued)**





**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002**Cash
      Flows From Financing Activities**Net
      increase in demand deposits, NOW account,savings
      accounts, and money market deposits
    
    
    205,162
    
    
    158,863
    
    
    94,271Net
      increase in certificates of deposits
    
    
    157,058
    
    
    125,834
    
    
    33,881Proceeds
      from issuance of preferred stock
    
    
    -
    
    
    26,549
    
    
    2,450Proceeds
      from issuance of common stock
    
    
    29,200
    
    
    -
    
    
    -Proceeds
      from issuance of junior subordinated debentures
    
    
    32,000
    
    
    20,000
    
    
    5,000Proceeds
      from issuance of subordinated debt
    
    
    -
    
    
    -
    
    
    5,000(Decrease)
      / increase in other borrowings
    
    
    -
    
    
    (5,000
    )
    
    5,000Purchase
      of common stock to pre-fund ESOP
    
    
    (6,997
    )
    
    -
    
    
    -Purchase
      of treasury stock
    
    
    (1,612
    )
    
    (1,884
    )
    
    -Net
      change in FHLB advances
    
    
    (5,000
    )
    
    137,000
    
    
    42,000Proceeds
      from exercise of warrants
    
    
    1,007
    
    
    30
    
    
    -Redemption
      of Series A preferred stock (includingcash
      paid in excess of cost)
    
    
    (2,501
    )
    
    -
    
    
    -Redemption
      and conversion of Series B preferred stock(including
      cash paid in excess of cost)
    
    
    (76
    )
    
    -
    
    
    -Cash
      paid in lieu of fractional sharesof
      stock dividend
    
    
    (15
    )
    
    (4
    )
    
    -Cash
      paid in lieu of fractional sharesof
      Series B conversion
    
    
    (2
    )
    
    -
    
    
    -Dividends
      paid on preferred stock
    
    
    (702
    )
    
    (637
    )
    
    -Dividends
      paid on common stock
    
    
    (938
    )
    
    (149
    )
    
    -Proceeds
      from exercise of stock options
    
    
    1,218
    
    
    317
    
    
    350**Net
      Cash Provided by Financing Activities**
    
    
    407,802
    
    
    460,919
    
    
    187,952**Net
      (Decrease) / Increase in Cash and Cash
Equivalents**
    
    
    (35,691
    )
    
    24,880
    
    
    18,652**Cash
      and Cash Equivalents**,
      Beginning of Year
    
    
    58,242
    
    
    33,362
    
    
    14,710**Cash
      and Cash Equivalents**,
      End of Year
    
    $
    22,551
    
    $
    58,242
    
    $
    33,362**Supplementary
      Information**Change
      in valuation allowancefor
      investment securities
    
    $
    594
    
    $
    (5,422
    )
    $
    248Conversion
      of convertible debentures
    
    $
    -
    
    $
    -
    
    $
    3,551Conversion
      of Series B preferred stock
    
    $
    26,491
    
    $
    -
    
    $
    -Income
      taxes paid
    
    $
    11,910
    
    $
    9,716
    
    $
    876Interest
      paid
    
    $
    21,900
    
    $
    10,519
    
    $
    5,770Transfer
      of loans to other real estate owned
    
    $
    -
    
    $
    111
    
    $
    -Tax
      benefit for exercise ofnon-qualified
      stock options
    
    $
    473
    
    $
    -
    
    $
    -





The
accompanying notes are an integral part of these financial
statements.












63





**Note
#1 - Summary of Significant Accounting Policies**




The
accounting and reporting policies of Vineyard National Bancorp and subsidiary
(the “Company”) conform to accounting principles generally accepted in the
United States of America and to general practices within the banking industry. A
summary of the Company's significant accounting and reporting policies
consistently applied in the preparation of the accompanying financial statements
follows:




Principles
of Consolidation




The
consolidated financial statements include the Company and its wholly owned
subsidiary, Vineyard Bank (the “Bank”). Inter-company balances and transactions
have been eliminated.




Nature
of Operations




The
Company is a bank holding company. The Company’s principal asset is the capital
stock of the Bank, a California-chartered commercial bank, headquartered in the
Inland Empire region of Southern California. The Bank operates nine banking
centers within San Bernardino, Riverside and Los Angeles counties of California,
as well as three loan production offices in San Diego and Orange counties of
California. The Company is dedicated to relationship banking and the success of
its customers. The Company caters to the needs of small-to-mid-size commercial
businesses, retail community businesses, single family residence
developers/builders, individuals and local public and private organizations by
offering specialty product solutions. The Company attracts deposits from the
communities where it has established banking centers by offering competitive
interest rate products and providing value-added consumer services.





Investment
in Nonconsolidated Subsidiaries




The
Company accounts for its investments in its wholly owned special purpose
entities, Vineyard Statutory Trust I, Vineyard Statutory Trust II, Vineyard
Statutory Trust III, Vineyard Statutory Trust IV, Vineyard Statutory Trust V,
Vineyard Statutory Trust VI and Vineyard Statutory Trust VII, using the equity
method under which the subsidiaries’ net earnings are recognized in the
Company’s statement of income.




Use of
Estimates




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.




Estimates
that are particularly susceptible to significant changes relate to the
determination of the allowance for losses on loans and the valuation of real
estate acquired in connection with foreclosures or in satisfaction of loans.




While
management uses available information to recognize losses on loans and
foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination process, periodically review the Bank's
allowances for losses on loans and foreclosed real estate. Such agencies may
require the Bank to recognize additions to the allowances based on their
judgments about information available to them at the time of their examination.
Because of these factors, it is reasonably possible that the allowances for
losses on loans and foreclosed real estate may change.




Cash
and Cash Equivalents




For
purposes of reporting cash flows, cash and cash equivalents include cash, due
from banks and federal funds sold. Generally, federal funds are sold for one-day
periods.




64





Cash
and Due From Banks




Banking
regulations require that all banks maintain a percentage of their deposits as
reserves in cash or on deposit with the Federal Reserve Bank. The Bank complied
with the reserve requirements as of December 31, 2004.




The Bank
maintains amounts due from banks that exceed federally insured limits. The Bank
has not experienced any losses in such accounts as of December 31,
2004.




Investment
Securities




In
accordance with SFAS No. 115, *"Accounting
for Certain Investments in Debt and Equity Securities,"* which
addresses the accounting for investments in equity securities that have readily
determinable fair values and for investments in all debt securities, securities
are classified in three categories and accounted for as follows: debt securities
that the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and are measured at amortized cost; debt and
equity securities bought and held principally for the purpose of selling in the
near term are classified as trading securities and are measured at fair value,
with unrealized gains and losses included in earnings; debt and equity
securities deemed as available-for-sale are measured at fair value, with
unrealized gains and losses reported in a separate component of stockholders'
equity. Gains or losses on sales of investment securities are determined on the
specific identification method. Premiums and discounts on investment securities
are amortized or accreted using the interest method over the expected lives of
the related securities.




Loans
and Interest on Loan **s**




Loans
receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
unpaid principal balances reduced by any charge-offs or specific valuation
accounts and net of any deferred fees or costs on originated loans.




Loan
origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan.




Loans on
which the accrual of interest has been discontinued are designated as nonaccrual
loans. The accrual of interest on loans is discontinued when in the opinion of
management, there is reasonable doubt as to collectibility, or when principal or
interest is past due 90 days, unless the loan is both well secured and in
process of collection. When loans are placed on nonaccrual status, all interest
previously accrued but not collected is reversed against current period interest
income. Income on nonaccrual loans is subsequently recognized only to the extent
that cash is received and the loan's principal balance is deemed collectible.
Interest accruals are resumed on such loans only when they are brought fully
current with respect to interest and principal and when, in the judgment of
management, the loans are estimated to be fully collectible as to both principal
and interest.




The Bank
considers a loan to be impaired when it is probable that the Bank will be unable
to collect all amounts due (principal and interest) according to the contractual
terms of the loan agreement. Measurement of impairment is based on the expected
future cash flows of an impaired loan which are to be discounted at the loan's
effective interest rate, or measured by reference to an observable market value
of the loan, if one exists, or the fair value of the collateral for a
collateral-dependent loan. The Bank selects the measurement method on a
loan-by-loan basis except that collateral-dependent loans for which foreclosure
is probable are measured at the fair value of the collateral. The Bank
recognizes interest income on impaired loans based on its existing methods of
recognizing interest income on nonaccrual and troubled debt restructured
loans.




To
calculate the gain (loss) on sale of loans, the Bank's investment in the loan is
allocated among the retained portion of the loan, the servicing retained, the
interest-only strip and the sold portion of the loan, based on the relative fair
market value of each portion. The gain (loss) on the sold portion of the loan is
recognized at the time of sale based on the difference between the sale proceeds
and the allocated investment. As a result of the relative fair value allocation,
the carrying value of the retained portion is discounted, with the discount
accreted to interest income over the life of the loan. That portion of the
excess servicing fees that represent contractually specified servicing fees
(contractual servicing) are reflected as a servicing asset which is amortized to
other expense over an estimated life using a method approximating the level
yield method; in the event future prepayments exceed management's estimates and
future expected cash flows are inadequate to cover the unamortized servicing
asset, additional amortization would be recognized. The portion of excess
servicing fees in excess of the contractual servicing fees is reflected as
interest-only strips receivable, which are classified as interest-only strips
receivable available for sale and are carried at fair value.





65





Loans
Held for Sale





Mortgage
loans held for sale in the secondary market are carried at the lower of cost or
estimated market value in the aggregate market. Net unrealized losses are
recognized through a valuation allowance by charges to income. Gains or losses
realized on the sales are recognized at the time of sale and are determined by
the difference between the net proceeds and the carrying value of the loans
sold. Gains and losses on sales of loans are included in non-interest
income.





Allowance
for Loan and Lease Losses




The
allowance for loan and lease losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in the loan
and lease portfolio. The amount of the allowance is based on management's
evaluation of the collectibility of the loan portfolio, including the nature of
the portfolio, credit concentrations, trends in historical loss experience,
specific impaired loans and economic conditions. The allowance is increased by a
provision for loan and lease losses, which is charged to expense and reduced by
charge-offs, net of recoveries.




Premises
and Equipment




Land is
carried at cost. Bank premises and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives, which ranges from three to
ten years for furniture and fixtures and forty years for buildings. Leasehold
improvements are amortized using the straight-line method over the estimated
useful lives of the improvements or the remaining lease term, whichever is
shorter. Expenditures for betterments or major repairs are capitalized and those
for ordinary repairs and maintenance are charged to operations as incurred.
Total depreciation expense for the reporting periods ending December 31, 2004,
2003 and 2002, was $2.0 million, $1.0 million and $0.7 million,
respectively.





Other
Real Estate Owned




Other
real estate owned, which represents real estate acquired through foreclosure, is
stated at the lower of the carrying value of the loan or the estimated fair
value less estimated selling costs of the related real estate. Loan balances in
excess of the fair value of the real estate acquired at the date of acquisition
are charged against the allowance for loan losses. Any subsequent declines in
estimated fair value less selling costs, operating expenses or income and gains
or losses on disposition of such properties are charged to current operations.
At December 31, 2004, 2003 and 2002, other real estate owned, which was included
in “other assets” on the Company’s Consolidated Balance Sheet, was $0, $0.1
million and $0, respectively.




Income
Taxes




Provisions
for income taxes are based on amounts reported in the statements of income
(after exclusion of non-taxable income such as interest on state and municipal
securities) and include deferred taxes on temporary differences in the
recognition of income and expense for tax and financial statement purposes.
Deferred taxes are computed on the liability method as prescribed in SFAS
No. 109, *"Accounting
for Income Taxes."*




Advertising
Costs





The
Company expenses the costs of advertising in the period benefited.





Earnings
Per Share (“EPS”)





Basic EPS
excludes dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS 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 entity.





66





Stock-Based
Compensation





The
Company has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, *“Accounting
for Stock Issued to Employees,”* (“APB
No. 25”) ** and
related interpretations. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of the Company’s
stock at the date of the grant over the amount an employee must pay to acquire
the stock.




In
December 2004, FASB issued FASB Statement No. 123R “ *Share-Based
Payment* ” (“SFAS
No. 123R”), which is a revision to SFAS No.123, “ *Accounting
for Stock-Based Compensation* ” (“SFAS
No. 123”), and addresses the accounting for transactions in which an enterprise
receives employee services in exchange for (a) equity instruments of the
enterprise or (b) liabilities that are based on the fair value of the
enterprise’s equity instruments or that may be settled by the issuance of such
equity instruments. This statement eliminates the ability to account for
share-based compensation transactions using APB No. 25, and generally would
require instead that such transactions be accounted for using a fair-value-based
method. The statement does not change the accounting in SFAS No. 123, for
transactions in which an enterprise exchanges its equity instruments for
services of parties other than employees or the accounting for employee stock
ownership plans, which are subject to AICPA Statement of Position 93-6, *Employers’
Accounting for Employee Stock Ownership Plans* . The
phase-in period for this statement begins in the third quarter of 2005, at which
time the Company will account for stock-based compensation based on this new
pronouncement. The Company is in the process of determining the impact that the
adoption of SFAS No. 123R will have on the financial condition or operating
results of the Company.




Had
compensation cost for the Company’s stock option plan been determined based on
the fair value at the grant dates for awards under those plan consistent with
the method of SFAS Nos. 123 and 123R, the Company’s net income and EPS would
have been reduced to the pro forma amounts indicated below. The EPS was adjusted
to reflect the two-for-one stock in August 2004, and 5% stock dividends paid in
January 2004 and January 2003.




**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002Net
      income:As
      reported
    
    $
    13,987
    
    $
    7,992
    
    $
    3,008Stock-based
      compensation that would have been reportedusing
      the fair value method of SFAS No. 123
    
    
    (339
    )
    
    (189
    )
    
    (301
    )Pro
      forma net income
    
    
    13,648
    
    
    7,803
    
    
    2,707Basic
      Shares
    
    
    7,692,057
    
    
    6,097,036
    
    
    4,779,253Diluted
      Shares
    
    
    8,929,860
    
    
    7,193,604
    
    
    6,033,591Basic
      earnings per share:As
      reported
    
    $
    1.72
    
    $
    1.21
    
    $
    0.63Pro
      forma
    
    $
    1.67
    
    $
    1.18
    
    $
    0.57Diluted
      earnings per share:As
      reported
    
    $
    1.55
    
    $
    1.09
    
    $
    0.52Pro
      forma
    
    $
    1.52
    
    $
    1.06
    
    $
    0.47





Comprehensive
Income





The
Company follows SFAS No. 130, *“Reporting
Comprehensive Income,* ” which
requires the disclosure of comprehensive income and its components. Changes in
unrealized gains/ (losses) on available-for-sale securities, net of income
taxes, is the only component of accumulated other comprehensive income for the
Company.




67





Reclassifications




Certain
reclassifications have been made to the 2003 and 2002 financial statements to
conform to 2004 classifications.




Current
Accounting Pronouncements




In
January 2003, FASB issued the Emerging Information Task Force Issue 03-1, *The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investors,* which
was updated in March 2004 ** (“EITF
03-1”). EITF 03-1 addresses the meaning of other-than-temporary impairment and
its application to certain debt and equity securities. EITF 03-1 aids in the
determination of impairment of an investment and gives guidance as to the
measurement of impairment loss and the recognition and disclosures of
other-than-temporary investments. EITF 03-1 also provides a model to determine
other-than-temporary impairment using evidence-based judgment about the recovery
of the fair value up to the cost of the investment by considering the severity
and duration of the impairment in relation to the forecasted recovery of the
fair value. The March 2004 update to EITF 03-1 included application guidance as
to the determination of impairment, disclosures required by an impairment, and
guidance for the transition period and effective dates of disclosure
requirements. In March 2004, FASB also issued two proposed FASB Staff Positions
(“FSP”): FSP EITF Issue 03-1-a, which gives additional guidance on the
determination of impairment for debt securities impaired because of interest
rate and/or sector spread increases, and FSP EITF Issue 03-1-b, which delays the
disclosure effective date for debt securities impaired because of interest rate
and/or sector spread increases. The comment deadlines for the proposed FSP EITF
Issues 03-1-a and 03-1-b were October 29, 2004 and September 29, 2004,
respectively, and the application and effective dates of portions of EITF 03-1
are deferred until the issuance of FSP EITF Issue 03-1-a and FSP EITF Issue
03-1-b. The adoption of EITF 03-1 and FSP EITF Issues 03-1-a and 03-1-b are not
expected to have a material impact on the financial condition or operating
results of the Company.




In May
2003, FASB issued SFAS No. 150, “ *Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity* ” (“SFAS
No. 150”). SFAS No. 150 established standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances.) Many of those instruments were previously classified as
equity. SFAS No. 150 is generally effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. The adoption of SFAS
No. 150 did not have a material impact on the financial condition or operating
results of the Company.




In
December 2004, FASB proposed FIN 46R-b, an addition to FASB Interpretation No.
46, *Consolidation
of Variable Interest Entities* (“FIN
46R”), which addresses whether a reporting enterprise should consider whether it
has an implicit variable interest in a variable interest entity. An entity may
be considered the primary beneficiary of a variable interest and have an
implicit variable interest in a variable interest entity when the following
conditions exist: (i) a variable interest in the variable interest entity is
held by a related party; or (ii) if two or more related parties hold variable
interests in the same entity, and the aggregate variable interest held by those
parties would, if held by a single party, identify that party as the primary
beneficiary, then the party, within the related party group, that is most
closely associated with the variable interest entity is the primary beneficiary.
This proposed statement, when issued, will relate only to entities to which FIN
46R applies. The comment period for this proposed statement ends January 20,
2005. The adoption of FIN 46R-b is not expected to have a material impact on the
financial condition or operating results of the Company.





In
December 2003, the AICPA issued Statement of Position 03-3, Accounting for
Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”). SOP 03-3
addresses accounting for differences between contractual cash flows and cash
flows expected to be collected from an investor’s initial investment in loans or
debt securities (loans) acquired in a transfer if those differences are
attributable, at least in part, to credit quality. SOP 03-3 does not apply to
loans originated by the entity. SOP 03-3 limits the yield that may be accreted
(accretable yield) to the excess of the investor’s estimate of undiscounted
expected principal, interest, and other cash flows over the investor’s initial
investment in the loan. SOP 03-3 requires that the excess of contractual cash
flows over cash flows expected to be collected not be recognized as an
adjustment of yield, loss accrual, or valuation allowance. SOP 03-3 prohibits
investors from displaying accretable yield and nonaccretable difference in the
balance sheet. Subsequent increases in cash flows expected to be collected
generally should be recognized prospectively through adjustment of the loan’s
yield over its remaining life. Decreases in cash flows expected to be collected
should be recognized as impairment. SOP 03-3 is effective for loans acquired in
fiscal years beginning after December 15, 2004. The adoption of SOP 03-3 is not
expected to have a material impact on the financial condition or operating
results of the Company.





68






**Note
#2 - Investment Securities**




At
December 31, 2004 and 2003, the investment securities portfolio was comprised of
securities classified as available-for-sale. In accordance with SFAS No. 115,
investment securities available-for-sale are carried at fair value and adjusted
for amortization of premiums and accretions of discounts.




The
amortized cost and fair values of investment securities available-for-sale at
December 31, 2004, were as follows:




**(Dollars
      in Thousands)**
    
    
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    UnrealizedCost
    
    Gains
    
    Losses
    
    Fair
      ValueU.S.
      agency securities
    
    $
    11,033
    
    $
    -
    
    $
    (532
    )
    $
    10,501Mortgage
      backed securities
    
    
    215,045
    
    
    116
    
    
    (4,228
    )
    
    210,933Mutual
      Funds
    
    
    2,042
    
    
    4
    
    
    -
    
    
    2,046Total
    
    $
    228,120
    
    $
    120
    
    $
    (4,760
    )
    $
    223,480





The
amortized cost and fair values of investment securities available-for-sale at
December 31, 2003, were as follows:





**(Dollars
      in Thousands)**
    
    
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    UnrealizedCost
    
    Gains
    
    Losses
    
    Fair
      ValueU.S.
      agency securities
    
    $
    10,359
    
    $
    -
    
    $
    (454
    )
    $
    9,905Mortgage
      backed securities
    
    
    194,943
    
    
    287
    
    
    (5,067
    )
    
    190,163Mutual
      Funds
    
    
    2,000
    
    
    -
    
    
    -
    
    
    2,000Total
    
    $
    207,302
    
    $
    287
    
    $
    (5,521
    )
    $
    202,068





The
amortized cost and fair values of investment securities available-for-sale at
December 31, 2004, by expected maturity are shown below. Expected maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.





**(Dollars
      in Thousands)**
    
    
    
    SecuritiesAvailable-for-SaleAmortizedMaturity
    
    Cost
    
    Fair
      ValueU.S.
      agency securities
    
    
    After
      10 years
    
    $
    11,033
    
    $
    10,501Mortgage-backed
      securities
    
    
    5-10
      years
    
    
    19,700
    
    
    19,803After
      10 years
    
    
    195,345
    
    
    191,130Mutual
      funds
    
    
    
    
    
    2,042
    
    
    2,046$
    228,120
    
    $
    223,480





Proceeds
from sales of investment securities available-for-sale during 2004 were $60.8
million. Gross gains on those sales were $0.4 million. Included in stockholders’
equity at December 31, 2004 is $2.7 million of net unrealized losses (net of
$1.9 million estimated tax benefit) on investment securities
available-for-sale.





Proceeds
from sales of investment securities available-for-sale during 2003 were $232.2
million. Gross gains on those sales were $2.1 million. Included in stockholders’
equity at December 31, 2003 is $3.1 million of net unrealized losses (net of
$2.2 million estimated tax benefit) on investment securities
available-for-sale.





Proceeds
from sales of investment securities available-for-sale during 2002 were $137.4
million. Gross gains on those sales were $1.3 million. Included in stockholders’
equity at December 31, 2002 is $0.1 million of net unrealized gains (net of
approximately $80,000 estimated tax provision) on investment securities
available-for-sale.




69





Securities
with a carrying value and fair value of $221.4 million and $200.1 million at
December 31, 2004 and 2003, respectively, were pledged to secure public monies
as required by law and FHLB advances.




The table
below shows the Company’s investment securities’ gross unrealized losses and
fair value by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2004. The
Company has reviewed individual securities classified as available-for-sale to
determine whether a decline in fair value below the amortized cost basis is
other-than-temporary. If it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the debt security
not impaired at acquisition, an other-than-temporary impairment shall be
considered to have occurred. If an other-than-temporary impairment occurs, the
cost basis of the security would be written down to its fair value as the new
cost basis and the write down accounted for as a realized loss.




**(Dollars
      in Thousands)**
    
    Less
      than 12 months
    
    12
      months or Longer
    
    TotalGross
    
    
    
    Gross
    
    
    
    GrossUnrealized
    
    
    
    Unrealized
    
    
    
    UnrealizedHolding
    
    
    
    Holding
    
    
    
    HoldingFair
      Value
    
    Losses
    
    Fair
      Value
    
    Losses
    
    Fair
      Value
    
    LossesU.S.
      agency securities
    
    $
    -
    
    $
    -
    
    $
    10,501
    
    $
    (532
    )
    $
    10,501
    
    $
    (532
    )Mortgage
      backed securities
    
    
    56,497
    
    
    (225
    )
    
    139,523
    
    
    (4,003
    )
    
    196,020
    
    
    (4,228
    )Mutual
      Funds
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
    
    $
    56,497
    
    $
    (225
    )
    $
    150,024
    
    $
    (4,535
    )
    $
    206,521
    
    $
    (4,760
    )





Despite
the unrealized loss position of these securities, the Company has concluded, as
of December 31, 2004, that these investments are not other-than-temporarily
impaired. This assessment was based on the following factors: i) the length of
time and the extent to which the market value has been less than cost; ii) the
financial condition and near-term prospects of the issuer; iii) the intent and
ability of the Company to retain its investment in a security for a period of
time sufficient to allow for any anticipated recovery in market value; and iv)
general market conditions which reflect prospects for the economy as a whole,
including interest rates and sector credit spreads.








70






**Note
#3 -** **Loans**




Almost
all of the Bank's loans, commitments, and commercial and standby letters of
credit are granted to customers in the Company's market area, which includes San
Bernardino, Riverside, Los Angeles and Orange counties in California. These
loans are collateralized in accordance with the Company’s policy. The
concentrations of credit by type of loan are outlined as follows:




**(Dollars
      in Thousands)**
    
    As
      ofDecember
      31, 2004
    
    December
      31, 2003Commercial,
      financial and agricultural
    
    $
    36,095
    
    $
    26,827Real
      estate construction:Singe-family
      coastal
    
    
    298,984
    
    
    212,727Singe-family
      tract
    
    
    129,900
    
    
    104,511Commercial
    
    
    36,215
    
    
    20,947Real
      estate mortgage:Commercial
    
    
    216,609
    
    
    153,632Multi-family
      residential
    
    
    189,912
    
    
    27,986Land
    
    
    61,979
    
    
    15,030All
      other residential
    
    
    56,983
    
    
    32,856Consumer
      loans
    
    
    2,905
    
    
    4,887All
      other loans (including overdrafts)
    
    
    137
    
    
    291,029,719
    
    
    599,432Unearned
      premium (discount) on loans
    
    
    541
    
    
    (5
    )Deferred
      loan fees
    
    
    (3,223
    )
    
    (2,420
    )Loans,
      Net of Unearned Income
    
    $
    1,027,037
    
    $
    597,007





The Bank
had approximately $307.7 million and $67.5 million in loans pledged to secure
FHLB borrowings at December 31, 2004 and 2003, respectively.




The
following is a summary of information pertaining to impaired loans for the dates
and periods specified.




**(Dollars
      in Thousands)**
    
    At
      December 31,2004
    
    2003
    
    2002Impaired
      loans with a valuation allowance
    
    $
    -
    
    $
    -
    
    $
    -Impaired
      loans without a valuation allowance
    
    
    -
    
    
    173
    
    
    -Total
      impaired loans
    
    $
    -
    
    $
    173
    
    $
    -Valuation
      allowance related to impaired loans
    
    $
    -
    
    $
    -
    
    $
    -







**(Dollars
      in Thousands)**
    
    Years
      Ended December 31,2004
    
    2003
    
    2002Average
      recorded investment in impaired loans
    
    $
    238
    
    $
    97
    
    $
    22Cash
      receipts applied to reduce principal balance
    
    
    671
    
    
    -
    
    
    -Interest
      income recognized for cash payments
    
    
    21
    
    
    -
    
    
    -





No
additional funds were committed to be advanced in connection with impaired
loans.




All of
the loans identified in the tables above were non-accrual loans at year end and
none had any related allocated allowance. If interest on non-accrual loans had
been recognized at the original interest rates, interest income would have
increased approximately $38,000, $11,000 and $0 for the years ended 2004, 2003
and 2002, respectively.




At
December 31, 2004 and 2003, the Company had no loans past due 90 days or more in
interest or principal and still accruing interest.




71





At
December 31, 2004 and 2003, no loans were classified as troubled debt
restructurings.




The Bank
also originates Small Business Administration (“SBA”) loans for sale to
governmental agencies and institutional investors. At December 31, 2004 and
2003, the unpaid principal balance of SBA loans serviced for others totaled
$29.0 million and $12.9 million, respectively. The gain on sale of SBA loans was
$1.6 million, $1.0 million, and $0.3 million for the years ended December 31,
2004, 2003, and 2002, respectively.




The
balance of capitalized servicing rights included in “other assets” on the
Company’s Consolidated Balance Sheets at December 31, 2004 and 2003, was $1.7
million and approximately $0.8 million, respectively. The fair values of these
rights approximate their book values respectively.




The
following summarizes servicing rights capitalized and amortized:





**(Dollars
      in Thousands)**
    
    Years
      Ended December 31,2004
    
    2003
    
    2002Mortgage
      servicing rights capitalized
    
    $
    1,143
    
    $
    721
    
    $
    193Mortgage
      servicing rights amortized
    
    
    269
    
    
    82
    
    
    1Valuation
      allowances
    
    
    -
    
    
    -
    
    
    -








**Note
#4 - Allowance for Loan and Lease** **Losses**




Transactions
in the allowance for loan and lease losses are summarized as
follows:




**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002Balance,
      Beginning of year
    
    $
    7,537
    
    $
    3,003
    
    $
    1,450Credit
      from purchase of loan portfolio
    
    
    -
    
    
    -
    
    
    197Credit
      from acquisition of Southland Bank
    
    
    -
    
    
    895
    
    
    -Recoveries
      on loans previously charged off
    
    
    122
    
    
    72
    
    
    167Loans
      charged off
    
    
    (392
    )
    
    (143
    )
    
    (241
    )Provision
      charged to operating expense
    
    
    5,734
    
    
    3,710
    
    
    1,430Balance,
      End of year
    
    $
    13,001
    
    $
    7,537
    
    $
    3,003







**Note
#5 - Related Party Transactions**




In the
ordinary course of business, the Company has granted loans to certain Directors
and Officers and the companies with which they are associated. All such loans
were made under the terms which are consistent with the Bank's normal lending
policies. The outstanding loans to Directors and Officers at December 31, 2004
and 2003, amounted to $0.3 million and $0.5 million, respectively. Not included
in the balances outstanding at December 31, 2004 and 2003, were
undisbursed commitments to lend of $0.7 million and $0.4 million, respectively.
There were no non-accruing loans to Directors and Officers or loans classified
by the Company's regulatory agency or by the Company in 2004 and
2003.




The
following table shows the activity of loans to Officers and Directors for the
dates specified:





**(Dollars
      in thousands)**
    
    As
      of December 31,2004
    
    2003Balance,
      Beginning of year
    
    $
    466
    
    $
    1,020Credit
      granted, including renewals
    
    $
    656
    
    $
    344Repayments
    
    $
    (775
    )
    $
    (898
    )Balance,
      End of year
    
    $
    347
    
    $
    466





Deposits
from related parties held by the Bank at December 31, 2004 and 2003 amounted to
$1.0 million and $2.7 million, respectively.







72





**Note
#6 - Premises and Equipment**




Major
classifications of the Company’s premises and equipment are summarized as
follows:




**(Dollars
      in Thousands)**
    
    December
      31,2004
    
    2003Building
    
    $
    4,255
    
    $
    3,642Furniture
      and equipment
    
    
    10,284
    
    
    6,834Leasehold
      improvements
    
    
    3,392
    
    
    2,994Bank
      owned autos
    
    
    812
    
    
    75418,743
    
    
    14,224Less:
      Accumulated depreciation and amortization
    
    
    (8,116
    )
    
    (6,074
    )Construction
      in Progress
    
    
    487
    
    
    110Land
    
    
    1,285
    
    
    1,285Total
    
    $
    12,399
    
    $
    9,545





The
Company is obligated under leases for equipment and property. The original terms
of the leases range from one to fifteen years. Property leases contain options
to extend for periods from one year to twenty years. Options to extend which
have been exercised and the related lease costs are included below. The
following is a schedule of future minimum lease payments based upon obligations
at December 31, 2004:




**(Dollars
      in Thousands)**Year
      Ending December 31,2005
    
    $
    2,2272006
    
    
    2,2632007
    
    
    2,1222008
    
    
    2,1222009
    
    
    2,143Thereafter
    
    
    10,744Total
    
    $
    21,621





Total
property and equipment lease expense for the years ended December 31, 2004, 2003
and 2002, was approximately $1.3 million, $0.8 million and $0.3 million,
respectively.




Under the
Company’s ten-year lease agreement for its Corona Pointe property, the Company
has the option to purchase the property for $7.7 million after the first year of
the lease term, therefore eliminating nine years of lease obligations. If the
Company exercises this option, it would decrease the obligations listed in the
above table by $5.8 million.








**Note
#7 - Time Deposit Liabilities**


The
aggregate amount of time certificates of deposit in denominations of $100,000 or
more at December 31, 2004 and 2003 was $204.0 million and $116.7 million,
respectively. At December 31, 2004, the scheduled maturities of total time
certificates of deposit are as follows:




**(Dollars
      in Thousands)**Maturity2005
    
    $
    290,8152006
    
    
    95,9912007
    
    
    255$
    387,061








73


****





**Note
#8 - Borrowings**




The Bank
has unsecured borrowing lines with six correspondent banks totaling $66.0
million and a secured borrowing line with FHLB totaling $522.2 million as of
December 31, 2004, representing 40% of total assets of the Bank. In March 2004,
the Company obtained a $15.0 million line of credit and a $5.0 million offering
line of credit (collectively, the “credit facility”) with a correspondent bank.
The $5.0 million offering line of credit is at the discretion of the
correspondent bank at the time of request for funding by the Company. There was
no outstanding balance under the credit facility as of December 31, 2004.




FHLB
Advances




Pursuant
to collateral agreements with FHLB, advances are secured by all capital stock in
FHLB, certain investment securities, and certain qualifying loans. FHLB advances
consist of the following as of December 31, 2004:




**(Dollars
      in Thousands)**
    
    WeightedAverageMaturity
    
    Rate
    
    Amount2005
    
    
    1.89
    %
    $
    162,0002006
    
    
    2.60
    %
    
    15,0001.95
    %
    $
    177,000





Subordinated
Debentures




During
2002, the Company issued $5.0 million in subordinated debt. The debt bears a
floating rate of interest of 3.05% over the three month LIBOR, and has a
fifteen-year maturity, with quarterly interest payments. The outstanding balance
of this subordinated debt was $5.0 million at December 31, 2004 and 2003, and
the effective interest rate at December 31, 2004 was 5.00%.







**Note
#9 - Junior Subordinated Debentures**





In
December 2001, December 2002, September 2003, December 2003, March 2004, May
2004, and December 2004 the Company issued Floating Rate Junior Subordinated
Deferrable Interest Debentures (the “debt securities”) to Vineyard Statutory
Trust I, Vineyard Statutory Trust II, Vineyard Statutory Trust III, Vineyard
Statutory Trust IV, Vineyard Statutory Trust V, Vineyard Statutory Trust VI, and
Vineyard Statutory Trust VII (the “Trusts”), respectively, which are statutory
trusts created under the laws of the State of Connecticut. These debt securities
are subordinated to effectively all borrowings of the Company. The Company also
owns a 3% minority interest in each of the Trusts. The balance of the equity of
the Trusts is comprised of mandatorily redeemable preferred securities and is
included in “other assets” on the Company’s Consolidated Balance
Sheets.




The
following table sets forth information on each of the Trusts:





**(Dollars
      in Thousands)**
    
    
    
    
    
    
    
    **As
      of December 31, 2004****Interest
      Rate**
    
    **Due
      Date**
    
    **Minority
      Interest**
    
    **Effective
      Interest Rate**
    
    **Balance**Vineyard
      Statutory Trust I
    
    
    3-month
      LIBOR + 3.60
    %
    
    December
      18, 2031
    
    $
    372
    
    
    5.51
    %
    $
    12,372Vineyard
      Statutory Trust II
    
    
    3-month
      LIBOR + 3.35
    %
    
    December
      26, 2032
    
    
    155
    
    
    5.42
    %
    
    5,155Vineyard
      Statutory Trust III
    
    
    3-month
      LIBOR + 3.05
    %
    
    October
      8, 2033
    
    
    310
    
    
    5.12
    %
    
    10,310Vineyard
      Statutory Trust IV
    
    
    3-month
      LIBOR + 2.85
    %
    
    January
      23, 2034
    
    
    310
    
    
    5.01
    %
    
    10,310Vineyard
      Statutory Trust V
    
    
    3-month
      LIBOR + 2.85
    %
    
    April
      23, 2034
    
    
    310
    
    
    4.92
    %
    
    10,310Vineyard
      Statutory Trust VI
    
    
    3-month
      LIBOR + 2.85
    %
    
    July
      23, 2034
    
    
    372
    
    
    4.95
    %
    
    12,372Vineyard
      Statutory Trust VII
    
    
    3-month
      LIBOR + 2.00
    %
    
    December
      16, 2034
    
    
    310
    
    
    4.50
    %
    
    10,310$
    2,139
    
    
    
    
    $
    71,139





Under FIN
No. 46R, the Company is not allowed to consolidate the Trusts into the Company’s
consolidated financial statements. Prior to the issuance of FIN No. 46R, bank
holding companies typically consolidated these entities. The Company has
excluded the Trusts from its consolidated financial statements. On May 6, 2004,
the FRB issued a notice of proposed rulemaking in regards to trust preferred
securities and the definition of capital. In general, the FRB proposed to allow
the continued inclusion of outstanding and prospective issuances of trust
preferred securities in Tier 1 capital of bank holding companies, subject to
stricter quantitative limits and qualitative standards. The quantitative limits
would become effective after a three-year transition period. As of December 31,
2004, the Company has included the net junior subordinated debt in its Tier 1
Capital for regulatory capital purposes.





74






**Note
#10 - Acquisitions**





On July
4, 2003, the Bank acquired Southland Bank located in Irwindale, California. The
shareholders of Southland Bank received total consideration of $3.2 million for
the 527,906 shares of Southland Bank common stock outstanding which was paid in
349,044 newly issued shares of common stock of the Company.





The Bank
accounted for the acquisition as a purchase using the accounting standards SFAS
No. 141, “ *Business
Combinations* ,” and
SFAS No. 142, “ *Goodwill
and Other Intangible Assets* .” The
accounting rules require that the goodwill arising from the purchase method of
accounting not be amortized, however, it must be tested for impairment at least
annually.





The
estimated fair values of assets acquired and liabilities assumed at July 4, 2003
are as follows:





**(Dollars
      in Thousands)**Cash
    
    $
    12,766Loans,
      net
    
    
    19,736Goodwill
      on purchase
    
    
    238Other
      assets
    
    
    1,860Total
      assets acquired
    
    
    34,600Demand,
      NOW, savings andmoney
      market deposits
    
    
    23,007Time
      deposits
    
    
    8,089Other
      liabilities
    
    
    304Total
      liabilities assumed
    
    
    31,400Net
      assets acquired
    
    $
    3,200








**Note
#1** **1
- Income Taxes**




The
provision for income taxes consists of the following:





**(Dollars
      in Thousands)**
    
    Year
      Ended December 31,2004
    
    2003
    
    2002Federal
      Income TaxCurrent
    
    $
    6,889
    
    $
    6,013
    
    $
    2,303Deferred
      / (credit)
    
    
    25
    
    
    (1,863
    )
    
    (752
    )Total
      Federal Income Tax
    
    
    6,914
    
    
    4,150
    
    
    1,551State
      Franchise TaxCurrent
    
    
    2,748
    
    
    2,132
    
    
    747Deferred
      / (credit)
    
    
    7
    
    
    (742
    )
    
    (217
    )Total
      State Franchise Tax
    
    
    2,755
    
    
    1,390
    
    
    530Change
      in valuation allowance
    
    
    -
    
    
    -
    
    
    -Total
      Income Taxes
    
    $
    9,669
    
    $
    5,540
    
    $
    2,081




75





As a
result of the following items, the total income tax provision/(benefit) for the
years ended December 31, 2004, 2003 and 2002, was different than the amount
computed by applying the statutory U.S. federal income tax rate to income before
taxes:





**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002Percent
    
    
    
    Percent
    
    
    
    Percentof
      Pretax
    
    
    
    of
      Pretax
    
    
    
    of
      PretaxAmount
    
    Income
    
    Amount
    
    Income
    
    Amount
    
    IncomeFederal
      rate
    
    $
    8,280
    
    
    35.0
    %
    $
    4,601
    
    
    34.0
    %
    $
    1,730
    
    
    34.0
    %Changes
      due to state incometax,
      net of federal tax benefit
    
    
    1,680
    
    
    7.1
    %
    
    961
    
    
    7.1
    %
    
    361
    
    
    7.1
    %Change
      in valuation allowance
    
    
    -
    
    
    0.0
    %
    
    -
    
    
    0.0
    %
    
    -
    
    
    0.0
    %Other
    
    
    (291
    )
    
    -1.2
    %
    
    (22
    )
    
    -0.2
    %
    
    (10
    )
    
    -0.2
    %Total
    
    $
    9,669
    
    
    40.9
    %
    $
    5,540
    
    
    40.9
    %
    $
    2,081
    
    
    40.9
    %





The
deferred tax assets and liabilities of the Company are composed of the following
tax-affected cumulative timing differences:




**(Dollars
      in Thousands)**
    
    December
      31,2004
    
    2003Deferred
      Tax AssetsReserve
      for loan losses
    
    $
    5,367
    
    $
    2,912Deferred
      compensation
    
    
    955
    
    
    646Deferred
      fees
    
    
    -
    
    
    996Non-deductible
      reserves
    
    
    753
    
    
    595Net
      operating loss
    
    
    897
    
    
    960Other
      assets and liabilities
    
    
    934
    
    
    725Other
      unrealized loss on securities
    
    
    1,903
    
    
    2,14610,809
    
    
    8,980Deferred
      Tax LiabilitiesOther
      assets and liabilities
    
    
    (520
    )
    
    -Deferred
      costs
    
    
    (1,371
    )
    
    -Fixed
      assets
    
    
    (722
    )
    
    (509
    )(2,613
    )
    
    (509
    )Net
      Deferred Tax Assets
    
    $
    8,196
    
    $
    8,471





In
conjunction with the acquisition of Southland Bank, the Company has a net
operating loss available for carry forward of approximately $2.3 million for
federal income tax purposes which expires through 2021. In addition, the Company
has a net operating loss carry forward of approximately $1.3 million for state
franchise tax purposes, which expires through 2013. Due to the "ownership
change" as defined under Internal Revenue Code Section 382, the Company's net
operating losses are subject to limitation, which amounts to approximately
$139,000 per year. Under Section 382, which has also been adopted under
California law, if, during any three-year period there is more than a
50 percent change in the ownership, then the future use of any pre-change
net operating losses or built-in losses are subject to an annual percentage
limitation based on the value of the company at the ownership change
date.








**Note
#1** **2
- Commitments and Contingencies**




In the
normal course of business, the Company is a party to financial instruments with
off-balance-sheet risk. These financial instruments include commitments to
extend credit and letters of credit. To varying degrees, these instruments
involve elements of credit and interest rate risk in excess of the amount
recognized in the statement of financial position. The Company's exposure to
credit loss in the event of non-performance by the other party to the financial
instruments for undisbursed loan funds and letters of credit is represented by
the contractual amount of those instruments. At December 31, 2004 and 2003, the
amounts of the Company’s undisbursed loan funds were $439.4 million and $361.4
million, respectively, and obligations under standby and commercial letters of
credit were $1.7 million and $0.7 million, respectively.




76





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit
evaluation. Collateral held varies but may include accounts receivable,
inventory, property, plant and equipment, income-producing commercial
properties, residential properties and properties under
construction.




Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. Commercial letters of credit are
conditional commitments issued by the Company to facilitate trade or commerce.
The credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loans to customers.




On
October 25, 1999, a jury rendered a verdict against the Bank in the amount of
approximately $3.5 million arising from a lawsuit by a borrower who also leased
to the Bank a branch office. The Bank foreclosed on the real property securing
its loan to the borrower. The borrower claimed that the foreclosure was
wrongful. On February 25, 2000, the trial judge found that the jury verdict was
excessive and ordered a new trial on damages if the borrower did not agree to a
reduction to $0.9 million. During 1999, the Bank accrued a loss of $0.9 million
in recognition of the amount of liability determined by the court which is
included in litigation expense. During 2000, the lawsuit was settled. In 2002,
the Bank received $0.5 million in litigation recovery from its insurance
carriers and is included in “other income” on the Company’s Consolidated
Statement of Income.




In the
normal course of business, the Company is subject to legal actions and
complaints. At December 31, 2004, management is not aware of any material
pending legal action or complaint asserted against the Company.







**Note
#13 - Employee Stock Ownership Plan**





During
April 2004, the Company’s Board of Directors approved the formation of a
company-sponsored Employee Stock Ownership Plan (the “ESOP”) under the Vineyard
National Bancorp Employee Stock Ownership Plan Trust (the “ESOP Trust”) for the
benefit of the Company’s eligible full-time employees. This leveraged ESOP is
funded by a loan, which is secured by the ESOP shares. The number of shares
released is based on the principal pay down of the loan balance. The amount of
shares allocated to each participant under the ESOP is based on the employee’s
annual compensation. ESOP shares become fully vested to employees upon the
completion of five years of service with the Company. ESOP participants are
entitled to receive distributions from the ESOP account generally upon
termination of service, which includes retirement and death.




To fund
the purchase in the open market of shares of common stock of the Company, the
ESOP Trust secured a loan in the amount of $7.0 million with a third party bank
which was guaranteed by the Company. The ESOP loan bears a floating interest
rate of 0.5% over the national prime rate and is scheduled to mature ten years
after the date of initial advance. During the fourth quarter of 2004, the ESOP
Trust refinanced the ESOP loan with a new note with the same terms through the
Company and paid off the note with the third party bank, therefore eliminating
the loan payable balance on the Company’s financial statements. The outstanding
balance of the ESOP loan is collateralized by the assets of the ESOP and
guaranteed by the Company. Dividends paid on the unallocated shares owned by the
ESOP may be used to pay debt service or to pay trustee fees at the Company’s
election. Shares held by the ESOP are held by an independent trustee for
allocation among participants as the loan is repaid.




The ESOP
used the full amount of the loan to purchase 149,000 shares of the Company’s
common stock in the open market. As a result of the stock split in August 2004,
the ESOP held 298,000 shares of the Company’s common stock. As of December 31,
2004, 6,006 shares held by the ESOP were allocated to participants. The fair
value of unallocated ESOP shares as of December 31, 2004 was $9.7 million. The
291,994 unallocated shares represent 3.0% of the total number of common shares
outstanding at December 31, 2004. The cost of shares held by the ESOP and not
yet allocated to employees is reported as a reduction of stockholders’ equity.
Upon allocation of the shares, allocated shares of the ESOP are charged to
compensation expense based on the fair value of the shares transferred, with a
corresponding credit to the Company’s equity. The Company recognized $0.1
million of compensation expense for the year ended December 31, 2004.





77






**Note
#14 - Perpetual Preferred Stock**





On
December 18, 2002, the Company issued fifty shares of 7.0% Series A Preferred
Stock at $50,000 per share to eight individual investors for aggregate gross
proceeds of $2.5 million. Each share of Series A Preferred Stock was entitled to
a noncumulative, annual dividend of 7.0%, payable quarterly. The Series A
Preferred Stock was not convertible into common stock and was redeemable at the
option of the Company at face value, plus any unpaid dividends declared.




With each
share of Series A Preferred Stock, the Company issued a warrant to purchase
4,410 shares of the Company’s common stock at an exercise price of $6.80 per
share as adjusted to reflect the Company’s stock dividends. Each Series A
warrant must be exercised prior to December 18, 2005 or it will expire pursuant
to its terms. As of December 31, 2004, 152,510 Series A warrants have been
exercised. On May 19, 2004, the Company redeemed all 50 outstanding shares of
its Series A Preferred Stock pursuant to their terms at a redemption price of
$50,000 per share plus accrued interest, for an aggregate approximate amount of
$2.5 million.




On
September 19, 2003, the Company issued 1,150,000 shares of 5.6% noncumulative
convertible Series B Preferred Stock at $25.00 per share for aggregate proceeds
of approximately $28.8 million. Each share of Series B Preferred Stock was
entitled to a noncumulative, annual dividend of 5.6%, payable quarterly. Each
share of Series B Preferred Stock was convertible at the shareholder’s option at
any time into shares of the Company’s common stock at a conversion price of
$16.61 per share of common stock. The Series B Preferred Stock was redeemable at
the option of the Company at $25.00 per share, plus any unpaid dividends
declared, on or after September 19, 2005. The Series B Preferred Stock was also
redeemable at the option of the Company prior to September 19, 2005, in whole or
in part, at $25.00 per share if the last reported sale price of the Company’s
common stock had equaled or exceeded 125% of the Series B Preferred Stock
conversion price of $16.61 per share for at least 30 consecutive trading days.




In April
2004, the Company’s common stock price satisfied the redemption requirements. On
May 4, 2004, the Company announced that it would redeem all 1,150,000
outstanding shares of its Series B Preferred Stock on June 3, 2004. Holders of
the Series B Preferred Stock had the right to convert their shares of Series B
Preferred Stock into shares of common stock. Prior to the redemption date,
1,147,595 shares of Series B Preferred Stock elected to convert into 1,727,182
shares of common stock. On June 3, 2004, the Company redeemed the remaining
2,405 shares of its Series B Preferred Stock outstanding at a redemption price
of $25.00 per share, plus declared and unpaid dividends, for an aggregate
approximate amount of $0.3 million. Prior to the redemption, the Series B
Preferred Stock was traded on the American Stock Exchange under the symbol “VLP
PrB.”








**Note
#15 - Dividends and Stock Splits**




The
Company initiated a cash dividend program in 2003 and paid $0.01 per share cash
dividend in August 2003 and $0.02 per share cash dividend in November 2003.
During 2004, the Company paid $0.02, $0.03, $0.03, and $0.04 per share cash
dividend for the first, second, third, and fourth quarters, respectively. The
total amount of cash dividends on common stock paid during the year ended
December 31, 2004 and 2003 was $0.9 million and $0.1 million,
respectively.




On
December 23, 2002, the Company declared a 5% stock dividend paid on January 15,
2003 to stockholders of record as of December 23, 2002. Additionally, on
December 23, 2003, the Company declared a 5% stock dividend paid on January 26,
2004 to stockholders of record as of January 12, 2004. On July 21, 2004, the
Company declared a two-for-one stock split, to be effected in the form of a
stock dividend. Shareholders received one additional share of common stock for
each share that they held on the record date of August 20, 2004. The additional
shares were distributed on August 30, 2004. All share and per share data has
been retroactively adjusted to reflect these stock dividends.






78




**Note
#16 - Sale of Capital Stock in Private Placement**





During
June 2004, the Company issued and sold 800,000 shares of its common stock to
institutional investors through a private placement, which raised $15.2 million
in additional capital, net of fees and expenses. The Company also granted the
investors warrants (the “Warrants”) to purchase up to 160,000 additional shares
of common stock. The Warrants entitle the holders to exercise their Warrants and
purchase shares of common stock for $25.00 per share (the “Exercise Price”) at
any time through June 21, 2011 (the “Expiration Date”). The Warrants exercised
prior to the Expiration Date can be settled on a “net share” basis, wherein
investors receive common stock equal to the difference between the Exercise
Price and the average closing sale price for the common shares over the five
trading days immediately preceding the Exercise Date. At expiration, the Company
may elect to settle the Warrants on a net share basis, provided certain
conditions are satisfied. As of December 31, 2004, there have been no exercises
of the Warrants and all Warrants issued remain outstanding. The Company down
streamed $10.0 million of the proceeds from this private placement to the Bank
to support the continued growth of the Bank, and the remaining proceeds are used
by the Company for general corporate purposes.




The
Company filed a registration statement with the Securities and Exchange
Commission to register all of the shares of common stock issued in the June 2004
private placement and the shares of common stock issuable upon exercise of the
Warrants. The registration statement was declared effective on August 3, 2004.




During
December 2004, the Company issued and sold 483,100 shares of its common stock to
institutional investors through a private placement, which raised $14.0 million
in additional capital, net of fees and expenses. The Company also granted the
investors the right (the “Right”) to purchase an additional 120,775 shares of
common stock for $31.05 per share. These Rights extend for a period of ninety
business days after the effective date of the registration statement, after
which time the Rights become void and of no value. As of December 31, 2004,
there have been no exercises of the Rights and all Rights issued remain
outstanding. The Company used the proceeds from this private placement for the
payoff of the ESOP loan with the third party bank, repayment of other debt, and
other corporate purposes.




The
Company filed a registration statement with the Securities and Exchange
Commission to register all of the shares of common stock issued in the December
2004 private placement and the shares of common stock issuable upon exercise of
the Rights. The registration statement was declared effective on February 4,
2005.








**Note
#17 - Regulatory Matters**





The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements administered by federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Company’s and the Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of the Company’s and the Bank's
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The Company’s and the Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors. Prompt corrective action
provisions are not applicable to bank holding companies.





Following
a regular joint examination by the FDIC and the DFI in November 2003, the Bank’s
Board of Directors approved and signed an Agreement with the FDIC and DFI on
July 7, 2004. In relation to the Bank’s significant growth over the last several
years, the Bank continues to assess and develop its policies and procedures to
facilitate the successful implementation of its strategic plan and capital
adequacy plan while maintaining the safety and soundness of the Bank. The
adoption of the Agreement formalizes many of the actions that the Bank has
already taken to strengthen its operational procedures, broaden its directorship
and augment its senior management team. The Bank continues to maintain capital
ratios in excess of regulatory requirements. Operating performance and asset
quality continues to be strong, and deposit generation and liquidity continues
to be satisfactory to support its operations.




Prior to
entering into the Agreement, the Bank’s existing three-year strategic plan and
capital adequacy plan called for a measured growth. In accordance with the
Agreement, the Bank will notify the FDIC and DFI of any deviations beyond its
strategic plan, including any growth beyond 25% of its total assets per annum,
which level is within the existing strategic plan’s framework. Consistent with
the terms of the Agreement, the Bank added one new director to its Board of
Directors by December 31, 2004, and subsequently added another director in
January 2005. The Bank believes it is in fulfillment of the Agreement, and the
Agreement will not materially adversely affect the successful implementation of
the Company’s strategic business plan, the Company’s financial condition or
results of operations, or the Company’s previously announced earnings guidance.




79





Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2004, that the
Company and the Bank meet all capital adequacy requirements to which they are
subject.




As of the
most recent formal notification from the FDIC, the Bank was categorized as well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Bank must maintain minimum capital ratios
as set forth in the table below. The following table also sets forth the Bank's
actual regulatory capital amounts and ratios:





**(Dollars
      in Thousands)**
    
    
    
    
    
    Capital
      NeededTo
      Be WellCapitalized
      UnderFor
      Capital
    
    Prompt
      CorrectiveActual
      Regulatory
    
    Adequacy
      Purposes
    
    Action
      ProvisionsCapital
    
    
    
    Capital
    
    
    
    CapitalAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio**As
      of December 31, 2004**Total
      capital to risk-weighted assets:Bank
    
    $
    160,509
    
    
    13.49
    %
    $
    95,159
    
    
    8.00
    %
    $
    118,949
    
    
    10.00
    %Consolidated
    
    $
    174,212
    
    
    14.60
    %
    $
    95,474
    
    
    8.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to risk-weighted assets:Bank
    
    $
    147,508
    
    
    12.40
    %
    $
    47,580
    
    
    4.00
    %
    $
    71,369
    
    
    6.00
    %Consolidated
    
    $
    116,280
    
    
    9.74
    %
    $
    47,737
    
    
    4.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to average assets:Bank
    
    $
    147,508
    
    
    11.33
    %
    $
    52,066
    
    
    4.00
    %
    $
    65,083
    
    
    5.00
    %Consolidated
    
    $
    116,280
    
    
    8.90
    %
    $
    52,276
    
    
    4.00
    %
    
    N/A
    
    
    N/A**As
      of December 31, 2003**Total
      capital to risk-weighted assets:Bank
    
    $
    93,311
    
    
    13.85
    %
    $
    53,911
    
    
    8.00
    %
    $
    67,411
    
    
    10.00
    %Consolidated
    
    $
    105,439
    
    
    15.57
    %
    $
    54,189
    
    
    8.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to risk-weighted assets:Bank
    
    $
    85,774
    
    
    12.73
    %
    $
    26,974
    
    
    4.00
    %
    $
    40,424
    
    
    6.00
    %Consolidated
    
    $
    73,007
    
    
    10.78
    %
    $
    27,107
    
    
    4.00
    %
    
    N/A
    
    
    N/ATier
      1 capital to average assets:Bank
    
    $
    85,774
    
    
    10.34
    %
    $
    33,174
    
    
    4.00
    %
    $
    41,474
    
    
    5.00
    %Consolidated
    
    $
    73,007
    
    
    8.77
    %
    $
    33,307
    
    
    4.00
    %
    
    N/A
    
    
    N/A





As
disclosed in Note #9 - Junior Subordinated Debentures, the proceeds from the
issuance of trust preferred securities by the Trusts are considered Tier 1
capital, subject to percentage limitations, by the Company for regulatory
purposes. However, as a result of the issuance of FIN 46 and FIN 46R, the Trusts
are not consolidated in these financial statements. The Company secures the
proceeds from the issuance of the trust preferred securities by the Trusts
through the issuance of subordinated debt to the Trusts. The Federal Reserve FRB
has indicated that it would review the regulatory implications of this change in
financial reporting that deconsolidates these trust subsidiaries and the
continued inclusion of these amounts in regulatory capital. The FRB has advised
bank holding companies to continue to report the amount of the trust preferred
securities in regulatory reports as a minority interest and thereby included in
Tier 1 capital.




80


****





**Note
#18 - Employee and Director Benefit Plans**





**A.**  **Deferred
Compensation Plan**





The
Company has a Nonqualified Deferred Compensation Plan for certain key management
personnel (participants) whereby they may defer compensation which will then
provide for certain payments at the benefit distribution date. The plan provides
for payments commencing upon retirement, death, participant termination or plan
termination. The plan also permits hardship withdrawals. Participants always
have a fully vested right to benefits attributable to deferrals and company
contributions made under the plan. The Company may make matching contributions
of officers' deferrals up to a maximum of 25% to 100% of participants' deferrals
to a maximum of 10% of the participant’s pre-tax annual base salary. The
Company's contribution, in the aggregate, for all participants shall not exceed
4% of compensation of all Company employees. The deferred compensation expense
was $0.1 million, $0.1 million and approximately $40,000 for the years ended
December 31, 2004, 2003 and 2002, respectively.





**B.**  **Defined
Contribution Plan**





The
Company has a qualified defined contribution plan (401(k) Retirement Savings
Plan) for all eligible employees. Employees may contribute from 1% to 100% of
their compensation with a maximum of $13,000 for 2004. During 2004, the Company
added a catch-up provision, which allows an additional annual employee
contribution of $3,000 for any eligible employee who is at least 50 years old.
The Company's contribution to the plan is based upon an amount equal to 50% of
each participant's eligible contribution for the plan year not to exceed 6% of
the employee's compensation. The Company's matching contribution becomes vested
immediately. The expense was $0.2 million, $0.1 million, and $0.1 million for
the years ended December 31, 2004, 2003, and 2002, respectively.





**C.**  **Directors'
Deferred Compensation Plan**





The
Company adopted a new Directors' Deferred Compensation Plan effective January 1,
2001. The plan allows directors to defer board of directors' fees and interest
which will then provide for retirement benefits to be paid upon retirement,
resignation, death, or disability. The Company is under no obligation to make
matching contributions to the plan. During 2004, 2003 and 2002, approximately
$0.2 million, $0.2 million and $0.1 million (inclusive of deferred board fees
and interest at a rate equal to the national bank prime (at the first day of
each calendar year) plus 2% fixed for the term of the calendar year),
respectively, was expensed for this plan.





**D.**  **Supplemental
Executive Retirement Plan**




The
Company has a Supplemental Executive Retirement Plan, which will provide
retirement benefits for the former chief executive officer of the Bank. Benefits
under this plan are fully vested upon participation. During 2004, 2003 and 2002,
$0.1 million, $0.2 million and approximately $28,000, respectively, were
expensed for this plan. The benefits to be paid amount to $75,000 per year for
15 years, and commenced in 2003.





**E.**  **Restricted
Stock Plan** **s**




The
Company adopted Restricted Stock Plans during 2004, 2003, and 2002 for the
benefit of key employees whereby shares of the Company’s stock are purchased in
the open market and granted to employees. During 2004, 2003, and 2002, 45,030,
26,776 and 50,716 shares of restricted stock were granted which cliff vest in
four years. All share amounts have been adjusted to reflect the 5% stock
dividends paid in January 2003 and January 2004 and the two-for-one stock split
in August 2004. Compensation is based upon the fair market value of the stock on
the grant date and is recognized evenly over the vesting period. Total expense
recorded during 2004, 2003, and 2002 was $0.3 million, $0.1 million, and
approximately $19,000, respectively, related to these restricted
shares.





81






**Note
# 19 - Stock Repurchase Program**




In July
2002, the Company adopted a stock repurchase program in the initial amount of
$2.0 million. In December 2003, the Company approved an increase in its stock
repurchase program of $5.0 million for a total amount of $7.0 million. Under its
stock repurchase program, the Company has been acquiring its common stock shares
in the open market. The shares repurchased by the Company under the stock
repurchase program are to be held as treasury shares or shares under the 2004
Restricted Share Plan. The Company’s stock repurchase program does not have an
expiration date. During the year ended December 31, 2004, 32,850 shares were
repurchased under the 2004 Restricted Stock Plan and 82,200 shares were
repurchased as treasury stock. As of December 31, 2004, the Company had $2.0
million remaining for the repurchase of common stock shares under the stock
repurchase program. During January 2005, the Company announced a $5.0 million
increase to the stock repurchase program. The shares repurchased by the Company
under the stock repurchase program are to be held as treasury shares or shares
under the 2004 Restricted Share Plan.








**Note
#20 - Incentive Stock Option Plan**





An
incentive stock option plan (the “1987 Plan”) was approved by the stockholders
in 1987 covering an aggregate of 277,830 shares. The plan provides that options
of the Company’s unissued common stock may be granted to officers and key
employees at prices not less than the fair market value of such shares at dates
of grant. Options vest at a rate of 33.33% every two years with all options
vesting at the end of the sixth year after the date of grant. Options granted
expire on such date as the Compensation Committee or Board of Directors may
determine, but not later than the sixth anniversary of the date on which the
option is granted.





During
1996, the Board of Directors of the Company elected to modify the existing
incentive stock option plan. Under the new agreement the options granted expire
on such date as the Compensation Committee or Board shall determine, but not
later than the seventh anniversary of the date on which the option is
granted.





During
1997, the Board of Directors and stockholders of the Company elected to
terminate the existing 1987 Plan and approve the 1997 Incentive Stock Option
Plan (the “Plan”). The Plan initially authorized 441,000 shares of the Company’s
authorized but unissued common stock to be combined with the 117,560 shares
which remain under the 1987 Plan. In addition, during 2002, the Board of
Directors and shareholders of the Company approved an increase in the authorized
stock option capacity of the Plan by 441,000 shares. The 1987 Plan and the Plan
authorized a total of 1,159,830 shares to be granted. Directors of the Company
are eligible to participate under the Plan. Options vest at a rate determined by
the Board of Directors. Options granted expire on such date as the Compensation
Committee or Board of Directors may determine, but not later than the tenth
anniversary date on which the option is granted.





The fair
value of each option granted during 2003 and 2002, respectively, were estimated
on the date of grant using the Black-Scholes option pricing model with the
following assumptions: risk-free rates of 3.35% and 3.31%, respectively;
dividend yield of 0.1% and 0.0%, respectively; volatility of 36% for both years;
and expected life of 7 years for both years. There were no options granted
during 2004.





A summary
of the status of the Plan as of December 31, 2004, 2003 and 2002, respectively,
and changes during the years ending on those dates is presented below. All share
amounts have been adjusted to reflect the 5% stock dividends paid in January
2003 and January 2004 and the two-for-one stock split in August 2004.





2004
    
    2003Number
      of Shares
    
    Weighted-
    
    Number
      of Shares
    
    Weighted-Available
    
    
    
    Average
    
    Available
    
    
    
    AverageFor
    
    
    
    Exercise
    
    For
    
    
    
    ExerciseGranting
    
    Outstanding
    
    Price
    
    Granting
    
    Outstanding
    
    PriceOutstanding
      at beginning of year
    
    
    7,572
    
    
    786,454
    
    $
    4.06
    
    
    92,464
    
    
    844,882
    
    $
    3.15Exercised
    
    
    -
    
    
    (214,329
    )
    $
    3.48
    
    
    -
    
    
    (143,320
    )
    $
    2.22Cancelled
    
    
    -
    
    
    -
    
    
    -
    
    
    25,358
    
    
    (25,358
    )
    $
    4.26Granted
    
    
    -
    
    
    -
    
    
    -
    
    
    (110,250
    )
    
    110,250
    
    $
    8.69Outstanding
      at end of year
    
    
    7,572
    
    
    572,125
    
    $
    4.25
    
    
    7,572
    
    
    786,454
    
    $
    4.06Options
      exercisable at year-end
    
    
    
    
    
    478,376
    
    $
    4.23
    
    
    
    
    
    398,748
    
    $
    3.27Weighted-average
      fair value ofoptions
      granted during the year
    
    
    
    
    $
    -
    
    
    
    
    
    
    
    $
    3.82








82








2002Number
      of Shares
    
    Weighted-Available
    
    
    
    AverageFor
    
    
    
    ExerciseGranting
    
    Outstanding
    
    PriceOutstanding
      at beginning of year
    
    
    145,750
    
    
    544,636
    
    $
    1.87Additional
      options authorized
    
    
    441,000
    
    
    -
    
    
    -Exercised
    
    
    -
    
    
    (194,040
    )
    $
    1.81Cancelled
    
    
    93,346
    
    
    (93,346
    )
    $
    2.32Granted
    
    
    (587,632
    )
    
    587,632
    
    $
    3.76Outstanding
      at end of year
    
    
    92,464
    
    
    844,882
    
    $
    3.15Options
      exercisable at year-end
    
    
    
    
    
    325,972
    
    $
    3.38Weighted-average
      fair value ofoptions
      granted during the year
    
    
    
    
    $
    1.67





The
following table summarizes information about incentive stock options outstanding
as of December 31, 2004:





Options
      Outstanding
    
    Options
      ExercisableWeighted-
    
    Weighted-
    
    
    
    Weighted-Average
    
    Average
    
    
    
    AverageExercise
    
    Number
    
    Remaining
    
    Exercise
    
    Number
    
    ExercisePrice
    
    Outstanding
    
    Contractual
      Life
    
    Price
    
    Exercisable
    
    Price$1.36
      - $2.27
    
    
    126,474
    
    
    6.08
      Years
    
    $
    1.78
    
    
    109,201
    
    $
    1.74$2.95
      - $4.08
    
    
    335,401
    
    
    7.32
      Years
    
    $
    3.73
    
    
    272,925
    
    $
    3.81$7.62
      - $13.33
    
    
    110,250
    
    
    8.23
      Years
    
    $
    8.69
    
    
    96,250
    
    $
    8.24572,125
    
    
    7.22
      Years
    
    $
    4.25
    
    
    478,376
    
    $
    4.23








**Note
#21 - Restriction on Subsidiary Transactions**





There are
legal limitations on the ability of the Bank to provide funds to the Company.
Dividends declared by the Bank may not exceed, in any calendar year, without
approval of the regulatory authorities, net income for the year and the retained
net income for the preceding two years. The Bank paid $4.0 million in dividends
to the Company in 2004 and $0 in 2003. Section 23A of the Federal Reserve Act
restricts the Bank from extending credit to the Company and other affiliates
amounting to more than 20% of its contributed capital and retained earnings. The
Company contributed $49.0 million in 2004 and $35.0 million in 2003 to the Bank.
At December 31, 2004, the maximum combined amount of funds available from these
two sources amounted to approximately $55.4 million or 38% of the Bank's
stockholders’ equity.











83






**Note
#22 - Other Expenses**





The
following is a breakdown of other expenses for the years ended December 31,
2004, 2003 and 2002:





**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002Data
      processing
    
    $
    740
    
    $
    670
    
    $
    676Marketing
      expenses
    
    
    855
    
    
    518
    
    
    265Professional
      expenses
    
    
    1,309
    
    
    870
    
    
    708Office
      supplies, postage and telephone
    
    
    1,423
    
    
    985
    
    
    643Insurance
      and assessment expense
    
    
    558
    
    
    320
    
    
    197Administrative
      expense
    
    
    507
    
    
    279
    
    
    161Convertible
      debentures conversion expense
    
    
    -
    
    
    -
    
    
    274Business
      development
    
    
    1,103
    
    
    866
    
    
    448Other
    
    
    1,052
    
    
    583
    
    
    511Total
      other expenses
    
    $
    7,547
    
    $
    5,091
    
    $
    3,883








**Note
#23 - Income per Common and Common Equivalent Share**





The
following is a reconciliation of net income and shares outstanding to the net
income and number of shares used to compute EPS. All share and per share data
has been adjusted to reflect the two-for-one stock split in August 2004 and the
5% stock dividends paid in January 2004 and 2003.




**(Dollars
      in Thousands)**
    
    2004
    
    2003
    
    2002Income
    
    Shares
    
    Income
    
    Shares
    
    Income
    
    SharesNet
      income as reported
    
    $
    13,987
    
    
    
    
    $
    7,992
    
    
    
    
    $
    3,008Less
      preferred stock dividends
    
    
    (702
    )
    
    
    
    
    (637
    )
    
    
    
    
    -Less
      excess cost to redeem preferred stock
    
    
    (71
    )
    
    
    
    
    -
    
    
    
    
    
    -Shares
      outstanding at year-end
    
    
    
    
    
    9,581,941
    
    
    
    
    
    6,291,430
    
    
    
    
    
    5,983,450Unallocated
      ESOP shares
    
    
    
    
    
    (291,994
    )
    
    
    
    
    -
    
    
    
    
    
    -Impact
      of weighting sharespurchased
      during the year
    
    
    
    
    
    (1,597,890
    )
    
    
    
    
    (194,394
    )
    
    
    
    
    (1,204,197
    )Used
      in basic EPS
    
    
    13,214
    
    
    7,692,057
    
    
    7,355
    
    
    6,097,036
    
    
    3,008
    
    
    4,779,253Add:
      Cash dividends on Series Bconvertible
      preferred stock
    
    
    634
    
    
    
    
    
    456
    
    
    
    
    
    -Dilutive
      effect of outstandingstock
      options and warrants
    
    
    
    
    
    1,237,703
    
    
    
    
    
    1,096,568
    
    
    
    
    
    171,835Add:
      Anti-dilutive effects of redemption of
    
    
    20
    
    
    
    
    
    -
    
    
    
    
    
    -Series
      B convertible preferred stockDilutive
      effect of convertibledebentures
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    147
    
    
    1,082,503Used
      in diluted EPS
    
    $
    13,868
    
    
    8,929,760
    
    $
    7,811
    
    
    7,193,604
    
    $
    3,155
    
    
    6,033,591





**Note
#24 - Fair Value of Financial Instruments**





SFAS No.
107, “ *Disclosures
About Fair Value of Financial Instruments* ” (SFAS
No. 107) requires disclosure of fair value information about financial
instruments, whether or not recognized in the statement of financial condition.
In cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instruments.
SFAS No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the
Company.





84





The
following table presents the carrying amounts and fair values of financial
instruments at December 31, 2004 and 2003, respectively. SFAS No.
107 ** defines
the fair value of a financial instrument as the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale.





**(Dollars
      in Thousands)**
    
    December
      31, 2004
    
    December
      31, 2003Carrying
    
    
    
    CarryingAmount
    
    Fair
      Value
    
    Amount
    
    Fair
      ValueAssetsCash
      and cash equivalents
    
    $
    22,551
    
    $
    22,551
    
    $
    58,242
    
    $
    58,242Investment
      securities
    
    
    223,480
    
    
    223,480
    
    
    202,068
    
    
    202,068Loans
      receivable held for investment
    
    
    1,027,037
    
    
    1,025,366
    
    
    597,007
    
    
    599,758Accrued
      interest receivable
    
    
    5,423
    
    
    5,423
    
    
    3,107
    
    
    3,107LiabilitiesNon-interest
      bearing deposits
    
    $
    127,466
    
    $
    127,466
    
    $
    94,162
    
    $
    94,162Interest
      bearing deposits
    
    
    838,080
    
    
    837,198
    
    
    509,164
    
    
    509,607FHLB
      advances
    
    
    177,000
    
    
    176,896
    
    
    182,000
    
    
    181,988Subordinated
      debentures
    
    
    5,000
    
    
    5,000
    
    
    5,000
    
    
    5,000Junior
      subordinated debentures
    
    
    71,139
    
    
    71,139
    
    
    38,147
    
    
    38,147Accrued
      interest payable
    
    
    1,937
    
    
    1,937
    
    
    1,783
    
    
    1,783Notional
    
    
    Cost
      to Cede
    
    
    Notional
    
    
    Cost
      to CedeAmount
    
    
    or
      Assume
    
    
    Amount
    
    
    or
      AssumeOff-Balance
      Sheet InstrumentsCommitments
      to extend credit andstandby
      letters of credit
    
    $
    441,087
    
    $
    4,411
    
    $
    362,110
    
    $
    3,621





The
following methods and assumptions were used by the Bank in estimating fair value
disclosures:





·
    Cash
      and Cash Equivalents





The
carrying amounts reported in the balance sheet for cash and cash equivalents
approximate those assets' fair values due to the short-term nature of the
assets.





·
    Investment
      Securities





Fair
values are based upon quoted market prices, where available.





·
    Loans





For
variable-rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying amounts. The fair values for
other loans (for example, fixed rate commercial real estate and rental property
mortgage loans and commercial and industrial loans) are estimated using
discounted cash flow analysis, based on interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality. Loan fair
value estimates include judgments regarding future expected loss experience and
risk characteristics. The carrying amount of accrued interest receivable
approximates its fair value.





·
    Deposits





The fair
values disclosed for demand deposits (for example, interest-bearing checking
accounts and passbook accounts) are, by definition, equal to the amount payable
on demand at the reporting date (that is, their carrying amounts). The fair
values for money market demand deposits and certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated contractual
maturities on such time deposits. The carrying amount of accrued interest
payable approximates fair value.





·
    FHLB
      Advances





The fair
value of fixed-rate FHLB advances is determined by discounting contractual cash
flows at current market interest rates.





85




·
    Subordinated
      Debt




The
carrying value of variable-rate subordinated debt approximates its fair
value.





·
    Off-Balance
      Sheet Instruments





Fair
values of loan commitments and financial guarantees are based upon fees
currently charged to enter similar agreements, taking into account the remaining
terms of the agreement and the counterparties' credit standing.





86






**Note
#25 - Condensed Financial Information of Vineyard National Bancorp (Parent
Company)**





**Balance
      Sheets**
    ******(Dollars
      in thousands)**
    
    December
      31,2004
    
    2003
    
    2002**Assets**Cash
      and due from bank
    
    $
    11,072
    
    $
    9,745
    
    $
    7,533Investment
      in subsidiary
    
    
    145,524
    
    
    83,194
    
    
    38,908Prepaid
      expenses
    
    
    2,287
    
    
    1,431
    
    
    848Other
      assets
    
    
    3,997
    
    
    1,958
    
    
    830**Total
      Assets**
    
    $
    162,880
    
    $
    96,328
    
    $
    48,119**Liabilities**Accrued
      interest and other liabilities
    
    $
    1,514
    
    $
    1,006
    
    $
    634Other
      borrowings
    
    
    -
    
    
    -
    
    
    5,000Subordinated
      debentures
    
    
    5,000
    
    
    5,000
    
    
    5,000Junior
      subordinated debentures
    
    
    71,139
    
    
    38,147
    
    
    17,527**Total
      Liabilities**
    
    
    77,653
    
    
    44,153
    
    
    28,161**Stockholders'
      Equity**Preferred
      stock
    
    
    -
    
    
    28,999
    
    
    2,450Common
      stock
    
    
    70,536
    
    
    9,739
    
    
    6,052Stock
      dividends to be distributed
    
    
    -
    
    
    4,981
    
    
    2,026Additional
      paid-in capital
    
    
    3,772
    
    
    3,307
    
    
    3,307Unallocated
      ESOP shares
    
    
    (6,856
    )
    
    -
    
    
    -Retained
      earnings
    
    
    17,775
    
    
    5,149
    
    
    6,123**Total
      Stockholders' Equity**
    
    
    85,227
    
    
    52,175
    
    
    19,958**Total
      Liabilities and Stockholders' Equity**
    
    $
    162,880
    
    $
    96,328
    
    $
    48,119








**Statements
      of Income**
    ********
    ****
    ****
    ****
    ****
    ****
    ****
    ******(Dollars
      in thousands)**
    
    For
      the years ended December 31,2004
    
    2003
    
    2002**Income**Other
      income
    
    $
    76
    
    $
    30
    
    $
    21**Total
      Income**
    
    
    76
    
    
    30
    
    
    21**Expenses**Interest
      expense
    
    
    3,304
    
    
    1,414
    
    
    1,044Salaries
      and benefits
    
    
    706
    
    
    277
    
    
    78Conversion
      expense on convertible debentures
    
    
    -
    
    
    -
    
    
    274Other
    
    
    1,189
    
    
    541
    
    
    403Allocated
      income tax benefit
    
    
    (2,131
    )
    
    (911
    )
    
    (737
    )**Total
      Expenses**
    
    
    3,068
    
    
    1,321
    
    
    1,062**Loss
      Before Equity in Undistributed****Income
      of Subsidiary**
    
    
    (2,992
    )
    
    (1,291
    )
    
    (1,041
    )**Equity
      in Undistributed Income of Subsidiary**
    
    
    16,979
    
    
    9,283
    
    
    4,049**Net
      Income**
    
    $
    13,987
    
    $
    7,992
    
    $
    3,008








87








**(Dollars
      in thousands)**
    
    For
      the years ended December 31,2004
    
    2003
    
    2002**Increase
      in Cash****Cash
      Flows From Operating Activities**Net
      Income
    
    $
    13,987
    
    $
    7,992
    
    $
    3,008Adjustments
      to Reconcile Net Incometo
      Net Cash Provided By Operating ActivitiesIncrease
      in other assets
    
    
    (1,903
    )
    
    (931
    )
    
    (174
    )Allocation
      of ESOP shares
    
    
    133
    
    
    -
    
    
    -Undistributed
      earnings of subsidiary
    
    
    (16,979
    )
    
    (9,283
    )
    
    (4,049
    )Increase
      in other liabilities
    
    
    507
    
    
    212
    
    
    607Net
      Cash Used In Operating Activities
    
    
    (4,255
    )
    
    (2,010
    )
    
    (608
    )**Cash
      Flows From Investing Activities**Investment
      in subsidiary
    
    
    (49,000
    )
    
    (35,000
    )
    
    (13,155
    )Dividends
      received from subsidiary
    
    
    4,000
    
    
    -
    
    
    -Net
      Cash Used In Investing Activities
    
    
    (45,000
    )
    
    (35,000
    )
    
    (13,155
    )**Cash
      Flows From Financing Activities**Proceeds
      from issuance of junior subordinated debentures
    
    
    32,000
    
    
    20,000
    
    
    5,000Proceeds
      from issuance of convertible debentures
    
    
    -
    
    
    -
    
    
    -Proceeds
      from issuance of subordinated debentures
    
    
    -
    
    
    -
    
    
    5,000Proceeds
      from issuance of common stock
    
    
    29,200
    
    
    -
    
    
    -(Decrease)/Increase
      in other borrowings
    
    
    -
    
    
    (5,000
    )
    
    5,000Redemption
      and conversion of preferred stock
    
    
    (2,579
    )
    
    -
    
    
    -Purchase
      of common stock to pre-fund ESOP
    
    
    (6,997
    )
    
    -
    
    
    -Proceeds
      from issuance of preferred stock
    
    
    -
    
    
    26,549
    
    
    2,450Stock
      repurchased
    
    
    (1,612
    )
    
    (1,884
    )
    
    -Cash
      dividends paid
    
    
    (1,640
    )
    
    (786
    )
    
    -Cash
      paid in lieu of fractional shares
    
    
    (15
    )
    
    (4
    )
    
    -Proceeds
      from exercise of warrants
    
    
    1,007
    
    
    30
    
    
    -Proceeds
      from exercise of stock options
    
    
    1,218
    
    
    317
    
    
    350Net
      Cash Provided By Financing Activities
    
    
    50,582
    
    
    39,222
    
    
    17,800**Net
      Increase in Cash and Cash Equivalents**
    
    
    1,327
    
    
    2,212
    
    
    4,037**Cash
      and Cash Equivalents**,
      Beginning of Year
    
    
    9,745
    
    
    7,533
    
    
    3,496**Cash
      and Cash Equivalents**,
      End of Year
    
    $
    11,072
    
    $
    9,745
    
    $
    7,533**Supplemental
      Information**Conversion
      of Series B preferred stock
    
    $
    26,491
    
    $
    -
    
    $
    -Tax
      benefit from exercise of non-qualified stock options
    
    $
    473
    
    $
    -
    
    $
    -






**Note
#26 - Subsequent Event**





On
January 24, 2005, the Company announced an increase in its quarterly cash
dividend to $0.05 per share, payable on February 25, 2005 to shareholders of
record as of February 11, 2005. The Company also announced an increase of $5.0
million in its stock repurchase program. The stock repurchase program was
established in July 2002. The shares repurchased by the Company under the stock
repurchase program are to be held as treasury shares or shares under the 2004
Restricted Share Plan.







88





**SELECTED
QUARTERLY FINANCIAL DATA**




**For
      the Year Ended December 31, 2004****(Dollars
      in thousands, except per share amounts)**
    
    **First**
    
    **Second**
    
    **Third**
    
    **Fourth****Quarter**
    
    **Quarter**
    
    **Quarter**
    
    **Quarter**
    
    **Annual******Interest
      income
    
    $
    15,182
    
    $
    18,056
    
    $
    20,313
    
    $
    21,505
    
    $
    75,056Interest
      expense
    
    
    4,068
    
    
    5,077
    
    
    6,161
    
    
    6,748
    
    
    22,054Net
      interest income
    
    
    11,114
    
    
    12,979
    
    
    14,152
    
    
    14,757
    
    
    53,002Provision
      for possible loan losses
    
    
    (1,800
    )
    
    (1,683
    )
    
    (1,350
    )
    
    (901
    )
    
    (5,734
    )Net
      interest income after provision forpossible
      loan losses
    
    
    9,314
    
    
    11,296
    
    
    12,802
    
    
    13,856
    
    
    47,268Non-interest
      income
    
    
    1,639
    
    
    890
    
    
    1,526
    
    
    1,402
    
    
    5,457Non-interest
      expense
    
    
    5,930
    
    
    6,631
    
    
    8,123
    
    
    8,385
    
    
    29,069Income
      before income taxes
    
    
    5,023
    
    
    5,555
    
    
    6,205
    
    
    6,873
    
    
    23,656Income
      tax provision
    
    
    2,054
    
    
    2,270
    
    
    2,535
    
    
    2,810
    
    
    9,669Net
      income
    
    $
    2,969
    
    $
    3,285
    
    $
    3,670
    
    $
    4,063
    
    $
    13,987Net
      income per common share:Basic(1)
    
    $
    0.40
    
    $
    0.42
    
    $
    0.43
    
    $
    0.46
    
    $
    1.72Fully
      diluted(1)
    
    $
    0.34
    
    $
    0.37
    
    $
    0.40
    
    $
    0.43
    
    $
    1.55


**For
      the Year Ended December 31, 2003****(Dollars
      in thousands, except per share amounts)**
    
    **First**
    
    **Second**
    
    **Third**
    
    **Fourth****Quarter**
    
    **Quarter**
    
    **Quarter**
    
    **Quarter**
    
    **Annual******Interest
      income
    
    $
    6,630
    
    $
    8,581
    
    $
    10,993
    
    $
    13,333
    
    $
    39,537Interest
      expense
    
    
    2,110
    
    
    2,598
    
    
    3,085
    
    
    3,590
    
    
    11,383Net
      interest income
    
    
    4,520
    
    
    5,983
    
    
    7,908
    
    
    9,743
    
    
    28,154Provision
      for possible loan losses
    
    
    (500
    )
    
    (1,250
    )
    
    (460
    )
    
    (1,500
    )
    
    (3,710
    )Net
      interest income after provision forpossible
      loan losses
    
    
    4,020
    
    
    4,733
    
    
    7,448
    
    
    8,243
    
    
    24,444Non-interest
      income
    
    
    1,334
    
    
    1,993
    
    
    955
    
    
    1,546
    
    
    5,828Non-interest
      expense
    
    
    3,233
    
    
    3,619
    
    
    4,487
    
    
    5,401
    
    
    16,740Income
      before income taxes
    
    
    2,121
    
    
    3,107
    
    
    3,916
    
    
    4,388
    
    
    13,532Income
      tax provision
    
    
    867
    
    
    1,272
    
    
    1,608
    
    
    1,793
    
    
    5,540Net
      income
    
    $
    1,254
    
    $
    1,835
    
    $
    2,308
    
    $
    2,595
    
    $
    7,992Net
      income per common share:Basic
      (1)
    
    $
    0.20
    
    $
    0.30
    
    $
    0.36
    
    $
    0.33
    
    $
    1.21Fully
      diluted(1)
    
    $
    0.19
    
    $
    0.28
    
    $
    0.32
    
    $
    0.29
    
    $
    1.09


________________________





(1) Per
share data has been adjusted to reflect the Company’s two-for-one stock split in
August 2004 and 5% stock dividends paid in January 2004 and January
2003**.**







89


**ITEM
9.** **Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure**




None.




**ITEM
9A.**  **Controls
and Procedures**





As
required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the
supervision and with the participation of the Company’s management, including
the Company’s Chief Executive Officer along with the Company’s Senior Vice
President and Chief Financial Officer, of the effectiveness of the design and
operation of the Company’s disclosure controls and procedures as of the end of
the period covered by this report. The evaluation of disclosure controls and
procedures includes an evaluation of some components of the Company’s internal
control over financial reporting, and internal control over financial reporting
is also separately evaluated on an annual basis for purposes of providing the
management report which is set forth below. Based upon that evaluation, the
Company’s Chief Executive Officer along with the Company’s Senior Vice President
and Chief Financial Officer concluded that the Company’s disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiary) required to be
included in the Company’s periodic SEC filings. There have been no significant
changes in the Company’s internal control over financial reporting during the
Company’s most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.




Disclosure
controls and procedures are Company’s controls and other procedures that are
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by the Company in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the Company’s management,
including its Chief Executive Officer and Senior Vice President and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.





**Management’s
Report on Internal Control Over Financial Reporting**




The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act of 1934). The Company’s management assessed the effectiveness
of its internal control over financial reporting as of December 31, 2004. In
making this assessment, the Company’s management used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in
Internal Control-Integrated Framework. This framework consists of eight
components: internal environment, objective setting, event identification, risk
assessment, risk response, control activities, information and communication,
and monitoring. The Company’s management concluded that, as of December 31,
2004, its internal control over financial reporting is effective based on these
criteria. The Company’s independent registered public accounting firm, Vavrinek,
Trine, Day, & Co., LLP, have issued an audit report on the Company’s
assessment of its internal control over financial reporting, which is included
herein.




The
Company’s management, including its Chief Executive Officer and Chief Financial
Officer, does not expect that its disclosure controls and procedures, or its
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefit of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected.







90










**Report
of Independent Registered Public Accounting Firm**







Board of
Directors and Stockholders


Vineyard
National Bancorp and subsidiary


Rancho
Cucamonga, California





We have
audited management’s assessment, included in the accompanying Report of
Management, that Vineyard National Bancorp and subsidiary (the “Company”)
maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management’s assessment and an
opinion on the effectiveness of the Company’s internal control over financial
reporting based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
generally accepted accounting principles. Because management’s assessment and
our audit were conducted to also meet the reporting requirements of Section 112
of the Federal Deposit Insurance Corporation Improvement Act (FDICIA),
management’s assessment and our audit of the Company’s internal control over
financial reporting included controls over the preparation of financial
statements in accordance with instructions to the Consolidated Financial
Statements for Bank Holding Companies (Form FR Y-9 C). A company’s internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and the receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





In our
opinion, management’s assessment that Vineyard National Bancorp and subsidiary
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Also in our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO).





91





We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets as of December
31, 2004 and 2003, and the related consolidated statements of income,
stockholders equity and cash flows for each of the years in the period ended
December 31, 2004 and our report dated March 9, 2005 expressed an unqualified
opinion.








/s/
Vavrinek, Trine, Day & Company LLP


Rancho
Cucamonga, California


March 9,
2005










92








**ITEM
9B. Other Information**




None









**PART** **III**





**ITEM
10. Directors and Executive** **Officer of the Registrant**




The
information required in response to this item is incorporated by reference from
the information contained in the sections captioned “Nominees for Director”,
“Executive Officers Who Are Not Directors” and “Executive Compensation -
Compliance with Section 16(a) of the Securities Exchange Act of 1934,” in the
Registrant’s Proxy Statement for the 2005 Annual Meeting of Shareholders (the
“Proxy Statement”).




The
Company has adopted a code of ethics (“Code of Ethics”) that applies to its
executive officers. A copy of the Code of Ethics is filed as an exhibit
hereto.




**ITEM
11. Executive Compensation**




The
information in response to this item is incorporated by reference from the
information contained in the section captioned “Executive Compensation” in the
Registrant’s Proxy Statement.




**ITEM** **12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters**




The
information required in response to this item is incorporated by reference from
the information contained in the section captioned “Beneficial Ownership of the
Common Stock” in the Registrant’s Proxy Statement. The information required by
Item 201(d) of Regulation S-K is incorporated by reference from the information
contained in the section captioned “Executive Compensation-Equity Compensation
Plan Information” in the Registrant’s Proxy Statement.




**ITEM
13. Certain Relationships and Related Transactions**




The
information required in response to this item is incorporated by reference from
the information contained in the section captioned “Certain Transactions” in the
Registrant’s Proxy Statement.




**ITEM
14.** **Principal Accountant Fees and Services**







The
information required in response to this item is incorporated by reference from
the information contained in the section captioned “Ratification of the
Selection of Independent Auditors" in the Registrant’s Proxy
Statement.






**PART
IV**







**ITEM
15.** **Exhibits
and Financial Statement Schedules**




(a)  Documents
filed as part of this report.




(1)  The
following documents are filed as part of this Annual Report on Form 10-K and are
incorporated herein by reference to Item 8 hereof:




Independent
Auditors’ Report.




93





Consolidated
Balance Sheets as of December 31, 2004 and 2003.




Consolidated
Statements of Income for the Years Ended December 31, 2004, 2003 and
2002.




Consolidated
Statements of Changes in Stockholders’ Equity for the Years Ended December 31,
2004, 2003 and 2002.




Consolidated
Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and
2002.




Notes to
Consolidated Financial Statements.




(2)  All
schedules for which provision is made in the applicable accounting regulation of
the SEC are omitted because they are not applicable or the required information
is included in the Consolidated Financial Statements or notes
thereto.




(3)(a)  The
following exhibits are filed as part of this Form 10-K, and this list includes
the Exhibit Index.




EXHIBIT
      NO.
    DESCRIPTION3.1
    
    Articles
      of Incorporation of Vineyard National Bancorp, as amended(6)3.2
    
    Bylaws
      of Vineyard National Bancorp(1)4
    
    Specimen
      Common Stock Certificate of Vineyard National Bancorp(2)4.1
    
    Registration
      Rights Agreement(8)4.2
    
    Form
      of Warrant to Purchase Shares of Common Stock(3)4.3
    
    Debenture
      Subscription Agreement, dated as of December 19, 2002, between Vineyard
      National Bancorp and Vineyard Statutory Trust II(6)4.4
    
    Additional
      Investment Right (11)4.5
    
    Registration
      Rights Agreement (11)10.1
    
    Vineyard
      National Bancorp Nonqualified Deferred Compensation Plan(6)*10.2
    
    Vineyard
      National Bancorp Directors’ Deferred Compensation Plan(6)*10.3
    
    Vineyard
      National Bancorp 1997 Incentive Stock Option Plan(6)*10.4
    
    Form
      of Vineyard National Bancorp 1997 Incentive Stock Option Plan Notice of
      Stock Option Grant*10.5
    
    Vineyard
      National Bancorp 2002 Restricted Share Plan(6)*10.6
    
    Form
      of 2002 Restricted Share Award Agreement*10.7
    
    Vineyard
      National Bancorp 2003 Restricted Share Plan *10.8
    
    Form
      of 2003 Restricted Share Award Agreement*10.9
    
    Vineyard
      National Bancorp 2004 Restricted Share Plan(9)*10.10
    
    Form
      of 2004 Restricted Share Award Agreement*10.11
    
    Employment
      Agreement between Vineyard National Bancorp, Vineyard Bank and Norman A.
      Morales(5)*10.12
    
    Indenture,
      dated as of December 19, 2002, between Vineyard National Bancorp, as
      Issuer, and Wilmington Trust Company, as Trustee, relating to the floating
      rate junior subordinated debt securities due 2033(6)10.13
    
    Amended
      and Restated Declaration of Trust by and among State Street Bank and Trust
      Company of Connecticut, National Association, as Institutional Trustee and
      Vineyard National Bancorp, as Sponsor, dated as of December 18, 2001(6)10.14
    
    Guarantee
      Agreement by and between Vineyard National Bancorp and State Street Bank
      and Trust Company of Connecticut and National Association, dated as of
      December 18, 2001(6)10.15
    
    Amended
      and Restated Declaration of Trust, dated as of December 19, 2002, of
      Vineyard Statutory Trust II(6)
  94
 
 10.16
    
    Guarantee
      Agreement, dated as of December 19, 2002(6)10.17
    
    Indenture
      dated as of December 19, 2002, between Vineyard National Bancorp, as
      Issuer, and State Street Bank and Trust Company of Connecticut, National
      Association, as Trustee, relating to the floating rate junior subordinated
      debentures due 2017(6)10.18
    
    Indenture
      dated as of September 25, 2003, between Vineyard National Bancorp, as
      Issuer, and Wilmington Trust Company, as Trustee, relating to the floating
      rate junior subordinated debentures due 2033(4)10.19
    
    Amended
      and Restated Declaration of Trust, dated as of September 25, 2003, of
      Vineyard Statutory Trust III(4)10.20
    
    Guarantee
      Agreement, dated as of September 25, 2003(4)10.21
    
    Indenture
      dated as of December 19, 2003, between Vineyard National Bancorp, as
      Issuer, and Wilmington Trust Company, as Trustee, relating to the floating
      rate junior subordinated debentures due 2034
    (10)10.22
    
    Amended
      and Restated Declaration of Trust, dated as of December 19, 2003, of
      Vineyard Statutory Trust IV(10)10.23
    
    Guarantee
      Agreement, dated as of December 19, 2003
(10)10.24
    
    Indenture
      dated as of March 25, 2004, between Vineyard National Bancorp, as Issuer,
      and Wilmington Trust Company, as Trustee, relating to the floating rate
      junior subordinated debentures due 203410.25
    
    Amended
      and Restated Declaration of Trust, dated as of March 25, 2004, of Vineyard
      Statutory Trust V10.26
    
    Guarantee
      Agreement, dated as of March 25, 200410.27
    
    Indenture
      dated as of May 18, 2004, between Vineyard National Bancorp, as Issuer,
      and Wilmington Trust Company, as Trustee, relating to the floating rate
      junior subordinated debentures due 203410.28
    
    Amended
      and Restated Declaration of Trust, dated as of May 18, 2004, of Vineyard
      Statutory Trust VI10.29
    
    Guarantee
      Agreement, dated as of May 18, 200410.30
    
    Indenture
      dated as of December 22, 2004, between Vineyard National Bancorp, as
      Issuer, and Wilmington Trust Company, as Trustee, relating to the floating
      rate junior subordinated debentures due 203410.31
    
    Amended
      and Restated Declaration of Trust, dated as of December 22, 2004, of
      Vineyard Statutory Trust VII10.32
    
    Guarantee
      Agreement, dated as of December 22, 200411
    
    Statement
      regarding computation of per share earnings. See Note 21 to the
      Consolidated Financial Statements included in Item 8
  hereof14
    
    Code
      of Ethics (10)21
    
    Subsidiary
      of the Registrant (See “Business” in Item 1 hereof for the required
      information)23.1
    
    Consent
      of Vavrinek, Trine, Day & Co., LLP31.1
    
    Certification
      of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of
      200231.2
    
    Certification
      of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of
      200232
    
    Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to Section
      906 of the Sarbanes-Oxley Act 0f 2002


_____________________________





(1)
    Incorporated
      by reference from the Registrant’s Registration Statement on Form S-8
      (File No. 333-18217) filed by the Registrant with the SEC on December 19,
      1996.





(2)
    Incorporated
      by reference from the Registrant’s Annual Report on Form 10-K for the year
      ended December 31, 1988 filed by the Registrant with the
    SEC.





(3)
    Incorporated
      by reference from the Registrant’s Proxy Statement for a special meeting
      held on December 18, 2002 filed by the Registrant with the SEC on November
      25, 2002.





(4)
    Incorporated
      by reference from the Registrant’s Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2003 filed by the Registrant with the SEC on
      November 7, 2003.





95


(5)
    Incorporated
      by reference from the Registrant’s Annual Report on Form 10-K for the year
      ended December 31, 2000 filed by the Registrant with the SEC on March 30,
      2001.





(6)
    Incorporated
      by reference from the Registrant’s Annual Report on Form 10-K for the year
      ended December 31, 2002 filed by the Registrant with the SEC on March 28,
      2003.





(7)
    Incorporated
      by reference from the Registrant’s Registration Statement on Form S-2
      (File No. 333-107493) filed by the Registrant with the SEC on July 30,
      2003.





(8)
    Incorporated
      by reference from the Registrant’s Form 8-K filed with the SEC on June 21,
      2004.





(9)
    Incorporated
      by reference from the Registrant’s Proxy Statement for an annual meeting
      held on May 22, 2003 filed with the SEC on April 14,
  2003.





(10)
    Incorporated
      by reference from the Registrant’s Annual Report on Form 10-K for the year
      ended December 31, 2003 filed by the Registrant with the SEC on March 22,
      2004.





(11)
    Incorporated
      by reference from the Registrant’s Form 8-K filed with the SEC on December
      10, 2004.





*
    Management
      contract or compensatory plan or
arrangement.














96





**SIGNATURES**





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereto duly authorized on this 10th day of March,
2005.




**VINEYARD
      NATIONAL BANCORP**By:
    */s/
      Norman A. Morales*Norman
      A. MoralesPresident
      and Chief Executive OfficerBy:
    */s/
      Gordon Fong*Gordon
      FongSenior
      Vice President and Chief Financial Officer





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.




**NAME**
    
    **TITLE**
    **DATE***/s/
      Norman A. Morales*
    
    
    March
      10, 2005Norman
      A. Morales
    
    President,
      Chief Executive Officer and Director (Principal Executive
      Officer)*/s/
      Frank S. Alvarez*
    
    
    March
      10, 2005Frank
      S. Alvarez
    
    Chairman
      of the Board*/s/
      Charles L. Keagle*
    
    
    March
      10, 2005Charles
      L. Keagle
    
    Director*/s/
      Joel H. Ravitz*Joel
      H. Ravitz
    
    Director
    March
      10, 2005*/s/
      James G. LeSieur III*James
      G. LeSieur III
    
    Director
    March
      10, 2005March
      10, 2005*/s/
      David A. Buxbaum*David
      A. Buxbaum
    
    Director*/s/
      Gordon Fong*Gordon
      Fong
    
    Senior
      Vice President and Chief Financial Officer (Principal Financial Officer
      and Principal Accounting Officer)
    March
      10, 2005







97