UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.   20549





FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the Quarterly Period Ended: September 30, 2009





OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the Transition Period From ____________ to _____________





000-50914


(Commission
File Number)





Bridge Capital
Holdings


(Exact
name of registrant as specified in its charter)





California
              80-0123855(State
      or other jurisdiction of
              (I.R.S.
      Employer Identification Number)incorporation
      or organization)





55 Almaden Boulevard, San
Jose, CA   95113


(Address
of principal executive offices, including zip code)





Registrant’s
telephone number, including area code:  (408)
423-8500





Bridge
Bank, N.A. (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 and (2)
has been subject to such filing requirements for the past 90 days.




Yes x  No
 ̈




Indicate
by checkmark whether registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer”, “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.  (Check one):





Large accelerated filer  ̈
            Accelerated filer x
            Non-accelerated filer  ̈
            Smaller reporting company  ̈(Do
      not check if a smallerreporting
      company)





Indicate
by checkmark whether the registrant is a shell company (as defined in Rule 12b-2
of the Act).


Yes  ̈  No
x




The number of shares of Common Stock
outstanding as of November 2, 2009:  6,999,644








TABLE
OF CONTENTS





PART I - FINANCIAL
    INFORMATIONItem
      1
                        Financial
      Statements
                        4Interim
      Consolidated Balance Sheets
                        4Interim
      Consolidated Statements of Operations
                        5Interim
      Consolidated Statements of Cash Flows
                        6Notes
      to Interim Consolidated Financial Statements
                        7Item
      2
                        Management's
      Discussion and Analysis of Financial Condition and
                        19Results
      of OperationsItem
      3
                        Quantitative
      and Qualitative Disclosures About Market Risk
                        44Item
      4
                        Controls
      and Procedures
                        46PART II - OTHER INFORMATIONItem
      1
                        Legal
      Proceedings
                        47Item
      1A
                        Risk
      Factors
                        47Item
      2
                        Unregistered
      Sales of Equity Securities and Use of Proceeds
                        47Item
      3
                        Defaults
      Upon Senior Securities
                        47Item
      4
                        Submission
      of Matters to a Vote of Security Holders
                        47Item
      5
                        Other
      Information
                        47Item
      6
                        Exhibits
                        47Signatures
                        48Index
      to Exhibits
                        49




2




FORWARD-LOOKING
STATEMENTS





IN ADDITION TO THE HISTORICAL
INFORMATION, THIS QUARTERLY REPORT CONTAINS CERTAIN FORWARD-LOOKING INFORMATION
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, AND WHICH ARE
SUBJECT TO THE “SAFE HARBOR” CREATED BY THOSE SECTIONS. THE READER OF THIS
QUARTERLY REPORT SHOULD UNDERSTAND THAT ALL SUCH FORWARD-LOOKING STATEMENTS ARE
SUBJECT TO VARIOUS UNCERTAINTIES AND RISKS THAT COULD AFFECT THEIR
OUTCOME.  THE COMPANY’S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE SUGGESTED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES
INCLUDE, AMONG OTHERS, (1) COMPETITIVE PRESSURE IN THE BANKING INDUSTRY
INCREASES SIGNIFICANTLY; (2) CHANGES IN THE INTEREST RATE ENVIRONMENT REDUCES
MARGIN; (3) GENERAL ECONOMIC CONDITIONS, EITHER NATIONALLY OR REGIONALLY,
ARE LESS FAVORABLE THAN EXPECTED, RESULTING IN, AMONG OTHER THINGS, A
DETERIORATION IN CREDIT QUALITY; (4) CHANGES IN THE REGULATORY ENVIRONMENT; (5)
CHANGES IN BUSINESS CONDITIONS AND INFLATION; (6) COSTS AND EXPENSES OF
COMPLYING WITH THE INTERNAL CONTROL PROVISIONS OF THE SARBANES-OXLEY ACT AND OUR
DEGREE OF SUCCESS IN ACHIEVING COMPLIANCE; (7) CHANGES IN SECURITIES MARKETS;
(8) FUTURE CREDIT LOSS EXPERIENCE; (9) CIVIL DISTURBANCES OR TERRORIST THREATS
OR ACTS, OR APPREHENSION ABOUT POSSIBLE FUTURE OCCURANCES OF ACTS OF THIS TYPE;
AND (10) THE INVOLVEMENT OF THE UNITED STATES IN WAR OR OTHER
HOSTILITIES.   THEREFORE,THE INFORMATION IN THIS QUARTERLY
REPORT SHOULD BE CAREFULLY CONSIDERED WHEN EVALUATING THE BUSINESS PROSPECTS OF
THE COMPANY.





Forward-looking
statements are generally identifiable by the use of terms such as "believe",
"expect", "intend", "anticipate", "estimate", "project", "assume," "plan,"
"predict," "forecast," “in management’s opinion,” “management considers” or
similar expressions.  Wherever such phrases are used, such statements
are as of and based upon the knowledge of Management, at the time made and are
subject to change by the passage of time and/or subsequent events, and
accordingly such statements are subject to the same risks and uncertainties
noted above with respect to forward-looking statements.





The
Company’s primary operations and most of its customers are located in
California. Other events, including those of September 11, 2001, have increased
the uncertainty related to the national and California economic outlook and
could have an effect on the future operations of the Company or its customers,
including borrowers. The Company does not undertake, and specifically disclaims
any obligation, to update any forward-looking statements to reflect occurrences
or unanticipated events or circumstances after the date of such
statements.





The
reader should refer to the more complete discussion of such risks in the
Company’s Annual Reports on Form 10-K.


3


PART
I - FINANCIAL INFORMATION





ITEM
1 – FINANCIAL STATEMENTS





BRIDGE
CAPITAL HOLDINGS AND SUBSIDIARY


Interim
Consolidated Balance Sheets


(dollars
in thousands)





(unaudited)September 30,
                                    
                                    
                                    December 31,2009
                                    
                                    
                                    2008ASSETSCash
      and due from banks
                                    
                                    $
                                    15,327
                                    
                                    
                                    $
                                    18,421Federal
      funds sold
                                    
                                    
                                    157,845
                                    
                                    
                                    
                                    199,525Total
      cash and equivalents
                                    
                                    
                                    173,172
                                    
                                    
                                    
                                    217,946Interest
      bearing deposits in other banks
                                    
                                    
                                    19,120
                                    
                                    
                                    
                                    7,268Investment
      securities available for sale
                                    
                                    
                                    40,761
                                    
                                    
                                    
                                    -Loans,
      net of allowance for credit losses of $16,922 atSeptember
      30, 2009 and $18,554 at December 31, 2008
                                    
                                    
                                    555,254
                                    
                                    
                                    
                                    679,451Premises
      and equipment, net
                                    
                                    
                                    3,909
                                    
                                    
                                    
                                    4,790Other
      Real Estate Owned
                                    
                                    
                                    4,333
                                    
                                    
                                    
                                    1,096Accrued
      interest receivable
                                    
                                    
                                    2,825
                                    
                                    
                                    
                                    3,137Other
      assets
                                    
                                    
                                    35,454
                                    
                                    
                                    
                                    33,908Total
      assets
                                    
                                    $
                                    834,828
                                    
                                    
                                    $
                                    947,596LIABILITIES
      AND SHAREHOLDERS' EQUITYDeposits:Demand
      noninterest-bearing
                                    
                                    $
                                    313,228
                                    
                                    
                                    $
                                    284,319Demand
      interest-bearing
                                    
                                    
                                    4,255
                                    
                                    
                                    
                                    4,267Money
      market and savings
                                    
                                    
                                    259,282
                                    
                                    
                                    
                                    335,200Time
                                    
                                    
                                    115,294
                                    
                                    
                                    
                                    153,459Total
      deposits
                                    
                                    
                                    692,059
                                    
                                    
                                    
                                    777,245Junior
      subordinated debt securities
                                    
                                    
                                    17,527
                                    
                                    
                                    
                                    17,527Other
      borrowings
                                    
                                    
                                    -
                                    
                                    
                                    
                                    30,000Accrued
      interest payable
                                    
                                    
                                    337
                                    
                                    
                                    
                                    511Other
      liabilities
                                    
                                    
                                    16,204
                                    
                                    
                                    
                                    9,823Total
      liabilities
                                    
                                    
                                    726,127
                                    
                                    
                                    
                                    835,106Commitments
      and contingencies
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -SHAREHOLDERS'
      EQUITYPreferred
      stock, no par value; 10,000,000 shares authorized;323,864
      shares issued and outstanding at September 30, 2009 andDecember
      31, 2008
                                    
                                    
                                    53,864
                                    
                                    
                                    
                                    53,864Common
      stock, no par value; 30,000,000 shares authorized;6,999,644
      shares issued and outstanding at September 30, 2009;6,888,424
      shares issued and outstanding at December 31, 2008;
                                    
                                    
                                    37,153
                                    
                                    
                                    
                                    36,833Additional
      paid in capital
                                    
                                    
                                    3,503
                                    
                                    
                                    
                                    2,822Retained
      earnings
                                    
                                    
                                    14,798
                                    
                                    
                                    
                                    17,916Accumulated
      other comprehensive income
                                    
                                    
                                    (617
                                    )
                                    
                                    
                                    1,055Total
      shareholders' equity
                                    
                                    
                                    108,701
                                    
                                    
                                    
                                    112,490Total
      liabilities and shareholders' equity
                                    
                                    $
                                    834,828
                                    
                                    
                                    $
                                    947,596




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


4


BRIDGE
CAPITAL HOLDINGS AND SUBSIDIARY


Interim
Consolidated Statements of Operations (unaudited)


(dollars
in thousands, except per share data)





Three months ended
                                      
                                      
                                      Nine months endedSeptember 30,
                                      
                                      
                                      September 30,2009
                                      
                                      
                                      2008
                                      
                                      
                                      2009
                                      
                                      
                                      2008INTEREST
      INCOME:Loans
                                      
                                      $
                                      10,181
                                      
                                      
                                      $
                                      13,632
                                      
                                      
                                      $
                                      33,218
                                      
                                      
                                      $
                                      43,107Federal
      funds sold
                                      
                                      
                                      106
                                      
                                      
                                      
                                      512
                                      
                                      
                                      
                                      300
                                      
                                      
                                      
                                      835Investment
      securities available for sale
                                      
                                      
                                      117
                                      
                                      
                                      
                                      69
                                      
                                      
                                      
                                      146
                                      
                                      
                                      
                                      1,204Other
                                      
                                      
                                      111
                                      
                                      
                                      
                                      45
                                      
                                      
                                      
                                      287
                                      
                                      
                                      
                                      81Total
      interest income
                                      
                                      
                                      10,515
                                      
                                      
                                      
                                      14,258
                                      
                                      
                                      
                                      33,951
                                      
                                      
                                      
                                      45,227INTEREST
      EXPENSE:Deposits:Interest-bearing
      demand
                                      
                                      
                                      2
                                      
                                      
                                      
                                      3
                                      
                                      
                                      
                                      4
                                      
                                      
                                      
                                      10Money
      market and savings
                                      
                                      
                                      435
                                      
                                      
                                      
                                      2,083
                                      
                                      
                                      
                                      1,749
                                      
                                      
                                      
                                      6,662Certificates
      of deposit
                                      
                                      
                                      825
                                      
                                      
                                      
                                      894
                                      
                                      
                                      
                                      2,777
                                      
                                      
                                      
                                      2,923Other
                                      
                                      
                                      261
                                      
                                      
                                      
                                      291
                                      
                                      
                                      
                                      1,086
                                      
                                      
                                      
                                      889Total
      interest expense
                                      
                                      
                                      1,523
                                      
                                      
                                      
                                      3,271
                                      
                                      
                                      
                                      5,616
                                      
                                      
                                      
                                      10,484Net
      interest income
                                      
                                      
                                      8,992
                                      
                                      
                                      
                                      10,987
                                      
                                      
                                      
                                      28,335
                                      
                                      
                                      
                                      34,743Provision
      for credit losses
                                      
                                      
                                      650
                                      
                                      
                                      
                                      19,000
                                      
                                      
                                      
                                      8,300
                                      
                                      
                                      
                                      27,570Net
      interest income after provisionfor
      credit losses
                                      
                                      
                                      8,342
                                      
                                      
                                      
                                      (8,013
                                      )
                                      
                                      
                                      20,035
                                      
                                      
                                      
                                      7,173NON-INTEREST
      INCOME:Service
      charges on deposit accounts
                                      
                                      
                                      498
                                      
                                      
                                      
                                      327
                                      
                                      
                                      
                                      1,394
                                      
                                      
                                      
                                      814International
      fee income
                                      
                                      
                                      315
                                      
                                      
                                      
                                      594
                                      
                                      
                                      
                                      1,137
                                      
                                      
                                      
                                      1,403Cash
      flow hedge
                                      
                                      
                                      301
                                      
                                      
                                      
                                      151
                                      
                                      
                                      
                                      3,221
                                      
                                      
                                      
                                      603Gain
      on sale of SBA loans
                                      
                                      
                                      220
                                      
                                      
                                      
                                      87
                                      
                                      
                                      
                                      611
                                      
                                      
                                      
                                      556Other
      non interest income
                                      
                                      
                                      355
                                      
                                      
                                      
                                      796
                                      
                                      
                                      
                                      1,656
                                      
                                      
                                      
                                      1,965Total
      non-interest income
                                      
                                      
                                      1,689
                                      
                                      
                                      
                                      1,955
                                      
                                      
                                      
                                      8,019
                                      
                                      
                                      
                                      5,341OPERATING
      EXPENSES:Salaries
      and benefits
                                      
                                      
                                      5,081
                                      
                                      
                                      
                                      5,859
                                      
                                      
                                      
                                      15,749
                                      
                                      
                                      
                                      17,421Premises
      and fixed assets
                                      
                                      
                                      1,118
                                      
                                      
                                      
                                      1,163
                                      
                                      
                                      
                                      3,336
                                      
                                      
                                      
                                      3,424Other
                                      
                                      
                                      3,003
                                      
                                      
                                      
                                      2,780
                                      
                                      
                                      
                                      8,923
                                      
                                      
                                      
                                      7,204Total
      operating expenses
                                      
                                      
                                      9,202
                                      
                                      
                                      
                                      9,802
                                      
                                      
                                      
                                      28,008
                                      
                                      
                                      
                                      28,049Income
      (loss) before income taxes
                                      
                                      
                                      829
                                      
                                      
                                      
                                      (15,860
                                      )
                                      
                                      
                                      46
                                      
                                      
                                      
                                      (15,535
                                      )Income
      taxes
                                      
                                      
                                      290
                                      
                                      
                                      
                                      (6,655
                                      )
                                      
                                      
                                      16
                                      
                                      
                                      
                                      (6,525
                                      )Net
      income (loss)
                                      
                                      $
                                      539
                                      
                                      
                                      $
                                      (9,205
                                      )
                                      
                                      $
                                      30
                                      
                                      
                                      $
                                      (9,010
                                      )Preferred
      dividends
                                      
                                      
                                      1,064
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      3,138
                                      
                                      
                                      
                                      -Net
      income (loss) available tocommon
      shareholders
                                      
                                      $
                                      (525
                                      )
                                      
                                      $
                                      (9,205
                                      )
                                      
                                      $
                                      (3,108
                                      )
                                      
                                      $
                                      (9,010
                                      )Basic
      earnings (loss) per share
                                      
                                      $
                                      (0.08
                                      )
                                      
                                      $
                                      (1.41
                                      )
                                      
                                      $
                                      (0.47
                                      )
                                      
                                      $
                                      (1.38
                                      )Diluted
      earnings (loss) per share
                                      
                                      $
                                      (0.08
                                      )
                                      
                                      $
                                      (1.41
                                      )
                                      
                                      $
                                      (0.47
                                      )
                                      
                                      $
                                      (1.38
                                      )Average
      common shares outstanding
                                      
                                      
                                      6,571,479
                                      
                                      
                                      
                                      6,533,545
                                      
                                      
                                      
                                      6,571,479
                                      
                                      
                                      
                                      6,487,200Average
      common and equivalentshares
      outstanding
                                      
                                      
                                      6,571,479
                                      
                                      
                                      
                                      6,533,545
                                      
                                      
                                      
                                      6,571,479
                                      
                                      
                                      
                                      6,487,200





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


5


BRIDGE
CAPITAL HOLDINGS AND SUBSIDIARY


Interim
Consolidated Statements of Cash Flows (unaudited)


(dollars
in thousands)





Nine months ended September 30,2009
                                    
                                    
                                    2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
                                    
                                    $
                                    30
                                    
                                    
                                    $
                                    (9,010
                                    )Adjustments
      to reconcile net income to net cashprovided
      by (used in) operating activities:Provision
      for credit losses
                                    
                                    
                                    8,300
                                    
                                    
                                    
                                    27,570Depreciation
      and amortization
                                    
                                    
                                    1,330
                                    
                                    
                                    
                                    1,200Stock
      based compensation
                                    
                                    
                                    1,091
                                    
                                    
                                    
                                    1,029Loans
      originated for sale
                                    
                                    
                                    (7,528
                                    )
                                    
                                    
                                    (38,419
                                    )Proceeds
      from loan sales
                                    
                                    
                                    18,164
                                    
                                    
                                    
                                    20,254Gain
      from sale of securities
                                    
                                    
                                    -
                                    
                                    
                                    
                                    711Increase
      (decrease) in accrued interest receivableand
      other assets
                                    
                                    
                                    (1,558
                                    )
                                    
                                    
                                    (10,137
                                    )Increase
      (decrease) in accrued interest payableand
      other liabilities
                                    
                                    
                                    7,332
                                    
                                    
                                    
                                    351Net
      cash provided by (used in) operating activities
                                    
                                    
                                    27,161
                                    
                                    
                                    
                                    (6,451
                                    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of securities available for sale
                                    
                                    
                                    (40,654
                                    )
                                    
                                    
                                    -Proceeds
      from sale/maturity of securities available for sale
                                    
                                    
                                    -
                                    
                                    
                                    
                                    53,939Purchase
      of interest bearing deposits
                                    
                                    
                                    (11,852
                                    )
                                    
                                    
                                    (4,915
                                    )Net
      decrease (increase) in loans
                                    
                                    
                                    98,486
                                    
                                    
                                    
                                    (34,963
                                    )Purchase
      of fixed assets
                                    
                                    
                                    (294
                                    )
                                    
                                    
                                    (1,220
                                    )Net
      cash provided by (used in) investing activities
                                    
                                    
                                    45,686
                                    
                                    
                                    
                                    12,841CASH
      FLOW FROM FINANCING ACTIVITIES:Net
      (decrease) increase in deposits
                                    
                                    
                                    (85,186
                                    )
                                    
                                    
                                    67,383Decrease
      in other borrowings
                                    
                                    
                                    (30,000
                                    )
                                    
                                    
                                    20,000Common
      stock issued
                                    
                                    
                                    -
                                    
                                    
                                    
                                    413Payment
      of cash dividends
                                    
                                    
                                    (2,335
                                    )
                                    
                                    
                                    -Preferred
      stock issuance costs
                                    
                                    
                                    (100
                                    )
                                    
                                    
                                    -Net
      cash provided by (used in) financing activities
                                    
                                    
                                    (117,621
                                    )
                                    
                                    
                                    87,796NET
      INCREASE (DECREASE) IN CASH AND EQUIVALENTS:
                                    
                                    
                                    (44,774
                                    )
                                    
                                    
                                    94,186Cash
      and equivalents at beginning of period
                                    
                                    
                                    217,946
                                    
                                    
                                    
                                    40,835Cash
      and equivalents at end of period
                                    
                                    $
                                    173,172
                                    
                                    
                                    $
                                    135,021OTHER
      CASH FLOW INFORMATION:Cash
      paid for interest
                                    
                                    $
                                    3,148
                                    
                                    
                                    $
                                    10,355Cash
      paid for income taxes
                                    
                                    $
                                    16
                                    
                                    
                                    $
                                    4,638





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




6




BRIDGE
CAPITAL HOLDINGS AND SUBSIDIARY


Notes
to Interim Consolidated Financial Statements (Unaudited)





1.           Summary
of Significant Accounting Policies





Basis
of Presentation





The
accompanying unaudited financial statements of Bridge Capital Holdings and
Bridge Bank, N.A. have been prepared in accordance with generally accepted
accounting principles and pursuant to the rules and regulations of the
SEC.  The interim financial data as of September 30, 2009 and for the
three and nine months ended September 30, 2009 is unaudited; however, in the
opinion of the Company, the interim data includes all adjustments, consisting
only of normal recurring adjustments, necessary for a fair statement of the
results for the interim periods.   Certain information and note
disclosures normally included in annual financial statements have been omitted
pursuant to SEC rules and regulations; however, the Company believes the
disclosures made are adequate to ensure that the information presented is not
misleading.  Results of operations for the quarter and nine months
ended September 30, 2009 are not necessarily indicative of full year
results.





The
comparative balance sheet information as of December 31, 2008 is derived from
the audited financial statements; however, it does not include all disclosures
required by accounting principles generally accepted in the United States of
America.





Use
of Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect reported amounts of assets, liabilities, revenues and expenses, and
disclosure of contingent assets and liabilities as of the dates and for the
periods presented.  A significant estimate included in the
accompanying financial statements is the allowance for loan
losses.  Actual results could differ from those
estimates.





Recent
Accounting Pronouncements





In
June 2009, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Codification (the “Codification” or “ASC”), an accounting
standard which established the Codification to become the single source of
authoritative GAAP recognized by the FASB to be applied by nongovernmental
entities, with the exception of guidance issued by the U.S. Securities and
Exchange Commission (the “SEC”) and its staff.  All guidance contained in
the Codification carries an equal level of authority.  The Codification is
not intended to change GAAP, but rather is expected to simplify accounting
research by reorganizing current GAAP into approximately 90 accounting
topics.  The adoption of this accounting standard, which was subsequently
codified into FASB ASC 105, “Generally Accepted Accounting Principles,” had no
impact on retained earnings or Company’s statements of income and
condition.





In April
2009, the FASB issued guidance related to fair value and impairment charges (see
Note 8 -Fair Values of Assets and Liabilities), for interim and annual periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. The guidance amended previously-issued standards to better
determine fair value when there is no active market or where the price inputs
being used represent distressed sales, and requires disclosures if application
of the guidance results in any changes in valuation techniques or related
inputs. The guidance also affirmed the requirement that the entire impairment of
an impaired debt security be recognized as an other-than-temporary impairment
(OTTI) in earnings if it is likely that the security will be sold prior to
recovery of the security's cost basis, but allows an entity to recognize the
non-credit related portion of the security’s OTTI as part of other comprehensive
income rather than earnings if it is more likely that an impaired security will
be held until its cost basis can be recovered. It also requires additional
qualitative fair value disclosures for interim periods for public companies, in
addition to the preexisting annual requirement. Except for the increased
frequency of disclosure, this guidance has not impacted the Company. As noted in
the previous paragraph, this guidance has been incorporated into FASB's
Codification.




7




In May
2009, the FASB established general standards for the accounting and disclosure
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. In particular, these
standards set forth (i) the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, (ii)
the circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and (iii)
the disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. These standards became effective with
interim or annual financial periods ending after June 15, 2009. The guidance
provided by these standards has been incorporated into FASB's
Codification.





In June
2009, the FASB issued an accounting standard which amends current GAAP related
to the accounting for transfers and servicing of financial assets and
extinguishments of liabilities, including the removal of the concept of a
qualifying special-purpose entity from GAAP. This new accounting standard also
clarifies that a transferor must evaluate whether it has maintained effective
control of a financial asset by considering its continuing direct or indirect
involvement with the transferred financial asset. This accounting standard is
effective for financial asset transfers occurring after December 31, 2009. The
adoption of this accounting standard is not expected to have any impact on the
Company's financial statements.





Earnings
Per Share





Basic net
income per share is computed by dividing net income applicable to common
shareholders by the weighted average number of common shares outstanding during
the period.  Diluted net income per share is determined using the
weighted average number of common shares outstanding during the period, adjusted
for the dilutive effect of common stock equivalents, consisting of shares that
might be issued upon exercise of common stock options and vesting of restricted
stock.  Common stock equivalents are included in the diluted net
income per share calculation to the extent these shares are
dilutive.  See Note 2 to the financial statements for additional
information on earnings per share.





Stock-Based
Compensation





On
January 1, 2006, the Company adopted SFAS No. 123 (revised 2004) (SFAS
No. 123R), Share-Based Payments, which addresses the accounting for
stock-based payment 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.  The Company uses the Black-Scholes-Merton (“BSM”)
option-pricing model to determine the fair-value of stock-based awards under
SFAS No. 123R, consistent with that used for pro forma disclosures under
SFAS No. 123, Accounting for Stock-Based Compensation.  The
Company has recorded an incremental $345,000 ($273,000 net of tax) and $1.1
million ($875,000 net of tax) of stock-based compensation expense during the
three and nine months ended September 30, 2009, respectively, as a result of the
adoption of SFAS No. 123R.




No
stock-based compensation costs were capitalized as part of the cost of an asset
as of September 30, 2009.   As of September 30, 2009, $3.3
million of total unrecognized compensation cost related to stock options and
restricted stock units are expected to be recognized over a weighted-average
period of 3.1 years.





The
impact of implementing SFAS No. 123R reduced basic earnings per share by $0.04
and $0.13 and diluted earnings per share by $0.03 and $0.12 for the three and
nine months ended September 30, 2009, respectively.




Comprehensive
Income





SFAS No.
130, Reporting Comprehensive Income, requires that all items recognized under
accounting standards as components of comprehensive earnings be reported in an
annual financial statement that is displayed with the same prominence as other
annual financial statements. This Statement also requires that an entity
classify items of other comprehensive earnings by their nature in an annual
financial statement.  Other comprehensive earnings include the SFAS
No. 158 adjustment to fully recognize the liability associated with the
supplemental executive retirement plan, unrealized gains and losses, net of tax,
on cash flow hedges and unrealized gains and losses, net of tax, on marketable
securities classified as available-for-sale.  The Company had a
cumulative other comprehensive loss totaling $(617,000), net of tax, as of
September 30, 2009 and cumulative other comprehensive income of $1.1 million,
net of tax, as of December 31, 2008.




8




Three months ended
                                      
                                      
                                      Nine months ended(dollars in thousands)
                                      
                                      September 30,
                                      
                                      
                                      September 30,2009
                                      
                                      
                                      2008
                                      
                                      
                                      2009
                                      
                                      
                                      2008Net
      income (loss)
                                      
                                      $
                                      539
                                      
                                      
                                      $
                                      (9,205
                                      )
                                      
                                      $
                                      30
                                      
                                      
                                      $
                                      (9,010
                                      )Other
      comprehensive earnings-Net
      unrealized gains (losses) onsecurities
      available for sale
                                      
                                      
                                      116
                                      
                                      
                                      
                                      (276
                                      )
                                      
                                      
                                      158
                                      
                                      
                                      
                                      (489
                                      )Net
      unrealized gains (losses) onFAS
      158 adjustment - supplementalexecutive
      retirement plan
                                      
                                      
                                      13
                                      
                                      
                                      
                                      70
                                      
                                      
                                      
                                      37
                                      
                                      
                                      
                                      172Net
      unrealized gains (losses) oncash
      flow hedges
                                      
                                      
                                      (490
                                      )
                                      
                                      
                                      484
                                      
                                      
                                      
                                      (1,866
                                      )
                                      
                                      
                                      492Total
      comprehensive income (loss)
                                      
                                      $
                                      178
                                      
                                      
                                      $
                                      (8,927
                                      )
                                      
                                      $
                                      (1,641
                                      )
                                      
                                      $
                                      (8,835
                                      )





Segment
Information





SFAS No.
131, Disclosure about Segments of an Enterprise and Related Information,
requires certain information about the operating segments of the
Company.  The objective of requiring disclosures about segments of an
enterprise and related information is to provide information about the different
types of business activities in which an enterprise engages and the different
economic environment in which it operates to help users of financial statements
better understand its performance, better assess its prospects for future cash
flows and make more informed judgments about the enterprise as a
whole.  The Company has determined that it has one segment, general
commercial banking, and therefore, it is appropriate to aggregate the Company’s
operations into a single operating segment.





Derivative
Instruments and Hedging Activities





SFAS No.
161, Disclosures about Derivative Instruments and Hedging Activities, an
amendment of SFAS No. 133 (SFAS 161), amends and expands the disclosure
requirements of SFAS 133 with the intent to provide users of financial
statements with an enhanced understanding of: (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged items
are accounted for under SFAS 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. SFAS 161 requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative
disclosures about the fair value of and gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative instruments.





As
required by SFAS 133, the Company records all derivatives on the balance sheet
at fair value.  The accounting for changes in the fair value of derivatives
depends on the intended use of the derivative, whether the Company has elected
to designate a derivative in a hedging relationship and apply hedge accounting
and whether the hedging relationship has satisfied the criteria necessary to
apply hedge accounting. Derivatives designated and qualified as a hedge of the
exposure to changes in the fair value of an asset, liability, or firm commitment
attributable to a particular risk, such as interest rate risk, are considered
fair value hedges. Derivatives designated and that qualify as a hedge of the
exposure to variability in expected future cash flows, or other types of
forecasted transactions, are considered cash flow hedges. Hedge accounting
generally provides for the matching of the timing of gain or loss recognition on
the hedging instrument with the recognition of the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk in a fair
value hedge or the earnings effect of the hedged forecasted transactions in a
cash flow hedge.  The Company may enter into derivative contracts that
are intended to economically hedge certain of its risks, even though hedge
accounting does not apply or the Company elects not to apply hedge accounting
under SFAS 133.  See Note 9 to the financial statements for additional
information on derivative instruments and hedging activities.




9


2.           Earnings
Per Share





Basic net
earnings per share is computed by dividing net earnings applicable to common
shareholders by the weighted average number of common shares outstanding during
the period.  Diluted net earnings per share is determined using the
weighted average number of common shares outstanding during the period, adjusted
for the dilutive effect of common stock equivalents, consisting of shares that
might be issued upon exercise of common stock options.  Common stock
equivalents are included in the diluted net earnings per share calculation to
the extent these shares are dilutive.  A reconciliation of the
numerator and denominator used in the calculation of basic and diluted net
earnings per share available to common shareholders is as follows (in thousands,
except for per share amounts):





Three months ended
                        
                        
                        Nine months ended(dollars in thousands)
                        
                        September 30,
                        
                        
                        September 30,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008Net
      income (loss)
                        
                        $
                        539
                        
                        
                        $
                        (9,205
                        )
                        
                        $
                        30
                        
                        
                        $
                        (9,010
                        )Less:Dividends
      on preferred shares
                        
                        
                        (1,064
                        )
                        
                        
                        -
                        
                        
                        
                        (3,138
                        )
                        
                        
                        -Net
      income (loss) available forcommon
      shareholders
                        
                        $
                        (525
                        )
                        
                        $
                        (9,205
                        )
                        
                        $
                        (3,108
                        )
                        
                        $
                        (9,010
                        )Weighted
      average shares:Basic
      common shares
                        
                        
                        6,571,479
                        
                        
                        
                        6,533,545
                        
                        
                        
                        6,571,479
                        
                        
                        
                        6,487,200Diluted
      potential common sharesrelated
      to stock based awards,using
      the treasury stock method
                        
                        
                        0
                        
                        
                        
                        0
                        
                        
                        
                        0
                        
                        
                        
                        0Total
      average common equivalent shares
                        
                        
                        6,571,479
                        
                        
                        
                        6,533,545
                        
                        
                        
                        6,571,479
                        
                        
                        
                        6,487,200Basic
      earnings (loss) per share
                        
                        $
                        (0.08
                        )
                        
                        $
                        (1.41
                        )
                        
                        $
                        (0.47
                        )
                        
                        $
                        (1.38
                        )Diluted
      earnings (loss) per share
                        
                        $
                        (0.08
                        )
                        
                        $
                        (1.41
                        )
                        
                        $
                        (0.47
                        )
                        
                        $
                        (1.38
                        )





3.           Securities




The
amortized cost and approximate fair values of securities at September 30, 2009
are as follows:




(dollars in thousands)
                  
                  As of September 30, 2009Gross Unrealized
                  
                  
                  FairCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  ValueU.S.
      government agency notes
                  
                  $
                  38,383
                  
                  
                  $
                  263
                  
                  
                  $
                  -
                  
                  
                  $
                  38,646Mortgage
      backed securities
                  
                  
                  2,114
                  
                  
                  
                  1
                  
                  
                  
                  -
                  
                  
                  
                  2,115Total
      securities available for sale
                  
                  
                  40,497
                  
                  
                  
                  264
                  
                  
                  
                  -
                  
                  
                  
                  40,761Total
      investment securities
                  
                  $
                  40,497
                  
                  
                  $
                  264
                  
                  
                  $
                  -
                  
                  
                  $
                  40,761




The
scheduled maturities of securities available for sale at September 30, 2009 were
as follows:




10




(dollars in thousands)
                  
                  September 30, 2009Amortized
                  
                  
                  FairCost
                  
                  
                  ValueDue
      in one year or less
                  
                  $
                  -
                  
                  
                  $
                  -Due
      after one year through five years
                  
                  
                  40,497
                  
                  
                  
                  40,761Due
      after five years through ten years
                  
                  
                  -
                  
                  
                  
                  -Due
      after ten years
                  
                  
                  -
                  
                  
                  
                  -Total
      securities available for sale
                  
                  
                  40,497
                  
                  
                  
                  40,761Total
      investment securities
                  
                  $
                  40,497
                  
                  
                  $
                  40,761





As of
September 30, 2009, no investment securities were pledged as
collateral.   As of September 30, 2009, there were no unrealized
losses attributable to securities maturing in greater than 12
months.





As of
December 31, 2008 the Company did not own any securities.




4.           Loans




The
balances in the various loan categories are as follows as of September 30, 2009
and December 31, 2008:




September 30,
                
                
                December 31,(dollars in thousands)
                
                2009
                
                
                2008Commercial
                
                $
                257,703
                
                
                $
                301,024SBA
                
                
                59,606
                
                
                
                77,043Real
      estate construction
                
                
                52,888
                
                
                
                98,105Land
      development
                
                
                13,530
                
                
                
                23,535Real
      estate other
                
                
                135,326
                
                
                
                134,767Factoring
      and asset based lending
                
                
                48,413
                
                
                
                55,761Other
                
                
                6,228
                
                
                
                9,371Loans,
      gross
                
                
                573,694
                
                
                
                699,606Unearned
      fee income
                
                
                (1,518
                )
                
                
                (1,601
                )Total
      loan portfolio
                
                
                572,176
                
                
                
                698,005Less
      allowance for credit losses
                
                
                (16,922
                )
                
                
                (18,554
                )Loans,
      net
                
                $
                555,254
                
                
                $
                679,451





5. Premises and
Equipment





Premises
and equipment are stated at cost less accumulated depreciation and
amortization.  Depreciation and amortization are computed on a
straight-line basis over the shorter of the lease term, generally three to
fifteen years, or the estimated useful lives of the assets, generally three to
five years.





Premises
and equipment at September 30, 2009 and December 31, 2008 are comprised of the
following:





11





(dollars in thousands)
                        
                        September 30, 2009Accumulated
                        
                        
                        Net BookCost
                        
                        
                        Depreciation
                        
                        
                        ValueLeasehold
      improvements
                        
                        $
                        5,391
                        
                        
                        $
                        (2,691
                        )
                        
                        $
                        2,700Furniture
      and fixtures
                        
                        
                        1,059
                        
                        
                        
                        (840
                        )
                        
                        
                        219Capitalized
      software
                        
                        
                        3,070
                        
                        
                        
                        (2,440
                        )
                        
                        
                        630Equipment
                        
                        
                        2,151
                        
                        
                        
                        (1,794
                        )
                        
                        
                        357Construction
      in process
                        
                        
                        3
                        
                        
                        
                        -
                        
                        
                        
                        3Totals
                        
                        $
                        11,674
                        
                        
                        $
                        (7,765
                        )
                        
                        $
                        3,909





December 31, 2008Accumulated
                        
                        
                        Net bookCost
                        
                        
                        Depreciation
                        
                        
                        ValueLeasehold
      improvements
                        
                        $
                        5,378
                        
                        
                        $
                        (2,196
                        )
                        
                        $
                        3,182Furniture
      and fixtures
                        
                        
                        1,149
                        
                        
                        
                        (759
                        )
                        
                        
                        390Capitalized
      software
                        
                        
                        2,816
                        
                        
                        
                        (2,056
                        )
                        
                        
                        760Equipment
                        
                        
                        2,015
                        
                        
                        
                        (1,557
                        )
                        
                        
                        458Construction
      in process
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Totals
                        
                        $
                        11,358
                        
                        
                        $
                        (6,568
                        )
                        
                        $
                        4,790





6.           Junior
Subordinated Debt Securities and Other Borrowings





Junior
Subordinated Debt Securities





On
December 21, 2004, the Company issued $12,372,000 of junior subordinated debt
securities (the “debt securities”) to Bridge Capital Trust I, a statutory trust
created under the laws of the State of California.  These debt
securities are subordinated to effectively all borrowings of the Company and are
due and payable in March 2035.  Interest is payable quarterly on these
debt securities at a fixed rate of 5.90% for the first five years, and
thereafter interest accrues at LIBOR plus 1.98%.  The debt securities
can be redeemed at par at the Company’s option beginning in March 2010; they can
also be redeemed at par if certain events occur that impact the tax treatment or
the capital treatment of the issuance.





The
Company also purchased a 3% minority interest in the Trust.  The
balance of the equity of the Trust is comprised of mandatorily redeemable
preferred securities.





On March
30, 2006 the Company issued $5,155,000 of junior subordinated debt securities
(the “debt securities”) to Bridge Capital Trust II, a statutory trust created
under the laws of the State of Delaware.  These debt securities are
subordinated to effectively all borrowings of the Company and are due and
payable in March 2037.  Interest is payable quarterly on these debt
securities at a fixed rate of  6.60% for the first five years, and
thereafter interest accrues at LIBOR plus 1.38%.  The debt securities
can be redeemed at par at the Company’s option beginning in April 2011; they can
also be redeemed at par if certain events occur that impact the tax treatment or
the capital treatment of the issuance.





The
Company also purchased a 3% minority interest in the Trust.  The
balance of the equity of the Trust is comprised of mandatorily redeemable
preferred securities.





Under
FASB Interpretation No.46 (FIN 46), Consolidation of Variable Interest Entities,
an interpretation of ARB No. 51, these Trusts are not consolidated into the
company’s financial statements.  Prior to the issuance of FIN 46, bank
holding companies typically consolidated these entities.  The Federal
Reserve Board has ruled that subordinated notes payable to unconsolidated
special purpose entities (“SPE’s”) such as these Trusts, net of the bank holding
company’s investment in the SPE, qualify as Tier 1 Capital, subject to certain
limits.





12





Other
Borrowings





There
were no other borrowings at September 30, 2009 and $30.0 million in other
borrowings at December 31, 2008.





As of
September 30, 2009, the Company had a total borrowing capacity with the Federal
Home Loan Bank of San Francisco of approximately $124.0 million for which the
Company had collateral in place to borrow $41.0 million.  As of
September 30, 2008, $12.0 million of this borrowing capacity was pledged to
secure a letter of credit.





The Bank
also has unsecured borrowing lines with correspondent banks totaling $25.0
million.  At September 30, 2009, there were no balances outstanding on
these lines.





7.           Stock-Based
Compensation




SFAS
No. 123R requires the use of a valuation model to calculate the fair value
of stock-based awards.  The Company has elected to use the BSM
option-pricing model, which incorporates various assumptions including
volatility, expected life, and interest rates.  The expected volatility is
based on the historical volatility of the Company’s common stock over the most
recent period commensurate with the estimated expected life of
the Company’s stock options, adjusted for the impact of unusual
fluctuations not reasonably expected to recur and other relevant factors
including implied volatility in market traded options on the Company’s common
stock. The expected life of an award is based on historical experience and on
the terms and conditions of the stock awards granted to employees.




The
weighted average assumptions used for the three and nine month periods ended
September 30, 2009 and 2008 and the resulting estimates of weighted-average fair
value per share of stock-based awards granted during those periods are as
follows:





Three months ended
                
                
                Nine months endedSeptember 30,
                
                
                September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Expected
      life
                
                75
      months
                
                
                75
      months
                
                
                75
      months
                
                
                75
      monthsStock
      volatility
                
                
                28.00
                %
                
                
                22.00
                %
                
                
                28.00
                %
                
                
                22.00
                %Risk
      free interest rate
                
                
                2.74
                %
                
                
                3.19
                %
                
                
                2.21
                %
                
                
                3.25
                %Dividend
      yield
                
                
                0.00
                %
                
                
                0.00
                %
                
                
                0.00
                %
                
                
                0.00
                %Fair
      value per share
                
                $
                1.94
                
                
                $
                3.53
                
                
                $
                1.68
                
                
                $
                4.96





8.           Fair
Values of Assets and Liabilities





In
accordance with SFAS No. 157, the Company groups its financial assets and
financial liabilities measured at fair value in three levels, based on the
markets in which the assets and liabilities are traded and the reliability of
the assumptions used to determine fair value.  These levels
are:





Level 1 –
Valuations for assets and liabilities traded in active exchange markets, such as
the New York Stock Exchange.  Level 1 also includes U.S. Treasury,
other U.S. government and agency mortgage-backed securities that are traded by
dealers or brokers in active markets.  Valuations are obtained from
readily available pricing sources for market transactions involving identical
assets or liabilities.





Level 2 –
Valuations for assets and liabilities traded in less active dealer or broker
markets.  Valuations are obtained from third party pricing services
for identical or comparable assets or liabilities.





Level 3 –
Valuations for assets and liabilities that are derived from other valuation
methodologies, including option pricing models, discounted cash flow models and
similar techniques, and not based on market exchange, dealer, or broker traded
transactions.  Level 3 valuations incorporate certain assumptions and
projections in determining the fair value assigned to such assets or
liabilities.




13


The
balances of assets and liabilities measured at fair value on a recurring basis
are as follows:





(dollars in thousands)
                
                As of September 30, 2009Total
                
                
                Level 1
                
                
                Level 2
                
                
                Level 3Securities
      available for sale
                
                $
                40,761
                
                
                $
                40,761
                
                
                $
                -
                
                
                $
                -Impaired
      loans
                
                $
                27,745
                
                
                
                -
                
                
                
                -
                
                
                
                27,745Cash
      flow hedge
                
                
                986
                
                
                
                -
                
                
                
                986
                
                
                
                -Warrant
      portfolio
                
                
                743
                
                
                
                -
                
                
                
                -
                
                
                
                743Mortgage
      servicing rights
                
                
                711
                
                
                
                -
                
                
                
                711
                
                
                
                -Total
                
                $
                70,946
                
                
                $
                40,761
                
                
                $
                1,697
                
                
                $
                28,488





The
changes in Level 3 assets and liabilities measured at fair value on a recurring
basis were not material for the quarter ended September 30, 2009.





The
Company may be required, from time to time, to measure certain other financial
assets at fair value on a non-recurring basis in accordance with
GAAP.  These adjustments to fair value usually result from application
of lower-of-cost-or-market accounting or write-downs of individual
assets.  The assets measured at fair value on a non-recurring basis
were not material for the quarter ended September 30, 2009.





The
following estimated fair value amounts have been determined by using available
market information and appropriate valuation methodologies.  However,
considerable judgment is required to interpret market data to develop the
estimates of fair value.  Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current market
exchange.  The use of different market assumptions and/or estimation
techniques may have a material effect on the estimated fair value
amounts.





The
following table presents the carrying amount and estimated fair value of certain
assets and liabilities of the Company at September 30, 2009 and December 31,
2008.  The carrying amounts reported in the balance sheets approximate
fair value for the following financial instruments: cash and due from banks,
federal funds sold, interest-bearing deposits in other banks, demand and savings
deposits (see Note 3 for information regarding securities).





(dollars in thousands)September 30, 2009
                    
                    
                    December 30, 2008Carrying
                    
                    
                    Fair
                    
                    
                    Carrying
                    
                    
                    FairValue
                    
                    
                    Value
                    
                    
                    Value
                    
                    
                    ValueFinancial
      assets:Cash
      and due from banks
                    
                    $
                    15,327
                    
                    
                    $
                    15,327
                    
                    
                    $
                    18,421
                    
                    
                    $
                    18,421Federal
      funds sold
                    
                    
                    157,845
                    
                    
                    
                    157,845
                    
                    
                    
                    199,525
                    
                    
                    
                    199,525Interest
      bearing depositsin
      other banks
                    
                    
                    19,120
                    
                    
                    
                    19,077
                    
                    
                    
                    7,268
                    
                    
                    
                    7,256Investments
      securities
                    
                    
                    40,761
                    
                    
                    
                    39,991
                    
                    
                    
                    -
                    
                    
                    
                    -Loans
      and leases, gross
                    
                    
                    573,694
                    
                    
                    
                    581,504
                    
                    
                    
                    699,780
                    
                    
                    
                    721,856Bank
      owned life insurance
                    
                    
                    9,882
                    
                    
                    
                    9,882
                    
                    
                    
                    9,580
                    
                    
                    
                    9,580Cash
      flow hedge
                    
                    
                    (953
                    )
                    
                    
                    (953
                    )
                    
                    
                    (1,445
                    )
                    
                    
                    (1,445
                    )Financial
      liabilities:Deposits
                    
                    
                    692,060
                    
                    
                    
                    690,389
                    
                    
                    
                    777,246
                    
                    
                    
                    775,922Trust
      preferred securities
                    
                    
                    17,527
                    
                    
                    
                    17,843
                    
                    
                    
                    17,527
                    
                    
                    
                    17,595Other
      borrowings
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    30,000
                    
                    
                    
                    29,959





14





Loans




The fair
value of loans with fixed rates is estimated by discounting the future cash
flows using current rates at which similar loans would be made to borrowers with
similar credit ratings.  For loans with variable rates that adjust
with changes in market rates of interest, the carrying amount is a reasonable
estimate of fair value.





Time
deposits




The fair
value of fixed maturity certificates of deposit is estimated using rates
currently offered for deposits of similar remaining maturities.





Commitments
to extend credit and standby letters of credit




Commitments
to extend credit and standby letters of credit are issued in the normal course
of business by the Bank.  Commitments to extend credit are issued with
variable interest rates tied to market interest rates at the time the
commitments are funded and the amount of the commitments equals their fair
value.  Standby letters of credit are supported by commitments to
extend credit with variable interest rates tied to market interest rates at the
time the commitments are funded.





9.           Derivatives
and Hedging Activities





The
Company is exposed to certain risks arising from both its business operations
and economic conditions.  The Company principally manages its
exposures to a wide variety of business and operational risks through management
of its core business activities. The Company manages economic risks, including
interest rate, liquidity, and credit risk, primarily by managing the amount,
sources, and duration of its assets and liabilities and through the use of
derivative financial instruments.  Specifically, the Company enters
into derivative financial instruments to manage exposures that arise from
business activities that result in the receipt or payment of future known and
uncertain cash amounts, the value of which are determined by interest
rates.  The Company’s derivative financial instruments are used to
manage differences in the amount, timing, and duration of the Company’s known or
expected cash receipts and its known or expected cash payments principally
related to certain variable rate loan assets and variable rate
borrowings.  The Company does not use derivatives for trading or
speculative purposes and currently does not have any derivatives that are not
designated in qualifying hedging relationships.





Fair
Values of Derivative Instruments on the Balance Sheet





The table
below presents the fair value of the Company’s derivative instruments that were
liabilities, as well as their classification on the balance sheet, as of
September 30, 2009 and December 31, 2008.  The Company did not have
any derivative instruments that were assets as of September 30, 2009 and
December 31, 2008.





(dollars
in thousands)





Fair ValueDerivatives Designated as Hedging
                      
                      Balance Sheet
                      
                      September 30,
                      
                      
                      December 31,Instruments
      Under SFAS 133
                      
                      Location
                      
                      2009
                      
                      
                      2008Interest
      rate contracts
                      
                      Other
      assets
                      
                      $
                      -
                      
                      
                      $
                      (1,445
                      )Interest
      rate contracts
                      
                      Other liabilities
                      
                      $
                      (953
                      )
                      
                      $
                      -Total
      hedged derivatives
                      
                      
                      
                      $
                      (953
                      )
                      
                      $
                      (1,445
                      )




15


Cash
Flow Hedges of Interest Rate Risk





The
Company’s objectives in using interest rate derivatives are to add stability to
interest income and expense and to manage its exposure to interest rate
movements. To accomplish this objective, the Company primarily uses interest
rate swaps as part of its interest rate risk management strategy.  For
hedges of the Company’s variable-rate loan assets, interest rate swaps
designated as cash flow hedges involve the receipt of fixed-rate amounts from a
counterparty in exchange for the Company making variable-rate payments over the
life of the agreements without exchange of the underlying notional
amount.  For hedges of the Company’s variable-rate borrowings,
interest rate swaps designated as cash flow hedges involve the receipt of
variable-rate amounts from a counterparty in exchange for the Company making
fixed-rate payments. As of September 30, 2009, the Company had two interest rate
swaps with an aggregate notional amount of $17.5 million that were designated as
cash flow hedges of interest rate risk associated with the Company’s
variable-rate borrowings.





The
effective portion of changes in the fair value of derivatives designated and
that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive
Income (“AOCI”) and is subsequently reclassified into earnings in the period
that the hedged forecasted transaction affects earnings. During the three and
nine months ended September 30, 2009 and 2008, such derivatives were used to
hedge the forecasted variable cash outflows associated with subordinated debt
related to trust preferred securities.  During the three and nine
months ended September 30, 2008, interest rate derivatives, which have since
been terminated, were also used to hedge the cash inflows associated with
existing pools of Prime-based loan assets.  During the three and nine
months ended September 30, 2009, the amount of pre-tax gain/(loss) recorded in
AOCI due to the effective portion of changes in fair value of derivatives
designated as cash flow hedges was $(398,000) and $460,000,
respectively.  During the three and nine months ended September 30,
2008, the amount of pre-tax gain recorded in AOCI due to the effective portion
of changes in fair value of derivatives designated as cash flow hedges was $1.5
million and $2.3 million, respectively.  During the three and nine
months ended September 30, 2009, $135,000 and $487,000, respectively was
reclassified into earnings related to the effective portion of cash flow
hedges.  During the three and nine months ended September 30, 2008,
$550,000 and $1.5 million, respectively was reclassified into earnings related
to the effective portion of cash flow hedges.





The
ineffective portion of the change in fair value of the derivatives is recognized
directly in earnings. During the three and nine months ended September 30, 2008,
the Company recognized a loss of $133,000 and $198,000, respectively, for hedge
ineffectiveness attributable to a mismatch between the swap notional and the
aggregate principal amount of the designated loan pools. No hedge
ineffectiveness was recognized during the three and nine months ended September
30, 2009.





Amounts
reported in AOCI related to derivatives will be reclassified to interest income
or expense, as applicable, as interest payments are received / made on the
Company’s variable-rate assets/liabilities. During the next twelve months, the
Company estimates that $338,000 will be reclassified as an increase to interest
income and $227,000 will be reclassified as an increase to interest
expense.  During the three and nine months ended September 30, 2009
and 2008, the Company accelerated the reclassification of amounts in other
comprehensive income to earnings as a result of the hedged forecasted
transactions related to certain terminated interest rate swaps becoming probable
not to occur.  The accelerated amounts for the three and nine months
ended September 30, 2009 were a gain of $301,000 and $3.2 million, respectively.
The accelerated amounts for the three and nine months ended September 30, 2008
were a gain of $113,000 and $486,000, respectively.





The
tables below presents the effect of the Company’s derivative financial
instruments, interest rate contracts, on the income statement for the three and
nine months ended September 30, 2009 and 2008.


16





Interest Income
                                                    
                                                    
                                                    Non-Interest Income
                                                    
                                                    
                                                    Total IncomeThree months ended
                                                    
                                                    
                                                    Three months ended
                                                    
                                                    
                                                    Three months endedSeptember 30,
                                                    
                                                    
                                                    September 30,
                                                    
                                                    
                                                    September 30,2009
                                                    
                                                    
                                                    2008
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    2008
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    2008Amount
      of gain reclassified from AOCIinto
      income - effective portion
                                                    
                                                    $
                                                    135
                                                    
                                                    
                                                    $
                                                    550
                                                    
                                                    
                                                    $
                                                    301
                                                    
                                                    
                                                    $
                                                    113
                                                    
                                                    
                                                    $
                                                    436
                                                    
                                                    
                                                    $
                                                    663Amount
      of gain recognized in incomeon
      derivative - ineffective portion andamount
      excluded from effectivenesstesting
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (133
                                                    )
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (133
                                                    )Total
      derivative income
                                                    
                                                    $
                                                    135
                                                    
                                                    
                                                    $
                                                    550
                                                    
                                                    
                                                    $
                                                    301
                                                    
                                                    
                                                    $
                                                    (20
                                                    )
                                                    
                                                    $
                                                    436
                                                    
                                                    
                                                    $
                                                    530Interest
      Income
                                                    
                                                    
                                                    Non-Interest
      Income
                                                    
                                                    
                                                    Total
      IncomeNine
      months ended
                                                    
                                                    
                                                    Nine
      months ended
                                                    
                                                    
                                                    Nine
      months endedSeptember
      30,
                                                    
                                                    
                                                    September
      30,
                                                    
                                                    
                                                    September
      30,2009
                                                    
                                                    
                                                    2008
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    2008
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    2008Amount
      of gain reclassified from AOCIinto
      income - effective portion
                                                    
                                                    $
                                                    487
                                                    
                                                    
                                                    $
                                                    1,494
                                                    
                                                    
                                                    $
                                                    3,221
                                                    
                                                    
                                                    $
                                                    486
                                                    
                                                    
                                                    $
                                                    3,708
                                                    
                                                    
                                                    $
                                                    1,980Amount
      of gain recognized in incomeon
      derivative - ineffective portion andamount
      excluded from effectivenesstesting
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (198
                                                    )
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (198
                                                    )Total
      derivative income
                                                    
                                                    $
                                                    487
                                                    
                                                    
                                                    $
                                                    1,494
                                                    
                                                    
                                                    $
                                                    3,221
                                                    
                                                    
                                                    $
                                                    288
                                                    
                                                    
                                                    $
                                                    3,708
                                                    
                                                    
                                                    $
                                                    1,782





Credit
Risk Related Contingent Features





The
Company has an agreement with one of its derivative counterparties that contain
a provision where if the Company defaults on any of its indebtedness,
including default where repayment of the indebtedness has not been
accelerated by the lender, then the Company could also be declared in
default on its derivative obligations.




The
Company also has agreements with certain of its derivative counterparties that
contain a provision where if the Company fails to maintain its status as a well
/ adequate capitalized institution, then the counterparty could terminate the
derivative positions and the Company would be required to settle its obligations
under the agreements.





As of
September 30, 2009 the fair value of derivatives in a net liability position,
which includes accrued interest but excludes any adjustment for nonperformance
risk, related to these agreements was $933,000. As of September 30, 2009, the
Company has minimum collateral posting thresholds with certain of its derivative
counterparties and has posted collateral of $890,000 against its obligations
under these agreements. If the Company had breached any of these provisions at
September 30, 2009, it would have been required to settle its obligations under
the agreements at the termination value.


17


10.           Preferred
Stock




On
November 13, 2008, the United States Treasury Department (the Treasury) approved
the Company’s participation in the TARP Capital Purchase Program, subject to the
Company raising additional equity in an amount satisfactory to
Treasury.  On December 4, 2008, investors agreed to purchase $30
million of the Company’s Series B and B-1 Mandatorily Convertible Cumulative
Perpetual Preferred Stock in a private placement, subject to the Treasury
approving the Company’s participation in the TARP Capital Purchase Program and
its ability to satisfy all legal requirements for selling equity securities to
the Treasury under the program.  Based on discussions with the
Treasury representatives, the Company understood that raising $30 million would
satisfy the requirement that we raise additional equity.  The Company
sold $30 million of our Series B and B-1 Preferred Stock in a private placement
on December 17, 2008 and subsequently sold $23.9 million in TARP securities to
the Treasury on December 23, 2008.  In addition the Company issued a
warrant to the Treasury to purchase up to 396,412 shares of the Company’s common
stock.  See “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Capital Resources” for additional
preferred stock discussion.




The
Company performed a net present value calculation to determine a relative fair
value of $17.7 million for the preferred stock issued to the U.S. Treasury
Department.  The calculation assumed that the preferred stock would be
repurchased by the Company in five years and utilized a twelve percent discount
rate.




The
Company performed a Black-Scholes calculation to determine a relative fair value
of $52,000 for the warrants issued to the U.S. Treasury
Department.  The calculation assumed the following:




Company
      Stock Price
                  
                  $
                  4.40Warrant
      Conversion Price
                  
                  $
                  9.03Expected
      Life (Years)
                  
                  
                  5.00Annualized
      Volatility
                  
                  
                  22.00
                  %Annual
      Dividend Rate
                  
                  
                  0.00
                  %Discount
      Rate (Bond Equivalent Rate)
                  
                  
                  1.53
                  %




In order
to determine the amount of TARP capital that should be allocated to the
warrants, the Company calculated a warrant allocation ratio (APB Opinion No.
14).  This ratio is equal to the value of the fair value of the
warrants divided by the sum of the fair value of the warrants plus the fair
value of the straight preferred stock.  This ratio was then multiplied
by the total amount of TARP capital issued resulting in a value of approximately
$70,000 being allocated to the warrants (i.e. the discount on the TARP related
preferred stock).  The assumed life of the warrants is five years and
therefore the discount is being amortized over that time period.  Due
to immateriality, the discount is being amortized utilizing the straight-line
method.  Additionally, the amortization of the discount has been
immaterial to net income available to common shareholders and has had no impact
on earnings per common share.


18


ITEM
2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





In
addition to the historical information, this quarterly report contains certain
forward-looking information 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, and which are subject to the “Safe Harbor” created by those
sections.   The reader of this quarterly report should understand
that all such forward-looking statements are subject to various uncertainties
and risks that could affect their outcome.  The Company’s actual
results could differ materially from those suggested by such forward-looking
statements.     Such risks and uncertainties include,
among others, (1) competitive pressure in the banking industry increases
significantly; (2) changes in interest rate environment reduces margin; (3)
general economic conditions, either nationally or regionally are less favorable
than expected, resulting in, among other things, a deterioration in credit
quality; (4) changes in the regulatory environment; (5) changes in business
conditions and inflation; (6) costs and expenses of complying with the internal
control provisions of the Sarbanes-Oxley Act and our degree of success in
achieving compliance; (7) changes in securities markets; (8) future credit loss
experience; (9) civil disturbances of terrorist threats or acts, or apprehension
about possible future occurrences of acts of this type; and (10) the involvement
of the United States in war or other hostilities.  Therefore, the
information in this quarterly report should be carefully considered when
evaluating the business prospects of the Company.





Critical
Accounting Policies





Our
accounting policies are integral to understanding the results
reported.  Our most complex accounting policies require management’s
judgment to ascertain the valuation of assets, liabilities, commitments and
contingencies. We have established detailed policies and control procedures that
are intended to ensure that valuation methods are well controlled and applied
consistently from period to period. In addition, the policies and procedures are
intended to ensure that the process for changing methodologies occurs in an
appropriate manner. The following is a brief description of our current
accounting policies involving significant management valuation
judgments.





Allowance
for Loan Losses: The allowance for loan losses represents management’s best
estimate of losses inherent in the existing loan portfolio. The allowance for
loan losses is increased by the provision for loan losses charged to expense and
reduced by loans charged off, net of recoveries. The provision for loan losses
is determined based on management’s assessment of several factors: reviews and
evaluation of specific loans, changes in the nature and volume of the loan
portfolio, current economic conditions and the related impact on specific
borrowers and industry groups, historical loan loss experiences, the level of
classified and nonperforming loans and the results of regulatory
examinations.





Loans are
considered impaired if, based on current information and events, it is probable
that we will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement. The
measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the historical effective interest rate
stipulated in the loan agreement, except that all collateral-dependent loans are
measured for impairment based on the fair value of the collateral. In measuring
the fair value of the collateral, management uses assumptions and methodologies
consistent with those that would be utilized by unrelated third
parties.





Changes
in the financial condition of individual borrowers, in economic conditions, in
historical loss experience and in the condition of the various markets in which
collateral may be sold may all affect the required level of the allowance for
loan losses and the associated provision for loan losses.





The
accrual of interest on loans is discontinued and any accrued and unpaid interest
is reversed when, in the opinion of management, there is significant doubt as to
the collectability of interest or principal or when the payment of principal or
interest is ninety days past due, unless the amount is well-secured and in the
process of collection.





The
Company has the ability and the intent to sell all or a portion of certain SBA
loans in the loan portfolio and, as such, carries the saleable portion of these
loans at the lower of aggregate cost or fair value.  At September 30,
2009 and December 31, 2008, the fair value of SBA loans exceeded aggregate cost
and therefore, SBA loans were carried at aggregate cost.





In
calculating gain on the sale of SBA loans, the Company performs an allocation
based on the relative fair values of the sold portion and retained portion of
the loan.  The Company’s assumptions are validated by reference to external
market information.


19


Available-for-sale
securities: the fair value of most securities classified as available-for-sale
is based on quoted market prices. If quoted market prices are not available,
fair values are extrapolated from the quoted prices of similar
instruments.





Supplemental
Employee Retirement Plan:  The Company has entered into supplemental
employee retirement agreements with certain executive and senior
officers.  The measurement of the liability under these agreements
includes estimates involving life expectancy, length of time before retirement,
and expected benefit levels.  Should these estimates prove materially
wrong, we could incur additional or reduced expense to provide the
benefits.


20


Selected
Financial Data





The
following table reflects selected financial data and ratios as of and for the
quarters and nine months ended September 30, 2009 and 2008.





(dollars
in thousands, except per share data)





Three
      months ended
                              
                              
                              Nine
      months endedSeptember
      30,
                              
                              
                              September
      30,Statement
      of Operations Data:
                              
                              2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Interest
      income
                              
                              $
                              10,515
                              
                              
                              $
                              14,258
                              
                              
                              $
                              33,951
                              
                              
                              $
                              45,227Interest
      expense
                              
                              
                              1,523
                              
                              
                              
                              3,271
                              
                              
                              
                              5,616
                              
                              
                              
                              10,484Net
      interest income
                              
                              
                              8,992
                              
                              
                              
                              10,987
                              
                              
                              
                              28,335
                              
                              
                              
                              34,743Provision
      for credit losses
                              
                              
                              650
                              
                              
                              
                              19,000
                              
                              
                              
                              8,300
                              
                              
                              
                              27,570Net
      interest income after provisionfor
      credit losses
                              
                              
                              8,342
                              
                              
                              
                              (8,013
                              )
                              
                              
                              20,035
                              
                              
                              
                              7,173Other
      income
                              
                              
                              1,689
                              
                              
                              
                              1,955
                              
                              
                              
                              8,019
                              
                              
                              
                              5,341Other
      expenses
                              
                              
                              9,202
                              
                              
                              
                              9,802
                              
                              
                              
                              28,008
                              
                              
                              
                              28,049Income
      (loss) before income taxes
                              
                              
                              829
                              
                              
                              
                              (15,860
                              )
                              
                              
                              46
                              
                              
                              
                              (15,535
                              )Income
      taxes
                              
                              
                              290
                              
                              
                              
                              (6,655
                              )
                              
                              
                              16
                              
                              
                              
                              (6,525
                              )Net
      income (loss)
                              
                              $
                              539
                              
                              
                              $
                              (9,205
                              )
                              
                              $
                              30
                              
                              
                              $
                              (9,010
                              )Preferred
      dividends
                              
                              
                              1,064
                              
                              
                              
                              -
                              
                              
                              
                              3,138
                              
                              
                              
                              -Net
      income available tocommon
      shareholders
                              
                              $
                              (525
                              )
                              
                              $
                              (9,205
                              )
                              
                              $
                              (3,108
                              )
                              
                              $
                              (9,010
                              )Per
      Share Data:Basic
      earnings (loss) per share
                              
                              $
                              (0.08
                              )
                              
                              $
                              (1.41
                              )
                              
                              $
                              (0.47
                              )
                              
                              $
                              (1.38
                              )Diluted
      earnings (loss) per share
                              
                              $
                              (0.08
                              )
                              
                              
                              (1.41
                              )
                              
                              
                              (0.47
                              )
                              
                              
                              (1.38
                              )Book
      value per common share
                              
                              
                              7.83
                              
                              
                              
                              8.74
                              
                              
                              
                              7.83
                              
                              
                              
                              8.74Cash
      dividend per common share
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Balance
      Sheet Data:Balance
      sheet totals:Assets
                              
                              $
                              834,828
                              
                              
                              $
                              855,407Loans,
      net
                              
                              
                              555,254
                              
                              
                              
                              667,142Deposits
                              
                              
                              692,059
                              
                              
                              
                              738,739Shareholders'
      equity
                              
                              
                              108,701
                              
                              
                              
                              57,691Average
      balance sheet amounts:Assets
                              
                              $
                              854,247
                              
                              
                              $
                              858,555
                              
                              
                              $
                              874,329
                              
                              
                              $
                              814,683Gross
      loans
                              
                              
                              589,343
                              
                              
                              
                              705,402
                              
                              
                              
                              630,354
                              
                              
                              
                              684,690Deposits
                              
                              
                              714,497
                              
                              
                              
                              763,361
                              
                              
                              
                              722,275
                              
                              
                              
                              715,224Shareholders'
      equity
                              
                              
                              109,160
                              
                              
                              
                              67,222
                              
                              
                              
                              110,933
                              
                              
                              
                              68,017Selected
      Ratios:Return
      on average assets
                              
                              
                              0.25
                              %
                              
                              
                              -4.27
                              %
                              
                              
                              0.00
                              %
                              
                              
                              -1.48
                              %Return
      on average equity
                              
                              
                              1.96
                              %
                              
                              
                              -54.48
                              %
                              
                              
                              0.04
                              %
                              
                              
                              -17.69
                              %Efficiency
      ratio
                              
                              
                              86.15
                              %
                              
                              
                              75.74
                              %
                              
                              
                              77.04
                              %
                              
                              
                              69.98
                              %Total
      risk based capital ratio
                              
                              
                              19.57
                              %
                              
                              
                              10.27
                              %Net
      chargeoffs to average gross loans
                              
                              
                              0.30
                              %
                              
                              
                              2.31
                              %
                              
                              
                              1.58
                              %
                              
                              
                              2.69
                              %Allowance
      for loan losses to total loans
                              
                              
                              2.95
                              %
                              
                              
                              2.59
                              %Average
      equity to average assets
                              
                              
                              12.78
                              %
                              
                              
                              7.83
                              %
                              
                              
                              12.69
                              %
                              
                              
                              8.35
                              %


21


Summary
of Financial Results – Quarter ended September 30, 2009





The
Company reported a net loss available to common shareholders of $(0.5) million,
or $(0.08) per diluted common share, for the three months ended September 30,
2009 representing a decrease in net loss of $8.7 million, or 94.3%, compared to
a net loss of $9.2 million, or $(1.41) per diluted common share, for the same
period one year ago.  The net loss available to common shareholders
was impacted by preferred dividends of $1.1 million during the third quarter of
2009.  There were no preferred dividends during the third quarter of
2008.  The increase in earnings resulted primarily from a decrease in
provision for credit losses.





The table
below highlights the changes in the nature and sources of income and
expense.





Three
      months endedSeptember
      30,
                      
                      
                      Increase(dollars
      in thousands)
                      
                      2009
                      
                      
                      2008
                      
                      
                      (Decrease)Interest
      income
                      
                      $
                      10,515
                      
                      
                      $
                      14,258
                      
                      
                      $
                      (3,743
                      )Interest
      expense
                      
                      
                      1,523
                      
                      
                      
                      3,271
                      
                      
                      
                      (1,748
                      )Net
      interest income
                      
                      
                      8,992
                      
                      
                      
                      10,987
                      
                      
                      
                      (1,995
                      )Provision
      for credit losses
                      
                      
                      650
                      
                      
                      
                      19,000
                      
                      
                      
                      (18,350
                      )Net
      interest income after provision for credit losses
                      
                      
                      8,342
                      
                      
                      
                      (8,013
                      )
                      
                      
                      16,355Other
      income
                      
                      
                      1,689
                      
                      
                      
                      1,955
                      
                      
                      
                      (266
                      )Other
      expenses
                      
                      
                      9,202
                      
                      
                      
                      9,802
                      
                      
                      
                      (600
                      )Income
      (loss) before income taxes
                      
                      
                      829
                      
                      
                      
                      (15,860
                      )
                      
                      
                      16,689Income
      taxes
                      
                      
                      290
                      
                      
                      
                      (6,655
                      )
                      
                      
                      6,945Net
      income (loss)
                      
                      $
                      539
                      
                      
                      $
                      (9,205
                      )
                      
                      $
                      9,744Preferred
      dividends
                      
                      
                      1,064
                      
                      
                      
                      0
                      
                      
                      
                      1,064Net
      income (loss) available to common shareholders
                      
                      $
                      (525
                      )
                      
                      $
                      (9,205
                      )
                      
                      $
                      8,680





Net
Interest Income and Margin





Net
interest income, the difference between interest earned on loans and investments
and interest paid on deposits is the principal component of the Company's
earnings.  Net interest income is affected by changes in the nature
and volume of earning assets held during the quarter, the rates earned on such
assets and the rates paid on interest bearing liabilities.





Net
interest income for the quarter ended September 30, 2009 was $9.0 million, which
was comprised of $10.5 million in interest income and $1.5 million in interest
expense. Net interest income for the quarter ended September 30, 2008 was $11.0
million, which was comprised of $14.3 million in interest income and $3.3
million in interest expense.  Net interest income for the quarter
ended September 30, 2009 represented a decrease of $2.0 million or 18.2% from
the same period one year earlier.





The
composition of the average balance sheet impacts growth in net interest
income.  For the quarter ended September 30, 2009 average earning
assets of $813.6 million represented a decrease of $7.6 million, or 0.9%,
compared to $821.2 million for the same period in 2008.  The Company’s
loan-to-deposit ratio, a measure of leverage, averaged 82.48% during the quarter
ended September 30, 2009, which represented a decrease compared to an average of
92.41% for the same quarter of 2008 as a result of slower loan growth relative
to deposit funding.





Changes
in short-term interest rates also impact growth in net interest income as the
interest rate earned on a majority of the Company’s assets, specifically the
loan portfolio, adjust with changes in short-term market rates.  As
such, the nature of the Company’s balance sheet is that, over time as short-term
interest rates change, income on interest earning assets has a greater impact on
net interest income than interest paid on liabilities.  The Company’s
prime rate averaged 3.25% in the quarter ended September 30, 2009 compared to
5.00% in the same period one year earlier.


22





The
Company’s net interest margin (net interest income divided by average earning
assets) for the quarter ended September 30, 2009 was 4.38% compared to 5.32% in
the same period one year earlier.  The decrease in net interest margin
from 2008 to 2009 was primarily a result of the decrease in short term interest
rates, a decrease in income from interest rate swaps, and an increased level of
nonperforming assets.  During the quarter ended September 30, 2009,
the net settlement from interest rate swaps contributed $135,000 to support net
interest income compared to $550,000 for the quarter ended September 30,
2008.  The increased level of nonperforming assets resulted in a
negative impact on the Company’s net interest margin of 29 basis points in the
third quarter of 2009 from reversed or foregone interest.





The
following table details the average balances, interest income and expense and
the effective yields/rates for earning assets and interest-bearing liabilities
for the quarters ended September 30, 2009 and 2008.





Three
      months ended September 30,(dollars
      in thousands)
                                    
                                    2009
                                    
                                    
                                    2008Yields
                                    
                                    
                                    Interest
                                    
                                    
                                    
                                    
                                    
                                    Yields
                                    
                                    
                                    InterestAverage
                                    
                                    
                                    or
                                    
                                    
                                    Income/
                                    
                                    
                                    Average
                                    
                                    
                                    or
                                    
                                    
                                    Income/Balance
                                    
                                    
                                    Rates
                                    
                                    
                                    Expense
                                    
                                    
                                    Balance
                                    
                                    
                                    Rates
                                    
                                    
                                    ExpenseASSETSInterest
      earning assets (2):Loans
      (1)
                                    
                                    $
                                    589,343
                                    
                                    
                                    
                                    6.9
                                    %
                                    
                                    $
                                    10,181
                                    
                                    
                                    $
                                    705,402
                                    
                                    
                                    
                                    7.7
                                    %
                                    
                                    $
                                    13,632Federal
      funds sold
                                    
                                    
                                    167,480
                                    
                                    
                                    
                                    0.3
                                    %
                                    
                                    
                                    106
                                    
                                    
                                    
                                    104,909
                                    
                                    
                                    
                                    1.9
                                    %
                                    
                                    
                                    512Investment
      securities
                                    
                                    
                                    35,161
                                    
                                    
                                    
                                    1.3
                                    %
                                    
                                    
                                    117
                                    
                                    
                                    
                                    5,419
                                    
                                    
                                    
                                    5.1
                                    %
                                    
                                    
                                    69Other
                                    
                                    
                                    21,591
                                    
                                    
                                    
                                    2.0
                                    %
                                    
                                    
                                    111
                                    
                                    
                                    
                                    5,481
                                    
                                    
                                    
                                    3.3
                                    %
                                    
                                    
                                    45Total
      interest earning assets
                                    
                                    
                                    813,575
                                    
                                    
                                    
                                    5.1
                                    %
                                    
                                    
                                    10,515
                                    
                                    
                                    
                                    821,211
                                    
                                    
                                    
                                    6.9
                                    %
                                    
                                    
                                    14,258Noninterest-earning
      assets:Cash
      and due from banks
                                    
                                    
                                    15,185
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    18,154All
      other assets (3)
                                    
                                    
                                    25,487
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    19,190TOTAL
                                    
                                    $
                                    854,247
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    858,555LIABILITIES AND
      SHAREHOLDERS'
      EQUITYInterest
      bearing liabilities:Deposits:Demand
                                    
                                    $
                                    4,349
                                    
                                    
                                    
                                    0.1
                                    %
                                    
                                    $
                                    1
                                    
                                    
                                    $
                                    5,340
                                    
                                    
                                    
                                    0.2
                                    %
                                    
                                    $
                                    3Savings
                                    
                                    
                                    280,640
                                    
                                    
                                    
                                    0.6
                                    %
                                    
                                    
                                    435
                                    
                                    
                                    
                                    420,900
                                    
                                    
                                    
                                    2.0
                                    %
                                    
                                    
                                    2,083Time
                                    
                                    
                                    137,139
                                    
                                    
                                    
                                    2.4
                                    %
                                    
                                    
                                    826
                                    
                                    
                                    
                                    99,290
                                    
                                    
                                    
                                    3.6
                                    %
                                    
                                    
                                    894Other
                                    
                                    
                                    17,527
                                    
                                    
                                    
                                    5.9
                                    %
                                    
                                    
                                    261
                                    
                                    
                                    
                                    21,386
                                    
                                    
                                    
                                    5.4
                                    %
                                    
                                    
                                    291Total
      interest bearing liabilities
                                    
                                    
                                    439,655
                                    
                                    
                                    
                                    1.4
                                    %
                                    
                                    
                                    1,523
                                    
                                    
                                    
                                    546,916
                                    
                                    
                                    
                                    2.4
                                    %
                                    
                                    
                                    3,271Noninterest-bearing
      liabilities:Demand
      deposits
                                    
                                    
                                    292,370
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    237,831Accrued
      expenses andother
      liabilities
                                    
                                    
                                    13,062
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    6,586Shareholders'
      equity
                                    
                                    
                                    109,160
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    67,222TOTAL
                                    
                                    $
                                    854,247
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    858,555Net
      interest income and margin
                                    
                                    
                                    
                                    
                                    
                                    
                                    4.4
                                    %
                                    
                                    $
                                    8,992
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    5.3
                                    %
                                    
                                    $
                                    10,987





(1)
            Loan
      fee amortization of $833,000 and $1.2 million, respectively, is included
      in interest income.  Nonperforming loans have been included in
      average loan balances.


(2)
            Interest
      income is reflected on an actual basis, not a fully taxable equivalent
      basis.  Yields are based on amortized
  cost.


(3)
            Net
      of average allowance for credit losses of $17.7 million and $15.8 million,
      respectively.


23





The
following table shows the effect of the interest differential of volume and rate
changes for the quarters ended September 30, 2009 and 2008.  The
change in interest due to both rate and volume has been allocated in proportion
to the relationship of absolute dollar amounts of change in each.





(dollars
      in thousands)
                                                    
                                                    Three
      months ended September 30,2009
      vs. 2008Increase
      (decrease)due
      to change inAverage
                                                    
                                                    
                                                    Average
                                                    
                                                    
                                                    TotalVolume
                                                    
                                                    
                                                    Rate
                                                    
                                                    
                                                    ChangeInterest
      income:Loans
                                                    
                                                    $
                                                    (2,005
                                                    )
                                                    
                                                    $
                                                    (1,446
                                                    )
                                                    
                                                    $
                                                    (3,451
                                                    )Federal
      funds sold
                                                    
                                                    
                                                    40
                                                    
                                                    
                                                    
                                                    (446
                                                    )
                                                    
                                                    
                                                    (406
                                                    )Investment
      securities
                                                    
                                                    
                                                    99
                                                    
                                                    
                                                    
                                                    (51
                                                    )
                                                    
                                                    
                                                    48Other
                                                    
                                                    
                                                    83
                                                    
                                                    
                                                    
                                                    (17
                                                    )
                                                    
                                                    
                                                    66Total
      interest income
                                                    
                                                    
                                                    (1,784
                                                    )
                                                    
                                                    
                                                    (1,959
                                                    )
                                                    
                                                    
                                                    (3,743
                                                    )Interest
      expense:Demand
                                                    
                                                    
                                                    (0
                                                    )
                                                    
                                                    
                                                    (2
                                                    )
                                                    
                                                    
                                                    (2
                                                    )Savings
                                                    
                                                    
                                                    (217
                                                    )
                                                    
                                                    
                                                    (1,431
                                                    )
                                                    
                                                    
                                                    (1,648
                                                    )Time
                                                    
                                                    
                                                    228
                                                    
                                                    
                                                    
                                                    (296
                                                    )
                                                    
                                                    
                                                    (68
                                                    )Other
                                                    
                                                    
                                                    (57
                                                    )
                                                    
                                                    
                                                    27
                                                    
                                                    
                                                    
                                                    (30
                                                    )Total
      interest expense
                                                    
                                                    
                                                    (47
                                                    )
                                                    
                                                    
                                                    (1,701
                                                    )
                                                    
                                                    
                                                    (1,748
                                                    )Change
      in net interest income
                                                    
                                                    $
                                                    (1,736
                                                    )
                                                    
                                                    $
                                                    (259
                                                    )
                                                    
                                                    $
                                                    (1,995
                                                    )





Net
interest income is the principal source of the Company’s operating
earnings.   Significant factors affecting net interest income
are: rates, volumes and mix of the loan, investment and deposit
portfolios.   Due to the nature of the Company’s lending markets,
in which the majority of loans are generally tied to prime rate, it is believed
that an increase in interest rates should positively affect the Company’s future
earnings, while a decline should have a negative impact.  However, it
is not feasible to provide an accurate measure of such a change because of the
many factors (many of them uncontrollable) influencing the result.





Interest Income





Interest
income of $10.5 million in the quarter ended September 30, 2009 represented a
decrease of $3.7 million, or 26.3%, from $14.3 million in the same quarter one
year earlier.  The decrease in interest income was primarily due to a
decrease in interest rates, a decrease in income from interest rate swaps, and
an increased level of nonperforming assets.





Average
gross loans were $589.3 million for three months ended September 30, 2009, a
decrease of $116.1 million or 16.5% from $705.4 million for the same period one
year earlier.  Average loans comprised 72.4% of average earning assets
in the three months ended September 30, 2009 compared to 85.9% in the third
quarter of 2008.





The
average yield on earning assets was 5.13% for the quarter ended September 30,
2009 and 6.91% for the quarter ended September 30, 2008.  As noted
above, the majority of the Company’s earning assets, including a majority of
loans, are priced to adjust with movements in short-term interest rates,
particularly the prime rate, and the decrease in yield was primarily due to
decreases in the prime rate during 2009 and the later part of 2008 and interest
reversed or foregone on nonperforming assets offset, in part, by income from
interest rate swaps.





Other
earning assets, consisting of investment securities, federal funds sold and
interest-bearing deposits, averaged $224.2 million for the quarter ended
September 30, 2009, an increase of $108.4 million or 93.6% from $115.8 million
for the three months ended September 30, 2008.


24




Interest
Expense




Interest
expense was $1.5 million for the quarter ended September 30, 2009, which
represented a decrease of $1.7 million, or 53.4% from $3.3 million for the
comparable period of 2008.  The decrease in interest expense reflects
lower interest rates paid on liabilities in 2009 compared to
2008.  Average interest-bearing liabilities were $439.7 million for
the three months ended September 30, 2009, a decrease of $107.3 million, or
19.6%, from $546.9 million for the same period one year earlier.





Average
interest bearing deposits were $422.1 million for the quarter ended September
30, 2009, which represented 96.0% of total average deposits and was a decrease
of $103.4 million, or 19.7%, from $525.5 million representing 96.1% of total
average deposits in the third quarter of 2008.





Other
(non-deposit) interest bearing liabilities are primarily comprised of junior
subordinated debt securities issued by the Company and other
borrowings.  The junior subordinated debt is intended to supplement
capital requirements of the Company at a rate of interest that is fixed for five
years.  Other interest bearing liabilities averaged $17.5 million and
$21.4 million in the three months ended September 30, 2009 and 2008,
respectively.





The
average rate paid on interest-bearing liabilities of 1.37% in the quarter ended
September 30, 2009 compared to 2.37% in the third quarter of 2008.





Credit
Risk and Provision for Credit Losses





The
Company maintains an allowance for credit losses which is based, in part, on the
Company's and industry loss experience, the impact of economic conditions within
the Company's market area and, as applicable, the State of California and/or
national macroeconomic conditions, the value of underlying collateral, loan
performance, and inherent risks in the loan portfolio. The allowance is reduced
by charge-offs and increased by provisions for credit losses charged to
operating expense and recoveries of previously charged-off loans.





The
Company provided $0.7 million to the allowance for credit losses for the three
months ended September 30, 2009, compared to $19.0 million for the same period
in 2008.





The
Company’s loan charge-offs totaled $1.7 million during the third quarter ended
September 30, 2009, compared to $15.9 million for the same period one year
earlier.  The Company recognized $11,000 and $34,000 in loan
recoveries for the three months ended September 30, 2009 and 2008,
respectively.





The
following schedule provides an analysis of the allowance for credit losses for
the quarter ended September 30, 2009 and 2008, respectively:





Three
      months ended(dollars
      in thousands)
                  
                  September
      30,2009
                  
                  
                  2008Balance,
      beginning of period
                  
                  $
                  17,968
                  
                  
                  $
                  14,608Provision
      for credit losses
                  
                  
                  650
                  
                  
                  
                  19,000Charge-offs
                  
                  
                  (1,707
                  )
                  
                  
                  (15,878
                  )Recoveries
                  
                  
                  11
                  
                  
                  
                  34Balance,
      end of period
                  
                  $
                  16,922
                  
                  
                  $
                  17,764





The
decrease in the allowance for loan losses of $0.8 million from $17.8 million at
September 30, 2008 to $16.9 million at September 30, 2009 is primarily
attributable to (1) a decrease in total gross loans; and (2) a decrease in
unidentified probable, estimable losses due to proactive loss recognition in the
earlier periods of the fiscal year.





Based on
an evaluation of the individual credits, historical credit loss experience by
loan type, economic conditions, and the Company’s reassessment of risks noted
above, management has allocated the allowance for loan losses as follows for the
periods ending September 30, 2009 and December 31, 2008:


25





(dollars
      in thousands)
                  
                  September
      30, 2009
                  
                  
                  December
      31, 2008Percent
      of
                  
                  
                  
                  
                  
                  Percent
      ofALLL in each
                  
                  
                  
                  
                  
                  ALLL in eachcategory
      to
                  
                  
                  
                  
                  
                  category
      toAmount
                  
                  
                  gross
      loans
                  
                  
                  Amount
                  
                  
                  gross
      loansCommercial
                  
                  $
                  7,374
                  
                  
                  
                  1.29
                  %
                  
                  $
                  6,179
                  
                  
                  
                  0.88
                  %SBA
                  
                  
                  1,125
                  
                  
                  
                  0.20
                  %
                  
                  
                  1,673
                  
                  
                  
                  0.24
                  %Real
      estate construction
                  
                  
                  3,044
                  
                  
                  
                  0.53
                  %
                  
                  
                  5,197
                  
                  
                  
                  0.74
                  %Land
      loans
                  
                  
                  970
                  
                  
                  
                  0.17
                  %
                  
                  
                  1,592
                  
                  
                  
                  0.23
                  %Real
      estate other
                  
                  
                  3,411
                  
                  
                  
                  0.59
                  %
                  
                  
                  2,495
                  
                  
                  
                  0.36
                  %Factoring/ABL
                  
                  
                  865
                  
                  
                  
                  0.15
                  %
                  
                  
                  1,222
                  
                  
                  
                  0.17
                  %Other
                  
                  
                  133
                  
                  
                  
                  0.02
                  %
                  
                  
                  196
                  
                  
                  
                  0.03
                  %$
                  16,922
                  
                  
                  
                  2.95
                  %
                  
                  $
                  18,554
                  
                  
                  
                  2.65
                  %





Beginning
in the second quarter of 2008, deterioration in economic conditions within the
Company's market area and, as applicable, the State of California and/or
national macroeconomic conditions resulted in increased stress to the loan
portfolio, specifically construction and land development loans outside of the
Company’s primary market of Santa Clara County and contiguous portions of San
Mateo and Alameda counties.





In
response to the deteriorating market conditions, the Company undertook steps to
aggressively reduce the exposure to construction and land development loans with
particular emphasis on loans outside of its primary
market.  Management curtailed new loan origination, thoroughly
reviewed collateral values of projects approaching maturity and conservatively
evaluated the market prospects of collateral for indications of
impairments.





At
September 30, 2009, the Company’s land development portfolio was reduced to
$13.5 million with just $7.1 million remaining exposure outside of the primary
market area.  Further, over 50% of the remaining loans in this
category are underwritten to amortizing term structures supported by cash flow
from liquidity of the borrowers.





Construction
loans at September 30, 2009 were reduced to $52.9 million with $19.5 million
remaining on projects outside of the primary market area.  In
addition, at that date $19.0 million, or 35.9%, were loans to finance commercial
projects and $9.4 million, or 17.7% were loans to finance residential projects
of five or more units.





The
aggressive management of credits in this category has resulted in elevated
levels of nonperforming assets as loans are placed on nonaccrual through the
marketing phase of the underlying project.  In addition, loans placed
on nonaccrual have been reduced to the level of indicated
impairments.  This has resulted in an elevated level of
charge-offs.  Management believes that this practice results in a
recorded level of nonperforming assets that generally has been reduced to a net
liquidation value, and as these assets are liquidated do not expect to incur
additional significant losses.  Non performing loans at September 30,
2009, on average, have been reduced by approximately 30% of the remaining
contractual balance, which was taken as a charge-off against the allowance for
loan losses.





In
response to the elevated level of charge-offs, migration of construction and
land portfolios, and general deterioration in economic conditions the Company
also increased provisions for potential loans losses and built the reserve to
approximately 2.95% of total loans.  The coverage ratio, the ratio of
allowance for loan losses to nonperforming loans was 60.99% at September 30,
2009.  Management believes that the coverage ratio reflects the
conservative charge-off practice and that the allowance is adequate for losses
not specifically identified in impairment analysis.





At
September 30, 2009 nonperforming assets represented 3.84% of total assets,
compared to 1.78% of total assets on December 31, 2008.  Nonperforming
assets have increased primarily as a result of substantial deterioration in the
real estate market and the Company’s commitment to aggressively manage credit
exposure.  The following summarizes nonperforming assets at September
30, 2009 and December 31, 2008.


26





September 30,
                      
                      
                      December 31,(dollars in
      thousands)
                      
                      2009
                      
                      
                      2008Loans
      accounted for on a non-accrual basis
                      
                      $
                      27,745
                      
                      
                      $
                      15,772Other
      loans with principal or interest contracturally past due90
      days or more
                      
                      
                      -
                      
                      
                      
                      -Total
      nonperforming loans
                      
                      
                      27,745
                      
                      
                      
                      15,772Other
      real estate owned
                      
                      
                      4,333
                      
                      
                      
                      1,096Total
      nonperforming assets
                      
                      $
                      32,078
                      
                      
                      $
                      16,868





The
nonperforming assets at September 30, 2009 consisted of loans on nonaccrual or
90 days or more past due totaling $27.7 million, and other real estate owned
valued at $4.3 million.  Nonperforming loans at September 30, 2009
were comprised of loans with legal contractual balances totaling approximately
$41.4 million reduced by impairment charges of $13.7 million which have been
charged against the allowance for credit losses.   As a result,
there no longer was an indicated potential loss exposure pertaining to
nonperforming loans and no impairment reserves were required to be included in
the allowance for credit losses.





The
following table sets forth the components of nonperforming loans as of September
30, 2009.


27





(dollars
in thousands)





September
      30, 2009Classification
                              
                              Amount
                              
                              CollateralLand
                              
                              $
                              2,482
                              
                              Lots
      for retail development in Sacramento CountyLand
                              
                              
                              956
                              
                              Lots
      for commercial development in Ventura CountyLand
                              
                              
                              911
                              
                              Lots
      for single family homes in IdahoLand
                              
                              
                              434
                              
                              Lots
      for single family homes and commercial office space in Alameda
      CountyLand
                              
                              
                              40
                              
                              Lot
      for single family home in Calaveras County4,823Construction
                              
                              
                              7,030
                              
                              Commercial
      condominiums in Sacramento CountyConstruction
                              
                              
                              3,327
                              
                              Condominiums/townhomes
      in Santa Clara CountyConstruction
                              
                              
                              2,849
                              
                              2
      completed SFRs in Morgan Hill, CAConstruction
                              
                              
                              1,927
                              
                              Residential
      property in Menlo Park, CaConstruction
                              
                              
                              346
                              
                              Partially
      completed home in San Mateo County15,479Real
      Estate Other
                              
                              
                              3,996
                              
                              RE
      Investment - officeReal
      Estate (SBA)
                              
                              
                              1,679
                              
                              Retail
      development in Southern CaliforniaReal
      Estate (SBA)
                              
                              
                              627
                              
                              RE
      Commercial, Owner occupied officeReal
      Estate Other
                              
                              
                              510
                              
                              Single
      family residence in Central CaliforniaReal
      Estate other
                              
                              
                              196
                              
                              Single
      family residencesReal
      Estate (SBA)
                              
                              
                              20
                              
                              RE
      Commercial, RetailReal
      Estate (SBA)
                              
                              
                              15
                              
                              RE
      Commercial, Warehouse7,043Commercial
                              
                              
                              294
                              
                              Previously
      Unsec, Currently D/TCommercial
                              
                              
                              102
                              
                              Business
      assetsCommercial
                              
                              
                              4
                              
                              None400Total
      nonperforming loans
                              
                              $
                              27,745




Management
undertakes significant processes in order to identify potential problem loans in
a timely manner.  In addition to regular interaction with the
Company’s borrowers, the relationship managers review the credit ratings for
each loan on a monthly basis and identify any potential
downgrades.  For commercial, SBA, and factoring/asset-based loans, the
Company receives quarterly financial statements and other pertinent reporting,
such as borrowing bases for asset-based facilities, so as to identify any
deteriorating financial trends.  Covenant compliance for these loans
is also monitored on a quarterly basis.  For real estate construction
and land loans, the development, construction and lease up or sell out status of
each project is monitored on a monthly basis.  For loans secured by
standing commercial or residential property, the Company receives updated rent
rolls and operating statements on an annual basis.  In addition, home
equity loans are reviewed annually for deterioration in either the underlying
property value or the borrower’s payment history.  Management also
engages a third party loan review firm that reviews the loan portfolio every
four months to further identify potential problem loans.  The loan
review includes assessment of underwriting, quality of legal documents,
management of the loan relationship, and adherence to the credit policy along
with acceptable risk mitigation and rationale for exceptions to the
policy.


28




As part
of the loan approval process, management identifies the nature and type of
underlying collateral supporting individual loans.  Prior to or at the
time of initial advances, any required lien positions are verified using UCC
lien searches for personal property collateral, or title insurance for real
property collateral.  The Company engages a third party loan review
firm to conduct an annual review of its loan documentation and the related
policies and procedures regarding the loan documentation process.




The
Company primarily relies on fair market appraisals to determine the value of
underlying collateral.  Appraisals are required for real property
secured loans of $250,000 or more, including increases to existing loans of
$250,000 or more.  In the event there is evidence of deterioration in
values, an evaluation of the collateral value and/or a full new appraisal is
required for an extension of the loan maturity.  Potential problem
loans are reappraised at a minimum of every 6-12 months depending on current
economic conditions. The appraisals are performed by Board approved appraisers
that have appropriate licensing and experience.  When a prospective
loan amount exceeds $1.5 million, the completed appraisal is further reviewed by
a qualified third party review appraiser.  To determine the value of
underlying collateral for formula lines of credit that are predicated on a
borrowing base of eligible assets, the Company requires a pre loan funding field
audit of the borrower’s financial records to verify the accounts receivable,
their eligibility for inclusion in the borrowing base, performance of the
collateral and any asset concentrations.




On a
monthly basis, relationship managers assess the collateral position of
individual loans and identify any potential collateral shortfalls which, if left
uncorrected, could result in deterioration of the repayment prospects for the
loan at some future date.  Any potential collateral shortfalls are
incorporated into a written corrective action plan.  The status of the
correction action plans are reviewed by executive management.  Review
of ability to acquire additional collateral and the related timeframes are
addressed on an individual loan basis.




At the
time a loan is classified as substandard (which includes any loans on
non-accrual), the Company performs an impairment analysis of the collateral
based on appraisals, field audits, other market value indicators, and
Management’s judgment.  Any shortfall between the collateral’s
realization value and the loan balance is charged-off at that
time.  Impairment analyses are updated on a monthly
basis.  Additionally, as underlying collateral is reappraised the
value of the collateral is reassessed and any additional charge-off is taken at
that time.  A similar practice is followed for downward adjustments to
the Company’s OREO carrying value.





Management
is of the opinion that the allowance for credit losses is maintained at a level
adequate for known and unidentified losses inherent in the loan
portfolio.  However, the Company's construction and land loan
portfolios, representing approximately 11.6% of the total loan portfolio, could
be adversely affected if California economic conditions and the real estate
market in the Company's market area were to weaken.  The effect of
such events, although uncertain at this time, could result in an increase in the
level of non-performing loans and other real estate owned and the level of the
allowance for loan losses, which could adversely affect the Company's future
growth and profitability.





Non-interest
Income





The
following table sets forth the components of other income and the percentage
distribution of such income for the three months ended September 30, 2009 and
2008:


29





Three
      months ended September 30,(dollars
      in thousands)
                
                2009
                
                
                2008Amount
                
                
                Percent
                
                
                Amount
                
                
                PercentDepositor
      service charges
                
                $
                498
                
                
                
                29.5
                %
                
                $
                327
                
                
                
                16.7
                %International
      fee income
                
                
                315
                
                
                
                18.7
                %
                
                
                594
                
                
                
                30.4
                %Other
      income - cash flow hedge
                
                
                301
                
                
                
                17.8
                %
                
                
                151
                
                
                
                7.7
                %Gain
      on sale of SBA loans
                
                
                220
                
                
                
                13.0
                %
                
                
                87
                
                
                
                4.5
                %Other
      operating income
                
                
                127
                
                
                
                7.5
                %
                
                
                173
                
                
                
                8.8
                %SBA
      loan servicing income
                
                
                108
                
                
                
                6.4
                %
                
                
                113
                
                
                
                5.8
                %Increase
      in value of life insurance
                
                
                97
                
                
                
                5.7
                %
                
                
                97
                
                
                
                5.0
                %Gain
      on sale-OREO
                
                
                23
                
                
                
                1.4
                %
                
                
                -
                
                
                
                0.0
                %Gain
      on sale of securities
                
                
                -
                
                
                
                0.0
                %
                
                
                413
                
                
                
                21.1
                %$
                1,689
                
                
                
                100.0
                %
                
                $
                1,955
                
                
                
                100.0
                %





Non-interest
income totaled $1.7 million in the third quarter of 2009, a decrease of $266,000
or 13.6% from $2.0 million in the third quarter of 2008.  Non-interest
income generally consists primarily of service charge income on deposit
accounts, foreign exchange income, gains recognized on sales of SBA loans, and
SBA loan servicing income.  However, the decrease in non-interest
income during the quarter ending September 30, 2009 was primarily attributable
to a gain of $413,000 recognized on the sale of securities in 2008 with no
corresponding gain in 2009.





For the
quarter ended September 30, 2009 service charge income on deposit accounts was
$498,000, representing an increase of $171,000, or 52.3%, compared to $327,000
for the same period one year ago.  The increase is attributable to an
increase in deposit accounts and deposit related analysis charges.





The
Company generates international fee income on spot contracts (binding agreements
for the purchase or sale of currency for immediate delivery and settlement) and
forward contracts (a contractual commitment for a fixed amount of foreign
currency on a future date at an agreed upon exchange rate) in connection with
client’s cross-border activities. The transactions incurred are during the
ordinary course of business and are not speculative in nature.  The
Company recognizes income on a cash basis at the time of contract settlement in
an amount equal to the spread created by the exchange rate charged to the client
versus the actual exchange rate negotiated by the Company in the open
market.  During the third quarter of 2009, the Company recognized
$315,000 in international fee income, representing a decrease of $279,000, or
47.0%, compared to $594,000 for the same period one year ago.  The
decrease was primarily caused by a decrease in client demand for international
services as a result of the current economic environment.




Revenue
from sales of SBA loans is dependant on consistent origination and funding of
new loan volumes, the timing of which may be impacted, from time to time, by (1)
increased competition from other lenders; (2) the relative attractiveness of SBA
borrowing to other financing options; (3) adjustments to programs by the SBA;
(4) changes in activities of secondary market participants and; (5) other
factors.  Gains recognized on sales of SBA loans were $220,000 in the
quarter ended September 30, 2009 which represented an increase of $133,000 or
152.9% compared to $87,000 the same period one year earlier.





Non-interest
Expense





The
components of other expense as a percentage of average earnings assets are set
forth in the following table for the three months ended September 30, 2009 and
2008.


30




Three
      months ended September 30,(dollars
      in thousands)
                  
                  2009
                  
                  
                  2008Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  PercentSalaries
      and benefits
                  
                  $
                  5,080
                  
                  
                  
                  2.5
                  %
                  
                  $
                  5,859
                  
                  
                  
                  2.9
                  %Occupancy
                  
                  
                  897
                  
                  
                  
                  0.4
                  %
                  
                  
                  910
                  
                  
                  
                  0.4
                  %FDIC/OCC
      assessments
                  
                  
                  468
                  
                  
                  
                  0.2
                  %
                  
                  
                  164
                  
                  
                  
                  0.1
                  %Data
      processing
                  
                  
                  692
                  
                  
                  
                  0.3
                  %
                  
                  
                  609
                  
                  
                  
                  0.3
                  %Loan/OREO
      expense
                  
                  
                  248
                  
                  
                  
                  0.1
                  %
                  
                  
                  250
                  
                  
                  
                  0.1
                  %Legal
      and professional
                  
                  
                  431
                  
                  
                  
                  0.2
                  %
                  
                  
                  433
                  
                  
                  
                  0.2
                  %Deposit
      services
                  
                  
                  220
                  
                  
                  
                  0.1
                  %
                  
                  
                  224
                  
                  
                  
                  0.1
                  %Furniture
      and equipment
                  
                  
                  221
                  
                  
                  
                  0.1
                  %
                  
                  
                  253
                  
                  
                  
                  0.1
                  %Director/shareholder
      expense
                  
                  
                  198
                  
                  
                  
                  0.1
                  %
                  
                  
                  318
                  
                  
                  
                  0.2
                  %Marketing
      and advertising
                  
                  
                  216
                  
                  
                  
                  0.1
                  %
                  
                  
                  309
                  
                  
                  
                  0.2
                  %Other
                  
                  
                  531
                  
                  
                  
                  0.3
                  %
                  
                  
                  473
                  
                  
                  
                  0.2
                  %$
                  9,202
                  
                  
                  
                  4.5
                  %
                  
                  $
                  9,802
                  
                  
                  
                  4.8
                  %





Operating
expenses were $9.2 million for the three months ended September 30, 2009, a
decrease of $600,000 or 6.1% from $9.8 million at September 30,
2008.   As a percentage of average earning assets, other expenses
for the three months ended September 30, 2009 and 2008 were 4.5% and 4.8%,
respectively, on an annualized basis. In 2009, operating expenses were comprised
primarily of salaries and benefits of $5.1 million, which compared to $5.9
million in 2008.  At September 30, 2009, the Company employed 163
full-time equivalents (FTE) compared to 170 FTE on the same date one year
earlier.  In addition, salaries and benefits included a charge of
$345,000 and $322,000 to recognize compensation related to stock option grants
as a result of the implementation of FAS No. 123R in the third quarter of 2009
and 2008, respectively.





As of the
filing date of the Company’s Form 10-K for December 31, 2008, the FDIC had
proposed changes to the deposit insurance assessment system beginning with the
second quarter of 2009 to make the increase in assessments fairer by requiring
riskier institutions to pay a larger share (based upon four risk
categories).  Based upon the Company’s risk profile, it was
anticipated that the FDIC assessment for 2009 would be approximately $1.4
million compared to approximately $530,000 for the same period one year
earlier.  During the third quarter of 2009, the Company recognized
$468,000 of this assessment compared to $164,000 for the same period one year
earlier.




On
February 27, 2009, the FDIC announced a special emergency assessment of 20 basis
points that was payable September 30, 2009.  The Company accrued
$366,000 for this special assessment during the second quarter of
2009.





Summary
of Financial Results – Nine months ended September 30, 2009





The
Company reported a net loss available to common shareholders of $(3.1) million,
or $(0.47) per diluted common share, for the nine months ended September 30,
2009 representing an increase of $5.9 million, or 65.5%, compared to a net loss
of $9.0 million, or $(1.38) per diluted common share, for the same period one
year ago.  The net loss available to common shareholders was impacted
by preferred dividends of $3.1 million during the first nine months of
2009.  There were no preferred dividends during the first nine months
of 2008.


31





The table
below highlights the changes in the nature and sources of income and
expense.





Nine
      months endedSeptember
      30,
                          
                          
                          Increase(dollars
      in thousands)
                          
                          2009
                          
                          
                          2008
                          
                          
                          (Decrease)Interest
      income
                          
                          $
                          33,951
                          
                          
                          $
                          45,227
                          
                          
                          $
                          (11,276
                          )Interest
      expense
                          
                          
                          5,616
                          
                          
                          
                          10,484
                          
                          
                          
                          (4,868
                          )Net
      interest income
                          
                          
                          28,335
                          
                          
                          
                          34,743
                          
                          
                          
                          (6,408
                          )Provision
      for credit losses
                          
                          
                          8,300
                          
                          
                          
                          27,570
                          
                          
                          
                          (19,270
                          )Net
      interest income after provision for credit losses
                          
                          
                          20,035
                          
                          
                          
                          7,173
                          
                          
                          
                          12,862Other
      income
                          
                          
                          8,019
                          
                          
                          
                          5,341
                          
                          
                          
                          2,678Other
      expenses
                          
                          
                          28,008
                          
                          
                          
                          28,049
                          
                          
                          
                          (41
                          )Income
      (loss) before income taxes
                          
                          
                          46
                          
                          
                          
                          (15,535
                          )
                          
                          
                          15,581Income
      taxes
                          
                          
                          16
                          
                          
                          
                          (6,525
                          )
                          
                          
                          6,541Net
      income
                          
                          $
                          30
                          
                          
                          $
                          (9,010
                          )
                          
                          $
                          9,040Preferred
      dividends
                          
                          
                          3,138
                          
                          
                          
                          0
                          
                          
                          
                          3,138Net
      income (loss) available to common shareholders
                          
                          $
                          (3,108
                          )
                          
                          $
                          (9,010
                          )
                          
                          $
                          5,902





Net
Interest Income and Margin





Net
interest income, the difference between interest earned on loans and investments
and interest paid on deposits is the principal component of the Company's
earnings.  Net interest income is affected by changes in the nature
and volume of earning assets held during the nine months, the rates earned on
such assets and the rates paid on interest bearing liabilities.





Net
interest income for the nine months ended September 30, 2009 was $28.4 million,
which was comprised of $34.0 million in interest income and $5.6 million in
interest expense. Net interest income for the nine months ended September 30,
2008 was $34.7 million, which was comprised of $45.2 million in interest income
and $10.5 million in interest expense.  Net interest income for the
nine months ended September 30, 2009 represented a decrease of $6.4 million or
18.4% from the same period one year earlier.  The average balance
sheet and the general interest rate environment drive net interest
income.





Changes
in short-term interest rates also impact growth in net interest income as the
interest rate earned on a majority of the Company’s assets, specifically the
loan portfolio, adjust with changes in short-term market rates.  As
such, the nature of the Company’s balance sheet is that, over time as short-term
interest rates change, income on interest earning assets has a greater impact on
net interest income than interest paid on liabilities.  The Company’s
prime rate averaged 3.25% in the nine months ended September 30, 2009 compared
to 5.43% in the same period one year earlier.





The
Company’s net interest margin (net interest income divided by average earning
assets) for the nine months ended September 30, 2009 was 4.55% compared to 6.01%
for the same period one year earlier.  The decrease in net interest
margin from 2008 to 2009 was primarily a result of the decrease in short term
interest rates, a decrease in income from interest rate swaps, and an increased
level of nonperforming assets.  During the nine months ended September
30, 2009, the net settlement from interest rate swaps contributed $487,000 to
support net interest income compared to $1.5 million for the same period in
2008.  The increased level of nonperforming assets resulted in a
negative impact on the Company’s net interest margin of 24 basis points in the
first nine months of 2009 from reversed or foregone interest.





The
following table details the average balances, interest income and expense and
the effective yields/rates for earning assets and interest-bearing liabilities
for the nine months ended September 30, 2009 and 2008.


32





Nine
      months ended September 30,(dollars
      in thousands)
                                          
                                          2009
                                          
                                          
                                          2008Yields
                                          
                                          
                                          Interest
                                          
                                          
                                          
                                          
                                          
                                          Yields
                                          
                                          
                                          InterestAverage
                                          
                                          
                                          or
                                          
                                          
                                          Income/
                                          
                                          
                                          Average
                                          
                                          
                                          or
                                          
                                          
                                          Income/Balance
                                          
                                          
                                          Rates
                                          
                                          
                                          Expense
                                          
                                          
                                          Balance
                                          
                                          
                                          Rates
                                          
                                          
                                          ExpenseASSETSInterest
      earning assets (2):Loans
      (1)
                                          
                                          $
                                          630,354
                                          
                                          
                                          
                                          7.0
                                          %
                                          
                                          $
                                          33,218
                                          
                                          
                                          $
                                          684,690
                                          
                                          
                                          
                                          8.4
                                          %
                                          
                                          $
                                          43,107Federal
      funds sold
                                          
                                          
                                          169,113
                                          
                                          
                                          
                                          0.2
                                          %
                                          
                                          
                                          300
                                          
                                          
                                          
                                          52,514
                                          
                                          
                                          
                                          2.1
                                          %
                                          
                                          
                                          835Investment
      securities
                                          
                                          
                                          14,908
                                          
                                          
                                          
                                          1.3
                                          %
                                          
                                          
                                          146
                                          
                                          
                                          
                                          32,332
                                          
                                          
                                          
                                          5.0
                                          %
                                          
                                          
                                          1,204Other
                                          
                                          
                                          17,723
                                          
                                          
                                          
                                          2.2
                                          %
                                          
                                          
                                          287
                                          
                                          
                                          
                                          3,294
                                          
                                          
                                          
                                          3.3
                                          %
                                          
                                          
                                          81Total
      interest earning assets
                                          
                                          
                                          832,098
                                          
                                          
                                          
                                          5.5
                                          %
                                          
                                          
                                          33,951
                                          
                                          
                                          
                                          772,830
                                          
                                          
                                          
                                          7.8
                                          %
                                          
                                          
                                          45,227Noninterest-earning
      assets:Cash
      and due from banks
                                          
                                          
                                          18,001
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          19,062All
      other assets (3)
                                          
                                          
                                          24,230
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          22,791TOTAL
                                          
                                          $
                                          874,329
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          $
                                          814,683LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest
      bearing liabilities:Deposits:Demand
                                          
                                          $
                                          4,632
                                          
                                          
                                          
                                          0.1
                                          %
                                          
                                          $
                                          4
                                          
                                          
                                          $
                                          5,271
                                          
                                          
                                          
                                          0.3
                                          %
                                          
                                          $
                                          10Savings
                                          
                                          
                                          298,868
                                          
                                          
                                          
                                          0.8
                                          %
                                          
                                          
                                          1,749
                                          
                                          
                                          
                                          390,347
                                          
                                          
                                          
                                          2.3
                                          %
                                          
                                          
                                          6,662Time
                                          
                                          
                                          137,945
                                          
                                          
                                          
                                          2.7
                                          %
                                          
                                          
                                          2,777
                                          
                                          
                                          
                                          98,349
                                          
                                          
                                          
                                          4.0
                                          %
                                          
                                          
                                          2,923Other
                                          
                                          
                                          29,432
                                          
                                          
                                          
                                          4.9
                                          %
                                          
                                          
                                          1,086
                                          
                                          
                                          
                                          22,184
                                          
                                          
                                          
                                          5.4
                                          %
                                          
                                          
                                          889Total
      interest bearing liabilities
                                          
                                          
                                          470,877
                                          
                                          
                                          
                                          1.6
                                          %
                                          
                                          
                                          5,616
                                          
                                          
                                          
                                          516,151
                                          
                                          
                                          
                                          2.7
                                          %
                                          
                                          
                                          10,484Noninterest-bearing
      liabilities:Demand
      deposits
                                          
                                          
                                          280,830
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          221,257Accrued
      expenses and other liabilities
                                          
                                          
                                          11,689
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          9,258Shareholders'
      equity
                                          
                                          
                                          110,933
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          68,017TOTAL
                                          
                                          $
                                          874,329
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          $
                                          814,683Net
      interest income and margin
                                          
                                          
                                          
                                          
                                          
                                          
                                          4.6
                                          %
                                          
                                          $
                                          28,335
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          6.0
                                          %
                                          
                                          $
                                          34,743





(1)
            Loan
      fee amortization of $3.2 million and $4.3 million, respectively, is
      included in interest income.  Nonperforming loans have been
      included in average loan balances.


(2)
            Interest
      income is reflected on an actual basis, not a fully taxable equivalent
      basis.  Yields are based on amortized
  cost.


(3)
            Net
      of average allowance for credit losses of $17.9 million and $11.9 million,
      respectively.




The
following table shows the effect of the interest differential of volume and rate
changes for the nine months ended September 30, 2009 and 2008.  The
change in interest due to both rate and volume has been allocated in proportion
to the relationship of absolute dollar amounts of change in
each.


33





(dollars
      in thousands)
                                    
                                    Nine
      months ended September 30,2009
      vs. 2008Increase
      (decrease)due
      to change inAverage
                                    
                                    
                                    Average
                                    
                                    
                                    TotalVolume
                                    
                                    
                                    Rate
                                    
                                    
                                    ChangeInterest
      income:Loans
                                    
                                    
                                    (2,863
                                    )
                                    
                                    
                                    (7,026
                                    )
                                    
                                    $
                                    (9,889
                                    )Federal
      funds sold
                                    
                                    
                                    207
                                    
                                    
                                    
                                    (742
                                    )
                                    
                                    
                                    (535
                                    )Investment
      securities
                                    
                                    
                                    (171
                                    )
                                    
                                    
                                    (887
                                    )
                                    
                                    
                                    (1,058
                                    )Other
                                    
                                    
                                    234
                                    
                                    
                                    
                                    (28
                                    )
                                    
                                    
                                    206Total
      interest income
                                    
                                    
                                    (2,594
                                    )
                                    
                                    
                                    (8,682
                                    )
                                    
                                    
                                    (11,276
                                    )Interest
      expense:Demand
                                    
                                    
                                    (1
                                    )
                                    
                                    
                                    (5
                                    )
                                    
                                    
                                    (6
                                    )Savings
                                    
                                    
                                    (535
                                    )
                                    
                                    
                                    (4,378
                                    )
                                    
                                    
                                    (4,913
                                    )Time
                                    
                                    
                                    797
                                    
                                    
                                    
                                    (943
                                    )
                                    
                                    
                                    (146
                                    )Other
                                    
                                    
                                    267
                                    
                                    
                                    
                                    (70
                                    )
                                    
                                    
                                    197Total
      interest expense
                                    
                                    
                                    529
                                    
                                    
                                    
                                    (5,397
                                    )
                                    
                                    
                                    (4,868
                                    )Change
      in net interest income
                                    
                                    $
                                    (3,122
                                    )
                                    
                                    $
                                    (3,286
                                    )
                                    
                                    $
                                    (6,408
                                    )





Net
interest income is the principal source of the Company’s operating
earnings.   Significant factors affecting net interest income
are: rates, volumes and mix of the loan, investment and deposit
portfolios.   Due to the nature of the Company’s lending markets,
in which the majority of loans are generally tied to prime rate, it is believed
that an increase in interest rates should positively affect the Company’s future
earnings, while a decline should have a negative impact.  However, it
is not feasible to provide an accurate measure of such a change because of the
many factors (many of them uncontrollable) influencing the result.





Interest Income





Interest
income of $34.0 million in the nine months ended September 30, 2009 represented
a decrease of $11.2 million, or 24.9%, from $45.2 million in the same period one
year earlier.  The decrease in interest income was primarily due to a
decrease in interest rates and a decrease in income from interest rate swaps,
offset in part by growth in average earning assets.  Average earning
assets for the nine months ended September 30, 2009 were $832.1 million and
represented growth of $59.3 million or 7.7% over $772.8 million for the same
period in 2008.





Average
gross loans were $630.4 million for the nine months ended September 30, 2009, a
decrease of $54.3 million or 7.9% from $684.7 million for the same period one
year earlier.  Average loans comprised 75.8% of average earning assets
in the nine months ended September 30, 2009 compared to 88.6% in the first nine
months of 2008.  During the nine months ended September 30, 2009, the
ratio of average gross loans to average deposits (one measure of leverage) was
87.3%, compared to 95.7% in the comparable period of 2008.





The
average yield on earning assets was 5.46% for the nine months ended September
30, 2009 and 7.82% for the nine months ended September 30, 2008.  The
majority of the Company’s earning assets, including a majority of loans, are
priced to adjust with movements in short-term interest rates, particularly the
prime rate, and the decrease in yield was primarily due to decreases in the
prime rate during 2009 and the later part of 2008 and interest reversed or
foregone on nonperforming assets offset, in part, by income from interest rate
swaps.





Other
earning assets, consisting of investment securities, federal funds sold and
interest-bearing deposits, averaged $201.7 million for the nine months ended
September 30, 2009, a decrease of $113.6 million or 128.9% from $88.1 million
for the nine months ended September 30, 2008.


34




Interest
Expense




Interest
expense was $5.6 million for the nine months ended September 30, 2009, which
represented a decrease of $4.9 million or 46.4% from $10.5 million for the
comparable period of 2008.  The decrease in interest expense reflects
lower interest rates paid on liabilities in 2009 compared to
2008.  Average interest-bearing liabilities were $470.9 million for
the nine months ended September 30, 2009, a decrease of $45.3 million, or 8.8%,
from $516.2 million for the same period one year earlier.





Average
interest bearing deposits were $441.4 million for the nine months ended
September 30, 2009, which represented 93.7% of total average deposits and was a
decrease of $52.5 million, or 10.6%, from $494.0 million representing 95.7% of
total average deposits in the first nine months of 2008.





Other
(non-deposit) interest bearing liabilities are primarily comprised of junior
subordinated debt securities issued by the Company and other
borrowings.  The junior subordinated debt is intended to supplement
capital requirements of the Company at a rate of interest that is fixed for five
years.  Other interest bearing liabilities averaged $29.4 million in
the nine months ended September 30, 2009 compared to $22.2 million for the same
period one year earlier.





The
average rate paid on interest-bearing liabilities of 1.59% in the nine months
ended September 30, 2009 compared to 2.71% in the first nine months of
2008.





Credit
Risk and Provision for Credit Losses





The
Company maintains an allowance for credit losses which is based, in part, on the
Company's and industry loss experience, the impact of economic conditions within
the Company's market area and, as applicable, the State of California and/or
national macroeconomic conditions, the value of underlying collateral, loan
performance and inherent risks in the loan portfolio. The allowance is reduced
by charge-offs and increased by provisions for credit losses charged to
operating expense and recoveries of previously charged-off loans.





The
Company provided $8.3 million to the allowance for credit losses for the nine
months ended September 30, 2009, compared to $27.6 million for the same period
in 2008.





The
Company’s loan charge-offs totaled $10.3 million during the nine months ended
September 30, 2009, compared to $18.4 million for the same period one year
earlier.  The Company recognized $319,000 and $35,000 in loan
recoveries for the nine months ended September 30, 2009 and 2008,
respectively.





The
following schedule provides an analysis of the allowance for credit losses for
the nine months ended September 30, 2009 and 2008, respectively:





Nine
      months ended(dollars
      in thousands)
                      
                      September
      30,2009
                      
                      
                      2008Balance,
      beginning of period
                      
                      $
                      18,554
                      
                      
                      $
                      8,608Provision
      for credit losses
                      
                      
                      8,300
                      
                      
                      
                      27,570Charge-offs
                      
                      
                      (10,251
                      )
                      
                      
                      (18,449
                      )Recoveries
                      
                      
                      319
                      
                      
                      
                      35Balance,
      end of period
                      
                      $
                      16,922
                      
                      
                      $
                      17,764





See
“Summary of Financial Results – Quarter ended September 30, 2009 – Provision for
Credit Losses” for a discussion of the allowance for credit losses and
nonperforming assets.





Non-interest
Income





The
following table sets forth the components of other income and the percentage
distribution of such income for the nine months ended September 30, 2009 and
2008:


35





Nine
      months ended September 30,(dollars
      in thousands)
                                          
                                          2009
                                          
                                          
                                          2008Amount
                                          
                                          
                                          Percent
                                          
                                          
                                          Amount
                                          
                                          
                                          PercentOther
      income - cash flow hedge
                                          
                                          $
                                          3,221
                                          
                                          
                                          
                                          40.2
                                          %
                                          
                                          $
                                          603
                                          
                                          
                                          
                                          11.3
                                          %Depositor
      service charges
                                          
                                          
                                          1,394
                                          
                                          
                                          
                                          17.4
                                          %
                                          
                                          
                                          814
                                          
                                          
                                          
                                          15.2
                                          %International
      fee income
                                          
                                          
                                          1,137
                                          
                                          
                                          
                                          14.2
                                          %
                                          
                                          
                                          1,403
                                          
                                          
                                          
                                          26.3
                                          %Gain
      on sale-OREO
                                          
                                          
                                          700
                                          
                                          
                                          
                                          8.7
                                          %
                                          
                                          
                                          -
                                          
                                          
                                          
                                          0.0
                                          %Gain
      on sale of SBA loans
                                          
                                          
                                          611
                                          
                                          
                                          
                                          7.6
                                          %
                                          
                                          
                                          556
                                          
                                          
                                          
                                          10.4
                                          %Other
      operating income
                                          
                                          
                                          337
                                          
                                          
                                          
                                          4.2
                                          %
                                          
                                          
                                          625
                                          
                                          
                                          
                                          11.7
                                          %SBA
      loan servicing income
                                          
                                          
                                          316
                                          
                                          
                                          
                                          3.9
                                          %
                                          
                                          
                                          326
                                          
                                          
                                          
                                          6.1
                                          %Increase
      in value of life insurance
                                          
                                          
                                          303
                                          
                                          
                                          
                                          3.8
                                          %
                                          
                                          
                                          303
                                          
                                          
                                          
                                          5.7
                                          %Gain
      on sale of securities
                                          
                                          
                                          -
                                          
                                          
                                          
                                          0.0
                                          %
                                          
                                          
                                          711
                                          
                                          
                                          
                                          13.3
                                          %$
                                          8,019
                                          
                                          
                                          
                                          100.0
                                          %
                                          
                                          $
                                          5,341
                                          
                                          
                                          
                                          100.0
                                          %





Non-interest
income totaled $8.0 million and $5.3 million in the first nine months of 2009
and 2008, respectively.  Non-interest income generally consists
primarily of service charge income on deposit accounts, foreign exchange income,
gains recognized on sales of SBA loans, and SBA loan servicing
income.  However, the increase in non-interest income during the nine
months ending September 30, 2009 was primarily attributable to the acceleration
of a deferred gain of $3.2 million on interest rate swaps that were previously
terminated during the fourth quarter of 2008.  The acceleration of the
deferred gain during the first nine months of 2009 was a result of further
reductions in the loan pools that were originally designated as hedged against
interest rate swaps.





For the
nine months ended September 30, 2009 service charge income on deposit accounts
was $1.4 million, representing an increase of $580,000, or 71.3%, compared to
$814,000 for the same period one year ago.  The increase is
attributable to an increase in deposit accounts and deposit related analysis
charges.





The
Company generates international fee income on spot contracts (binding agreements
for the purchase or sale of currency for immediate delivery and settlement) and
forward contracts (a contractual commitment for a fixed amount of foreign
currency on a future date at an agreed upon exchange rate) in connection with
client’s cross-border activities. The transactions incurred are during the
ordinary course of business and are not speculative in nature.  The
Company recognizes income on a cash basis at the time of contract settlement in
an amount equal to the spread created by the exchange rate charged to the client
versus the actual exchange rate negotiated by the Company in the open
market.  During the first nine months of 2009, the Company recognized
$1.1 million in international fee income, representing a decrease of $266,000,
or 19.0%, compared to $1.4 million for the same period one year
ago.  The decrease was primarily caused by a decrease in client demand
for international services as a result of the current economic
environment.




Revenue
from sales of SBA loans is dependant on consistent origination and funding of
new loan volumes, the timing of which may be impacted, from time to time, by (1)
increased competition from other lenders; (2) the relative attractiveness of SBA
borrowing to other financing options; (3) adjustments to programs by the SBA;
(4) changes in activities of secondary market participants and; (5) other
factors.  Gains recognized on sales of SBA loans were $611,000 in the
nine months ended September 30, 2009 which represented an increase of $55,000 or
9.9% compared to $556,000 for the same period one year earlier.





Non-interest
Expense





The
components of other expense as a percentage of average earning assets are set
forth in the following table for the nine months ended September 30, 2009 and
2008.


36





Nine
      months ended September 30,(dollars
      in thousands)
                              
                              2009
                              
                              
                              2008Amount
                              
                              
                              Percent
                              
                              
                              Amount
                              
                              
                              PercentSalaries
      and benefits
                              
                              $
                              15,749
                              
                              
                              
                              3.8
                              %
                              
                              $
                              17,421
                              
                              
                              
                              4.7
                              %Occupancy
                              
                              
                              2,634
                              
                              
                              
                              0.6
                              %
                              
                              
                              2,693
                              
                              
                              
                              0.7
                              %Data
      processing
                              
                              
                              1,840
                              
                              
                              
                              0.4
                              %
                              
                              
                              1,769
                              
                              
                              
                              0.5
                              %Legal
      and professional
                              
                              
                              997
                              
                              
                              
                              0.2
                              %
                              
                              
                              738
                              
                              
                              
                              0.2
                              %FDIC/OCC
      assessments
                              
                              
                              1,306
                              
                              
                              
                              0.3
                              %
                              
                              
                              466
                              
                              
                              
                              0.1
                              %Loan/OREO
      expense
                              
                              
                              1,004
                              
                              
                              
                              0.2
                              %
                              
                              
                              474
                              
                              
                              
                              0.1
                              %Furniture
      and equipment
                              
                              
                              702
                              
                              
                              
                              0.2
                              %
                              
                              
                              731
                              
                              
                              
                              0.2
                              %Marketing
      and advertising
                              
                              
                              691
                              
                              
                              
                              0.2
                              %
                              
                              
                              993
                              
                              
                              
                              0.3
                              %Director/shareholder
      expense
                              
                              
                              660
                              
                              
                              
                              0.2
                              %
                              
                              
                              815
                              
                              
                              
                              0.2
                              %Deposit
      services
                              
                              
                              794
                              
                              
                              
                              0.2
                              %
                              
                              
                              612
                              
                              
                              
                              0.2
                              %Other
                              
                              
                              1,631
                              
                              
                              
                              0.4
                              %
                              
                              
                              1,337
                              
                              
                              
                              0.4
                              %$
                              28,008
                              
                              
                              
                              6.8
                              %
                              
                              $
                              28,049
                              
                              
                              
                              7.5
                              %





Operating
expenses were $28.0 million for the nine months ended September 30, 2009, a
decrease of $41,000 or 0.15% over $28.0 million for the nine months ended
September 30, 2008.   As a percentage of average earning assets,
other expenses for the nine months ended September 30, 2009 and 2008 were 6.8%
and 7.5%, respectively, on an annualized basis.  In 2009, operating
expenses were comprised primarily of salaries and benefits of $15.7 million,
which compared to $17.4 million in 2008.  At September 30, 2009, the
Company employed 163 FTE compared to 170 FTE on the same date one year
earlier.  In addition, salaries and benefits included a charge of $1.1
million and $1.0 million to recognize compensation related to stock option
grants as a result of the implementation of FAS No. 123R in 2009 and 2008,
respectively.





As of the
filing date of the Company’s Form 10-K for December 31, 2008, the FDIC had
proposed changes to the deposit insurance assessment system beginning with the
second quarter of 2009 to make the increase in assessments fairer by requiring
riskier institutions to pay a larger share (based upon four risk
categories).  Based upon the Company’s risk profile, it was
anticipated that the FDIC assessment for 2009 would be approximately $1.4
million compared to approximately $530,000 for the same period one year
earlier.  During the first nine months of 2009, the Company recognized
$940,000 of this assessment compared to $466,000 for the same period one year
earlier.




On
February 27, 2009, the FDIC announced a special emergency assessment of 20 basis
points that was payable September 30, 2009.  The Company accrued
$366,000 for this special assessment during the second quarter of
2009.





Loan/OREO
expense was $1.0 million for the first nine months of 2009 compared to $474,000
for the same period one year earlier.  The increase of $530,000, or
111.8%, was primarily attributable to loan related legal fees and sales related
expenses for “other real estate owned”.





Balance
Sheet





Total
assets of the Company at September 30, 2009 were $834.8 million, a decrease of
$112.8 million, or 11.9%, as compared to $947.6 million at December 31,
2008.  The reduction in total assets was principally due to a decrease
in loan balances and federal funds sold.





The
following table shows the Company’s loans by type and their percentage
distribution as of September 30, 2009 and December 31, 2008.


37





(dollars
      in thousands)
                
                September
      30,
                
                
                December
      31,2009
                
                
                2008Commercial
                
                $
                257,703
                
                
                $
                301,024Real
      estate construction
                
                
                52,888
                
                
                
                98,105Land
      loans
                
                
                13,530
                
                
                
                23,535Real
      estate other
                
                
                135,326
                
                
                
                134,767Factoring
      and asset based lending
                
                
                48,413
                
                
                
                55,761SBA
                
                
                59,606
                
                
                
                77,043Other
                
                
                6,228
                
                
                
                9,371Total
      gross loans
                
                
                573,694
                
                
                
                699,606Unearned
      fee income
                
                
                (1,518
                )
                
                
                (1,601
                )Total
      gross loans
                
                
                572,176
                
                
                
                698,005Less
      allowance for credit losses
                
                
                (16,922
                )
                
                
                (18,554
                )Total
      loans, net
                
                $
                555,254
                
                
                $
                679,451Commercial
                
                
                44.9
                %
                
                
                43.0
                %Real
      estate construction
                
                
                9.2
                %
                
                
                14.0
                %Land
      loans
                
                
                2.4
                %
                
                
                3.4
                %Real
      estate other
                
                
                23.6
                %
                
                
                19.3
                %Factoring
      and asset based lending
                
                
                8.4
                %
                
                
                8.0
                %SBA
                
                
                10.4
                %
                
                
                11.0
                %Other
                
                
                1.1
                %
                
                
                1.3
                %Total
      gross loans
                
                
                100.0
                %
                
                
                100.0
                %





Gross
loan balances were $573.7 million at September 30, 2009, which represented a
decrease of $125.9 million, or 18.0%, as compared to $699.6 million at December
31, 2008. The decrease in loans was primarily in commercial, construction, and
land loans without a concentration in any one specific category of
loans.





The
Company’s commercial loan portfolio represents loans to small and middle-market
businesses in the Santa Clara County region.  Commercial loans were
$257.7 million at September 30, 2009, which represented a decrease of $43.3
million, or 14.4%, compared to $301.0 million at December 31,
2008.  At September 30, 2009, commercial loans comprised 44.9% of
total loans outstanding compared to 43.0% at December 31, 2008.





The
Company’s construction and land development loan portfolio together totaled
approximately $66.4 million as of September 30, 2009 compared to $121.6 million
as of December 31, 2008, representing a decrease of $55.2 million or
45.4%.  Construction and land development loan balances at September
30, 2009 and December 31, 2008 comprised 11.6% and 17.4%, respectively, of total
loans.





Other
real estate loans increased $559,000 or 0.41% to $135.3 million at September 30,
2009 over $134.8 million at December 31, 2008.  The increase in other
real estate loans was approximately equally split between home equity lines of
credit and other real estate term loans.  Other real estate loans
represented 23.6% of total loans at September 30, 2009 compared to 19.3% at
December 31, 2008.





Factoring
and asset-based lending represents purchased accounts receivable (factoring) and
a structured accounts receivable lending program where the Company receives
client specific payment for client invoices.  Under the factoring
program, the Company purchases accounts receivable invoices from its clients and
then receives payment directly from the party obligated for the
receivable.   In most cases the Company purchases the receivables
subject to recourse from the Company’s factoring client.  The
asset-based lending program requires a security interest in all of a client’s
accounts receivable.  At September 30, 2009, factoring/asset- based
loans totaled $48.4 million or 8.4% of total loans, as compared to $55.8 million
or 8.0% of total loans at December 31, 2008.





The
Company, as a Preferred Lender, originates SBA loans and participates in the SBA
7A and 504 SBA lending programs.  Under the 7A program, a loan is made
for commercial or real estate purposes.  The SBA guarantees these
loans and the guarantee may range from 75% to 85% of the total loan. In
addition, the loan could be collateralized by a deed of trust on real
estate.  Under the 504 program, the Company lends directly to the
borrower and takes a first deed of trust to the subject property.  In
addition the SBA, through a Certified Development Corporation, makes an
additional loan to the borrower and takes a deed of trust subject to the
Company’s position. At September 30, 2009, SBA loans comprised $59.6 million, or
10.4%, of total loans, a decrease of $17.4 million, or 22.6%, from $77.0 million
at December 31, 2008. The Company has the ability and the intent to sell all or
a portion of the SBA loans and, as such, carries the saleable portion of SBA
loans at the lower of aggregate cost or fair value.   At
September 30, 2009 and December 31, 2008, the fair value of SBA loans exceeded
aggregate cost and therefore, SBA loans were carried at aggregate
cost.


38


Other
loans consist primarily of loans to individuals for personal uses, such as
installment purchases, overdraft protection loans and a variety of other
consumer purposes.  At September 30, 2009, other loans totaled $6.2
million as compared to $9.4 million at December 31, 2008.





Deposits
represent the Company’s principal source of funds.  Most of the
Company’s deposits are obtained from professionals, small-to-medium sized
businesses, and individuals within the Company’s market area.  The
Company’s deposit base consists of non-interest and interest-bearing demand
deposits, savings and money market accounts and certificates of
deposit.  The following table summarizes the composition of deposits
as of September 30, 2009 and December 31, 2008.





(dollars
      in thousands)
                
                September
      30,
                
                
                December
      31,2009
                
                
                2008Amount
                
                
                Percent
                
                
                Amount
                
                
                PercentNoninterest-bearing  demand
                
                $
                313,228
                
                
                
                45.26
                %
                
                $
                284,319
                
                
                
                36.58
                %Interest-bearing
      demand
                
                
                4,255
                
                
                
                0.61
                %
                
                
                4,267
                
                
                
                0.55
                %Money
      market and savings
                
                
                259,282
                
                
                
                37.47
                %
                
                
                335,200
                
                
                
                43.13
                %Certificates
      of deposit:Less
      than $100
                
                
                48,561
                
                
                
                7.02
                %
                
                
                92,997
                
                
                
                11.96
                %$100
      and more
                
                
                66,733
                
                
                
                9.64
                %
                
                
                60,462
                
                
                
                7.78
                %Total
      deposits
                
                $
                692,059
                
                
                
                100.00
                %
                
                $
                777,245
                
                
                
                100.00
                %





Deposits
decreased $85.2 million or 11.0% from $777.2 million at December 31, 2008 to
$692.1 million at September 30, 2009. The decrease in deposits was primarily in
money market and savings accounts.  As of September 30, 2009, demand
deposits and core deposits continued to represent 45.9% and 83.3% of total
deposits, respectively.





Leverage




Total gross loan balances at September
30, 2009 were $573.7 million.  The resulting loan to deposit ratio was
82.48%.  Other earning assets at September 30, 2009 were primarily
comprised of investment securities, federal funds sold and interest-bearing
deposits of $217.7 million. To date, the Company has deployed other earning
assets primarily in federal funds sold to address the potential volatility of
deposit balances and to accommodate projected loan funding, and in short term
fixed rate investments to mitigate interest rate risk associated with the
Company’s asset-sensitive balance sheet.   When deploying other
earning assets, the Company implements strategic decisions that may have
a beneficial or adverse impact on net interest income and on the net interest
margin to manage the business through a variety of economic cycles.




During the fourth quarter of 2008 and
throughout 2009, as part of a strategic decision the Companyeffectively
repositioned the composition of its balance sheet and improved its liquidity
position by deploying other earning assets primarily in federal funds in direct
response to the recent economic downturn and potential volatility of the deposit
portfolio.




Capital
Resources




The
Company and the Bank are subject to the capital guidelines and regulations
governing capital adequacy for bank holding companies and national
banks.  Additional capital requirements may be imposed on banks based
on market risk. The FDIC requires a leverage ratio of 8.00% for new banks during
the first three years of operation.




39




After the
first three years of operations, the Comptroller requires a minimum leverage
ratio of 3.00% for national banks that have received the highest composite
regulatory rating (a regulatory measurement of capital, assets, management,
earnings and liquidity) and that are not anticipating or experiencing any
significant growth.  All other institutions are required to maintain a
leverage ratio of at least 100 to 200 basis points above the 3.00%
minimum.




The
Comptroller's regulations also require national banks to maintain a minimum
ratio of qualifying total capital to risk-weighted assets of
8.00%.  Risk-based capital ratios are calculated with reference to
risk-weighted assets, including both on and off-balance sheet exposures, which
are multiplied by certain risk weights assigned by the Comptroller to those
assets.  At least one-half of the qualifying capital must be in the
form of Tier 1 capital.




The
risk-based capital ratio focuses principally on broad categories of credit risk,
and might not take into account many other factors that can affect a bank’s
financial condition.  These factors include overall interest rate risk
exposure; liquidity, funding and market risks; the quality and level of
earnings; concentrations of credit risk; certain risks arising from
nontraditional activities; the quality of loans and investments; the
effectiveness of loan and investment policies; and management’s overall ability
to monitor and control financial and operating risks, including the risk
presented by concentrations of credit and nontraditional
activities.  The Comptroller has addressed many of these areas in
related rule-making proposals. In addition to evaluating capital ratios, an
overall assessment of capital adequacy must take account of each of these other
factors including, in particular, the level and severity of problem and
adversely classified assets. For this reason, the final supervisory judgment on
a bank’s capital adequacy may differ significantly from the conclusions that
might be drawn solely from the absolute level of the Company’s risk-based
capital ratio.  The Comptroller has stated that banks generally are
expected to operate above the minimum risk-based capital ratio.  Banks
contemplating significant expansion plans, as well as those institutions with
high or inordinate levels of risk, should hold capital consistent with the level
and nature of the risks to which they are exposed.




Further,
the banking agencies have adopted modifications to the risk-based capital
regulations to include standards for interest rate risk
exposures.  Interest rate risk is the exposure of a bank’s current and
future earnings and equity capital arising from movements in interest
rates.  While interest rate risk is inherent in a bank’s role as
financial intermediary, it introduces volatility to bank earnings and to the
economic value of the Company.  The banking agencies have addressed
this problem by implementing changes to the capital standards to include a
bank’s exposure to declines in the economic value of its capital due to changes
in interest rates as a factor that the banking agencies consider in evaluating
an institution’s capital adequacy.  Bank examiners consider a bank’s
historical financial performance and its earnings exposure to interest rate
movements as well as qualitative factors such as the adequacy of a bank’s
internal interest rate risk management.




Finally,
institutions with significant trading activities must measure and hold capital
for exposure to general market risk arising from fluctuations in interest rates,
equity prices, foreign exchange rates and commodity prices and exposure to
specific risk associated with debt and equity positions in the trading
portfolio.  General market risk refers to changes in the market value
of on-balance-sheet assets and off-balance-sheet items resulting from broad
market movements.  Specific market risk refers to changes in the
market value of individual positions due to factors other than broad market
movements and includes such risks as the credit risk of an instrument’s
issuer.  The additional capital requirements apply effective January
1, 1998 to institutions with trading assets and liabilities equal to 10.0% or
more of total assets or trading activity of $1.0 billion or more.  The
federal banking agencies may apply the market risk regulations on a case-by-case
basis to institutions not meeting the eligibility criteria if necessary for
safety and soundness reasons.




In
connection with the recent regulatory attention to market risk and interest rate
risk, the federal banking agencies will evaluate an institution in its periodic
examination on the degree to which changes in interest rates, foreign exchange
rates, commodity prices or equity prices can affect a financial institution’s
earnings or capital.  In addition, the agencies focus in the
examination on an institution’s ability to monitor and manage its market risk,
and will provide management with a clearer and more focused indication of
supervisory concerns in this area.




Under
certain circumstances, the Comptroller may determine that the capital ratios for
a national bank shall be maintained at levels, which are higher than the minimum
levels required by the guidelines.  A national bank which does not
achieve and maintain adequate capital levels as required may be subject to
supervisory action by the Comptroller through the issuance of a capital
directive to ensure the maintenance of required capital levels.  In
addition, the Company is required to meet certain guidelines of the Comptroller
concerning the maintenance of an adequate allowance for loan and lease
losses.




40




In
response to increasing risk perceived in the economic environment, during the
fourth quarter of 2008 the Company raised $53.9 million of additional
capital.  The following is a summary of these
issuances:


Private
Placement




On
December 4, 2008, investors agreed to purchase $30 million of the Company’s
Series B and B-1 Mandatorily Convertible Cumulative Perpetual Preferred Stock in
a private placement, subject to the United States Department of the Treasury
approving our participation in the TARP Capital Purchase Program (see discussion
below) and the Company satisfying all legal requirements for selling equity
securities to the Treasury under the program.




On
December 17, 2008, the Company completed the private placement sale of 131,901
shares of its Series B Mandatorily Convertible Cumulative Perpetual Preferred
Stock and 168,099 shares of its Series B-1 Mandatorily Convertible Cumulative
Perpetual Preferred Stock, for aggregate consideration of $30 million, which is
$100 per share for both series of shares, to a private fund.  The
Series B and Series B-1 shares (collectively the “shares”) accrue dividends at a
rate of 10% per annum, payable quarterly.




The
holders of the Series B  and B-1 preferred shares have voting rights
at a rate of 10 votes per share and may convert their shares in to shares of the
Company’s common stock at a conversion rate of $10 per share, subject to
customary adjustments for splits, dividends and other similar
transactions.





Each
Series B and B-1 preferred share shall automatically convert to common stock
after the later of 18 months or such time that shareholder and regulatory
approvals, to the extent required for conversion, are received (“Mandatory
Conversion Date”).  If the average closing price of the Company’s
common stock does not equal or exceed $10 per share over the 20 consecutive
trading days immediately prior to the Mandatory Conversion Date (the Current
Market Price Condition), such date will be extended for successive six-month
periods until the Current Market Price Condition is met.





The
Company can force conversion of the shares into common stock on or after January
15, 2010 through September 30, 2010, if (a) the Company fully pays the accrued
dividends and prepays the dividends that would have accrued up through September
30, 2010, (b) the Company’s shareholders have approved the conversion and (c)
the Current Market Price condition is met.  Subsequent to September
30, 2010, the Company can force conversion of the shares into common stock if
the above three conditions are met, with the only exception being the necessity
to pay all dividends accrued through the date of conversion as opposed to
prepaying any such amount.





Troubled
Assets Relief Program (TARP)




On
November 13, 2008, the United States Department of the Treasury (the Treasury)
approved the Company’s participation in the TARP Capital Purchase Program,
subject to the Company raising additional equity in an amount satisfactory to
the Treasury.  On December 4, 2008, investors agreed to purchase $30
million of the Company’s Series B and B-1 Mandatorily Convertible Cumulative
Perpetual Preferred Stock in a private placement (see discussion above), subject
to the Treasury approving the Company’s participation in the TARP Capital
Purchase Program and its ability to satisfy all legal requirements for selling
equity securities to the Treasury under the program.  Based on
discussions with the Treasury representatives, the Company understood that
raising $30 million would satisfy the requirement of the Company raising
additional equity.




On
December 23, 2008, the Company issued 23,864 shares of its Fixed Rate Cumulative
Perpetual Series C Preferred Stock, having a liquidation value of $23,864,000,
to the Treasury. Dividends accrue at the rate of 5% per annum for the first five
years and then 9% per annum thereafter.  The dividends will be paid
only as declared by the Board of Directors of the Company.  However,
in the event such dividends have not been paid for six or more quarters, whether
or not consecutive, the Holders of the Series C Preferred shares will have the
right to elect two members to the Company’s Board of Directors.





In
addition the Company issued a warrant to purchase up to 396,412 shares of the
Company’s common stock at a purchase price of $9.03 per share, subject to
certain adjustment provisions such as stock splits, issuances of Common Stock at
or below a specified price relative to the then current market price of the
stock, and other provisions.  The Warrant expires ten years from the
issuance date.  The Warrant is exercisable in whole or in part at any
time except that the Treasury may not exercise more than one-half of the shares
underlying the Warrant prior to the earlier of i) December 31, 2009 or ii) the
date on which the Company receives gross proceeds of not less than $23,864,000
in one or more Qualified Equity Offerings.  In addition, the Treasury
has agreed not to exercise voting power with respect to any shares of Common
Stock issued upon exercise of the Warrant.


41


Prior to
December 31, 2011, unless the Company has redeemed the Series C Preferred shares
or the Treasury has transferred the Series C Preferred Shares to a third party,
consent of the Treasury will be required for the Company to 1) pay any dividend
or other distribution to the holders of the Common Stock or 2) redeem, purchase
or acquire any shares of Common Stock or other equity securities other than in
connection with benefit plans consistent with past practices.  In
addition, the Company’s ability to declare common dividends or repurchase Common
Stock or other equity securities will be subject to restrictions in the event
the Company fails to declare and pay, or set aside for payment, the full amount
of dividends on the Series C Preferred Shares.  Finally, the Company
has agreed, so long as the Treasury holds any securities of the Company, to
ensure that its benefit plans with respect to its senior executive officers
comply with the applicable provisions of the Emergency Economic Stabilization
Act of 2008 and the American Recovery and Reinvestment Act of 2009.





Issuance
costs of $569,000 incurred in connection with the issuance of both the private
placement and TARP securities have been charged against Additional Paid in
Capital.





The
Company’s Tier 1 capital at September 30, 2009 was $105.7 million, which was
comprised of preferred equity up to the allowable limit of $33.3 million, $40.6
million of capital stock and surplus, $14.8 million in retained earnings and
trust preferred securities up to the allowable limit of $17.0
million.





The
following table shows the Company’s capital ratios at September 30, 2009 and
December 31, 2008 as well as the minimum capital ratios required to be deemed
“well capitalized” under the regulatory framework.





As
      of September 30,
                            
                            
                            As
      of December 31,(dollars
      in thousands)
                            
                            2009
                            
                            
                            2008Amount
                            
                            
                            Ratio
                            
                            
                            Amount
                            
                            
                            RatioCompany
      Capital RatiosTier
      1 Capital
                            
                            $
                            105,732
                            
                            
                            
                            15.32
                            %
                            
                            $
                            109,221
                            
                            
                            
                            13.31
                            %(to
      Risk Weighted Assets)Tier
      1 capital minimum requirement
                            
                            $
                            41,413
                            
                            
                            
                            6.00
                            %
                            
                            $
                            49,252
                            
                            
                            
                            6.00
                            %Total
      Capital
                            
                            $
                            135,047
                            
                            
                            
                            19.57
                            %
                            
                            $
                            138,725
                            
                            
                            
                            11.67
                            %(to
      Risk Weighted Assets)Total
      capital minimum requirement
                            
                            $
                            69,021
                            
                            
                            
                            10.00
                            %
                            
                            $
                            82,086
                            
                            
                            
                            10.00
                            %Company
      LeverageTier
      1 Capital
                            
                            $
                            105,732
                            
                            
                            
                            12.38
                            %
                            
                            $
                            109,221
                            
                            
                            
                            10.66
                            %(to
      Average Assets)Tier
      1 capital minimum requirement
                            
                            $
                            42,712
                            
                            
                            
                            5.00
                            %
                            
                            $
                            44,170
                            
                            
                            
                            5.00
                            %Bank
      Capital RatiosTier
      1 Capital
                            
                            $
                            108,524
                            
                            
                            
                            15.73
                            %
                            
                            $
                            106,137
                            
                            
                            
                            12.94
                            %(to
      Risk Weighted Assets)Tier
      1 capital minimum requirement
                            
                            $
                            41,400
                            
                            
                            
                            6.00
                            %
                            
                            $
                            49,206
                            
                            
                            
                            6.00
                            %Total
      Capital
                            
                            $
                            117,251
                            
                            
                            
                            16.99
                            %
                            
                            $
                            116,388
                            
                            
                            
                            14.19
                            %(to
      Risk Weighted Assets)Total
      capital minimum requirement
                            
                            $
                            69,000
                            
                            
                            
                            10.00
                            %
                            
                            $
                            82,010
                            
                            
                            
                            10.00
                            %Bank
      LeverageTier
      1 Capital
                            
                            $
                            108,524
                            
                            
                            
                            12.72
                            %
                            
                            $
                            106,137
                            
                            
                            
                            12.03
                            %(to
      Average Assets)Tier
      1 capital minimum requirement
                            
                            $
                            42,670
                            
                            
                            
                            5.00
                            %
                            
                            $
                            44,125
                            
                            
                            
                            5.00
                            %


42





The
Company and the Bank were considered well capitalized at September 30,
2009.





Stock
Repurchase Program





Effective
May 5 2008, the Company announced a stock repurchase program to repurchase up to
$5.0 million in shares of the Company for a nineteen month period extending to
December 31, 2009.  Buying under the program will be at management’s
discretion taking into consideration such factors as the market price of the
stock, available cash flow, general economic conditions and other
factors.  As of September 30, 2009, no share repurchases have
occurred.


43


ITEM
3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK




Liquidity/Interest
Rate Sensitivity




The
Company manages its liquidity to provide adequate funds at an acceptable cost to
support borrowing requirements and deposit flows of its
customers.  The increased level of nonperforming assets at September
30, 2009 may have the potential to impact the Company’s ability to raise
deposits and could result in higher deposit costs and/or lower
liquidity.  At September 30, 2009 and December 31, 2008, liquid assets
as a percentage of deposits were 33.7% and 29.0%, respectively.  In
addition to cash and due from banks, liquid assets include interest-bearing
deposits in other banks, Federal funds sold and securities available for
sale.  The Company has $25.0 million in Federal funds lines of credit
available with correspondent banks to meet liquidity needs.  At
September 30, 2009, there were no balances outstanding on these
lines.  Additionally, as of September 30, 2009, the Company had a
total borrowing capacity with the Federal Home Loan Bank of San Francisco of
approximately $124.0 million for which the Company had collateral in place to
borrow $41.0 million.  As of September 30, 2009, $12.0 million of this
borrowing capacity was pledged to secure a letter of credit.





The
Company’s balance sheet position is asset-sensitive (based upon the significant
amount of variable rate loans and the repricing characteristics of its deposit
accounts).   This balance sheet position generally provides a
hedge against rising interest rates, but has a detrimental effect during times
of interest rate decreases.  Net interest income is generally
negatively impacted in the short term by a decline in interest
rates.  Conversely, an increase in interest rates should have a
short-term positive impact on net interest income.





The
following table sets forth the distribution of repricing opportunities, based on
contractual terms of the Company’s earning assets and interest-bearing
liabilities at September 30, 2009, the interest rate sensitivity gap (i.e.
interest rate sensitive assets less interest rate sensitive liabilities), the
cumulative interest rate sensitivity gap, the interest rate sensitivity gap
ratio (i.e. interest rate sensitive assets divided by interest rate sensitive
liabilities) and the cumulative interest rate sensitivity gap
ratio.





(dollars
      in thousands)
                  
                  As
      of September 30, 2009After
      three
                  
                  
                  After
      six
                  
                  
                  After
      oneWithin
                  
                  
                  months
      but
                  
                  
                  months
      but
                  
                  
                  year
      but
                  
                  
                  Afterthree
                  
                  
                  within
      six
                  
                  
                  within
      one
                  
                  
                  within
                  
                  
                  fivemonths
                  
                  
                  months
                  
                  
                  year
                  
                  
                  five
      years
                  
                  
                  years
                  
                  
                  TotalFederal
      funds sold
                  
                  $
                  157,845
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  157,845Interest
      bearing deposits in other banks
                  
                  
                  9,320
                  
                  
                  
                  980
                  
                  
                  
                  4,900
                  
                  
                  
                  3,920
                  
                  
                  
                  -
                  
                  
                  
                  19,120Agency
      securities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  40,761
                  
                  
                  
                  -
                  
                  
                  
                  40,761Loans
                  
                  
                  191,832
                  
                  
                  
                  45,846
                  
                  
                  
                  79,714
                  
                  
                  
                  130,635
                  
                  
                  
                  125,667
                  
                  
                  
                  573,694Total
      earning assets
                  
                  $
                  358,997
                  
                  
                  $
                  46,826
                  
                  
                  $
                  84,614
                  
                  
                  $
                  175,316
                  
                  
                  $
                  125,667
                  
                  
                  $
                  791,420Interest
      checking, money market and savings
                  
                  
                  279,169
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  279,169Certificates
      of deposit:Less
      than $100,000
                  
                  
                  20,076
                  
                  
                  
                  11,870
                  
                  
                  
                  9,020
                  
                  
                  
                  7,595
                  
                  
                  
                  -
                  
                  
                  
                  48,561$100,000
      or more
                  
                  
                  38,529
                  
                  
                  
                  19,821
                  
                  
                  
                  6,731
                  
                  
                  
                  1,652
                  
                  
                  
                  
                  
                  
                  
                  66,733Other
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  17,527
                  
                  
                  
                  17,527Total
      interest-bearing liabilities
                  
                  $
                  337,774
                  
                  
                  $
                  31,691
                  
                  
                  $
                  15,751
                  
                  
                  $
                  9,247
                  
                  
                  $
                  17,527
                  
                  
                  $
                  411,990Interest
      rate gap
                  
                  $
                  21,223
                  
                  
                  $
                  15,135
                  
                  
                  $
                  68,863
                  
                  
                  $
                  166,069
                  
                  
                  $
                  108,140
                  
                  
                  $
                  379,430Cumulative
      interest rate gap
                  
                  $
                  21,223
                  
                  
                  $
                  36,358
                  
                  
                  $
                  105,221
                  
                  
                  $
                  271,290
                  
                  
                  $
                  379,430Interest
      rate gap ratio
                  
                  
                  0.06
                  
                  
                  
                  0.32
                  
                  
                  
                  0.81
                  
                  
                  
                  0.95
                  
                  
                  
                  0.86Cumulative
      interest rate gap ratio
                  
                  
                  0.06
                  
                  
                  
                  0.09
                  
                  
                  
                  0.21
                  
                  
                  
                  0.41
                  
                  
                  
                  0.48


44


Based on
the contractual terms of its assets and liabilities, the Company’s balance sheet
at September 30, 2009 was asset sensitive in terms of its short-term exposure to
interest rates.  That is, at September 30, 2009 the volume of assets
that might reprice within the next year exceeded the volume of liabilities that
might reprice.  This position provides a hedge against rising interest
rates, but has a detrimental effect during times of rate decreases. Net interest
income is negatively impacted by a decline in interest rates and positively
impacted by an increase in interest rates.  To partially mitigate the
adverse impact of declining rates, a significant portion of variable rate loans
made by the Company have been written with a minimum “floor” rate.





The
following table shows maturity and interest rate sensitivity of the loan
portfolio at September 30, 2009 and December 31, 2008.  At September
30, 2009, approximately 73.4% of the loan portfolio is priced with floating
interest rates which limit the exposure to interest rate risk on long-term
loans.





(dollars
      in thousands)
                
                As
      of September 30, 2009Due
      after oneDue
      one year
                
                
                year
      through
                
                
                Due
      afterAmount
                
                
                or
      less
                
                
                five
      years
                
                
                five
      yearsCommercial
      and other
                
                $
                257,703
                
                
                $
                146,286
                
                
                $
                85,973
                
                
                $
                25,444Real
      estate construction
                
                
                52,888
                
                
                
                49,124
                
                
                
                2,870
                
                
                
                894Land
      loans
                
                
                13,530
                
                
                
                5,844
                
                
                
                5,467
                
                
                
                2,219Real
      estate-other
                
                
                135,326
                
                
                
                17,227
                
                
                
                45,351
                
                
                
                72,748Factoring
      / Asset-Based Lending
                
                
                48,413
                
                
                
                43,245
                
                
                
                5,168SBA
                
                
                59,606
                
                
                
                7,109
                
                
                
                2,317
                
                
                
                50,180Other
                
                
                6,228
                
                
                
                5,532
                
                
                
                696Total
      loans
                
                $
                573,694
                
                
                $
                274,367
                
                
                $
                147,842
                
                
                $
                151,485





As
      of December 31, 2008Due
      after oneDue
      one year
                
                
                year
      through
                
                
                Due
      afterAmount
                
                
                or
      less
                
                
                five
      years
                
                
                five
      yearsCommercial
      and other
                
                $
                301,024
                
                
                $
                167,110
                
                
                $
                106,946
                
                
                $
                26,968Real
      estate construction
                
                
                98,105
                
                
                
                98,105
                
                
                
                -
                
                
                
                -Land
      loans
                
                
                23,535
                
                
                
                16,442
                
                
                
                4,834
                
                
                
                2,259Real
      estate-other
                
                
                134,767
                
                
                
                19,673
                
                
                
                36,475
                
                
                
                78,619Factoring
      / Asset-Based Lending
                
                
                55,761
                
                
                
                54,761
                
                
                
                1,000
                
                
                
                -SBA
                
                
                77,043
                
                
                
                6,874
                
                
                
                4,318
                
                
                
                65,851Other
                
                
                9,371
                
                
                
                9,100
                
                
                
                271
                
                
                
                -Total
      loans
                
                $
                699,606
                
                
                $
                372,065
                
                
                $
                153,844
                
                
                $
                173,697





Off-Balance
Sheet Arrangements and Aggregate Contractual Obligations





The
definition of “off-balance sheet arrangements” includes any transaction,
agreement or other contractual arrangement to which an entity is a party under
which we have:





·
            Any
      obligation under a guarantee contract that has the characteristics as
      defined in paragraph 3 of FASB Interpretation No. 45, “Guarantor’s
      Accounting and Disclosure Requirements for Guarantee including Indirect
      Guarantees of Indebtedness to Others” (“FIN
  45”);


·
            A
      retained or contingent interest in assets transferred to an unconsolidated
      entity or similar arrangement that serves as credit, liquidity or market
      risk support to that entity for such assets, such as a subordinated
      retained interest in a pool of receivables transferred to an
      unconsolidated entity;


·
            Any
      obligation, including a contingent obligation, under a contract that would
      be accounted for as a derivative instrument, except that it is both
      indexed to the registrant’s own stock and classified in stockholders’
      equity; or


·
            Any
      obligation, including contingent obligations, arising out of a material
      variable interest, as defined in FASB Interpretation No. 46,
      “Consolidation of Variable Interest Entities” (“FIN 46”), in an
      unconsolidated entity that provides financing, liquidity, market risk or
      credit risk support to the registrant, or engages in leasing, hedging or
      research and development services with the
  registrant.


45


In the
ordinary course of business, we have issued certain guarantees which qualify as
off-balance sheet arrangements, as of September 30, 2009 those guarantees
include the following:





·
            Standby
      Letters of Credit in the amount of $14.0
  million.





The table
below summarizes the Company’s off-balance sheet contractual
obligations:





(dollars
      in thousands)
                                                        
                                                        As
      of September 30, 2009Payments
      due by periodLess
      than
                                                        
                                                        
                                                        1 -
      3
                                                        
                                                        
                                                        3 -
      5
                                                        
                                                        
                                                        More
      thanTotal
                                                        
                                                        
                                                        1
      year
                                                        
                                                        
                                                        years
                                                        
                                                        
                                                        years
                                                        
                                                        
                                                        5
      yearsLong-term
      contracts
                                                        
                                                        
                                                        1,135
                                                        
                                                        
                                                        $
                                                        627
                                                        
                                                        
                                                        $
                                                        508
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        -Operating
      leases
                                                        
                                                        
                                                        11,804
                                                        
                                                        
                                                        
                                                        1,713
                                                        
                                                        
                                                        
                                                        3,305
                                                        
                                                        
                                                        
                                                        3,440
                                                        
                                                        
                                                        
                                                        3,346Total
                                                        
                                                        $
                                                        12,939
                                                        
                                                        
                                                        $
                                                        2,340
                                                        
                                                        
                                                        $
                                                        3,813
                                                        
                                                        
                                                        $
                                                        3,440
                                                        
                                                        
                                                        $
                                                        3,346





ITEM
4 – CONTROLS AND PROCEDURES





Disclosure
Controls and Procedures





As
required by SEC rules, the Company’s management evaluated the effectiveness, as
of September 30, 2009, of the Company’s disclosure controls and procedures. The
Company’s chief executive officer and chief financial officer participated in
the evaluation. Based on this evaluation, the Company’s chief executive officer
and chief financial officer concluded that the Company’s disclosure controls and
procedures were effective as of September 30, 2009.





Internal
Control over Financial Reporting





Internal
control over financial reporting is defined in Rule 13a-15(f) promulgated under
the Securities Exchange Act of 1934 as a process designed by, or under the
supervision of, the company’s principal executive and principal financial
officers and effected by the company’s board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:





Pertain
to the maintenance of records that in reasonable detail accurately and fairly
reflect the transactions and dispositions of assets of the company; provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use of 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. 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. No change occurred during the third
quarter of 2009 that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial
reporting.


46


PART
II – OTHER INFORMATION




ITEM
1 – LEGAL PROCEEDINGS





The
Company is not a defendant in any pending material legal proceedings and no such
proceedings are known to be contemplated. No director, officer, affiliate, more
than 5% shareholder of the Company, or any associate of these persons is a party
adverse to the Company or has a material interest adverse to the Company in any
material legal proceeding.




ITEM
1A – RISK FACTORS




There
were no material changes in the risk factors that were disclosed in Item 1A,
under the caption “Risk Factors” in Part I of our Annual Report on Form 10-K for
our fiscal year ended December 31, 2008.




ITEM
2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS




Not
applicable




ITEM
3 – DEFAULTS UPON SENIOR SECURITIES




Not
applicable




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




Not
applicable




ITEM
5 – OTHER INFORMATION




Not
applicable




ITEM
6 – EXHIBITS




(a)
Exhibits




See Index
to Exhibits at page 49 of this Quarterly Report on Form 10-Q.


47




SIGNATURES






Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.




BRIDGE
      CAPITAL HOLDINGSDated:
      November 5, 2009
                            By:
                            /s/ Daniel P. MyersDaniel
      P. MyersPresident
      and Chief Executive Officer(Principal
      Executive Officer)Dated:
      November 5, 2009
                            By:
                            /s/ Thomas A. SaThomas
      A. SaExecutive
      Vice PresidentChief
      Financial Officer(Principal
      Financial and Accounting
Officer)


48


INDEX
TO EXHIBITS




ExhibitNumber
            Description
      of Exhibit(31.1)
            Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002(31.2)
            Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002(32.1)
            Certification
      of Principal Executive Officer pursuant to 18 U.S.C. Section
      1350(32.2)
            Certification
      of Principal Financial Officer pursuant to 18 U.S.C. Section
      1350


49